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Fidelity’s brokerage claims industry price leadership

Posted on October 10, 2019 by -

Fidelity Investments, whose 21.8 million accounts make it America’s largest brokerage firm, said this week that it is the only firm to offer zero commissions for online U.S. stocks, exchange traded funds (ETFs) and option trades, automatically direct retail investors’ cash into higher yielding alternatives available for new brokerage and retirement accounts, and provide best execution practices with zero payment for order flow for stock and ETF trades.

The commission changes take effect on October 10, 2019 for individual investors and will be available on November 4, 2019 for registered investment advisors, a Fidelity release said.

“Vanguard now appears to be the last major discount broker to charge commissions to trade U.S. stocks,” according to a report in Barrons today, which refers to the pricing pressure created by Robinhood on E*Trade, Charles Schwab, TD Ameritrade, Fidelity and Vanguard. “Vanguard charges $7 to $20 a trade for investors with less than $500,000 in assets with the firm; trades cost $2 a pop for accounts of $500,000 to $1 million and are free on a limited basis above that level.”

Fidelity now claims that:

  • It is the only online brokerage firm to automatically direct investors’ cash into higher yielding alternatives available for new retail brokerage and retirement accounts as well as providing product choice, without any minimum requirements.
  • Its buy and sell order execution practices provide price improvement of $17.20 on average for a 1,000-share equity order, while the industry average is just $2.89, for aggregate client savings of more than $635 million in 2018.
  • It receives no payment for equity order flow from market makers, allowing us to provide better execution quality for customers.
  • It is the only brokerage firm to report quarterly price improvement savings and other execution statistics voluntarily using the Financial Information Forum (FIF) Rule 605/606 Working Group standards.
  • It displays the amount a customer has saved on each trade, as well as statistics on order execution and price improvement, and offers a tool that investors can use to calculate their potential price improvement savings.
  • It offers zero expense ratio index mutual funds, zero minimums for account opening, zero investment minimums on Fidelity retail and advisor mutual funds and 529 plans, zero account fees, and zero domestic money movement fees.
  • Its stock and bond index funds and sector ETFs have total net expenses lower than comparable funds at Vanguard, the Malvern, PA-based, investment manager that has historically claimed to be the investment industry’s low-cost leader and is Fidelity’s long-time rival in mutual funds and institutional retirement services.

© 2019 RIJ Publishing LLC. All rights reserved.

Federal judge dismisses adviser suit against ONL

Posted on October 10, 2019 by -

In a legal setback for financial advisers who filed a federal class-action suit against Ohio National Life for halting payments of promised variable annuity trail commissions, a federal judge in Ohio last week granted the life insurer its motion for a judgment in its favor.

A copy the decision in the case, Lance Browning v. Ohio National Life Insurance Company, et al (1:18-cv-763) U.S. District Court for the Southern District of Ohio, Western Division can be found here.

It was a whipsaw moment for the affected advisers, some of whom have had upwards of $1 million in trail commissions withheld. Last June 28, a state court judge had denied the insurer’s request, saying that its agreements to compensate broker-dealers—LPL Financial in this case—for variable annuity sales included the advisers individually as rightful parties to the agreements.

Adviser hopes rose on that ruling, then fell on October 4 when U.S. District Judge Susan Dlott reversed the state magistrate’s decision and dismissed the advisers’ claims on the grounds that Ohio National’s compensation agreement did not extend past the broker-dealer, and, moreover, that the Securities & Exchange Commission, via FINRA Rule 2320, bars life insurers from paying commissions directly to registered representatives of broker-dealers.

Advisers are, not surprisingly, angry. “Under Ohio state law, which is supposed to govern the contracts, a beneficiary of a contract has the same rights as the signer of the contract. That’s why the case moved forward,” said an adviser who asked not to be named because he is still a party to a suit over the trail commissions.

“Judge Dlott said FINRA doesn’t allow payment of commissions to reps, and that the broker-dealer had no obligation to pay the rep,” he added. “That’s not true. The rep agreement says that LPL was obligated to pay the reps as beneficiaries of the contract.”

This lawsuit is one of several against Ohio National by advisers or broker-dealers. The controversy partly reflects the fact that the variable annuities were very rich a decade ago. The richness produced immense sales, but the products were unsustainable for the carriers.

According to court filings cited by Yahoo Finance last March, Ohio National and its subsidiaries sold more than $10 billion in new variable annuities between 2012 and 2018, with between 50,000 and 75,000 independent broker-dealers being paid regular commissions until the insurer unilaterally terminated its contracts with them last year.

Many major VA issuers either got out of variable annuity business entirely or made their contracts more conservative. After staying in the game for years longer, Ohio National finally got out last December. It didn’t cancel its VA contracts—it can’t—but it did stop paying commissions to reps where it believed that its broker-dealer contracts allowed.

The controversy also reflects the fragmentation of the advisory community (or, as life insurers look at it, their retail distribution channels) and the varied relationships between advisers and broker-dealers. Under Ohio National’s agreement with Morgan Stanley, the wirehouse’s employee-advisers continue to receive trail commissions.

But at least some of the independent advisers who dealt directly with Ohio National wholesalers, and who each selected his or her own combination of upfront or trail commission, regard their broker-dealer as simply a pass-through of their rightful compensation. For them, FINRA 2320 is largely a regulatory formality required for compliance.

“Advisers are the primary beneficiaries of the broker-dealer contracts,” the adviser said. “We are supposed to get 75% to 95% of the [sales compensation]. The broker-dealer just gets a minimal amount. Under Ohio law, if you are a beneficiary of a contract you have a right to get paid under the contract. And the reps are third-party beneficiaries.”

But Judge Dlott described the advisers as mere “incidental beneficiaries” without “enforceable rights” under the broker-dealers’ contracts with Ohio National. Therefore the reps can’t “assert claims for breach of the Selling Agreement or for promissory estoppel against Ohio National.”

LPL advisers, represented by the Columbus law firms of Meyer-Wilson and Carlile Patchen & Murphy Law, sued Ohio National in federal court as a class. Individual broker-dealers are said to be filing their own lawsuits against Ohio National, but any judgments in those cases may apply only to broker-dealers and not to advisers. If those cases are settled and their proceedings sealed, they won’t affect adviser-driven litigation.

© 2019 RIJ Publishing LLC. All rights reserved.

Income-producing funds from New York Life

Posted on October 3, 2019 by -

Given the Fed’s recent pivot from tightening to loosening, risk-averse investors and retirees must continue to scrounge for income, sometimes in non-obvious places.

Short-duration high-yield bonds, taxable municipal bonds, taxable municipal bonds, and dividend-paying equities are all potential sources of excess yield, according to a new white paper from New York Life, which doesn’t issue index annuities but which has MainStay mutual fund for each of those asset sub-classes.

The white paper, “New York Life Investments Guide to Generating Income,” offers income-producing alternatives to the insurer’s own fixed annuities. The Fed lowered the Fed funds rate a quarter point in July and another quarter point in September.

“Given the current interest rate environment and bouts of volatility driven by trade rhetoric, geopolitical risk, and Fed uncertainty,” the white paper said, “there is a need to think outside the Barclay’s Aggregate Bond Index for income solutions.”

Short-duration high-yield bonds

If you’re looking for an investment with more kick than short-term bonds but less risk than high-yield bonds, this category offers a compromise.

“Historically, short-duration high yield has underperformed the broader high-yield market during periods of price appreciation and outperformed during market sell-offs when spreads widened. In a period of market volatility, we believe short-duration high-yield bonds compare favorably to investment-grade alternatives, offering a potentially higher yield with less interest rate risk.”

Taxable municipal bonds

This category, an alternative to corporate bonds, consists of high-quality taxable bonds that are used for infrastructure. “Deteriorating U.S. infrastructure requires $4 trillion of capital in order to be restored to a state of good repair,” the white paper said.

