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The Economic War-of-Choice on China

Posted on December 20, 2018 by -

The brewing conflict between the United States and China is typical of zero-sum contests among countries, firms, and individuals. The US is acting under the implicit assumption that if China’s GDP were to surpass that of the US in nominal dollar terms, US economic prospects would be reduced by an amount equal to the margin of China’s gain.

The idea that there needs to be a battle over trade or technological dominance at all is very much in keeping with US President Donald Trump’s approach to economic and foreign policy. The recent arrest of Huawei CFO Meng Wanzhou in Canada itself raises the notion that the Trump administration is resorting to increasingly cutthroat methods to get its way.

Yet lost behind the spectacle of high-profile arrests are a few basic economic facts. For starters, one country’s gain is not necessarily another’s loss. Both the US and China could have vibrant tech sectors that benefit from each other’s innovations. Moreover, China’s economy is a key driver of growth in many other countries, including the US. And given that its economy is already larger than America’s in terms of purchasing power parity, the fear that it will surpass the US in terms of nominal GDP – which is not the same thing as wealth – seems rather beside the point.

It is only natural for a dominant power that finds itself in second place to experience self-doubt or a loss of confidence. But the US will just have to get over it, as the rest of the world did when America became the single largest economy. Besides, the two primary factors behind long-term economic growth are the size of a country’s working-age population and its productivity. China has a significantly larger population than the US does, so it stands to reason that it will surpass the US in nominal size at some point (unless it were trapped in a permanent state of poor productivity). The same is true for India.

Another factor that has been overlooked is the Chinese consumer. For many businesses in a given economy, the size of the domestic consumer market is the strongest determinant of potential growth. At the start of this decade, Chinese government statistics showed that domestic consumption accounted for 38% of GDP; by the end of 2017, that figure had risen to 42-43%. In nominal terms, China’s consumer market is now around one-third the size of America’s, which is why iconic US companies like Apple sell so many iPhones there.

Ten years after the global financial crisis, US domestic consumption remains at around 70% of GDP. But it is unlikely that the global and US economies will be able to rely on this source of demand for another decade, which is precisely why the Chinese market’s rapid growth should be welcomed by all – not least Western companies, whose bottom lines will increasingly depend on Chinese consumers. Given its growth potential, the Chinese consumer market will continue to attract US companies and investors, including from Silicon Valley. So far, Chinese regulations do not seem to have discouraged the big US-based tech companies. Even Google, which left China eight years ago, is reportedly developing a censored search engine to meet the Chinese government’s conditions for re-entering the market. Similarly, leading Silicon Valley investors such as Sequoia have been highly active in Chinese venture-capital start-ups for years

Other countries can certainly disagree with China’s approach to domestic governance. But as a sovereign country, China is justified in pursuing the policies that it sees fit, at least until evidence emerges that its own people object to the course it has charted for itself. The widespread adoption of digital applications such as WeChat – a broader Chinese version of WhatsApp – suggests that Chinese consumers are not particularly put off by government controls, and quite enjoy the wealth of new platforms at their fingertips. Moreover, there has been evidence that some US tech companies appear not to have full control of their own platforms. China’s more controlling line on corporate behavior might not suit freewheeling businesses, but may have some social benefits.

As for the Huawei case, if it turned out that the company did indeed violate contractual obligations not to transfer US technology to Iran, then it is only reasonable that there should be consequences. That is true for any exporting business: US secondary sanctions mean that companies and governments everywhere must consider whether their business with Iran is more important than their business with the US.

But the US also needs to think carefully about its own actions. At some point, the dollar’s status as a global means of payment and reserve currency could be challenged. If the US is too aggressive in its enforcement of secondary sanctions, other countries might either develop payment systems of their own or forbid their companies from doing further business with US firms.

Whether China can become the world’s largest economy without also achieving technological dominance is an open question. But it is not one that other countries should be obsessing over at the expense of their own economic growth and long-term stability.

© 2018 Project-Syndicate.

