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Shekel by Shekel: How Israelis Save

Posted on February 14, 2019 by -

Like Americans and Europeans, Israelis have seen big changes in the way they fund their retirements. Until about 25 years ago, older Jewish Israelis in professional jobs could look forward to generous defined benefit (DB) pensions from one or more former employers.

“Once upon a time, it was simple in Israel,” Dan Galai, a fund manager and academic who has had a 50-year career here and in the US, told RIJ during a recent interview in his office in the Ramat Gam district of Tel Aviv.

Dan Galai

“If you were in the government, or affiliated with a university, or you had an army career, you got a pension that was paid out of the budget of the government. There were many different pension plans, and the government issued bonds for them with a guaranteed rate. It was an expensive subsidy.”

Equally unsustainable were private, multi-premium annuities, called pension insurance policies, said Abigail Hurwitz, an Israeli pension expert currently at the Wharton School in Philadelphia. “They insured individuals who didn’t belong either to the government or to any employee union,” she told RIJ. The annuity factor was set at purchase date, rather than at retirement. As life expectancies in Israel rose, these contracts turned out well for annuitants but disastrously for life insurers.

By 1995, the fragility of this fools’ paradise could no longer be ignored. The government eventually bailed out the big pension funds (at a reported cost of about $25 billion), closed them to new enrollment, and replaced them with a voluntary defined contribution system. The feckless practice of setting annuity factors at time-of-purchase for pension insurance policies was ended.

At the start of the 21st century, Benjamin “Bibi” Netanyahu (then Israel’s finance minister, now its prime minister) started rationalizing the economy. In 2003, the government broke the big banks’ cozy monopoly on financial services, forcing them to divest their mutual (aka “provident”) funds. In 2008, the government—acknowledging that the voluntary defined contribution (DC) system, as DC does in the US, left millions of workers without any retirement plan coverage—took a dramatic step and required all employers and workers to contribute to DC plans.

Here’s a pocket-sized overview of the post-2008 mixed retirement system to which Israelis have been adjusting. Most Israelis, like Americans, grope their way into retirement, with a grab-bag of DB pensions from long-past employers, pension insurance policies, unspent severance pay accounts, and new mandatory DC accounts. The different accounts from different periods are typically subject to different tax rules. The various elements often require a licensed pension advisor to sort out.

We’ll cover the high points of Israel’s safety-net pension and its mandatory DC program, which leads to mandatory partial annuitization. Warning: There’s a lot of information here. The Israeli retirement system was laid down in a succession of layers, and studying it requires a kind of archaeological excavation through the multi-dimensional strata of time and law.

Basic old age insurance (and health care)

This program, run by the National Institute of Insurance (NII) and funded by a payroll tax, resembles US-style Social Security, but gives all retires the same old age benefit, not counting certain supplements and adjustments. No one receives more than about $1,000 per month.

Abigail Hurwitz

The payroll tax has two tiers. There’s a 3.55% employer-paid tax on the first 6,164 shekels ($1,690) of income per month. Then there’s a 7.6% employer-paid tax and 7.0% employee-paid tax on income between 6,164 and 43,890 shekels ($12,043) per month. In addition, the employee pays a health insurance tax equal to 3.10% of the first 6,164 in salary and 5% for amounts above that, to 43,890 shekels.

Benefits start at the full retirement age (67 for men, 62 for women). Until age 70, benefits are means-tested, but not after age 70. The flat individual benefit is a modest 1,554 shekels (about $427 a month) in a country where the cost-of-living is comparable to that in the US. At age 80, the benefit notches up to 1,641 shekels ($451). Regarding health care: Israel has a public-private hybrid HMO-based health insurance system, funded by a combination of payroll taxes and co-pays. It continues in retirement.

A retired married couple can receive a spousal supplement of 781 shekels ($215), raising the couples’ pension to 2,335 shekels ($640) a month. Those with dependent children receive 492 shekels ($135) per child, up to two. For a retired couple with two dependent children, the pension would be $885 a month. “That’s peanuts,” a Tel Aviv cab driver told me. “Peanuts!”

Mandatory defined contribution

As Israel grew more market-driven under Netanyahu, the government wanted to shift financial responsibility for retirement onto the public. It made defined contribution plans mandatory, with fixed-percentage contributions from employers and employees.

Today, the employer contributes 6.5% of pay and the employee contributes another 6%. The employer contributes another 6% of salary toward an unemployment (“severance”) fund. If the employee never uses it, he or she can take it as a lump sum in retirement.

Employers in Israel aren’t plan sponsors per se and aren’t supposed to choose plan providers for their workers, although employers can choose their company’s default target date fund provider. Employees are intentionally given a lot of freedom to invest as they wish, and to switch investments (and providers?) at will. Every month, the employer sends a bulk contribution to a clearinghouse, which distributes each employee’s portion to his or her chosen fund provider.

Older Israeli in Jerusalem’s Mahane Yehuda market.

Employees typically send their contributions to a “pension fund” or a “provident fund;” the latter resemble mutual funds. The first offers a combination of retirement savings, life insurance and disability insurance, and contributions to them are capped because their returns are partly subsidized. Contributions to pension funds are tax-free up to a certain amount and excess contributions spill over into other investments.

The government evidently subsidizes the pension funds (not the provident funds) by allowing them to hold special government bonds, which yield a guaranteed 5.75% return (a slice of which 2% to the insurer that manages the fund). Up to 30% of a pension fund’s asset pool can consist of these special-purpose bonds.

The default investment options for participants in pension funds are like target-date funds. These funds have a 10% allocation to the subsidized bonds for people under 50. The allocation rises to 40% at age 50 ad to 60% at age 60 and thereafter in retirement. This glidepath, as in the US, serves as a buffer against sequence-of-returns risk.

Competition between fund providers is designed to keeps a lid on fees. Israelis pay a two-fold fee on their pension contributions. First, there’s an expense ratio for each contribution. Second, an expense ratio is charged on accumulated savings (assets under management). The fees for the two default funds, selected through a government bidding process in 2016, are especially low.

The two default providers are Meitav Dash Investments Ltd. and Halman Aldubi Investment House Ltd. Meitav Dash charges a one basis-point (0.01%) management fee on accrued savings and 131 basis points (1.31%) on each monthly deposit. Halman Aldubi collects an even slimmer one-tenth of one basis point (0.001%) management fee on accrued savings but charges 149 basis points (1.49%) on monthly deposits. As in the US, the default funds are popular.

In addition, employers may contribute on their employees’ behalf to tax-favored “study funds,” which can be withdrawn tax-free after a six-year minimum holding period. As in the US, contributions to pension funds and provident funds are tax-deductible up to a cap. The precise tax rules in Israel are too complex to address here.

Mandatory annuitization

Distribution from Israeli DC plans is more structured than distribution from 401(k) accounts in the US. In the US, distributions from tax-deferred accounts, either in the form of annuity payments, lump sums, or systematic withdrawals, are all taxed as ordinary income. Most US retirees resist taking distributions from tax-deferred accounts until the required age, 70½.

Israel, by contrast, drives partial annuitization (but only of savings since 2008) through a combination of requirements and incentives. Retirees must convert at least part of their tax-deferred savings to a lifetime income stream and pay no income tax on the portion that’s annuitized, up to a limit. Lump-sum withdrawals from pension funds can face up a significant tax. (Forced annuitization was less of a jolt to Israelis than it might be for Americans, since it mimicked their earlier DB pensions.)

Oded Sarig

Most of the new DC pensions are structured as life-with-20-years-certain annuities. “In order to qualify for the tax benefit, the retiree has to annuitize for life. But within that restriction you can select the number of years you want the benefits to last,” said Oded Sarig, a former chief of the Ministry of Finance’s Capital Market, Insurance and Savings Authority, in an interview with RIJ. “You can annuitize with 10 years or 20 years certain,” he added. “You can have joint-and-survivor contracts.”

The standard tax-free income stream is about 4,400 shekels or about $1,200 a month. A recent law, called Amendment 190, adds a new tax break for lump-sum withdrawals, a chance for additional tax-free monthly income from provident funds, and tax-free disbursements at death before age 75. (Amendment 190 is new and complicated, and this description could be flawed.)

An Israeli retiree who owns a provident fund would need to transfer it to a pension fund in order to convert to a monthly income stream. This would not entail buying an individual fixed income annuity from a life insurer, as in the US. The retiree would simply switch from contributing to his or her pension fund to receiving an income from it.

The first monthly payment is determined by dividing the retiree’s assets by a “conversion factor” based on gender, life expectancy at annuitization and an assumed interest rate (currently 4%). The current conversion factor for a payout from a post-2008 savings is about 200. Someone who saved a million shekels in a pension fund could, if they annuitize the whole amount, buy a 5,000-shekel-a-month annuity at today’s rates.

This income, like the income from a variable immediate annuity in the US, can rise or fall, depending on the returns of the underlying portfolio. A retiree’s portfolio would contain almost 100% bonds, 60% of which would be the subsidized special government bonds.

To spread the impact of potential volatility up or down, fund managers use a “smoothing” mechanism. Payments adjust to portfolio performance over rolling three-year periods instead of every month or year, so that the impact of a transient shock to the fund doesn’t fall on one unlucky cohort of retirees. “The participants bear the risks,” Sarig said. “It’s a form of mutual insurance. If the fund runs into problems, the retirees’ income comes down.”

If all this sounds like a hot mess, it is. In a coffee shop in Yehud, a 69-year-old retired electronics engineer and Army officer, Moshe Shahar, said his wife handles the details of his many retirement accounts. He’s nostalgic for the simpler, more generous DB pensions of the rapidly receding past. “The new system has turned out to be a nightmare,” he said, “You get much less than with the old pensions.”

© 2019 RIJ Publishing LLC.

A Genuine ‘Value Fund’ Is Hard to Find

Posted on February 7, 2019 by -

“Value” investors are the tortoises of the investing public, following the teaching and examples of Ben Graham and Warren Buffett. By purchasing funds that invest in companies whose share prices lag their fundamental “book” value, they expect eventually to outperform the “hares” —i.e., investors in “growth” companies with fast-rising share prices.

Martin Lettau, an economist at UC-Berkeley’s Haas School of Business, was a value fund investor for years. Then he studied the book-to-market ratios of the stocks—not just in his own funds but in a cross-section of active US funds from 1980 to 2016—and learned that he (and other value investors) have usually been rabbits in disguise.

Martin Lettau

“Many active value funds are closet growth funds,” Lettau told RIJ in an interview. “On average, they hold more growth stocks than value stocks. There are few exceptions. DFA’s [Dimensional Fund Advisors] value fund hold mostly value stocks. Only these funds are what I would call a ‘value fund.’ Growth funds, on the other hand, hold what you would expect them to.”

The upshot is that if you’ve been investing in value funds and are waiting for the value premium to show up and vindicate your patience, maybe you should stop holding your breath and look closer at your funds’ holdings.