“With only about 55% of the funding in place, municipalities and public-private partnerships will be expected to pay for the remaining approximately $2 trillion over the course of the next 10 years. Because of IRS limits to the amount of tax-exempt debt municipalities can issue, we believe that taxable municipal bonds will provide most of this new financing.”

Insured municipal bonds

Troubled municipalities can add a layer of insurance to their bonds to make them more attractive to investors. “This type of bond, as represented by the Bloomberg Barclays Municipal Insured Bond Index, have offered a higher total return over the past five years when compared to traditional municipal bonds.

Insured municipal bonds also have had attractive upside/downside characteristics, as they have captured essentially all the upside in the market, while participating in only about three-quarters of the downside,” New York Life said.

Dividend-paying equities

In this go-to category for income seekers, New York Life recommends the stocks that have consistently grown their dividends over the years. “Equity income strategies that focus on shareholder yield and companies that generate free cash flow tend to be lower risk than pure dividend-paying stocks,” the white paper said.

“Stocks that consistently increase their dividends have outperformed all other stocks over the past five decades. From March 1972 through the end of 2018, dividend growers have offered a very attractive annualized compound growth rate of 12.5%.”

Below are links to descriptions of these New York Life’s offerings, all with minimum investments of $15,000:

MainStay MacKay Short-Duration High-Yield (MDHAX, MDHIX). The expense ratio 1.05%, and there’s a 3% load for investments of $100,000 or less. Its largest sector exposure is in telecommunications.

MainStay MacKay Infrastructure Bond Fund (MGVAX, MGOIX). The expense ratio is 0.85%. There’s a 4.5% load for investments of $100,000 or less.

IQ MacKay Municipal Insured ETF. The expense ratio is 0.30%. The top holding is Detroit Michigan Sewer Disposal Revenue bonds.

MainStay Epoch U.S. Equity Yield Fund (EPLPX, EPLCX). The expense ratio 1.07%. The sales load ranges from 5.5% for investments under $50,000 to 2% for investments of $500k to $1 million.

© 2019 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on October 3, 2019 by -

Foreign central banks lower exposure to U.S. dollar

Appetite for the U.S. dollar has been shrinking to unprecedented levels among the world’s central banks, reflecting their fear of uncertainty in U.S. economic policy and the American political landscape, said the head of research with Global Markets, EMEA, and International Securities at Mitsubishi UFJ Financial Group, Inc. (MUFG), at a recent press event in New York.
The U.S. dollar’s share of currency reserves held by central banks around the world—as reported to the International Monetary Fund—has been declining since 2017 toward record lows. Central banks hold reserves in different currencies primarily to support their liabilities, and occasionally to support the values of their countries’ respective currencies.

“The U.S. dollar is still the world’s foremost reserve currency, but central banks appear to be reducing their exposure to it in a sustained manner,” Halpenny said. “The recent decline in the value of their dollar reserves is all the more striking given that the dollar has actually strengthened for most of 2019. This means central banks are diversifying away from the greenback fast enough to offset its rising value.”

Halpenny cited U.S. political and economic-policy uncertainty as likely reasons for central banks to trim their dollar exposure. “The U.S. administration’s shifting positions on trade—especially with China—have created confusion as economic officials of other countries attempt to formulate a response,” he said. “Additionally, as we approach the 2020 U.S. Presidential election with no clear victor in sight—and with the country’s two major political parties far apart from each other on geopolitical and economic-policy issues—the road ahead looks very ambiguous.”

Halpenny pointed to capital-flow data from the U.S. Treasury Department indicating that banks have been net sellers of U.S. Treasury bonds for four years now. In the 6-month period leading to the end of July, 2019, central banks from around the world sold $124 billion worth of bonds. They sold $180 billion in all of 2018, $149 billion in 2017, and $332 billion in 2016.

“The dollar’s position as the world’s most dominant reserve currency allows the United States to enjoy lower interest rates, increased investment, cheaper consumption, and the ability to borrow and spend well beyond what other nations can afford,” Halpenny said. “However, a continuation of the current trend among central banks could erode this enviable position.”

SOA seeks papers on retirement strategies, offers $10k award

The Society of Actuaries announces an essay competition focused on helping pre-retirees and retirees, by exploring innovations and ideas that:

(1) Identify retirement risks

(2) Plan for and maintain a secure retirement.

Essays should address new developments in tools, products and/or strategies not constrained by whether they currently exist. To the extent a concept is not feasible in the current market, authors are encouraged to identify what changes are needed for such concepts to become a reality.

A $10,000 award has been allocated for this call for essays. The review committee will select the leading essays and determine how to allocate the award money.

Deadlines:

November 18, 2019: Submission of essays

December 31, 2019: Awards announcement

For more information, contact Steven Siegel, Sr., Research Actuary, Society of Actuaries, at [email protected].

New FIA from Nassau Re

Nassau Financial Group this week announced its entry into the accumulation-focused fixed indexed annuity (FIA) space with its inaugural product, Nassau Growth Annuity.

The product introduction marks Nassau’s latest initiative in its insurance and annuity businesses. The company’s incubator, Nassau Re/Imagine, is active in the Hartford, CT region’s insurance and insurtech industry.

Nassau Growth Annuity “enables us to offer a full suite of fixed annuities to the underserved middle market,” said Phil Gass, chairman and CEO of Nassau Financial Group, in a release. “To date, we have attracted 12 insurance-related startups” to the Hartford area.
The new product offers exposure to either the S&P 500 Composite Stock Price Index or the Smart Passage SG Index, an exclusive new index sponsored by Société Générale.

© 2019 RIJ Publishing LLC. All rights reserved.

A More Impeachable Offense

Posted on October 3, 2019 by -

Do President Trump’s tweets about U.S. monetary policy have a measurable effect on that policy, on the behavior of market participants, or on the direction of market indices? Analysis of “tick-by-tick fed funds future data and a large collection of Trump tweets criticizing the conduct of monetary policy” by three economists suggests that the tweets do have an effect.

In a new working paper from the National Bureau of Economic Research, Howard Kung and Thilo Kind of London Business School and Francesco Bianchi of Duke, present “market based evidence” that President Trump’s tweets influence “expectations” about monetary policy.

“These collected tweets consistently advocate that the Fed lowers interest rates,” they write. “Identification in our high-frequency event study exploits a small time window around the precise time stamp for each tweet. The average effect of these tweets on the expected Fed funds rate is strongly statistically significant and negative, with a cumulative effect of around negative 10 bps.”

The authors of the paper conclude that “market participants believe that the Fed will succumb to the political pressure from the President, which poses a significant threat to central bank independence.” (See chart from paper below.)

This figure reports the federal funds upper limit target together with four event types: All FOMC meetings, the inauguration of Donald Trump on the on the 20th of January 2017, the nomination Jerome Powell for the Fed Chair position on the 1st of November 2017, and the first critical Tweet by Donald Trump which promotes lower interest rates on the 16th of April 2018.

The authors wrote, “the tweets do not simply affect expectations about the timing of changes that markets were already anticipating, but instead move market expectations about the stance of monetary policy.”

“One of the reasons behind the interest rate cut in July was that markets were anticipating a cut, and not following through would effectively be a stance of contractionary monetary policy,” the paper said. “Therefore, even if the Trump tweets only have a direct impact on market expectations, they can still indirectly affect policy due to how the Fed factors in market expectations when deciding on monetary policy.”

Market participants may no longer believe that the Fed operates independently of the White House, the paper said. Instead, the market may believe that this White House and perhaps future White Houses will keep interest rates ultra-low in order to sustain the bull market in stocks.

President Trump is currently the subject of a congressional investigation into the implications of his telephone conversation last July with the president of the Ukraine. The transcript of the call appears to show the president encouraging the Ukraine president to investigate a potential Trump political rival, former vice president Joe Biden, at a time when the White House was holding up the delivery of U.S. military equipment to the Ukraine.