Numbernomics’ Forecast for 2019

Posted on December 20, 2018 by -

Stock market jitters are making investors nervous. We understand why. The expansion is approaching its 10-year anniversary, which makes it geriatric. GDP growth overseas has slowed. Home sales have been shrinking steadily for a year.

However, we believe the stock market’s fears are overblown. For 2019 we expect:

  • GDP growth of 2.8%.
  • Inflation should be steady with the core CPI rising 2.3%.
  • The Fed will boost the funds rate twice in 2019 to 2.75%.
  • The stock market should reach a new record high level.
  • Sustained rapid growth in investment spending will quicken productivity and boost the economy’s speed limit to 2.8% by the end of this decade.
  • This expansion will not end in the foreseeable future.

To forecast GDP growth, we break it down into its major components – consumer spending, investment, trade, and government spending.

Consumer spending

Consumer spending, which is about two-thirds of the GDP, is likely to grow 2.6% in 2019.  While the stock market has fluctuated wildly for two months consumer confidence has been unfazed. Why? Jobs. The economy continues to crank out 190,000 new jobs per month. Job creation generates the income that allows us to spend.

Some economists note that consumer debt has climbed to a record high level. But consumer income has also risen and, as a result, debt in relation to income is near a record low level. Consumers are not saddled with excessive debt. If we were, delinquency rates should have begun to climb. That has not happened.

Bottom line: Look for consumer spending to grow 2.6% in 2019. Remember, consumers account for two-thirds of GDP.

Housing

The housing market has declined steadily throughout the year. While disquieting, we had a similar drop in 2014. Ex-Fed Chair Bernanke said that the Fed planned to slow its purchases of its U.S. Treasury bonds. The markets panicked. Long-term interest rates spiked and home sales got crushed. But eventually reality sank in and sales rebounded. We expected something like that to happen again. Is the recent decline attributable to a drop-off in demand? Or is it a supply constraint? We argue it is primarily the latter.

The National Association of Realtors (NAR) reports that there is currently a 4.3-month supply of homes available for sale and that a six-month supply is necessary for supply and demand to be in balance. Hence, there is a considerable shortage of homes available for sale. Realtors cannot sell what is not for sale. If enough homeowners were to put their houses on the market so that there was six-month supply, sales would be 5.8-6.0 million versus 5.2 million currently. Thus, the problem is largely a supply constraint.

Some economists contend that the combination of rising home prices and higher mortgage rates has made housing unaffordable. That is not true for most potential home buyers. The NAR’s housing affordability index, which includes prices, mortgage rates, and consumer income, has been rising steadily.

This index tells us that consumers have 45% more income than is necessary to purchase a median-priced home. In 2007 that same number was 14%. Housing was expensive at that time. That is not the case today.

On the demand side, the average length of time between listing a home and its sale is 33 days. In 2011 the comparable figure was 95-100 days. Clearly the demand for housing remains robust.

For builders the primary constraint seems to be a labor shortage. They cannot find an adequate supply of workers. That puts a lid on how many homes they can produce. Our sense is that housing will climb about 4.0% next year, but that is not fast enough to alleviate the extensive housing shortage.

Investment

Investment spending is another 15% of the GDP pie. Business confidence is soaring. That is true for manufacturers, non-manufacturing firms, small businesses, and big businesses. Small business confidence is particularly noteworthy since it has reached a 35-year high. Why? The tax cuts. All measures of confidence surged immediately after the November 2016 election. The combination of tax cuts, repatriation of overseas earnings at a favorable tax rate, and the elimination of unnecessary, overlapping, and confusing regulations has buoyed business optimism.

That confidence has stimulated investment spending, which surged in the first quarter of 2017 and continues to this day. While some economists suggest this is a short-term development triggered by the tax cuts, we do not share that view. A reduced tax rate and further deregulation will spur investment spending for years to come.