“Characteristics of Mutual Fund Portfolios: Where are the Value Funds?” co-authored by Lettau, Sydney Ludvigson and Paulo Mandel, all of Berkeley (NBER Working Paper 25381) analyzed 2,638 actively managed funds in the CRSP/Thomson-Reuters Database. Of those, 574 identified as value funds and 1,130 as growth funds. The sample also included 955 exchange-traded funds and 114 hedge funds. The number of active funds, they note, rose eight-fold, from 185 to 1,424, between 1980 and mid-2016.

The authors reviewed several characteristics of the stocks held by the funds, including the book-to-market ratio. They sorted the stocks into five book-to-market quintiles, from low to high. Then they assayed each fund to measure the percentage of its underlying stocks that belonged to each quintile.

“‘Value funds’ are missing from the US equity market,” they concluded. Counter-intuitively, a larger percentage (24%) of the stocks in value funds came from the lowest book-to-market quintile than from the highest (13%). More than half of all value funds held a larger share of low book-to-market stocks than high book-to-market stocks. Only 7% of value funds held more than 25% of their portfolios in high book-to-market stocks.

“While there are over 1,000 mutual funds with consistently low b-to-m ratios, there are virtually no high b-to-m funds in our sample… Even funds with an explicit ‘value’ objective hold a larger share of low b-to-m stocks than high b-to-m stocks in their portfolios,” the paper said.

“One rationale for having value funds is to exploit the value premium. That is, to get a higher return in the long run than growth funds. Our results show that even the funds that call themselves value funds don’t exploit the value premium,” Lettau told RIJ.

It wasn’t a question of whether or not fund managers have abandoned the book-to-market metric in the age of hard-to-value tech stocks. “We looked at a whole list of measures of value and growth,” Lettau said. “We saw the same pattern for any measure.”

“This pattern is true going back to the 80s, so it’s been consistently true. It’s not style drift on the part of fund managers. It’s a consistent pattern. The purpose of our paper was to survey these facts, which are not well-documented.”

Why don’t most value funds hold value stocks? Lettau says that this question is still unanswered and further research is needed. When he presented his findings to an audience at one of the largest asset management firms, the fund managers there didn’t deny his findings. They suggested however that they are only giving the investing public what it wants. “They said, ‘We’re demand-driven.’

“Apparently it’s easier to sell sexy growth funds rather than boring old value funds. But that goes against the value premium, which says that, on average, cheap stocks will perform better in the long run. But, for whatever reason, investors seem to demand growth and glamour.” Just as surprising to Lettau, seemed to be the fact that the value benchmarks that value fund managers use, such as the CRSP value indices, did not necessarily include only what he considered true value stocks.

Dimensional’s value funds are the exception, according to Lettau. In response to an RIJ query, Dimensional’s co-head of research, Marlena Lee, sent a written description of her company’s process when building value funds. “Are we surprised by Lettau et al. finding for our value funds? No,” she wrote. “In our value strategies, one of their primary focuses is purchasing stocks with low prices relative to a fundamental measure of firm value. Price-to-book ratio is the primary way we do this. Among those stocks, we use their profitability, market cap, momentum characteristics, etc. to improve expected returns. Lettau et al. find that our value funds have a strong focus on stocks with low price-to-book ratios because that is how we have designed them.

“Valuation theory suggests that low market prices relative to fundamental measures of firm size combined with high expectations of future cash flows to shareholders should indicate high expected returns… However, the theory doesn’t tell you the best way to measure and pursue the value premium,” Lee wrote.

Lee sent RIJ a table comparing the 15-year net returns (as of 12/31/2018) of five DFA value funds with the average returns of the corresponding Morningstar Categories, and with the DFA fund’s rank among the funds in each of those categories. Performance was higher than the Morningstar average in each category and the rank was in the top 10% or better for four out of five of the DFA funds. The DFA US Large Cap Value fund showed an annualized return of 7.85% over 15 years. The Morningstar average was 6.52% a year.

“Among the variables we use to identify stocks with higher expected returns are price-to-book, profitability, and market capitalization. These variables can be thought of as capturing different angles of value investing, because they help us identify stocks that have low market prices relative to current fundamental measures of firm value and what future cash flows investors expect to receive.”

In her letter, Lee supported Lettau’s idea that the book-to-market ratio has not become less meaningful or obsolete as a value indicator during the tech-stock era. DFA’s analyses “have not shown any downward trend in the informational content of BtM,” she wrote. “In developed and emerging markets outside the US… the explanatory power of price to book in the past 15 to 20 years is similar to its long-term average.”

Lettau has shared his paper informally with a range of reviewers. “The reaction has been varied,” he said. “Some people are surprised by the degree of the tilt. The fund industry already knows there’s more interest in sexy growth funds. What is surprising is that there are virtually no high book-to-market mutual funds. Different market participants knew vaguely about this, but not the extent of the tilt. In academia, this wasn’t known.

“I had a value fund in my own retirement portfolio. I thought I would capture the value premium. But after writing the paper I looked closer at my fund and saw that it didn’t do what I thought it was doing. Even if the fund says ‘value,’ there’s no likelihood that it’s a value fund.”

© 2019 RIJ Publishing LLC. All rights reserved.

Fourth Quarter Fears are Disappearing

Posted on February 7, 2019 by -

The stock market’s decline in the fourth quarter suggested that the economy was on the cusp of slipping into recession.  As we turn the corner into a new year it is evident that many of those fears were exaggerated.

We now know that employers ignored both the partial government shutdown and stock market turmoil and added 304 thousand jobs in January.  The Fed has made it abundantly clear that it is on hold for the foreseeable future and will have to be persuaded to raise rates again.

Manufacturing firms experienced an impressive rebound in orders and production in January.  Thus, recent indicators provide reassurance that the economy is chugging along in the first quarter at a pace roughly comparable to other recent quarters.

Two things are fascinating about the 304 thousand increase in employment in January.  First, the partial federal government shutdown had no impact on hiring.  Second, the jobs market seems to be strengthening.  The economy cranked out 183 thousand jobs monthly in 2017, followed by 220 thousand per month in 2018, and 266 thousand in the most recent 3-month period.  Perhaps the labor market is not nearly as tight as what most economists believe.

Following the December FOMC meeting the Fed raised the funds rate one-quarter point to a range of 2.25-2.5%.  Fed Chair Powell indicated at that time that while the Fed may keep rates steady for a while, he expected two additional rate hikes in 2019.  However, this past week he said that the Fed will sit tight for some time and will need to be persuaded to raise rates beyond their current level.  That is a distinctly different tone.

The Institute for Supply Management reported that its index for conditions in the manufacturing sector of the economy rose 2.3 points in January to 56.6.  The increase was led by the two most forward-looking components – orders and production – which registered gains of roughly seven points.  The overall series remains below levels attained late last summer.

However, the current level of the index is consistent with 4.0% GDP growth.  While no one anticipates 4.0% GDP growth this year, this index certainly seems to throw cold water on the notion that the pace of economic activity is succumbing to stock market gyrations, slower growth in China, tariffs, or rising inflation.

On the inflation front, the employment cost index rose 2.7% in the fourth quarter and 2.9% for 2018.  Clearly, the seemingly tight labor market is forcing employers to pay up to attract the workers they need.  That means that workers are receiving fatter paychecks and that is a good thing.  At the same time some worry that rising labor costs will push the inflation rate upwards.

But thus far, there is no evidence that is happening because productivity growth is countering the increased labor costs.  Unit labor costs, which measures labor costs adjusted for the increase in productivity, have risen just 0.9% in the past year – a 2.2% increase in compensation partially offset by 1.3% growth in productivity.  The Fed has a 2.0% inflation target.  If unit labor costs are rising by 0.9%, it is quite clear that the tight labor market is not putting upward pressure on the inflation rate.

It is also worth noting that the ISM price component for January fell 5.3 points to 49.6 after having declined 5.8 points in December.   That is the lowest reading for the price component since February 2016 and suggests that the PPI for January will register a decline.  Clearly, there is no hint that the inflation rate is on the verge of accelerating any time soon.

The stock market’s slide late last year was unnerving and suggested to many investors as well as economists that an economic downturn was likely by the end of this year.  Our sense was that the economic fundamentals remained solid and that the selloff was nothing more than exaggerated stock market noise.  We are breathing a sigh of relief that, perhaps, we are on the right track.

All these tidbits of information are restoring the faith of stock market investors.  The S&P 500 index has recovered about 60% of what it lost during the fourth quarter and now stands just 7.5% below its previous peak level.

© 2019 Numbernomics.

Honorable Mention

Posted on February 7, 2019 by -

Sweeping bipartisan retirement bill re-introduced

The Retirement Enhancement and Savings Act (RESA) has been reintroduced in the new Congress. The bipartisan bill introduced on Feb. 6 is sponsored by Reps. Ron Kind (D-WI) and Mike Kelly (R-PA), NAPANet reported.

The bill includes provisions intended to improve the retirement plan options available to small businesses by allowing unrelated employers to adopt a multiple employer plan (MEP). The legislation would give employers additional time to adopt a qualified retirement plan for the prior year up until the due date of the tax return (with extensions). The legislation provides for greater flexibility for a business to adopt a safe harbor 401(k) plan. The bill reduces the premiums charged to cooperative and small employer charity (CSEC) pension plans like the ones sponsored by some rural electric and agricultural cooperatives and the Girl Scouts.

The bill provides a tax credit of up to $5,000 to defray the cost of starting a retirement plan and adds an additional tax credit for plan designs with an automatic enrollment feature. It also enhances automated saving by removing the 10% cap on automatic employee contribution rate increases.

OneAmerica and Broadridge create CIT data resource

OneAmerica, in collaboration with Broadridge Advisor Solutions, has created a new website that offers an online repository of collective investment trust (CIT) for is retirement plan advisors who are considering CITs as an investment option for participants in their plans, according to a news release.

CITs are popular due to their flexibility and cost effectiveness, but a disadvantage that exists is “The inability to quickly and easily find information about the funds and important documents such as a declaration of trust” have slowed the adoption of CITs, OneAmerica said. The new online portal is designed to remedy that.

“The overhead associated with compliance and regulation [of CITs] isn’t as time-consuming as traditional mutual funds, therefore making them a cost-effective option for plans,” the release said.

OneAmerica is the marketing name for the companies of OneAmerica. The firm provides administrative and participant services for some 12,000 retirement plans with over $63 billion in assets under administration.

Empower launches Snapchat and Instagram campaigns

Empower Retirement, the nation’s second largest retirement services provider, has expanded its social media strategy to reach Generation Z and more millennials.

The firm has launched video campaigns on Snapchat, a mobile messaging application widely used by young adults, as well as Instagram Stories. Both campaigns speak directly to young adults ages 18 to 34 about the idea that it’s never too early to start saving for their future financial freedom.

Empower Retirement is among the first retirement services firms in the nation to take its message to Snapchat, which reported 186 million daily active users in Q3 2018. Pew Research Center reports that 78% of 18 to 24-year-olds use Snapchat and 71% visit the platform multiple times per day.