Given the remoteness of the Ukraine question, however, and the ambiguities of the transcript, a large part of the American public hasn’t recognized the content of the telephone call as an “impeachable” offense. And it may not be, except perhaps to those who see it as a last straw in a parade of unethical actions, including the president’s acquiescence to foreign interference in the 2016 election, that were driven mainly by his personal political and financial interests.

It could be argued that the president’s efforts to badger or maneuver the Fed chairman into lowering interest rates to boost the stock market and burnish Trump’s economic record for the sake of political gain would be a clearer abuse of presidential power—especially to those who have welcomed the gradual rise in rates since 2015.

© 2019 RIJ Publishing LLC. All rights reserved.

Asset managers need to design ‘vehicle-agnostic’ products: Cerulli

Posted on October 3, 2019 by -

Asset managers say that their product plans for the next 12 months are spread across mutual funds (27%), exchange-traded funds, or ETFs (25%), and separate accounts (29%), but they also include other vehicles (18%), such as collective investment trusts (CITs), private commingled funds, and interval funds, according to Cerulli Associates.

[Note: An interval fund is a closed-end fund whose shares don’t trade on the secondary market. Instead, the fund periodically offers to buy back a percentage of outstanding shares at net asset value (NAV).]

As asset managers seek to deliver a more vehicle-agnostic approach to product development, they must consider a number of factors in developing their roadmap to success, said Cerulli’s latest report, U.S. Product Development 2019: A Roadmap to Vehicle Proliferation.

“Increasing cost-awareness and a more stringent focus on fiduciary responsibility is causing mutual fund providers to prioritize development and distribution of other vehicles over the mutual fund,” the Boston-based global consulting firm said in releasing the report this week, noting that asset managers are trying to deliver a “more vehicle-agnostic” approach to product development.

Asset managers should enable clients “to consume a strategy in the wrapper of their own choosing, but this may not always be the best approach due to structural barriers and overall feasibility,” said Cerulli associate director Brendan Powers in the release.

As asset managers expand their vehicle offerings, he added, they should consider “the strategy they are seeking to distribute, their primary client target markets in which it will be distributed, and any changing demand from the client segments within those markets.”

In building a new vehicle, firms shouldn’t get caught up in deciding whether to clone an existing vehicle or create a different one, Cerulli cautioned. Instead, Powers said, firms base their new vehicle design on their capabilities and customer demand.

Even as the asset management industry moves toward vehicle-agnostic delivery of investment capabilities, Cerulli sees operational obstacles to vehicle proliferation.

“One of the most glaring is the sourcing, use, and harvesting back of seed capital,” said Matt Merritt, product development analyst at Cerulli, in the release. Product rationalization, fee compression, and the increased use of passive products are all compressing their budgets, so asset managers need to scrutinize the “lifecycle of seed capital” more than ever.

© 2019 RIJ Publishing LLC. All rights reserved.

Making Income Rise as Health Declines

Posted on October 3, 2019 by -

Pilates lovers, vegetarians and never-smokers are not the only people who should, can, or do buy life-contingent income annuities. People in poor health can get attractive annuity payouts by purchasing so-called impaired or “medically underwritten” income annuities.

Such purchases are rare in the U.S., to be sure. Only Mutual of Omaha offers a single premium income annuity with an impaired option, and its sales in this niche are slim. (Genworth dropped its offering last May when it suspended intermediary-sold products.)

But sales of impaired annuities aren’t entirely theoretical. Russell Wild, a fee-only planner in Philadelphia, has helped guide two clients—both older men in poor health without spouses, children or other legacy concerns—through the annuity purchase process, in part by showing them that the heightened yield from an impaired annuity would lighten the necessary withdrawal rate from their liquid investments.

A 7.32% annual yield

Russell Wild

One such client was a 68-year-old optometrist with a 50/50 portfolio of no-load funds from Vanguard and State Street Global Advisors that was worth about $700,000. “For a portfolio of that size I usually recommend 12 or 13 funds and ETFs,” said Wild, who is the author of Investing in ETFs for Dummies (Wiley, 2015) and other financial books.

“He was planning to retire that year because he had had several heart operations. He’d been in and out of the hospital,” said Wild, who worked with the client on an hourly fee basis, as he often does. “I thought that he might qualify for a ‘medical markup’ on an annuity, so I sent him to immediateannuities.com for a quote.” When the client called the agent, Wild was on the call too.

After submitting a sheaf of medical records to Mutual of Omaha for review, the client’s actuarial age was adjusted upwards by six years, to age 74. In other words, he received the same payout rate as a 74-year-old man. The annuity income plus Social Security would be more than the $50,000 that he was still earning by working part-time.

The client wanted $60,000 a year. “So we decided to use $300,000 of his IRA money to buy an impaired life annuity with a starting payout of $1,830 a month and a 2% annual cost of living adjustment (COLA), for a 7.32% yield. I suggested he take Social Security at age 69, which would give him another inflation-adjusted $2,650 a month.”

After an underwriting process of about six weeks, the client bought the annuity. The combined Social Security and annuity income was $53,764. To reach the desired $60,000, he would draw just over $6,000 a year from the $400,000 that remained in mutual funds and ETFs. The annual withdrawal rate on the 70% equities/30% fixed income funds would be about 1.6%.

[At today’s rates, a $300,000 immediate life-only fixed income annuity for a 74-year-old man pays about 22% more per month than would an identical annuity for a 68-year-old man, according to immediateannuities.com.]

“When I mention annuities to a client, the first thing I say is, ‘This is not a variable annuity,’” Wild told RIJ. “That puts them at ease. People are aware that annuities can have high commissions and are not always in the best interests of clients. I emphasized the simplicity of a SPIA contract. For comparison, I researched the income figures without the mark-up.

“But I was still on-the-fence myself about whether to recommend the annuity. My client could have withdrawn about five or six percent of his savings for life, which I thought wouldn’t be more than 20 years,” he told RIJ. Regarding the annuity inflation rider, Wild said he wasn’t “wed to having an inflation-rider or no inflation rider.”

A 12.63% annual yield

In a separate case, Wild arranged the sale of an impaired annuity to a 77-year-old widower who had recently been in and out of the hospital with various ailments. After reviewing his medical records, Mutual of Omaha rated his age at 82. “That made a substantial difference in price, because the mortality curve is steeper at that age. So we were looking at a 13% yield,” Wild said.

At the time, the client’s $600,000 portfolio was conservatively allocated to 40% stocks and 60% bonds. He already owned an income annuity paying $1,440 a month. He received an additional $2,505 a month from Social Security. To reach a desired income of about $90,000, he needed about $40,800 more per year. He could have achieved that by withdrawing about 6.8% a year from his portfolio.

Wild thought 6.8% “was pushing” the limits of safe withdrawal from a $600,000, so they explored the idea of taking pressure off the withdrawal rate by buying a medically underwritten annuity. They used $100,000 from the client’s own IRA and $100,000 from an IRA he inherited from his late spouse.

The impaired annuity would produce $2,105 per month or $25,260 each year for a yield of 12.63%. To reach his income goal (above the two annuities and Social Security), the client would need to withdraw only about $16,000 from his remaining $400,000 portfolio, for a withdrawal rate of just 4% a year.

Wild said the impaired annuities helped his clients cover all their basic living expenses at a reduced cost, and that the chance still exists that they will outlive actuarial expectations. “I know a woman with stage four breast cancer,” he told RIJ. “Doctors told her she’d be dead in six months. That was 10 years ago.”