Also, the 3.7% unemployment rate is the lowest in 50 years. Labor shortages are extensive. If firms cannot hire an adequate number of new workers, they might contemplate spending money on technology to make the company’s existing workers more productive. This will provide further stimulus for investment. Thus, we expect investment spending to grow 6.5% for the next several years.

Trade

Trade has gotten lots of attention recently. All economists support the notion of free trade. All countries benefit. But free trade is not fair trade. Not all countries play by the rules. Some cheat. The primary culprit is China, which does not respect intellectual property rights, steals trade secrets, and forces companies who want to do business in China to share their technology. The object of the trade negotiations is to encourage China to reform.

But Trump initially said he was concerned about the size of the trade deficit and wanted to shrink it. To that end, he imposed steel and aluminum tariffs on our neighbors, friends, and allies as well as China. They retaliated. Suddenly a trade war was underway.

While all countries lose as the result of a trade war, not all countries lose equally. As investors scoured the globe to find which countries might fare best in a trade war, their answer was the U.S. After all, trade only represents about 10% of the U.S. economy, versus about 50% elsewhere.

As a result, money has poured into the U.S. stock and bond markets since January. The dollar has climbed 9%. Tariffs imposed by other countries will reduce growth of U.S. exports, but the flood of money into the U.S. by foreign firms who start new businesses here and hire American workers will limit the damage.

That is not the case for emerging economies. They generally import the raw materials required by their manufacturing sector. But those commodities are all traded in dollars. When the dollar rises, their cost of goods sold increases. It becomes more difficult for them to compete in the global marketplace. As a result, their currencies decline. Their stock markets plunge. Indeed, the emerging markets stock index has fallen 23% since February. Slower GDP growth lies ahead.

In October the IMF lowered its projection of 2019 GDP growth for emerging economies by 0.3%. Growth in China should slip to 6.5% this year, the slowest rate of expansion since 1990. Even slower growth is expected in the years ahead. This slower pace of growth outside U.S. borders – China in particular – is one factor weighing on the U.S. stock market.

As growth prospects dim for these countries and the pain intensifies, there is increasing pressure on their leaders to strike a trade deal with the U.S. Thus far that has happened with Mexico and Canada. A deal with Europe seems close. China, not so much. But if Trump broadens and further raises tariffs on Chinese goods at the end of this year the pressure on both sides will intensify. We believe that by spring the U.S. and China will reach an agreement with both sides claiming victory.

Unfortunately, previously imposed tariffs on U.S. goods by China and other countries will reduce growth in U.S. exports, cause the trade gap to widen, and the trade component will subtract about 0.2% from U.S. GDP growth in 2019.

GDP expectations

When we combine these GDP components, we come up with projected GDP growth for 2019 of 2.8%. Our GDP forecast for the next several years differs from others because we expect rapid investment spending to continue for years, which will boost productivity growth and, eventually, raise our economic speed limit to 2.8%. Most other economists expect investment growth to fade soon and potential growth to remain at 1.8%.

Nobody knows exactly what the economy’s potential growth rate is, but we estimate it by adding the growth rate of the labor force to growth in productivity. If we know how many people are working and how efficient they are, we should be able to estimate how many goods and services they can produce.

In the 1990’s potential growth was believed to be 3.5%, consisting of 1.5% growth in the labor force and 2.0% growth in productivity. The economy grew at that rate for a decade and we concluded that in the good times the economy should grow by at least 3.0%.

But in recent years potential growth rate has slipped to 1.8%. The baby boomers are retiring, and labor force growth has slipped to 0.8%. Productivity growth has faded to 1.0% following a growth spurt triggered by the introduction of the Internet in the mid-1990’s and the cloud and apps in the early 2000’s.

While GDP growth of 1.8% is disappointing, it does not have to remain there forever. But to increase it we need to boost either growth in the labor force or growth in productivity. Labor force growth is unlikely to accelerate because the baby boomers will continue to retire for another decade. Fortunately, productivity growth is determined to a large extent by growth in investment. Our bet is that sustained rapid growth in investment will boost productivity growth from 1.0% in recent years to 2.0%, and the economy’s potential growth rate will climb from 1.8% to 2.8%. That means that the economy can grow at a steady 2.8% pace without triggering an upswing in inflation.