The first campaign features five new animated videos, developed by Empower, that have some fun with a “rare artifact” theme. The videos will run nationwide now through the end of February.

The second campaign provides financial “pro tips,” and allows users to “swipe up” for additional educational content. Both campaigns, designed vertically, specifically for Snapchat and Instagram Stories, are part of Empower Retirement’s expansive social media effort to continue an on-going conversation with millennial savers and start one with Generation Z (born from the mid 1990s to the early 2000s) about the importance of saving early. Longer videos will be featured on Facebook, Twitter and Instagram.

Empower has had previous success in connection with younger generations on social media. In its last Snapchat campaign the number of users in the 18 to 34-year-age range watching the entire video was nearly double the completion rate of other social media platforms.

Millennials (born between 1981 and 1994) are on track to replace 75% of their income in retirement compared to Generation X workers who are on track to replace 61% and baby boomers that are on track to replace 58%, according to an Empower Institute survey of 4,000 working Americans ages 18 to 65.4.

Equity funds rebound in January: TrimTabs

Retail investors jumped back into the equity markets in January, with all equity mutual funds taking in $11.0 billion in January, the most since February 2014, according to a TrimTabs Investment Research estimate.

The inflow of $3.3 billion into U.S. equity mutual funds was the most since February 2015, while the inflow of $7.8 billion into global equity mutual funds was the most since March 2018.

The buying in January came just one month after all equity mutual funds lost a record $89.3 billion in December. “Flows shifted dramatically last month,” said David Santschi, Director of Liquidity Research at TrimTabs.

“Mom and pop investors may simply have been chasing performance, or perhaps they were reassured by soothing words from central bankers or seeking out active management amid higher volatility.”

Equity exchange-traded fund flows fell sharply last month, TrimTabs noted in its research note. U.S. equity ETFs had their biggest monthly outflow on record, shedding $26.1 billion. Global equity ETFs issued $4.2 billion, their lowest monthly inflow since September 2018.

Oregon auto-IRA program gathers momentum

OregonSaves, a state-based, auto-enrolled IRA program for workers whose employers don’t offer retirement plans, reported milestones this week: $12.8 million in total savings so far, the receipt of an innovation award from Pensions & Investments magazine and the Defined Contribution Institutional Investors Association, and the testimony of an OregonSaves employer at a recent US House committee hearing on retirement security.

Luke Huffstutter, the co-owner of Annastasia Salon in Portland and one of the first small business owners to embrace OregonSaves, testified before the U.S. House Ways and Means Committee in a hearing focused on “Improving Retirement Security for America’s Workers.” The committee is chaired by U.S. Rep. Richard Neal, D-Mass., and includes U.S. Rep. Earl Blumenauer, D-Ore.

“OregonSaves is easy for my employees, but it’s also easy for me,” Hufstutter told the committee. “OregonSaves has changed the future for the people in my company. Please consider making it easier for other states to follow in Oregon’s steps.” His participating workers, almost all women, have saved an average of more than $2,200 each, he said.

OregonSaves provides an employment-based retirement savings option to an estimated one million Oregonians who lack the ability to save at work. It is overseen by the Oregon Retirement Savings Board and managed by the Oregon State Treasury.

Illinois and California launched their own state-based versions in the past year, and several other states and municipalities, including New York City, are considering similar programs. Local officials recognize that Americans have a collective retirement savings deficit of $6.8 trillion, and that an under-saved elderly population will put pressure on taxpayer-funded safety net programs.

OregonSaves is available for workers who lack a savings option through their employer, and individual Oregonians who want to sign up on their own at http://www.OregonSaves.com. Workers are automatically signed up, and have the ability to opt out at any time.

A recent poll that found more than 80% of Oregon’s population support for the program, which is rolling out in phases statewide. The current phase is for employers with between 20 and 49 workers. The program will finish the rollout phase at the end of 2020, and at that time will be available to workers at companies of any size, if those companies do not offer a different retirement savings option.

The combined savings of participants in OregonSaves is now increasing by more than $1 million a month, according to Feb. 1 data.

New Social Security Bill Calls for Tax and Benefit Hikes

Posted on February 7, 2019 by -

With the threat of a 25% cut in all Social Security benefits looming in 2034 if Congress doesn’t act to prevent it, House and Senate Democrats have proposed new legislation that would keep the old age and disability insurance program solvent through at least 2100.

John Larsen (D-CT) re-introduced the Social Security 2100 Act, which he first introduced in April 2017, when Republicans controlled the House. The bill has more than 200 co-sponsors. A similar bill, S. 269, was introduced in the Senate a week ago by Richard Blumenthal (D-CT).

The bills emphasize balancing Social Security’s books by raising revenue instead of cutting benefits. It proposes slowly raising the payroll tax by 1.2 percentage points for employers and employees over the next 23 years, and applies the payroll tax to incomes above $400,000 in addition to those below $132,900 (per current law).

The philosophy behind the new bills starkly contrasts with the Social Security reforms proposed in 2005. Some of the 2005 reforms would have diverted a portion of payroll taxes into individual accounts where savers could invest in the stock market. The new bills reject of the supply-side economic thinking behind the December 2017 Republican tax cut.

The current bills proposes to:

  • Raise benefits. The bills increase benefits for all current and new beneficiaries by about 2% of the average benefit. Today’s average benefit is about $1,340.
  • Inflation-protection. The bill adopts a CPI-Elderly formula for inflation adjustments instead of the annual cost-of-living adjustment (COLA) formula, to reflect seniors’ exposure to health care cost inflation.
  • Raise the minimum benefit. The new minimum benefit will be set at 25% above the poverty line ($12,490 in 2019 for one person) and would be tied to increases in wage levels.
  • Raise the earnings cap. Presently, Social Security benefits are taxed if non-Social Security income exceeds $25,000 for an individual or $32,000 for couples. The new proposal would raise that threshold to $50,000 and $100,000 respectively. Almost 12 million Social Security recipients would see a tax cut.
  • Hold SSI, Medicaid, and CHIP beneficiaries harmless. The bill ensures that any increase in benefits from the bill won’t reduce SSI benefits or eliminate eligibility for Medicaid or CHIP (Children’s Health Insurance Program).
  • Apply payroll tax to highest earners. Presently, payroll taxes are not collected on wages exceeding $132,900. This legislation would also apply the payroll tax to the 0.4% of Americans with wages above $400,000.
  • Introduce a higher payroll tax rate gradually. Starting in 2020, the payroll tax would start to rise in annual increments from the current 6.2% for workers and employers to 7.4% each in 2043. The average worker would pay an additional 50 cents per week per year.
  • Establish a unified Social Security Trust Fund. This provision combines the Old Age and Survivors Trust Fund and the Disability Insurance Trust Fund into one Social Security Trust Fund, to ensure that all benefits will be paid.

The proposals’ political viability remains to be seen. It would need support from Republican Senators and the signature of a Republican president. But the measure might be so broadly popular that it could gather that support. Democrats might, in a sense, dare Republicans to oppose it as the 2020 election approaches.

“One might consider this bill a Democratic first bargaining position, [since] it cuts back on no or almost no benefits, even those that are poorly designed, and it finances current law promises and additional benefit increases through tax increases,” Eugene Steuerle, a former Social Security official, told RIJ in an email this week.

Alicia Munnell, an economist and director of the Center of Retirement Research at Boston College, told RIJ, that, speaking for herself and not for the Center, “I am supportive of the approach that maintains and even enhances benefits and brings in additional money to ensure the long-term solvency of the program.  In my view, it’s useful to spell out clearly what it would take to finance the program and see if the American people support it.

“I could quibble with parts of the bill.  For example, I’m not sure about the COLA indexing change.  And I’m a big fan of separating out Social Security’s legacy debt from the long-run cost issue and handling it differently from the ongoing cost of the program.”

Her colleague, Steven Sass, added, “Given the importance of Social Security in the nation’s retirement income system and its fast approaching cash flow shortfall, restoring the program’s solvency (and that of Medicare and Medicaid) should be at the top of the nation’s domestic policy agenda.  Given Social Security’s generally low level of benefits, especially for those who claim at or before their FRA [full retirement age], raising revenues is far less painful.”

If past is prologue, opposition will come from those who call Social Security a “Ponzi” scheme, who believe that Millennials will pay high taxes for a program whose benefits they may never see, and who believe that more spending on retirees will crowd out federal spending on, for instance, education and infrastructure renewal.

The life insurance industry might decide to oppose the measure. Though not all retirement experts agree on this, some have written that Social Security crowds out the market for private annuities. Its inflation-protected, joint-and-survivor benefits are more generous than any private life insurer could match.

It’s a stubborn fact that not everyone’s Social Security benefits will be exactly commensurate with their contributions, Steuerle points out. “The public does seem to place limits on how much it will accept in taxes, whether for political or economic reasons, and I think that such transfers should go for the priorities in society. There’s also a generational issue,” he told RIJ.

“The design of Social Security and Medicare for about 80 years (and projected forward into the future) provided greater net transfers to older generations and less net transfers to younger generations.

“So, for instance, I’m old enough [that] I paid Social Security taxes at a lower rate than you for more years for roughly the same benefit (relative to taxes paid). And when the birth rate falls, somebody’s got to pay somehow with more taxes or fewer benefits, and I think that burden should be shared.

“And, on the supply side front, I do think that all these years in retirement (people now retire for 13 years more than they did in 1940) does reduce personal income and government revenues to support those who need support, retirees and non-retirees alike.”

© 2019 RIJ Publishing LLC. All rights reserved.

Alliance for Lifetime Income Sponsors Rolling Stones’ New Tour

Posted on February 7, 2019 by -

Rock and roll will never die; that’s a fact. So how better to tout the financial benefits of life annuities than by associating them with something that will live (and collect payments) forever?

And who better represents the immortality of rock than the British band whose members, no matter how haggard and wasted they may look today, always seem to have one more live concert tour in their bones?

The Alliance for Lifetime Income must have been thinking along these lines when its members—two dozen of the largest life insurers and asset managers, and others—decided, at whatever outrageous cost, to sponsor a Rolling Stones tour in the US this spring.

Yes, it’s true. Deferred annuities with lifetime withdrawal benefits will headline with the world’s longest-running rock band—those laughing bad boys whose lyrics mock death: Painting it black, midnight-rambling, mailing dead flowers to ex-girlfriends, and confessing sympathy for the devil.

The news release was embargoed until 12:01 a.m. today:

The Alliance for Lifetime Income is proud to announce that it is the sole sponsor of the 2019 Rolling Stones “No Filter” Tour. The tour will take place in the U.S. from April to June 2019.

The Rolling Stones are age-defying icons who continue to operate at the cutting edge of entertainment and business. Similarly, the Alliance is at the forefront of financial security education, creating awareness and helping educate Americans about the need for protected lifetime income.

Jean Statler, Executive Director of the Alliance said, “This partnership with the Tour gives us a great opportunity to educate young and old about the need for protected lifetime income and financial security, so that whatever your age, whatever adventure or road you choose, you can keep doing what you love.”