The underwriting process

Mutual of Omaha’s Ultra Income SPIA is the product that Wild’s clients purchased. The contract itself is not built for health-compromised clients, but “income enhancement is available for impaired risks,” according to contract information provided to RIJ by the insurer. The underwriting process works as follows:

  • The producer completes the SPIA quote application, choosing “rated-age SPIA.”
  • The application and pertinent medical information are emailed to the home office. Medical information should include at least 12 months of pertinent medical records. For example, if the client has a history of heart disease and cancer, include cardiology and oncology records.
  • The application and medical records are reviewed by a Medical Director. Based on his or her review, the Medical Director assigns a rated age. The rated age reflects the life expectancy of the applicant based on their age, sex and medical condition. For example, a 65-year-old male applicant might have a heart condition that makes his life expectancy the same as a 70-year-old male’s. The rated age in this example would be 70.
  • The rated age is reported back to the producer, who runs a new illustration using the rated age to determine the annuity payout for the selected income option and presents this to the client. Continuing the example above, the illustrated payout for a 70-year-old male would be higher than that for a 65-year-old male. The difference between the annuity payout for the rated age and the annuity payout for the actual age is the income enhancement provided for by the impaired risk underwriting process.
  • If acceptable to the client, the producer then submits the rated age quote with the formal application for final review and issuance of the policy.

© 2019 RIJ Publishing LLC. All rights reserved.

Life Insurance in a Bucketed Income Plan

Posted on September 26, 2019 by -

When a spouse dies during retirement, the loss deprives the widow or widower of love, support and companionship. It also deprives the the survivor of a second Social Security payment and sometimes part of a pension, shrinking the survivor’s income.

Advisers who work with older couples, especially couples who expect to rely heavily on Social Security and pensions for retirement income, are in a position to help them anticipate this risk and prepare for it.

At Wealth2k’s IFLM 2019 conference in Boston last month, Zach Parker, vice president of wealth management and product strategy at Securities America, the 2,500-adviser brokerage and advisory firm, presented a work-in-progress retirement income plan for just such a couple, using the IFLM (Income for Life Model) “bucketing” software.

Parker

The bucketing or “time-segmentation” method involves dividing a client’s retirement into periods of five to 10 years each. Monthly income during each segment is funded by a designated bucket of assets, which is liquidated and invested in short-term securities when its segment starts.

Academics sometimes describe bucketing as a “mental accounting” gimmick that requires frequent revisions and creates timing problems. That is, as clients age from segment to the next, like canal boats moving up a series of locks, the transitions won’t necessarily align with market conditions.  But advisers who use bucketing say that it can make the future seem less uncertain and less daunting, especially for “constrained” retirees who are at risk of running short of income.

Herb and Gigi

Parker’s case study was based on a real couple, both 60 years old, whom he calls “Herb and Gigi Hancock.” The Hancocks have saved $401,000, of which $340,000 is in qualified or pre-tax accounts. Herb was recently laid off from his job of many years. Gigi expects to work part-time for five more years.

The Hancocks’ guaranteed income sources in retirement include Herb’s pension of $3,102, his Social Security ($2,150 at age 65), Gigi’s Social Security ($1,200 at age 65). Gigi expects her job to net about $1,000 a month.

The Hancocks tell their adviser that they’ll need a gross real income of $6,200 each month to cover their essential expenses in retirement. They also aspire to leave a $600,000 legacy to their 32-year-old daughter.

Gigi and Herb are young enough to work for a few more years and delay claiming Social Security. They could also mobilize the equity in their home. But they ask their adviser for a plan under which Herb could retire right away, allow Gigi to retire in five years, and that wouldn’t dip into their home equity.

At first glance, barring catastrophe, the Hancocks’ vision of a secure retirement looks achievable. Over the first five years of retirement, their income from earnings and pension will be about $4,200, plus income from spending the $96,000 in their first bucket. Starting in the sixth year, they will receive $3,350 from their combined Social Security benefits plus Herb’s pension plus income from the investments in the second bucket. And so forth.

Their adviser uses IFLM software to create a preliminary plan that assigns their savings to six five-year buckets plus a seventh, legacy bucket. The segments look like this:

How does this compare to a 4%, inflation-adjusted withdrawal from a $401,000 total-return balanced mutual fund portfolio. Four percent times $401,000 is about $16,000 or $1,333 per month. If they don’t touch the $60,000 in the legacy fund, they would have an investment base of $340,000, yielding $13,600 per year or $1,133 per month. So the 4% method may not be attractive for this couple, especially if it require austerity measures during market downturns.

Mind the gap

But retirement is predictably unpredictable. The adviser alerts the Hancocks to the possibility that Herb might very well predecease Gigi during retirement. Since the survivor’s benefit of Herb’s pension is 50%, Gigi’s benefit would be only $1,551. Gigi would also lose her Social Security benefit when she stepped up to Herb’s. So her monthly income from guaranteed sources would shrink by about 43%.

How can the Hancocks deal with that possible shortfall? In Parker’s retelling of the case, the adviser at first suggests that the Hancocks buy $500,000 worth of life insurance on Herb. If Herb dies very early in retirement, for instance, Gigi would have $900,000 in savings to generate income in addition to her Social Security widow’s benefit and half of Herb’s pension.

Herb objected to that specific proposal, Parker said. He notes that if he lives to a ripe old age, then life insurance premiums will simply reduce the couple’s disposable income in retirement. The adviser then looks for a compromise between those two choices, and recommends the purchase of $267,000 worth of life insurance coverage.

Since the longer Herb lives, the less Gigi will need to make up her loss of his benefits, the adviser suggests a “staged term insurance/guaranteed universal life strategy.” It would give Gigi a benefit of $275,000 if Herb died during the next 20 years (based on the purchase of $150,000 worth of guaranteed universal life insurance and $125,000 worth of renewable term life on Herb for 20 years), after which the benefit would drop to $150,000. Parker estimated the cost of the insurance at about $400 per month.

Unknown unknowns

Retirement income planners often recommend life insurance for wealthy retirees as an estate-planning and tax-planning tool. But in the Hancocks’ case demonstrates a potential use for life insurance in a mass-affluent retiree’s income plan.

Before completing their plan, the Hancocks will inevitably need to contemplate more tactics and more risks. For example, they may decide to take more investment risk, mobilize their home equity as a first or last resort, reduce their legacy goal, or buy long-term care insurance.

In the income planning process, retirees must prepare for the expected and the unexpected—the “known knowns, the known unknowns, and the unknown unknowns,” as a former U.S. defense official famously said. Whatever a retiree’s initial plan might be, advisers know that it will need to be adjusted, perhaps many times. That’s what makes retirement income planning complex, challenging, and essential.

You can find previous case studies in this series here and here.

© 2019 RIJ Publishing LLC. All rights reserved.

TD Ameritrade to sell its first indexed annuity, a Pacific Life contract

Posted on September 26, 2019 by -

Pacific Index Foundation, a deferred fixed indexed annuity, is now available to TD Ameritrade clients. Although TD Ameritrade has offered fixed and fee-based variable annuities to clients since 2012, and Pacific Index Foundation is the first fixed indexed annuity to be offered on the platform.

Clients of TD Ameritrade can purchase a Pacific Index Foundation annuity directly from TD Ameritrade’s annuity specialists.

Pacific Index Foundation also offers a choice of two optional benefits for an additional cost: one for guaranteed lifetime income and the other for enhancing the financial legacy that clients leave to beneficiaries.

TD Ameritrade and Pacific Life are separate, unaffiliated firms. Annuities are provided to TD Ameritrade clients through The Insurance Agency of TD Ameritrade, LLC.

© 2019 RIJ Publishing LLC. All rights reserved.

Multi-Trillion Dollar Fiscal and Monetary Gambles

Posted on September 26, 2019 by -

Under pressure from President Trump and worried about a worldwide economic slowdown, the Federal Reserve recently cut short-term interest rates. By continuing to push rates down, the Fed may be doubling down on a $25 trillion gamble with future costs yet to be covered.

At the same time, the Trump Administration reportedly is considering tax cuts—that would add the deficit—to boost the economy in the short term. It too may be making another giant bet, with interest and debt repayments to be made by future taxpayers.

To understand why, keep in mind that what matters when government tries to spur economic growth is not the current rate of change in fiscal or monetary policy, but the change in the rate of change.