Core inflation

We estimate that the core inflation rate will edge upwards from 2.2% this year to 2.3% in 2019. There are components, like housing, that will put upward pressure on the inflation rate. Rents, which represent about one-third of the entire CPI index are growing by 3.3% which reflects the shortage of rental units.

But there are two factors that have kept inflation in check which are not widely discussed.

First, is the role of technology. Whenever we buy anything, we shop first on Amazon and can find the lowest price anywhere in the world. As a result, goods-producing firms in the U.S. have absolutely no pricing power. In the past year prices of goods have risen 0.2%. Prices of services have risen 2.9%. This means that inflation is virtually non-existent for one-third of the economy.

Second, productivity growth is countering most of the faster growth in wages. Given the tight labor market wage growth has accelerated from 2.0% to 3.0%. Most economists worry that this will cause an upswing in inflation. But they are looking at the wrong thing.

If employers pay their workers 3.0% higher wages because they are 3.0% more productive, they don’t care. They are getting 3.0% more output and have no incentive to raise prices. Workers have earned their fatter paychecks. Thus, we are supposed to look at “unit labor costs” which are labor costs adjusted for the increase in productivity. In the past year unit labor costs have risen 0.9%. The Fed has a 2.0% inflation target. As a result, the seemingly tight labor market is not putting upward pressure on the inflation rate.

Fed policy

If productivity continues to climb, it will help to keep the inflation rate in check.

If in 2019 we end up with 2.8% GDP growth and inflation is relatively steady at 2.3%, the Fed will be cautious about further rate hikes. For years the Fed thought that a “neutral” funds rate was about 3.0%. But recent speeches by Fed governors make it clear that the Fed is rethinking that objective and may lower it to 2.75%. Given that the funds rate currently is 2.2%, that implies only two rate hikes in 2019. The Fed is getting close to where it wants to be.

When will the expansion end? We do not know, but probably not before 2022. We want to see two things to happen before we call for a recession:

  • The funds rate should be at least 5.0%.
  • The yield curve must invert, meaning that short rates are higher than long rates.

We have found that the U.S. economy has never gone into recession until the funds rate has been above the 5.0% mark. If the Fed raises the funds rate to 2.75% by the end of next year and leaves it there, a 5.0% funds rate will not happen for the foreseeable future.

We have also found that when the yield curve (which we define as the difference between the yield on the 10-year note and the funds rate) inverts, a recession follows within a year. Today the 10-year note is 3.0%, the funds rate 2.2%, so the yield curve has a positive slope of 0.8%.

By the end of next year, we expect the funds rate to be 2.75% and the yield on the 10-year note to be 3.4%. The curve will have a positive spread of 0.65%. By the end of 2019 (and for 2020 and 2021), we expect neither of our preconditions for recession to be met.  For this reason, we believe the expansion will continue at least until 2022.

Positive scenario

We have described a very positive scenario. Potential GDP growth rises from 1.8% to 2.8%. Inflation remains steady at 2.3%. The Fed raises rates only twice more and the funds rate peaks at 2.75%. The stock market will climb to a record high level during 2019. But for this to happen, investment spending must continue to grow rapidly, and productivity must sustain a 2.0% pace.

© 2018 Numbernomics.

BlackRock, Microsoft & Retirement: What’s Up?

Posted on December 20, 2018 by -

Microsoft and BlackRock, have formed a partnership “to make it easier for people to both save for retirement and achieve the lifetime income they need through their employers’ workplace savings plan,” according to a press release the two companies issued December 13.

That sounds significant. An global tech firm and an global asset management firm are strategizing to analyze and manage some of the trillions of dollars of Boomer savings that reside in 401(k) funds. The Wall Street Journal first elaborated on the deal.