The 16-show “No Filter” Tour will kick off on April 20th at the Hard Rock Stadium in Miami then [move] to Jacksonville, Houston, New Orleans, Glendale, Pasadena, Santa Clara, Seattle, Denver, Washington D.C., Philadelphia, Foxborough, East Rutherford (two shows) and conclude with two shows on June 21st & 25th at Soldier Field in Chicago.

The tour was first announced last fall and reported in Billboard magazine and at Salon.com. “The tour will mark the band’s first extended run of shows in the U.S. since 2015’s “Zip Code” tour, though they played Desert Trip in Indio, California, two Las Vegas arena gigs and two private shows in 2016. In the past two years, they have only toured in Europe. Unlike the marathon tours of the past, they did just 14 shows in 2017 and another 14 [in 2018],” the Salon reporter wrote.

From left: Richards, Jagger, Wood, and Watts.

Two well-informed sources have told me that the Alliance started out last year with a budget of around $50 million, raised from the two dozen member firms. In a press call today, Statler wouldn’t say how much the tour sponsorship cost, but said it was “cheaper than a Super Bowl ad” and an “incredibly efficient” way to reach 1.5 million Rolling Stones fans directly through concert attendance plus another 24 million people through social media chatter.

“Most importantly we’ll have co-branded signage that will highlight the Alliance’s association” with the famous band, she said. “You can’t always get what you want. But that doesn’t mean you have to live with risk in retirement.” She mentioned that the Alliance will have access to concert tickets. I’m guessing that they’ll be offered to distributors.

The Alliance’s goal was to launch a two-year campaign to boost awareness and brighten the image of annuities among the US public, in the spirit of the famous “Got Milk?” campaign of the 1990s.

Last year, the Alliance produced slick network television commercials, spots on National Public Radio and full-page newspaper ads featuring several professional daredevils—a diver who swims with sharks, a woman who drag-races rocket cars, a volcano wrangler—all of whom, despite their acceptance of huge occupational risks, own annuities with living benefits to dampen post-retirement financial risk. There’s also been a national tour where passersby at big events can enter a blue Alliance for Lifetime Income trailer and experience sharks, drag racing and volcanoes through virtual-reality headsets.

An “Alliance for Lifetime Income” banner will presumably hang above the performers during the shows. If so, some people might mistakenly interpret that phrase as the reason why these four septuagenarian musicians are collaborating on another sure-to-be sold-out American tour.

I applaud the effort to teach Americans about the importance of establishing sources of guaranteed income during retirement. Whether they buy an annuity or not, middle-class baby boomers, I believe, can’t afford to enter retirement not knowing what annuities can do for them. But marketing is tricky. I’ll be curious to see if this campaign is too subtle in its avoidance of the word “annuity.”

If the Alliance doesn’t mention annuities by name, can it build enthusiasm for them? The campaign has a fantastic hook, and it may break through the noise. But what’s the explicit call to action? Also, the Alliance members specialize in deferred variable or indexed annuities, which carry lifetime income riders. If advisors present that feature as a secondary characteristic of the product, will the messaging be effective?

For the record: Mick Jagger will turn 76 next July, Charlie Watts will be 78 in June, Ronnie Wood will be 72 in June, and Keith Richards reached 75 last December.

© 2019 RIJ Publishing LLC. All rights reserved.

Trim Tabs notes ‘Powell put’

Posted on January 31, 2019 by -

“The Powell put and lots of dovish central bank chatter seem to have reassured retail investors, who are adding money to U.S. equity mutual funds for the first month in almost four years,” said David Santschi, Director of Liquidity Research at TrimTabs Investment Research.

After pulling record sums from equity mutual funds in December, mom and pop investors have turned into net buyers in January. U.S equity mutual funds and global equity mutual funds lost a combined $89.7 billion in December, the highest monthly outflow on record.

Inflows this month have reached an estimated $7.6 billion, putting this month’s inflow on track to be the highest since February 2016. U.S. equity mutual funds alone have taken in an estimated $3.4 billion in January, set for their first monthly inflow since February 2015.

Flows of equity exchange-traded funds have turned flat to negative this month.  U.S. equity ETFs have shed $14.3 billion, putting them on track for their first monthly outflow since June 2018 and their biggest monthly outflow since at least February 2018.  Global equity ETFs have issued $3.2 billion, set for their lowest monthly inflow since at least October 2018.

© 2019 RIJ Publishing LLC. All rights reserved.

Aging boomers drive flows into fixed income

Posted on January 31, 2019 by -

The January 2019 issue of The Cerulli Edge–U.S. Monthly Product Trends Edition analyzes mutual fund and exchange-traded fund (ETF) product trends as of December 2018. It also includes special coverage on the historical trends of institutional asset management strategies, and those trends that look to continue in 2019.

Highlights from this research:

More than half of the top-10 Morningstar categories by mutual fund and ETF net flows are fixed-income categories, including ultra-short bond ($87.4 billion), intermediate-term bond ($23.6 billion), and muni national intermediate ($16.6 billion).

Particularly in retail client channels, equity market conditions and client demographics can help explain the strong net flows into fixed-income products. Advisors are focused on downside risk protection and they commonly use taxable fixed income (83%) and municipal fixed income (74%) to achieve the objective for clients.

Mutual fund assets dipped 7.1% in December, with total assets closing 2018 at $13.6 trillion, just a few months removed from an August 2018 all-time high of $15.4 trillion. Mutual funds suffered staggering net negative flows of $131.0 billion in December and $156.8 billion during 2018. ETF assets closed 2018 at nearly $3.4 trillion, down roughly 1% from year-end 2017. This marks the first annual decline since 2008. Poor global equity market performance is the main culprit, as investors poured nearly $320 billion in net new flows into ETFs during the year.

Higher long-term rates helped institutions with long-term liabilities, including derisking corporate defined benefit (DB) plans and insurance general accounts. Coincident with higher long rates, U.S. long-duration strategies experienced tens of billions in net inflows (despite negative investment returns in most taxable fixed income during the year). Assuming long-term rates move higher, Cerulli expects continued corporate DB de-risking activity, including more assets devoted to liability-driven investing and equity risk mitigation strategies.

© 2019 Cerulli Associates. Used by permission.

‘Digital design’: A new line of defense against ERISA lawsuits?

Posted on January 31, 2019 by -

Voya Financial and UCLA behavioral finance specialist Shlomo Benartzi have produced a new thought-leadership document that explores the potential influence of “digital design” on a participant’s retirement savings decisions and on his or her welfare in retirement, according to press release this week.

The paper, “The Digital Fiduciary: Overseeing Retirement Plans in the Digital Age,” was written by Benartzi and is being promoted through the Voya Behavioral Finance Institute for Innovation. It suggests that improving participants’ online user experiences could represent a new line of defense against breach-of-fiduciary-duty lawsuits.

“Enhancing the design of an enrollment website can increase the number of workers who personalize their enrollment by 15% and increase overall plan contributions by 10%,” the release said. It cites double or triple default contribution rates, without a reduction in enrollment, after changes in online enrollment experience. The “number of blank lines on a retirement plan website can help shape an employee’s level of diversification,” Voya said.

“In the 20th century, overseeing an employee benefit plan meant having a deep knowledge and expertise of investing and plan design. Now, in the 21st century, retirement security often depends more on fast decisions made on smartphones, and the designs that influence them, than on investment performance,” said Benartzi, in the release.

“By introducing the digital fiduciary concept, our goal is to underscore that if you want to do the right thing for your employees and plan participants — if you want to act prudently on their behalf — then you need to understand how people think and decide in the digital world. It is therefore essential for plan sponsors to add effective digital design to their skill set.”

Voya points out that ERISA (the Employee Retirement Income Security Act of 1974), requires plan fiduciaries to act with diligence “under the circumstances then prevailing.” The paper suggests that leveraging the power of digital design could theoretically help minimize the legal liability associated with providing a retirement plan if it satisfies participants and produces positive retirement outcomes.

The paper suggests these steps for plan sponsors and advisors to consider:

Making the right thing easy:  “Default” options can strongly influence decision-making. In the online world, defaults are used for saving rates and expected retirement ages. Rethinking existing defaults and considering more optimal defaults can be easy and effective.

Testing and retesting: Plan sponsors should select plan providers that routinely test different digital designs. Such testing must be done in a rigorous, reiterative and careful manner for constant improvement.

Establishing a digital policy statement:  Sponsors should consider establishing a statement for digital policies, comparable to an investment policy statement, describing the objectives of a plan provider’s digital designs and the process for measuring and improving those designs.

“Regardless of future fiduciary regulations, history teaches us that a reliable way to avoid potential litigation is to keep the success of plan participants front and center, and to develop processes for determining which digital designs and elements are most relevant for participant success,” said Benartzi.

© 2019 RIJ Publishing LLC. All rights reserved.

Three advisor technology leaders to collaborate on retirement software

Posted on January 31, 2019 by -

Envestnet, PIEtech, and former eMoney CEO Edmond Walters have started Apprise Labs to build software that addresses “estate planning, lifetime cash flow and client retirement needs,” according to a release this week. Walters will lead Apprise.

The software will add detailed short-term cash flow and tax information to Envestnet Logix and MoneyGuide. The add-ons will allow advisors to collaborate with clients through an interactive user interface to plan for their family’s legacy needs, the release said.

Clients using the MoneyGuide platform or the Logix tool will have access to more advanced and interactive estate planning options later in 2019.

“These new capabilities will use visual, interactive technology to help clients manage important financial decisions pertaining to home sales, retirement investments and assets, inheritance gifts, endowment contributions and more,” said Jud Bergman, chairman and CEO of Envestnet, in a statement.

Embedded and integrated add-on features that will be available to users for each platform include:

Estate Planning: Client assets are displayed and broken down in one portfolio dashboard.

Cash Flow: Advisors can compartmentalize cash flow by strategy or focus area, such as retirement savings, inheritance gifts, or endowment contributions.

Content Updates: Information and content strategy from financial experts.

Snapshot: All expenses are tracked and displayed for the advisor.

Advisors at the T3 Advisor Conference this week could see a demonstration of the new software. Additional information about Apprise will be released at the Envestnet Advisor Summit in Austin, Texas from May 1-3, 2019.

© 2019 RIJ Publishing LLC. All rights reserved.

Two Cheers for Population Decline

Posted on January 31, 2019 by -

Since China abolished its one-child policy on January 1, 2016, annual births, after a temporary increase to 17.86 million that year, have actually fallen, from 16.55 million in 2015 to 15.23 million in 2018. The baby boom that wasn’t should surprise no one.

No other successful East Asian economy has ever imposed a one-child policy, but all have fertility rates far below replacement level. Japan’s fertility rate is 1.48 children per woman, South Korea’s is 1.32 and Taiwan’s 1.22. China’s fertility rate will almost certainly remain well below replacement level, even if all restrictions on family size are now removed.