For instance, the short-term economy grows (all else equal) when the Fed accelerates the pace of growth in the money supply or when Congress increases Treasury’s rate of borrowing by cutting taxes or increasing spending. Acceleration spurs growth, deceleration dampens it.

Suppose federal borrowing rises to 4% of national output. In a steady economy, merely keeping borrowing at 4% in future years adds no new stimulus. But raising the deficit to 5% of GDP, or more than $1 trillion today, would stimulate growth through a larger budget deficit relative to the size of the economy.

To keep the wheel spinning, Congress needs to borrow ever-greater amounts—increasing the rate of change in debt accumulation. In an actual downturn, that additional borrowing would be on top of the old rate of borrowing plus the new borrowing forced by the decline in revenues—which is why many economists fear that each new fiscal gamble in good times increasingly deters future fiscal responses to a recession.

The same goes for monetary policy. Though not the only factor involved, the extraordinarily low short-term interest rates the Fed has maintained over recent years has helped promote an increase in the rate of wealth accumulation. The measured wealth of households rose from a long-term average of less than 4 times GDP to well over 5 times GDP. While that ratio fell closer to its historical level in the Great Recession, it has since risen to an all-time high. That’s about a $25 trillion increase that, if history is a guide, could become a $25 trillion loss if the ratio of wealth relative to income merely reverts to its average.

All those additional budget deficits and increases in household wealth, in turn, spur consumption. For instance, a recent NBER working paper by Gabriel Chodorow-Reich, Plament T. Nenov, and Alp Simsek suggests that a $1 increase in corporate stock wealth increases annual consumer spending by 2.8 cents. Building on that estimate, conservatively suppose each dollar increase in all types of wealth boosts annual consumption by about 2 cents. That would mean that a $25 trillion wealth bubble would spur this year’s consumption by about $500 billion, or about 2.5%age points of GDP more than had wealth simply grown with income.

What do you do if you’re Congress and an economy operating at full employment starts to slow down a bit? To spur the economy, you need to increase budget deficits at an even faster rate than before. If you’re the Fed thinking about sustaining or increasing consumption based on the wealth effect, then you try to maintain or increase the wealth bubble by not allowing housing or stock prices to fall.

How does this end? Science tells us: Not well. For instance, imagine an insect species identifies a new food source. The insect population will multiply rapidly until the demand from its accelerating birth rate outstrips the supply of food and the insect population crashes.

The economist Herb Stein described this phenomenon as simply and clearly as possible: “If something cannot go on forever it will stop.”

Our fiscal situation may not be that dramatic, but large budget deficits can lead to economic stress, and eventually, a crash. That has been the fear historically, though the recent experience of easy money across the globe, very low interest rates, and associated wealth bubbles may have offered a reprieve of sorts. However, interest rates that turn negative on an after-inflation, after-tax basis can lead to unproductive investments, which, in turn, can slow real economic growth even without a crash.

The modern economy may protect us in some ways. For example, the flow of international trade may mitigate economic slowdowns in any one region. And a service economy may not face some of the tougher business cycles that threaten an industrial one. But none of these factors overcomes Stein’s Law: Fiscal and monetary policy cannot always operate on an accelerating basis. To maintain the flexibility to accelerate sometimes, they must decelerate at other times.

Right now, we’re living with a $25 trillion wealth gamble by the Fed and trillion-dollar deficit bets by the Congress and the President. We’ve yet to see how it all ends and how the bills will be paid. How safe do you feel that your winnings will cover your share of those bills?

© 2019 The Urban Institute.

The Seeds of Inflation are Beginning to Sprout

Posted on September 26, 2019 by -

The biggest surprise in recent years is that inflation has not begun to climb. The labor market has been at full employment for a while, we have seen upward pressure on wages, but inflation has remained dormant.

It is important to understand why that has happened. But that is history and, at long last, inflation is on the rise. How much might inflation accelerate in the next year? When might the Fed decide to reverse course and start raising short-term interest rates? No one is talking about that possibility.

Serious upward pressure on the inflation rate will originate from the labor market. Why? Because labor costs represent about two-thirds of a firm’s overall cost. If labor costs begin to climb firms will eventually be forced to raise prices to counter the negative impact on earnings. That process begins once the economy reaches “full employment.”

At that level every qualified worker who wants a job already has one. Fed officials peg that rate at about 4.2%. The unemployment rate has been below that “full employment” threshold since October 2017 and. as a result, worker compensation has begun to climb.

The indicator of wage pressures most people cite is average hourly earnings because it is readily available and can be observed monthly as part of the employment report. That measure of wages began to rise noticeably in mid-2015.

A broader and better measure of hourly compensation is included in the productivity report which is released quarterly. This measure of hourly compensation has also begun to accelerate and in the past four quarters has risen at a steamy 4.4% pace.

But we are still missing one final piece of the puzzle—worker productivity. If firms pay workers 3.0% higher wages and the workers are 3.0% more productive, firms don’t care. They are getting 3.0% more output and, therefore, they have no incentive to raise prices. But if they pay 3.0% higher wages and their workers are no more productive, then labor costs have clearly risen and they are likely to pass them through to their customers in the form of higher prices.

Focusing on any measure of hourly compensation is misguided. People should be looking at the increase in labor costs adjusted for the change in productivity, which economists call unit labor costs. This concept is the best gauge of upward pressure on the inflation rate caused by tightness in the labor market.

In the past year hourly compensation has risen 4.4%. Productivity has risen 1.8%. The difference between those two numbers is the increase in unit labor costs, which has climbed 2.6%. In mid-2016 ULC’s were climbing at an 0.8% pace which was far below the Fed’s 2.0% inflation target. The alleged tightness in the labor market was not generating any upward pressure on the inflation rate.

Since then ULC’s have begun to accelerate and the current 2.6% pace is higher than the Fed’s 2.0% target. For the first time, the well-documented labor shortage is putting upward pressure on inflation.

So what should we expect going forward? Labor costs are unlikely to rise less than the 4.4% increase registered in recent quarters. That is particularly true now since unions (as evidenced by the current UAW strike) and other workers are starting to exercise their power and demand higher wages.

If employers do not accede to those demands workers could easily jump ship to another employer who, facing a similar labor shortage, may be willing to better compensate them. We will take a stab that hourly compensation next year climbs 4.6%. Productivity growth is unlikely to keep pace.

Trump’s inconsistent trade policies and persistent badgering of Fed Chair Powell and his colleagues has undermined business confidence. As a result, investment spending has slowed considerably in the past several quarters which suggests that productivity growth next year might not accelerate further (as we had expected earlier) but remain at about 1.7%.

A 4.6% increase in compensation combined with a 1.7% increase in productivity implies an increase in unit labor costs of 2.9% in 2020.  hat is significantly higher than the 1.6% increase registered in the past 12 months and also significantly above the Fed’s 2.0% inflation target.

In fact, inflation could be almost as far above the Fed’s target by the end of next year as it was below target for the past several years.

© 2019 Numbernomics.

Life insurers fined over annuity exchanges

Posted on September 26, 2019 by -

Six life insurance companies have agreed to pay New York $1.8 million to settle allegations that they conducted deferred to immediate annuity replacement transactions that violated state regulations, FA-mag.com reported this week.

“These six carriers failed to properly disclose to consumers income comparisons and suitability information, causing consumers to exchange more financially favorable deferred annuities with immediate annuities,” the New York Department of Financial Services said in a press release.

The annuity replacement transactions resulted in less income for consumers for identical or substantially similar options, the department added.

Last year DFS issued a regulation that ensures recommendations related to life insurance and annuities are in the best interest of the consumer and appropriately address the insurance needs and financial objectives of the consumer at the time of the transaction.