Population decline will inevitably follow. According to the United Nations’ medium projection, East Asia’s total population will fall from 1.64 billion today to 1.2 billion in 2100. Nor is this simply an East Asian phenomenon. Iran’s fertility rate (1.62) is now well below replacement level, and Vietnam’s 1.95 slightly so. Across most of the Americas, from Canada (1.56) to Chile (1.76), rates are already well below two, or falling fast toward it.

The clear pattern is that successful economies have lower fertility rates: Chile’s rate is much lower than Argentina’s (2.27), and wealthier Indian states, such as Maharashtra and Karnataka, already have fertility rates around 1.8. In the poorer states of Uttar Pradesh and Bihar, fertility rates over three are still observed.

We should always be cautious about inferring universal rules of human behavior, but, as Darrel Bricker and John Ibbitson suggest in their recent book Empty Planet: The Shock of Global Population Decline, it seems we can identify one. Since US and Western European fertility rates first fell below two in the 1970s, higher rates (for example, in the US, which averaged just over two between 1990-2010) occur only where first-generation immigrants from poorer countries bring those rates with them.

In all successful economies where women are well educated and free to choose, a below-replacement fertility rate is the average result of diverse individual behavior. Some women (typically around 15-20%) choose to have no children, many choose one or two, and some still more. All their choices should be respected; on average, they will probably tend to result in eventual gradual population decline.

Many people decry this demographic contraction, because it implies that fewer workers will have to support a growing cohort of elderly people. But while very rapid population decline, such as Japan may experience, would be difficult to manage, fertility rates moderately below replacement level (say, 1.8) would not only be manageable, but also beneficial for human welfare.

Pension systems can be made affordable by increasing average retirement ages, which will create incentives for societies to enable healthy aging, with people enjoying good physical and mental health well into what used to be considered old age. Slightly declining workforces, by making labor scarcer, will help offset the adverse impact of automation on real wages and inequality.

Meanwhile, at the global level, the lower the eventual global population, the less severe will be the competition over land use which results from rising demand for food, the need for some bioenergy in a zero-carbon economy, and the desirability of preserving biodiversity and natural beauty.

Eventual gradual population decline, provided it results from free choice, should be welcomed. By contrast, male chauvinist authoritarians such as Russian President Vladimir Putin, Turkish President Recep Tayyip Erdoğan, or Brazilian President Jair Bolsonaro, see population growth as a national imperative, and high fertility as a female duty. And even many non-chauvinist commentators assume that there is something unnatural or unsustainable about population decline, that aging societies must inevitably be less dynamic, and that large-scale immigration is the essential response to demographic decline.

But the exhortations of chauvinist authoritarians will be ineffective as long as women are free to choose. And those who propose immigration as the necessary solution to an overstated problem must face a simple reality: if all people on Earth enjoyed prosperity and free choice, immigration from other planets would not be a feasible response to the global population decline that would likely result.

© 2019 Project-Syndicate.

An FIA Designed By RIAs

Posted on January 31, 2019 by -

With the new “ClearLine” fixed indexed annuity (FIA), Security Benefit Life and DPL Financial Partners have built a product based on what they heard first-hand from the registered investment advisory (RIA) firms that pay an annual administrative fee to be part of DPL’s nearly year-old commission-free insurance sales platform.

The DPL Financial platform is the creation of David Lau, formerly at Jefferson National Life. Security Benefit Life, now privately owned by Eldridge Industries LLC, whose CEO is former Guggenheim partner Todd Boehly, is one of a half-dozen insurers with products on the DPL platform.

Todd Boehly

The partnership represents a wager that, in a pension-less world. retiring boomers will, in growing numbers, begin to demand guaranteed income strategies from their fee-based advisors and that the most agreeable solution for advisors will be no-commission indexed annuities with living benefit riders.

ClearLine was custom-built for “pure” RIAs (those without broker-dealer affiliations or insurance licenses). Most FIA contracts tilt either toward higher growth or to a more generous lifetime income rider. In building ClearLine, Security Benefit used the premium freed up by stripping out the commissions to enhance both aspects of the product.

“We wanted something that would perform better than bonds as people are approaching retirement and de-risking, and to have principal protection for sequence risk, and then to allow people to turn it into income at the right time,” Lau (right) told RIJ this week.

(Despite the absence of a commission, the contract has a seven-year surrender period with a first-year charge of 5%. The surrender period allows the issuer to invest in longer-term bonds.)

The income rider on ClearLine costs only 50 basis points a year—half the usual fee—and can be elected only at issuance. Once income begins, the annual payout is simply a percentage of the account value. The percentages depend on the ages of the policyholders. At age 65, for instance, the annual payout rate is 5% of the account value for men, 4.8% for women and 4.3% for couples.

RIAs asked Lau for cheaper, simpler income riders. Security Benefit responded. “First we heard that ‘the riders are too complex,’ so we eliminated a rollup rate and a benefit base and introduced more competitive payout factors. The second message we heard was about cost. So we purposely lowered the cost of the rider,” Doug Wolff, president of Security Benefit Life, told RIJ in a phone interview.

RIAs wanted to offer clients inflation-protected income, so ClearLine’s payout rates automatically rise by two percent per year. “We heard that living benefits don’t keep pace with inflation and the customer loses purchasing power,” said Al Dal Porto, vice president, product development, at Security Benefit. “So we created the Rising Income Rider [guaranteed lifetime withdrawal benefit]. There’s a guarantee that the income will go up.”

Doug Wolff

RIAs also objected to the tax treatment of income from guaranteed lifetime withdrawal benefits (on non-qualified contracts), so Security Benefit found a solution it calls Income Power.

“The way living benefits are usually taxed, the gains come out first,” Lau said. “In this product, the gains and principal are coming out pro rata. So it’s tax advantaged. There are stipulations regarding how you do it. But, according to private letter rulings, you can treat the income as if the product had been annuitized.” In other words, the “exclusion ratio” can be used. That feature is not available for contracts purchased with IRA money.

Security Benefit Life is one of a limited shelf of insurers on the DPL platform, which includes Allianz Life, AXA, Great American, Great-West, Integrity and TIAA. Lau intends to offer a range of insurance products, including variable universal life and long-term care insurance, is expected to be offered on the platform.

The platform, which competes with the Envestnet Insurance Exchange and the RetireOne insurance platform, is not intended to be a portal to the entire universe of annuities. “We want some depth in each category, but we don’t want to be managing dozens of carrier relationships,” Lau told RIJ. “A limited offering is more compelling to RIAs; they want best-of-breed. We feel free to swap out to get the best.”

Al Dal Porto

Wolff and Dal Porto were asked if RIA advisors with no experience selling annuities would be able to “close” an annuity sale and obtain a client signature—an anxiety-producing process for all concerned. Since there’s no commission involved, there’s also less urgency to complete the process. On the DPL platform, the insurance agent employed by the platform is expected to be partner in that process.

“We assume that the IARs [investment advisor representatives who work at RIAs] are using our solution because they’re better than what the IAR is already using,” said Wolff, suggesting that a product substitution—an FIA for a bond fund, for instance—within the context of a holistic financial plan wouldn’t be as pressure-laden as an isolated sale. As for experience selling insurance, that’s what DPL’s in-house agents will bring to the table. “There’s no question that there’s a sales cycle. But that’s where the DPL insurance counselors come in. They’re independent, and that makes it work.”

FIAs have emerged as the most viable annuity product design, from a business perspective. The design doesn’t demand a lot of insurer capital, because it mainly invests in the insurer’s stable general account. At the same time, it generates enough potential upside—through equity derivatives—to pay for manufacturing, distribution, benefits, guarantees and profits.

On the other hand, FIAs still have a reputation for over-aggressive sales tactics that lingers from a period when only highly incented, lightly monitored, independent insurance agents sold them. RIAs and the advisors who work for them are required to act in their clients’ best interests.

© 2019 RIJ Publishing LLC. All rights reserved.

Ibbotson Taken to Task over Indexed Annuities

Posted on January 31, 2019 by -

If you read the January 28 edition of Advisor Perspectives (AP), you know that Michael Edesess and Bob Huebscher published a kind of takedown of Roger Ibbotson’s year-ago endorsement of fixed indexed annuities. In a March 2018 white paper, Ibbotson portrayed FIA as a generally prudent financial instrument. Historically, he calculated, an FIA would have yielded about half a percent more per year than long-term government bonds (5.8% vs. 5.3%).

This week’s AP response was titled, “A Close Look at Ibbotson’s Research on FIAs.” Edesess, a mathematician, economist and author, and Huebscher, AP’s publisher, make it a bit personal. They “reasonably assume” that Ibbotson, whose Zebra Capital firm does business with Annexus, the FIA design firm, was “financially incented to present a favorable view of FIAs.”

Ibbotson

Edesess and Huebscher proceed to examine a 12-year, two-year point-to-point Athene FIA and conclude that an adept advisor could safely outperform it “by purchasing, every two years, a high-quality two-year corporate bond and a two-year SPY at-the-money call option—a call on the SPDR ETF, which tracks the S&P 500.” No doubt.

FIAs have always attracted controversy. When I first heard of equity-indexed annuities, as they were still called in the early 2000s, they epitomized the “wild west” of the financial world. Bob MacDonald, who helped create that reputation by using irresistible commissions, island vacations and other incentives to fire up independent insurance agents, was still CEO of Allianz Life of North America, the top seller of indexed annuities. MacDonald, an unabashed huckster, wrote a lively book called Cheat to Win (Paradon, 2005).

A favorable environment nourished the growth of then-EIAs. As interest rates bottomed out (under Greenspan) after the dot-com bust, edgy investors were jones-ing for yield, and indexed annuities could offer 100% principal protection and potentially higher gains than certificates of deposit if the S&P 500 Index rose.

Few people understood EIAs, though the basic design is not complicated. Most of the premium goes into the insurer’s general fund and a fraction of it is applied to the purchase of options on an equity index. Data collected by the top EIA analyst at the time, Jack Marrion, suggested that they could return an average of between 3% and 4% a year with no risk of loss.

At that time, before the 2008 financial crisis, indexed annuities were on the cusp of a 10-year odyssey involving not one but two cycles of execration and redemption. The first cycle peaked in 2007 when the EIA industry frustrated an SEC attempt to regulate them as securities. The second cycle peaked when Donald Trump ended the Department of Labor’s crusade to hold variable and indexed annuity transactions to a sales-chilling level of ongoing scrutiny.

The EIA, renamed a “fixed indexed annuity” or FIA after the SEC affair, has by now cemented its grip as the top-selling annuity product. It is sold not just by independent insurance agents but in channels, such as the broker-dealer channel, where it was once shunned. More and more insurers are building them. Champions of the product have been vindicated by rising sales.

The product had achieved enough respectability by early 2018 that the venerable Roger Ibbotson, founder of Ibbotson Associates and emeritus professor of Yale, published his white paper endorsing the concept. As endorsements go, it was not much more emphatic than the American Dental Association’s famous inscription on tubes of Crest toothpaste. But there it was.

Edesess

I won’t comment on Roger Ibbotson’s motives; I wasn’t in his shoes. Regarding the Edesess-Huebscher article, it’s no surprise that they found a securities market solution better than the FIA they selected. (They picked a high-value target: an FIA with an egregious 12-year surrender period. They might have analyzed one of the new no-commission FIAs, or the value of an FIA guaranteed income rider.)

An investment solution will beat an insurance solution every day of the week and twice on Sunday—unless the insurable event occurs. And, in a world of average outcomes, those events never occur. Guarantees are an expense, not an asset (though agents might characterize FIAs as assets).

Personally, I’m not susceptible to the charms of FIAs, which, as far as I can tell, behave with the reassuring predictability of a knuckleball. But I can see how, during periods of low interest rates and market uncertainty, they can be an attractive substitute for CDs, bonds or cash. They can also serve as a hedge against sequence risk for near-retirees, and as a source of guaranteed income. Important from a marketing perspective, FIAs give salesmen the magical “you’re safe either way” mantra that liberates indecisive people to sign irrevocable contracts.

No one should be shocked that insurers build them and distributors sell them. They’re cheaper (in terms of capital) to produce than variable annuities, while gathering similar lump-sum premia. For producers, they require only a state insurance license to sell and they pay handsome commissions. They generate enough profit to attract private equity companies. Have they been mis-sold? That’s why the Bush SEC and Obama DOL went gunning for them.

When we see heated clashes over FIAs, what we’re witnessing, in one sense, is a manifestation of the Mars/Venus conflict between the insurance and investment worldviews. The two are fundamentally different. The tailwind of insurance product sales is fear; greed is the tailwind of investment product sales. Insurers sell guarantees; investment companies sell risk. Insurance has actuaries; investing has quants.

To refine the point, let me share something that an insurance man I know, who sells indexed annuities, told me recently. This adage was significant to him. And he wasn’t the first insurance man to tell me this. Listen closely.

“The best product is the one the client will buy,” he said. Think about that for a moment. The first time I heard it, I didn’t know how to respond. What did it mean? Was it a self-serving tautology? Was it a reference to “liberating indecisive people to act”? I’m not sure. But consider it a litmus test. If you sell investment advice, that motto will probably baffle you. If you sell insurance products, those may be words you live by.

© 2019 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on January 25, 2019 by -

In Georgia, auto-enrollment faces legal challenge

The defined contribution pension situation in Georgia is less than peachy. That’s Georgia, the gorgeously rugged crossroads of Europe and Central Asia; not Georgia, the southern US state that eternally occupies Ray Charles’ mind.

In July 2018, the Georgia parliament passed a law requiring employers and employees to each contribute 2% of pre-tax pay to an investment fund. The government added 2% for those earning less than $9,040 per year and 1% for those earning $9,040 and $22,500.

Following the path of other European countries, the ruling Georgia Dream government wanted to supplement the nation’s $75-a-month universal old-age pension, which was financed from the state budget, with a mandatory, auto-enrolled worksite defined contribution plan with investments in supervised pension funds.

The new system is mandatory for all employees up to age 40 as of August 2018, and voluntary for those older than 60 (men) and 55 (women). Those in between can opt out within five months, but no earlier than three months. Participation is voluntary for the self-employed—more than half of Georgia’s workforce—who pay in 4% of their earnings.

Early challenge

But only weeks after the new pension law took affect at the start of 2019, it has been challenged in court. The Georgian Democracy Initiative (GDI), a human rights organization, claims it violates Articles 11 (Right to Equality) and 19 (Right to Property) of the Georgian Constitution, according to a report at IPE.com.

GDI argued that the system’s mandatory nature interfered with citizens’ property rights. It also challenged the 2% employer levy, which, unlike the employee portion, would not be returned in any way to the contributor. The campaign group also asked the court to rule whether the contributions qualified as a new tax. Under Georgia’s constitution new taxes must be first approved by a referendum.

The new law provides for three types of investment portfolio (high, average and low risk) with participants choosing their own portfolios or defaulting to one of the three depending on their age. Investment limits in both equities and foreign-currency denominated assets range from 20% for low-risk portfolios to 60% for high-risk ones. Prohibited investments include derivatives (except for hedging purposes) and real estate.

External bodies such as the International Monetary Fund have long supported the new system, including the establishment of the Pensions Agency, as a means of stimulating domestic savings and the local currency capital markets.

Dollarization

Georgia’s new system also aims to boost local capital markets and keep money in the country. The auto-enrolment law established a separate legal entity, the Pensions Agency, whose functions include administering the system and providing investment services. Participants can use either the agency or an approved financial company to manage all or part of their pension assets.

Dollarization in the economy, while on the decline, is still high, accounting for significant shares of loans and deposits. In other words, Georgians are exchanging their lari for dollars, a hard currency with universal acceptance, stable value and myriad investment opportunities.

As credit rating agency Moody’s stated last July: “The accumulation of pension assets will complement Georgian authorities’ efforts to tackle the issue of high dollarization in the economy and support a plan to develop domestic capital markets by introducing a demand element for long-term lari [local currency] assets.”

Investors start to sweat over global warming: MSCI

The business and financial implications of global warming are beginning to register on investors, some of whom now incorporate climate considerations into their portfolios, according to a new report from index and analytics provider MSCI.

While investors still hope “some combination of technology and policy forces will limit emissions going forward, such that we can avoid the worst outcomes of climate change,” the risk of this not happening is “working its way into investor thinking in 2019,” the report said.

Investors in less liquid assets, like coastal property, whose valuations are routinely linked to longer time-frames, tend to be most concerned. Real estate, according to MSCI, was “a prime example of an asset class that will inevitably be impacted by climate in the next decade.”

If global emissions peak before 2030 and emissions fall back to today’s levels by 2030, the problem can be managed, MSCI said. If not, the atmosphere’s temperature will have risen by 1.5°C by 2040, the limit above which coastlines would be inundated and drought intensified, triggering poverty and mass migration, according to the Intergovernmental Panel on Climate Change.

This report originated at IPE.com.

© 2019 RIJ Publishing LLC. All rights reserved.

Jackson National launches second fee-based version of Elite Access VA

Posted on January 25, 2019 by -

Jackson National Life Insurance Company, the top seller of variable annuities in the US with more than $8 billion in sales in the first half of 2018, has launched a second version of its fee-based Elite Access Advisory investment-only variable annuity (IOVA) contract, whose first edition launched in early 2017.

Like its predecessor, the new contract, Elite Access Advisory II, is aimed at the fee-based, registered investment advisor (RIA) market. It differs from its immediate predecessor in a couple of ways. Where Elite Access Advisory I offered a three-year surrender fee period and a $10 monthly contract fee, Elite Advisory II offers no surrender period and a $20 monthly contract fee. Advisors can liquidate assets at any time.

The original B-share version of Elite Access, was launched in 2012. It made liquid alternatives—then a sought-after asset class because its performance was uncorrelated with that of stocks and bonds—accessible to the advisor market. Previously, only institutions such as endowment funds had access to such exotica. Jackson marketed the product aggressively—it even hired then-popular actor Ben Stein to promote it in handsome videos—and by 2014 it had zoomed to fifth place in variable annuity sales, with $1 billion in sales per quarter.

Today, sales of that product have cooled to about $500 million per quarter. In a steady bull market, its value proposition is weaker. But with the sudden return of stock market volatility in the last quarter of 2018, the appeal of volatility-buffering liquid alternatives may also return.

The earliest version of Elite Access also pioneered the so-called IOVA (“investment only variable annuities”) category, which distinguished VAs that was used mainly for tax-deferred trading and investing rather than for generating lifetime retirement income.

So far, Elite Access Advisory I does not appear to have broken into Morningstar’s list of the 50 best-selling variable annuity contracts. The new second edition, which has no surrender fee period, might generate more interest among fee-based advisors. The ability to sell its products to fee-based advisors has been and continues to be the number one distribution problem facing the annuity industry.

Jackson National, perhaps because of its acknowledged wholesaling expertise and brand strength, has succeeded in getting some traction in the fee-based space. Its relatively new Perspective Advisory II VA, a no-commission version of the industry’s most popular contract, had sales of $288 million in the first half of 2018. Jackson annuities will be available to RIAs on the new Envestnet Insurance Exchange.

Variable annuities do have a unique advantage, especially for high net worth investors. They remain the only instrument that allows individuals to invest a virtually unlimited of after-tax money for tax-deferred long-term growth as well as for tax-deferred trading. That’s important for those who have already reached maximum contributions to employer-based retirement savings plans and IRAs, and those who want to trade frequently without generating taxable gains.

According to a Jackson National press release this week, Elite Access Advisory II’s key features include:

Product cost: Monthly contract charge of $20 per month ($240 per year). There is no mortality, expense and administration charge, although the underlying investment subaccounts carry annual operating expenses.

No withdrawal charge: There is no surrender period and zero withdrawal charges. All or any portion of the contract may be withdrawn at any time prior to the Income Date. On contracts without a guaranteed minimum withdrawal benefit (GMWB), if the contract value remaining after withdrawal is less than $2,000, any withdrawal will be treated as a total withdrawal and the withdrawal value will be paid and the contract will terminate.

Compensation structure: Advisor compensation is fee-based, rather than commission-based. The contract has no mortality and expense (M&E) risk charges or administrative charges.

Investment freedom: More than 130 investment options are available. Investors may select up to a maximum of 99 investments and adjust options or allocations up to 25 times each contract year without transfer fees. To prevent abusive trading practices, Jackson restricts the frequency of transfers among variable investment options, including trading out of and back into the same subaccount within a 15-day period.

© 2019 RIJ Publishing LLC. All rights reserved.

Holy Annuities! RIJ Goes to Israel

Posted on January 25, 2019 by -

Oy! I can’t fall asleep on airplanes, so I’ve spent most of my first week in the Tel Aviv area jet-lagged and miserable. The symptoms are flu-like: Headache, muscle ache, cough, dehydration and narcolepsy. My Israeli cousin’s two-bedroom apartment, loaned to me for a few weeks, is sufficient except in one way. When I flipped the red wall switch to turn the flash heater on, the circuit breaker blew.

Goodbye hot shower. Goodbye broadband. Fortunately, with the help of a neighbor, I found the electrical panel on the terrazzo landing, restoring precious WIFI. I haven’t retried the hot water switch yet.

I confess to having become a fair weather journalist. If it’s winter in east-central Pennsylvania, then you can bet that RIJ’s virtual offices will be far from there, someplace where the weather is mild and the local retirement financing system promises an interesting case study. Two years ago we relocated to Costa Rica for a month. Last year the destination was Seville, Spain. This year, it’s Israel.

To get sorted quickly in another country, I’ve developed a drill. It begins with a stroll around my new neighborhood. My experience with middle-class neighborhoods in Europe and Asia is that you can readily find small shops or stalls that sell the essentials: Bread, eggs, bottled water, wine, fresh vegetables, laundry and barbering services, and so forth. This busy understory of informal commerce (thriving below the skyline of banks, office buildings and apartments) usually includes small clubs and restaurants as well.