These are the insurance companies that were cited for the violations, followed by the consumer restitution and penalty, respectively, that they agreed to pay:

  • Companion Life Insurance Co., $462,122, $186,000
  • Guardian Insurance & Annuity Company Inc., $218,589, $224,000
  • Northwestern Mutual Life Insurance Co., $31,937, $26,000
  • The Penn Mutual Life Insurance Co., $322,584, $133,000
  • The Prudential Insurance Company of America, $14,020, $35,000
  • The U.S. Life Insurance Company in New York City, $102,902, $69,000

The insurers will collectively pay $1.15 million in restitution and $673,000 in penalties, the department said.

As part of the agreements, the department said, many state consumers will receive additional restitution in the form of higher monthly payout amounts for the remainder of their contract terms. “The insurers have agreed to take corrective actions, including revising their disclosure statements to include side-by-side monthly income comparison information and revising their disclosure, suitability, and training procedures to comply with regulations,” the press release said.

The settlements are part of an ongoing, industry-wide investigation into immediate annuity replacement practices in the state, the department said.

© 2019 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on September 26, 2019 by -

Retirement assets total $29.8 trillion in 2Q2019: ICI

Total US retirement assets were $29.8 trillion as of June 30, 2019, up 2.3% from March 31, 2019. Retirement assets accounted for 33% of all household financial assets in the United States at the end of June 2019.

Assets in individual retirement accounts (IRAs) totaled $9.7 trillion at the end of the second quarter of 2019, an increase of 2.9 percent from the end of the first quarter of 2019. Defined contribution (DC) plan assets were $8.4 trillion at the end of the second quarter, up 2.6% from March 31, 2019.

Government defined benefit (DB) plans— including federal, state, and local government plans—held $6.2 trillion in assets as of the end of June 2019, a 0.7 percent increase from the end of March 2019. Private sector DB plans held $3.2 trillion in assets at the end of the second quarter of 2019, and annuity reserves outside of retirement accounts accounted for another $2.2 trillion.

Defined Contribution Plans

Americans held $8.4 trillion in all employer-based DC retirement plans on June 30, 2019, of which $5.8 trillion was held in 401(k) plans. In addition to 401(k) plans, at the end of the second quarter, $545 billion was held in other private-sector DC plans, $1.1 trillion in 403(b) plans, $339 billion in 457 plans, and $617 billion in the Federal Employees Retirement System’s Thrift Savings Plan (TSP). Mutual funds managed $3.8 trillion, or 65%, of assets held in 401(k) plans at the end of June 2019. With $2.2 trillion, equity funds were the most common type of funds held in 401(k) plans, followed by $1.1 trillion in hybrid funds, which include target date funds.

Individual Retirement Accounts

IRAs held $9.7 trillion in assets at the end of the second quarter of 2019. Forty-six percent of IRA assets, or $4.5 trillion, was invested in mutual funds. With $2.5 trillion, equity funds were the most common type of funds held in IRAs, followed by $952 billion in hybrid funds.

As of June 30, 2019, target date mutual fund assets totaled $1.3 trillion, up 4.1% from the end of March 2019. Retirement accounts held the bulk (87%) of target date mutual fund assets, with 68% held through DC plans and 19% held through IRAs.

T. Rowe Price model portfolios offered on Envestnet platform

T. Rowe Price Group, Inc. announced today that its T. Rowe Price Target Allocation Active Series Model Portfolios will now be available to financial advisors through the Envestnet Fund Strategist Portfolio (FSP) and Unified Managed Account (UMA) Programs.

The Target Allocation Active Series on the Envestnet platform consists of seven risk-based asset allocation models designed to meet a wide range of investment objectives. The model portfolios use T. Rowe Price equity and fixed income mutual funds as their underlying investments. The series will be available to advisors and companies leveraging Envestnet’s wealth management platform.

The Target Allocation Active Series is managed by T. Rowe Price Portfolio Managers Charles Shriver, Toby Thompson, Robert Panariello, Guido Stubenrauch, and Andrew Jacobs van Merlen. Each portfolio manager is a member of the T. Rowe Price Multi-Asset team, which had $332.5 billion in assets under management as of June 30, 2019.

27% of Americans very confident about retirement: TIAA

TIAA’s 2019 Lifetime Income Survey found that various uncertainties are key detractors of financial confidence among Americans– with just three-in-ten respondents saying they are very confident they will always feel financially secure, including during retirement.

Only a little more than one-in-three (35%) are very confident they will be able to maintain their lifestyle as long as they live. Uncertainty about the future of social programs and market performance, concerns about unexpected expenses and investment losses, and fear of saving too little are all major detractors of confidence.

The survey showed a number of skills and practices that build confidence. For example, the ability to plan long-term and invest effectively are key drivers of feeling secure. Those who rate highly their ability to invest effectively are roughly three times as likely to express confidence in always being financially secure, including throughout retirement. Long-term planning can also play a role in financial confidence, as those who are able to master this skill are at least twice as likely to feel confident.

U.S. ranks 18th in retirement security

The United States dropped two spots to No. 18 among developed nations on the 2019 Global Retirement Index, released this week by Natixis Investment Managers. The annual index found the U.S. ranked the same or lower in all four sub-indices:

  • Health
  • Material well-being
  • Finances
  • Quality of life

Three global risks to long-term sustainability weigh on retirees and policymakers—low interest rates, longer lifespans and the costs of global warming.

The Seventh Annual Natixis Global Retirement Index examines 18 factors that influence retiree welfare, producing a composite score for evaluating comparative retirement security worldwide.

Highlights of the 2019 Global Retirement Index include:

Factors affecting the US GRI ranking

For all four sub-indices, the US ranked the same or lower in this year’s Index compared to last year, including Material Wellbeing (28th from 26th), Finances (10th from 9th), Quality of Life (20th from 19th) and Health (held steady in 10th place). The following are notable factors affecting the US position:

Growing pressure on government resources

The US lost ground in the Finances category, but remains in the top 10. The Index reflects an increasing proportion of retirees to working adults, an ongoing trend that is putting growing pressure on Social Security and Medicare funds.

Rising government debt and tax pressures also contributed to the US’s lower score in the Finances category, which was offset by improvement in interest rates and fewer nonperforming bank loans.

Economic inequality widens

Despite rising employment, the gap between wealthy and poor continues to grow. The US has the eighth-worst score for income equality, even though it has the sixth-highest income per capita score among all GRI countries. These factors generated a lower score for the US in the Material Wellbeing category.

Lower life expectancy despite health spend

The US maintains its position in the top 10 (at 10th) for health due to an improvement in insured health expenditure, which measures the portion of that expenditure paid for by insurance, and by maintaining the highest score globally for per capita health spending. But the US experienced a decline in life expectancy as Americans’ longevity failed to keep pace with that of top-ranked Japan and other nations.

Quality of life in relation to retirement security

A lower score for happiness, which evaluates the quality of retirees’ current lives, weighed on the US’s Quality of Life performance. However, the US continues to achieve the seventh-highest score for air quality on the Index and it showed improvement in its environmental factors indicator score, though not enough to lift it out of the bottom 10 in that category.

Western Europe continues to lead as a region, with 15 countries finishing in the top 25 for the third year in a row. The Nordic countries maintain their strong performance in the top 10, including

Iceland (No. 1)

Norway (No. 3)

Sweden (No. 6)

Denmark (No. 7)

Ireland advanced to No. 4 from No. 14 two years ago due to an improved score in the Health sub-index, where it moves into the top 10 (from 19th), driven primarily by the country’s higher per capita health spending. The country also performed well in Finances, powered by improvements in bank nonperforming loans and government indebtedness.

Japan, which ranks No. 23, stands out for having the lowest score among GRI countries for old-age dependency, a measure of the number of active workers compared to the number of retirees. Japan has the highest life expectancy, but also one of the lowest fertility rates among developed countries.

Three pressing risks for retirement security

The Natixis report, “Global Security. Personal Risks,” supplements the 2019 Index and illustrates three pressing risks and their implications for retirees and future generations globally. The analysis serves to encourage dialogue among policymakers, employers and individuals to understand the impact and help manage the risks to society.

Interest rates: Interest rates do not appear to be rising anytime soon, and the related low yields on investments present hurdles for those looking to generate income in retirement. As a result, retirees may be forced to invest in higher-risk assets, thus exposing their portfolios to greater volatility at an age when they might not have time to recoup losses due to a market downturn. Indeed, more than four in ten Baby Boomers (aged 55–73 years old) in the US surveyed by Natixis earlier this year said they were blindsided by the market downturn in 2018.

Demographics

Longevity represents a key risk for retirees. In the US, the ratio of older adults to working-age adults is climbing. By 2020, there will be about 3.5 working-age adults for each retirement-age person; by 2060, that ratio will fall to just 2.5. This leaves policymakers with hard choices on how to address the funding crunch.

Financial and health impacts of climate change

The risk of climate change is often viewed through a long-term lens, but it poses tangible health and financial risks to today’s retirees. The costs associated with natural disasters help force up insurance rates and consume government resources. Severe events helped make 2018 the fourth-costliest year for insured losses since 1980, according to Munich Reinsurance Co. Extreme heat has increased the risk of illness among older adults, particularly those with chronic illnesses, according to the US Environmental Protection Agency.

Millennials lead emphasis on sustainable investing

The rapidly aging population in the US means a large percentage of people depend on Social Security payments at a rate that threatens the long-term sustainability of the nation’s retirement system. At the same time, younger generations are leading the charge for long-term sustainability, seeking to have a positive impact on the world and, ultimately, their retirement security.

© 2019 RIJ Publishing LLC. All rights reserved.

A VA Rider Designed for Inheritances

Posted on September 19, 2019 by -

A new variable annuity rider from Lincoln Financial, called Wealth Pass, allows non-spouse beneficiaries of variable annuities or retirement accounts to stretch the receipt of their inheritance over their own remaining years of life expectancy, with the added assurance that, if they live that long, no less the nominal value of the original inheritance would be paid out.

Under current law, widows or widowers can assume the ownership of inherited IRAs or inherited deferred annuities, but a non-spousal beneficiary faces different options. The new Lincoln rider is designed to encourage these non-spouses to keep the assets in their inherited VA, inherited IRA, or even a non-qualified account, to buy a new Lincoln VA with the assets.

“Suppose someone put $100,000 into a variable annuity today,” Del Campbell, vice president of variable product development at Lincoln Financial, told RIJ this week. “If he or she dies in 10 years, and the death benefit is $200,000, a non-spouse beneficiary, can take the contract, add the Wealth Pass rider, and then receive $200,000 over his or her own life expectancy.

The beneficiary would actually have several options under the Wealth Pass rider. To be assured of receiving the entire (nominal) inheritance, he must take out at least his required minimum distribution (RMD) each year (as determined by IRS life expectancy tables). Alternately, he could also take out a higher percentage, up to a limit set by Lincoln.

For instance, beneficiaries who are 60 years old have a life expectancy of 25 years. They can stretch the payments over 25 years, starting with an RMD of 4% ($8,000) in the first year. In each of the next 24 years, they would receive their RMD amount, unless they choose to cash out and end the contract. Alternately, they could withdraw up to 5.5% ($11,000 in the first year) and continue withdrawing at that pace until they receive the entire $200,000.

“They would still be invested in the market, so with good performance they could get more than that,” Campbell added. “If they then died before receiving all of their payments and they still had any account value, their beneficiaries could receive their remaining payments or the account value.” If the account value is zero when the second owner dies, the contract is cancelled and no further payments are issued.

Alternately, people who inherit a $100,000 traditional IRA, for instance, could invest the assets in a new Lincoln VA, add the Wealth Pass rider, and spread their inheritance and tax liability over their life expectancies, with the assurance that the entire $100,000 would be paid out while they’re living.

A hypothetical beneficiary

A Lincoln Financial web page illustrates the tax implications of using Wealth Pass, which adds a 1% annual fee (1.25% for those ages 66 to 80) to the mortality & expense risk fees and investment fees of the assumed or new variable annuity. The illustration imagines a hypothetical investor, Cynthia, 56, who inherits an IRA worth $500,000.

If Cynthia took the $500,000 in a lump sum, she would owe income tax of $165,000 (assuming a 37% marginal tax bracket). Her after-tax inheritance would be $335,000. If she took $100,000 per year for five years, she would pay an incremental $25,000 in federal income tax per year (assuming a 32% marginal tax bracket), leaving her with an after-tax inheritance of $375,000.

But if she used the $500,000 to buy a Lincoln VA with a variable annuity with Wealth Pass, she would receive her inheritance over her life expectancy or she could take it out at 5% per year for 20 years, with a guaranteed payout of at least $25,000 per year (assuming she followed the rules of the contract), paying $5,816 per year ($116,000 total) in income taxes. This assumes no growth; with market growth her income could be higher.

(There is a limitation on the portion of the VA account value that can be held in equities. See the prospectus for further details.)

As of today, the Wealth Pass rider can be added to either a qualified or non-qualified VA contract. But pending federal legislation, known as the SECURE Act, would effectively eliminate the so-called “stretch” strategy, which allows non-spouse beneficiaries of qualified accounts, such as IRAs, to receive distributions from the qualified account over their life expectancies. The SECURE Act would mean that Wealth Pass could only be attached to non-qualified VAs.

The SECURE Act passed almost unanimously in the House last May but has been hung up in the Senate, where certain senators, including Ted Cruz (R-TX), have objected to certain provisions. The SECURE Act would eliminate the ability of a non-spouse beneficiary to take a lifetime payout in most cases, and impose a maximum deadline of 10 years to distribute the full value of the qualified account. It remains unclear whether the SECURE Act and its Senate counterpart will be reconciled, passed and signed by the president during the current session of Congress.

© 2019 RIJ Publishing LLC. All rights reserved.

Investors Flocked to Money Funds in August

Posted on September 19, 2019 by -

The Federal Reserve’s quarter-point rate cut this week was meant to gladden Wall Street, boost the economy, and perhaps appease Donald Trump’s appetite for ideal economic numbers in advance of the gathering presidential race.

Citing uncertainties in the global economy and weakening fixed business investment and exports—factors heightened by the president’s shifting policies and provocative tweets—the Fed’s Board of Governors voted to reduce the fed funds rate to a range of 1.75% to 2%.

But, judging by investors’ sober reaction to the Fed’s last rate cut, on July 31, the latest monetary stimulus might only remind investors that the global and U.S. economies are slowing down.

According to the August Fund Flows report from Morningstar Research, investors reacted to the July 31 move by pulling a net $15.9 billion out of long-term open-end and exchange-traded funds in August.

It was the biggest outflow since the panicky stock sell-off in December 2018.

“Every major U.S. category group—except commodities—saw a decline in inflows or an increase in outflows compared with July,” Morningstar analysts wrote. “August’s long-term outflows were the greatest since December 2018, when capital markets were enduring a nasty correction.”

Instead of buying mutual funds, investors moved a net $80 billion into money market funds—even though the yields on those funds naturally went down after the Fed lowered its benchmark rate. “Money market funds have collected nearly $300 billion” for the first eight months of this year, “the greatest sum since 2009 when investors were just beginning to recover from the credit crisis,” the report said.

August also saw the value of passive U.S. equity funds surpass the value of U.S. actively managed equity funds by about $25 billion ($4.271 trillion vs. $4.246 trillion).

“This is a milestone that has been a long time coming as the trend toward low-cost fund investing has gained momentum. Active U.S. equity funds have had outflows every year since 2006, with roughly equivalent inflows into passive funds during that time,” Morningstar said.

“Over the past 10 years, active U.S. equity funds have had $1.3 trillion in outflows and their passive counterparts nearly $1.4 trillion in inflows,” the analysts wrote. “Still, 10 years ago, active U.S. equity funds had about 75% market share. And at that point we had recently entered one of the longest equity bull markets in U.S. history. If you had known this, would you have guessed that active U.S. equity funds were on track to lose $1.3 trillion to outflows?”