That’s been true of Yehud, the suburb east of Tel Aviv where I’m staying. But the mom-and-pop economy here looks endangered. Yehud is growing fast, with new luxury apartment towers rising amid grimy, laundry-hung apartment blocks from the 1970s and old, terra cotta-roofed stucco cottages from the preceding agricultural period. Underdevelopment is yielding to overdevelopment (i.e., gentrification) in real time. And the population seems relatively young. Children—in daycare centers, in strollers, in pairs walking home from school—are commonly seen and heard.

It’s a mother and child reunion, in Yehud.

But let’s stay on task. Retirement experts who know Israel, including Zvi Bodie, Moshe Milevsky and Meir Statman, have graciously furnished me with the names and email addresses of some of their contacts in academia, government and business here. I was able to find a few more on my own, including Shlomo Benartzi, the UCLA behavioral economist, author and consultant who divides his time between Israel and the US.

Wednesday morning, I reached the first of my contacts. Over Skype (I don’t have local cell service yet) I interviewed Jack Habib, recently retired as the director of research at the National Insurance Institute. Next week, I’ll meet over coffee with Orly Sade, a professor at Hebrew University, who recently wrote about the consequences of mandatory partial annuity purchases at retirement. On Sunday morning, I’ll have breakfast at Café Hillel in Jerusalem with Gil Weinreich, the former Research magazine editor who lives here now and works for seekingalpha.com.

Israel’s retirement policy pivoted in 2008. Workplace defined contribution (DC) plans became mandatory (though compliance is said to be incomplete among small firms). Workers contribute to pre-tax pension funds (which also provide disability and unemployment benefits), or to after-tax “provident funds,” or to a third option, called manager’s insurance (for high earners). Those who save in pension funds must use enough of their savings (since 2008) to buy an annuity paying about $1,200 a month; they can take the balance as a lump sum. That program is only 10 years old, so few people have reached the annuitization stage. I could be wrong on a few of these details–it’s confusing.

In addition to these “occupational schemes,” there’s a basic old age pension, akin to our Social Security. It provides 1,554 shekels ($423) per month for individuals and 2,335 shekels ($635) per month for couples. There are also supplements and adjustments for various situations. As in the US, many retirees, including former government workers and career military personnel, still receive defined benefit pensions from closed or ongoing plans. And there’s personal savings and investment, of course.

Between interviews and deadlines, I hope to visit some of the sites that so many have fought over for so long: Jerusalem, the Dead Sea, Masada, Beer Sheba and the Negev desert in the south, and Haifa, Acre, and the Sea of Galilee in the north. I arrived knowing little more about contemporary Israel than what I’ve seen in the American news media; only gruesome events in the Middle East tend to get coverage. So far, the reality seems busy but peaceful—at least in this middle-class suburb, mid-way between Tel Aviv and the West Bank frontier.

© 2019 RIJ Publishing LLC. All rights reserved.

iShares collect $36.1 billion in December: Morningstar

Posted on January 25, 2019 by -

In December, long-term U.S. funds had their greatest monthly outflows since October 2008 at $83 billion, and inflows for the year were the lowest since 2008. Money market funds saw inflows of $57 billion, for their best year since 2008, according to the Morningstar Direct Asset Flows Commentary for December and the year ending December 31 2018.

But it wasn’t a simple tale of flight-to-safety triggered by fourth-quarter volatility. U.S. equity funds, in fact, showed inflows of $14.1 billion. Investors were moving from active funds to passive ones. Investors pulled a record $143 billion from actively managed funds while moving $60 billion to passive funds.

In other highlights from the report:

  • December outflows spanned asset classes, with U.S. equity funds the only major group showing significant inflows—$14.1 billion despite December’s sell-off. On balance, these inflows went to passive funds. For all of 2018, long-term funds collected $157 billion in inflows, less than half the $350 billion average for 2008-17.
  • December’s outflows mostly came from actively managed funds, with investors pulling a record $143 billion, while passive funds collected nearly $60 billion in inflows. American Funds suffered the most with $8.7 billion in outflows, the fund family’s most since December 2011.
  • Taxable-bond funds had their greatest outflows since June 2013, $43 billion, as investors continued to cut credit risk and seek shelter among high-quality, short-duration vehicles. Intermediate-term bond funds got hit hardest with $17.0 billion in outflows, the Morningstar Category’s worst month since August 2013.
  • International equity, sector equity, allocation, and alternative funds all had their greatest outflows in at least 10 years in December.
  • iShares dominated December flows with a firm-record $36.1 billion, more than triple that of runner-up Vanguard’s $11.4 billion in inflows. Vanguard still came out ahead for 2018 with nearly $161 billion in inflows to iShares’ $136 billion.

© 2019 RIJ Publishing LLC. All rights reserved.

Notable Retirement Research of 2018

Posted on January 25, 2019 by -

Hundreds, maybe thousands, of academic papers in the field of retirement finance are written, presented at conferences, and published in journals every year, and it grieves me to know that I don’t even hear about most of them, let alone get a chance read them. But I try to keep up.

Here are ten of the articles that I read in 2018 that held my attention all the way through. Most of them came from the National Bureau of Economic Research, which sends me links to a fresh batch of its “working papers” twice a month or so. All of them made me look at the world, or at least the financial and retirement worlds, in a new way. I tried to condense them without losing the gist. You’re bound to find at least one or two of them useful.

We Can Build Better Retirement Products, But Will Anyone Buy Them? by Joseph A. Tomlinson.

Tomlinson, an advisor and actuary, proposes three income-enhancing products that retirees need but can’t find today: A bond ladder that would finance a delay of Social Security benefits to age 70; a single premium immediate annuity (SPIA) that offers inflation-protection for 11% less than the current cost; and a SPIA with accelerated benefits for medical expenses.

Social Security delay product

In a hypothetical case, Tomlinson imagines a 66-year-old individual with $750,000 in a 401(k) wants to retire immediately but delay Social Security claiming to age 70, when the benefits will be 32% higher ($31,680 vs. $24,000). To bridge the gap, an investment company could offer a ladder of Treasury Inflation Protected Securities (TIPS) at age 66 that would provide inflation-adjusted income until age 70. Assuming zero yield on TIPS, the TIPS ladder would cost about $127,000 and payout an inflation-adjusted $31,680 each year.

Improved inflation-adjusted SPIA

To support inflation-adjusted SPIAs less expensively, Tomlinson writes, life insurers could combine a non-inflation-adjusted SPIA with swap transactions that would substitute TIPS for regular Treasury bonds. The effect would be to create synthetic inflation-adjusted bonds with the same credit-spreads that insurers achieve on their regular fixed-income investing. Instead of costing $298,000, a $13,320-a-year inflation-adjusted SPIA would cost about $265,000. That’s a price reduction of 11% or $33,000 more liquidity for the retiree.

Life Care Annuity

Borrowing an idea from economist Mark Warshawsky (relias.com), Tomlinson proposes a standard SPIA but would pay an additional pop-up monthly income if the annuitant needed long-term care (that is, lacked two or more activities of daily living or suffering significant cognitive impairment and needed at least 90 days of care). The pop-up income could be set to double or triple the basic SPIA payouts, and the product could be offered with minimal underwriting because of the close correlation between potential LTC need and diminished longevity. “It might well be feasible to build a product that would be competitive with today’s inflation-adjusted SPIA pricing and provide the significant addition of an LTC pop-up benefit,” Tomlinson writes.

The Imbalances of the Bretton Woods System 1965 to 1973: US Inflation, the Elephant in the Room, by Michael Bordo.

Do you remember August 15, 1971? Richard Nixon ended the gold standard that day. Faced with rising inflation, a growing trade deficit, and the costs of the Vietnam War and Great Society social spending, he hoped to avoid raising interest rates and, in turn, avoid a recession.

The maneuver, which ended the Bretton Woods agreement, helped Nixon win reelection in 1972. But the next decade was financially ugly: a weaker dollar, the Arab oil embargo, the bear market of 1974-75, a rising cost-of-living, Volcker’s defibrillating rate shock and the 1982 recession. Who knew it was the prelude to a sensational bull market?

Michael D. Bordo, a noted economic historian, was teaching a class at Rutgers the day Bretton Woods collapsed, and urged his students to mark the calendar. In this paper, he compares and contrasts the situation then and now. Again, a US president is toying with tariffs and blaming foreigners for a trade deficit. Again, the dollar’s privileged status as the global reserve currency is at stake. Goldbugs should read this paper. So should someone in the Oval Office.

The Power of Working Longer, by Gila Bronshtein, Jason Scott, John B. Shoven, and Sita N. Slavov.

“Take this job and shove it.” There was a time when people, especially youngish people not yet resigned to the grindstone, enjoyed saying that. But they are oldish now, and, in many cases, feeling pressure to work far into their 60s, so they can save more, spend less, let their shares appreciate and maximize their Social Security benefits.

But this paper has good news for people who didn’t save enough for retirement. By working only three to six months longer, and claiming Social Security later, a person could boost his or her retirement income by as much as increasing retirement contributions by one percentage point over 30 years of employment.

For a 62-year-old, working until age 70 would increase retirement income by at least 40%, and for some individuals by more than 100%. “Deferring retirement by one year allows for an 8% higher standard of living for a couple and the subsequent survivor. The effect compounds for two, three, and four-year work extensions,” the authors write.

“The results are unequivocal,” they add. “Primary earners of ages 62 to 69 can substantially increase their retirement standard of living by working longer. The longer work can be sustained, the higher the retirement standard of living.” (In this case, standard of living is measured by the amount of purchasing power a same-age couple would have if they converted their savings at age 70 to an inflation-adjusted joint-life single premium immediate annuity.

The act of waiting to claim Social Security, as opposed to saving more in one’s 60s or giving investments a few more years to grow, turns out to the game-changer for the under-saved. Claiming Social Security at 66 instead of 62 increases retirement living standard by about one-third, the paper shows. Claiming at 70 instead of 62 increases the retirement living standard by almost 75%. The greater a person’s reliance on Social Security for retirement income, the greater he or she can benefit from retiring later.

A lower-wage worker needs to work only 2.1 months longer to equal the benefit of 30 years of saving an extra percentage point of income. A higher wage earner has to work 4.4 months longer to get the same benefit.

Any advisor who wants to show clients how much they can benefit from working longer and delaying Social Security will find this paper valuable.

Psychology-based Models of Asset Prices and Trading Volume, by Nicholas C. Barberis.

Every time someone announces the death of active fund management, someone else invokes Mark Twain and says its demise is highly exaggerated. In a new paper about the psychology that helps drive capital asset prices, Nicholas C. Barberis of the Yale School of Management, comes down in favor of active management.

“An active trading for rational investors, one where investors tilt their portfolios toward low price-to-earnings stocks and gently time the stock market to take advantage of return predictability” is the path to better returns, Barberis writes. As the paper unfolds, you realize that he’s making a case for factor-based investing without saying it too explicitly.