Despite the July 31 rate cut, taxable-bond funds had the highest inflows in August, with $16.3 billion in inflows. “This was the group’s second-lowest total of the year. Credit-oriented high-yield and bank-loan funds had about $8.9 billion in combined outflows. Municipal-bond funds’ inflows remained strong with $9.1 billion,” Morningstar said.

© 2019 RIJ Publishing LLC. All rights reserved.

Vantis Life to sell fixed annuities direct to the public

Posted on September 19, 2019 by -

Direct-to-consumer life insurance provider Vantis Life Insurance Company, a subsidiary of The Penn Mutual Life Insurance Company, is making an existing line of fixed deferred annuities available for direct purchase online for the first time. The annuities are:

  • TaxSaver Freedom ROP. This annuity provides a fixed interest rate with the safety of a return of premium (ROP) guarantee feature. With the ROP feature, customers can withdraw assets at any time without a penalty.
  • TaxSaver Freedom MVA. This product locks in an interest rate for the duration of the term. The market value adjustment (MVA) feature can positively or negatively impact the value in the contract if funds are withdrawn prior to the end of the guarantee period.

Both products provide a five-year rate guarantee and tax-deferred accumulation of interest gains, in addition to waivers for withdrawals triggered by nursing care or terminal illness. Vantis Life is rated A+ (Superior) by A.M. Best.

© 2019 RIJ Publishing LLC. All rights reserved.

More up ratings than down among U.S. insurers: AM Best

Posted on September 19, 2019 by -

In the first half of 2019, there were seven ratings upgrades and three downgrades in the life/annuity/health segments of the U.S. insurance industry, compared with eight upgrades and five downgrades in the first half of 2018, according to a new Best’s Special Report, “L/H Upgrades Outpace Downgrades in First-Half 2019.”

In the health segment, there were eight rating upgrades and one downgrade, compared with nine upgrades and three downgrades in first-half 2018. No upgrades or downgrades were made in the life reinsurance segment in first-half 2019, compared to one upgrade in the same prior-year period.

Despite AM Best’s revised L/A market segment outlook to stable from negative in December 2018, AM Best sees potential for a global economic slowdown, with a recession likely in 2020. That view is based on the prolonged trade/tariff war and the reduction in interest rates by the Federal Reserve this year.

The positive rating development in the L/A segment was based on factors that include improved risk-adjusted capitalization from an increase in profitability, owing to the Tax Cut and Jobs Act, as well as a modest increase in interest rates in 2018 and expense reductions.

The health segment continues to see strong operating results and positive earnings, along with favorable medical cost and growth trends, which have fostered positive rating development.

In first-half 2019, seven life/health rating units were placed under review, compared with 25 in the first-half of 2018. The high number in 2018 mainly reflected elevated merger and acquisition activity. Affirmations remained the most common rating action for the life/health industry at 79.9%, consistent with most years.

The industry has benefited from an easing in regulatory oversight, but changing fiscal and political dynamics could slow down or even reverse some of these gains. However, carriers have strengthened their risk-adjusted capitalization and enterprise-wide liquidity, which likely will mitigate the impact of investment credit and liquidity risk, which continue to rise for many carriers.

AM Best maintains a stable outlook on the U.S. health industry segment, based on positive earnings, strong results in all major lines of business, growth in capital and surplus, and a decline in near-term regulatory uncertainty. However, health insurers must remain watchful of rising cost trends and utilization.

© 2019 RIJ Publishing LLC. All rights reserved.

At the RIA Dance, Annuities Look for Partners

Posted on September 19, 2019 by -

Determined to follow advisors wherever they may go, the top annuity issuers continue to develop no-commission versions of their products and make them available where fee-based advisors can see them: on the custodial or turnkey asset management platforms that RIAs (Registered Investment Advisors) use.

This week, Nationwide Advisor Solutions added an income rider for its RIA-ready NARIA variable annuity and Great American announced that Pershing’s RIA custody platform would host Great American’s fee-based Index Protector 7 indexed annuity, which also has a lifetime income benefit rider.

So far, the excitement about the potential for RIAs to recommend annuities for their retirement clients has been more visible in the annuity world than in the RIA world. But annuity issuers figure that if RIAs are fiduciaries, and their Boomer clients need sequence risk protection and longevity risk protection, then RIAs will, ipso facto, have to start using annuities.

This fall, several annuity issuers received private letter rulings from the IRS that will make it easy for RIAs to receive their asset-based fees from annuities without causing a taxable distribution.

In any case, annuity issuers must go to the RIA dance because it’s where desirable advisors and clients will be. Whether their “dance cards,” to use a quaint expression, are filled or not remains to be seen. Nationwide (since its purchase of Jefferson National’s RIA/VA business in 2017) and Great American have been among the most assertive life insurers in adapting to the evolving world of RIAs and dually-registered (RIA and broker-dealer) advisors.

Nationwide adds income rider to its no-commission variable annuity

Nationwide has launched a new lifetime income rider and two new enhancements to its stripped-down, no-commission NARIA (Nationwide Advisory Retirement Income Annuity) variable annuity for Registered Investments Advisors (RIAs) and their Investment Advisor Representatives (IARs).

“A simple, transparent, low-cost variable annuity (VA) and one of the only VAs with ‘advisory-friendly’ fee management capabilities that will not erode the client’s benefit base, NARIA can help RIAs and fee-based advisors incorporate insurance into their practice for more holistic planning,” a Nationwide Advisor Solutions release said this week.

The announcement follows the recent IRS Private Letter Ruling allowing favorable tax treatment of advisory fees from non-qualified annuities.

NARIA now offers Nationwide Lifetime Income Rider Advisory (Nationwide L.inc Advisory), an optional living benefit with a 7% (simple interest) annual increase in the benefit base (the notional sum, independent of the account value, on whose basis annual payouts are calculated) during the accumulation period. When the client’s contract returns above 7% on the rider anniversary, the contract value is the benefit base.

“Nationwide L.inc Advisory is designed to help RIAs and fee-based advisors provide a retirement income solution compatible for a shorter accumulation period, which is important during those critical years between the ages of 65 to 75, when most clients start taking retirement income and need income protection,” the release said.

NARIA can now offer unconstrained 100% equity exposure when combined with “RIDER” (Retirement Income Developer), a lower cost optional living benefit launched earlier this year. RIDER has a ratchet feature to lock in growth. It is designed for longer accumulation periods, with newly increased equity exposure.

NARIA also now offers tiered pricing for its low-cost platform funds. More than 30 funds, including investment options from DFA, DoubleLine, Vanguard and Nationwide, are now available for between 10 bps and 35 bps, on top of NARIA’s annual mortality & expense risk fee of 20 bps. NARIA offers more than 150 underlying funds from more than 25 fund families.

Great American’s fee-based FIA joins Pershing RIA platform

Index Protector 7, Great American Life Insurance Company’s fee-based fixed indexed annuity, is now available on BNY Mellon’s Pershing (“Pershing”) registered investment advisor (RIA) custody platform, the insurer announced this week.

Index Protector 7 features an optional guaranteed income rider, Income Keeper, which offers lifetime income payments that could increase each year.

Great American Life launched the industry’s first fee-based fixed-indexed annuity in 2016, and the company continues to introduce new technology solutions that make it easier for RIAs to include an annuity in a fee-based portfolio. Most recently, Great American advocated for industry change and received an IRS Private Letter Ruling that permits advisory fees to be withdrawn from Great American Life’s fee-based non-qualified annuities without creating a taxable event, as long as certain conditions are met.

Great American Life Insurance Company, a member of Great American Insurance Group, is rated “A+” by Standard & Poor’s and “A” (Excellent) by A.M. Best for financial strength and operating performance.

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