Referring to factor-based funds, he writes, “New financial products have appeared that exploit mispricing” by mechanically buying and selling assets with these characteristics, which have “genuine predictive power.” (See below. The plus and minus signs indicate positive or negative predictive power):

  • Past three-year return –
  • Past six-month return +
  • Past one-month return –
  • Earning surprise +
  • Market capitalization –
  • Price-to-fundamentals ratio –
  • Issuance –
  • Systematic volatility –
  • Idiosyncratic volatility –
  • Profitability +

“Factor-based funds may be an attractive addition to a portfolio over and above index funds,” he told RIJ in an email. He refrains from mentioning factor investing in the paper, however, but he recommends them “so long as the fees are low, of course. My understanding is that some of these products do have low fees now – but not all, so some care is needed.”

The paper also describes Barberis’ search for a “unified psychology-based model of investor behavior might take.” He reviews existing literature on behavioral finance and concludes that such a model might combine “extrapolative beliefs” (where expectations about the future are based on past experience) and “gain-loss utility” (the idea that losses hurt more than gains feel good)—a pairing on which little work has been done, he writes.

The Life Expectancy of Older Couples and Surviving Spouses, by Janice Compton and Robert A. Pollak.

When working with retired couples, advisors face longevity uncertainties that are more complex than when they work with single retirees. Past research shows, and you’ve probably heard, that there’s a 25% chance that one member of a couple will reach age 90. For that reason, some advisors plan on a 25-year retirement after age 65.

But how long is a couple likely to live together in retirement before one dies (i.e., their joint life expectancy)? And how long might the survivor live as a widow or widower (i.e., the survivor life expectancy)? These are slippery projections, and the authors of this paper, “The Life Expectancy of Older Couples and Surviving Spouses,” try to get a reasonably firm grip on them.

For couples, analogous measures are the expected years both spouses will be alive (joint life expectancy) and the expected years the surviving spouse will spend as a widow or widower (survivor life expectancy).

In a hypothetical example, the authors consider a wife, 60, whose husband is 62. In 2010, her life expectancy at that age (the national average) was 24.5 years and her husband’s 20.2 years. But according to this paper, the couple’s joint life expectancy is only 17.7 years. And while her life expectancy is only four years longer than his, if he dies first (a 62% probability), she can expect to live 12.5 more years, to age 90, on average. If she dies first (a 38% probability) he can expect to live another 9.5 years, to 89, on average.

“Using individual life expectancies to calculate summary measures for couples yields substantially misleading results because the mortality distribution of husbands and wives overlap substantially,” the authors write.

Advisors can use these figures to show couples when, on average, the lesser of their Social Security payments could end, and how they might offset the shortfall. Discussions about mortality aren’t easy, but they can be empowering. These figures, interestingly, do not substantiate the perception that elderly couples often die in rapid succession. The averages do suggest that couples should plan for five more years of income than single people.

The Pivotal Role of Fairness: Which Consumers Like Annuities? by Suzanne B. Shu, Robert Zeithammer, and John Payne.

If you’re an advisor, you’ve surely encountered new clients who say, though perhaps not in so many words, “I’ll buy almost anything you recommend–except an annuity.” Depending on how you roll, you might either avoid the topic altogether or try to overcome their resistance.

But that begs the question: Why are they so resistant? Or, perhaps more constructively, how might an advisor tell which clients would be receptive to an annuity purchase?

In this paper, retirement researchers at UCLA and Duke find that older Americans who perceive annuities to be “fair,” who are concerned about being a burden to their children, and who are relatively less loss-averse, are the ones most likely to buy them.

“By far the strongest of all the individual differences we measured at predicting liking of annuities is the question of whether the individuals think annuities are ‘fair,’ wrote Suzanne Shu and Robert Zeithammer of UCLA and John Payne of Duke, three long-time contributors to research on the so-called “annuity puzzle.”

“From a positive perspective for marketers of these products… this suggests that the annuity puzzle [i.e., the low demand for longevity insurance among retirees] is more a problem of perception that of the financial tradeoffs inherent in the product,” they wrote.

They said that their research conclusions might be useful “for financial planners hoping to help their customers with [their] decumulation challenges.”

To determine perceptions of fairness, the authors first asked several hundred Americans ages 40 to 65 if they considered annuities “Completely unfair,” “Acceptable” or “Somewhat Unfair.” Then they asked them to indicate if they agreed or not with the following statements.

  • I feel like I understand the life annuity market well.
  • The system behind life annuities should be changed.
  • I would avoid companies that sell life annuities if I could.
  • It is clear where the money for this product comes from.
  • It is fair that the company is allowed to keep the excess funds.
  • I feel that I would have too little control over my retirement money if I bought an annuity.

“Prior research on consumer fairness has suggested that judgments of fairness are affected by the way that profits are shared between the firm and consumer, the intentions of the firm, the firm’s perceived wealth and power, and whether underlying costs are variable or fixed. In this project, our fairness measure was a simple one taken directly from Kahneman, Knetsch, and Thaler (1986),” the paper said.

Receptiveness toward annuities was found to be higher among the relatively less loss-averse and those who had a strong wish to protect their heirs. “Survey respondents… who clearly identify a family member as a potential beneficiary are significantly more likely to select annuities,” the paper said. “This intriguing result could suggest instead that individuals who are worried about becoming a burden on family are more open to the idea of annuities.”

Belief Disagreement and Portfolio Choice, by Maarten Meeuwis, Jonathan A. Parker, Antoinette Schoar, and Duncan I. Simester.

It’s well known that people tend to behave less than rationally with their money. Investor behavior after the election of Donald Trump in November 2016 provided fresh evidence of that to three MIT professors, who carefully studied investing trends in the months after that election.

Republican and Democratic investors alike could have seen, objectively, that the economy was likely to boom under a president who favored lower taxes and fewer regulations, the authors hold. In the year after the election, the Dow Jones Industrial Average grew 28.5%, from an already record-breaking base.

But while Republicans shifted into equities after the election, Democratic investors shifted measurably into bonds. The researchers were perplexed. They clearly didn’t think that the Democrats’ gloominess about Trump’s long-term effect on American democracy and the health of the biosphere would overwhelm their investing acumen.

“Our main finding is that (likely) Republicans increase the exposure of their investments to the US stock market relative to (likely) Democrats following the election. Democrats increase their relative holdings of bonds and cash-like securities,” the authors wrote.

In theory, market participants typically agree about the probability of different states of the world, the researchers wrote. But, in practice, they showed, different people have different “models of the world,” and make investment decisions on that basis.

The study was based on trading activity by individual retirement account holders at an unnamed major financial institution. Their average household income was $101,600 and the median was $78,000. The average investor in the study had $156,500 in investable wealth, of which 81% was in retirement accounts. The researchers did not include the wealthiest or poorest 10% of the population. The sample captured 40% of the US population and 47.3% of retirement wealth.

Swimming with Sharks: Longevity, Volatility and the Value of Risk Pooling, by Moshe Milevsky.

Moshe Milevsky, the well-known annuity expert at York University’s Schulich School of Business, introduces the fictional characters Heather (in glowing health) and Simon (in miserable health) to illustrate the point that people without long life expectancies can still get value from broad-based pensions like Social Security—but not as much from individual retail annuities, which are purchased voluntarily.

Even though healthy people receive more on average from a defined benefit (DB) pension system like Social Security—the healthy obviously live longer and collect benefits longer—shorter-lived people still get an important benefit because their life expectancies are less predictable, statistically speaking. Ironically, this gives them more “longevity risk” than healthy people, whose death rate clearly spikes in the mid-80s.

The message is timely. The US approaches a reckoning over Social Security reform. As policymakers contemplate raising the initial age of eligibility (62) and or the full retirement age (67) to save money, the impact on people with shorter life expectancies will be an issue. Meanwhile, many individual Boomers (of varying life expectancies) have difficulty gauging if retail annuities are a “good deal” or not. This paper can inform discussions of both issues.

Should the government be paying investment fees on $3 trillion of tax-deferred retirement assets? by Mattia Landoni and Stephen P. Zeldes.

A $16 billion annual federal subsidy for the asset management industry is hidden inside our system of incentivizing retirement savings with tax-deferral, according to this paper. That’s roughly the amount of revenue, the authors say, that the fund industry would not be collecting in fees if the US used a Roth-style system where contributions to retirement accounts were taxed up front rather than after age 70½.

“Record keepers, asset managers, and financial advisors charge fees for running retirement plans, managing assets, and advising clients,” write Landoni, of Southern Methodist University, and Zeldes, of Columbia. “These fees are typically charged as a percentage of assets under management (AUM). By deferring tax revenue with a traditional scheme, the government pays investment fees on the substantial amount of assets that sit in retirement accounts waiting to pay future taxes.”

The authors estimate that “substantial amount” at about $3 trillion. “The U.S. government’s implicit account is large,” according to the paper. “We estimate its size as the total amount of tax-deferred assets in DC plans and IRAs ($14.4 trillion) times 20%, a reasonable estimate of the average marginal tax rate in retirement, leading to our title figure of $2.9 trillion of retirement assets.

“We conservatively estimate fees to be about 72 basis points (bps) based on the lowest asset-weighted figures available. We assume that 21% of fees paid by the government are recovered via corporate taxation of the asset managers. Multiplying $2.9 trillion by .72%×(1 – .21), we reach our estimate of $16 billion per year—a cost for the government, and an annual subsidy to the asset management industry.”

How Persistent Low Expected Returns Alter Optimal Life Cycle Saving, Investment and Retirement Behavior, by Vanya Horneff, Raimond Maurer, and Olivia S. Mitchell.

After the 2008 financial crisis, the Fed reduced interest rates to historically low levels. Not long after that, the public’s interest in maximizing Social Security benefits seemed to spike and advisors touted their expertise in Social Security claiming strategies. That was no coincidence, according to the authors of this paper.

“When expected returns are high, the worker can claim early Social Security benefits without needing to withdraw as much from his retirement assets which continue to earn higher returns for a while longer,” write Olivia Mitchell, the director of the Pension Research Council at the Wharton School, and her German co-authors.

“But when the real interest rate is low, a worker can delay claiming Social Security in exchange for higher lifelong benefits, and the cost of taking more from his retirement account to support consumption is lower. …By delaying claiming, people can maximize the actuarial net present value of their lifetime Social Security benefits in times of low returns. But when returns are higher, claiming early maximizes the net present value of benefits.

The incentive to work and save is higher when interest rates are higher, they find. “When the interest rate is low, people work fewer hours per week early in life, compared to workers in the higher interest environment. For example, women work two hours per week less between ages 25-60 than they do in the two percent [real] interest rate scenario. The reason is that, in the higher return scenario, it is more attractive to build up savings early in life as these can grow at the higher rate.

“More work effort then generates higher labor income, and because of the progressive tax system, this results in a larger allocations to the tax-exempt retirement accounts. In addition, returns earned on assets held inside the 401(k) plan are tax-free. This second ©advantage is, of course, smaller in a zero return environment. Accordingly, when interest rates are low (or high), workers devote more (or less) of their savings to non-retirement accounts.”

© 2019 RIJ Publishing LLC. All rights reserved.