The two companies didn’t exactly commit themselves to the guaranteed lifetime income business, however. According to a report in Bank Investment Consultant that cited the Journal article,the envisioned Microsoft-BlackRock platform will offer “target-date funds and other investments like annuities.” “Like,” in this case, could easily mean “similar to” rather than “such as.”

BlackRock didn’t seem to announce anything very new. According to the press release the firm “intends to offer the platform” to retirement plan participants “in connection with next generation investment products that it will design and manage.” It would give participants “more regular engagement with their retirement assets so they have a clearer picture of how their contributions today will translate to long-term retirement income.”

BlackRock already is known to do those things. It offers LifePath dynamically managed target date funds to plan sponsors, it offers the “LifePath Spending Tool” that estimates how much a retiree can spend every year, and it offers the CoRI tool. This tool help pre-retirees figure out how much safe income (based on current bond yields rather than annuity payout rates), their savings can produce.

*                        *                        *

The newest news here may be the entry of Microsoft into the retirement space. And the catchiest part may be the Ex Machina sexiness that any mention of artificial intelligence (AI) implies. “Seems like [BlackRock and Microsoft are] hoping to get ahead of the AI curve,” one trade group executive told me.

When I observed that neither BlackRock nor Microsoft are 401(k) recordkeepers, and don’t have direct access to a mountain of big data, the executive said: “There are lots of ways to gather/access big data. The bigger question is what to do with it once you have access, which is where Microsoft comes in.”

The announcement was “short on details, by design,” said a DCIO executive. “This is more about positioning. It’s not about making a big bet. BlackRock has been putting a bet on every chip, but this is not about making a big new bet.” He was referring to BlackRock’s bets on fintech with the purchase of Future Advisor and stake in Acorns, on data analysis with the creation of Aladdin, on institutional investments with LifePath TDFs, and on registered investment advisors with its recent purchase of 5% of Envestnet. BlackRock also has a new deal to integrate its iRetire income support service with eMoneyAdvisor, the Fidelity-owned planning software firm.

“The press release put ‘retirement income’ pretty strong,” he added. “The moral imperative is always hard on income. But I don’t believe this is a reincarnation of SponsorMatch.” That was a reference to an aborted 2007 partnership between MetLife and Barclays Global Investors (purchased by BlackRock for $13.5 billion in June 2009) to offer plan participants an option that combined investments with incremental purchases of future guaranteed income.

Another source was more positive. He told RIJ that BlackRock CEO Larry Fink is serious about partnering with an insurance company on an investment product, such as BlackRock’s target date funds, with a lifetime income benefit and piloting it in the next year or two with a plan sponsor.

BlackRock, according to that version of the story, wants to persuade at least one life insurer that its future in the defined contribution space lies in putting insurance inside a BlackRock investment wrapper, so to speak, where the insurance part isn’t so visible and scary.

“The best way for the insurance industry to be successful is for the asset management industry to see [its products] as another asset class. All of a sudden, you’re no longer on the other side of the fence. The advisor will see [annuities] as a natural component in the portfolio. Then the opportunity for you to grow will be ten-fold. If insurance folks are smart, like the Alliance for Lifetime Income seems to be, they will be the first in line to support the mentality we’re starting to see from BlackRock.”

That might be overestimating both the enthusiasm of the life insurers for the defined contribution space, where Prudential’s IncomeFlex has gotten little penetration, as well as their appetite and capacity for a lot of new equity-linked risk. While the big variable annuity issuers support the Alliance for Lifetime Income’s public relations effort, the variable-annuity-with-lifetime-income-rider business has been shrinking since 2014.

Others are not convinced that BlackRock wants to take on the complexities of retirement risk mitigation. “On first pass, it looks RINO—retirement in name only—a defined contribution savings and investment (for retirement) play, not a process to manage risk exposures in retirement,” said Francois Gadenne, chairman and executive director of the Curve Triangle & Rectangle Institute and a long-time observer of the retirement industry landscape.

“I think BlackRock’s deal with Microsoft is similar to [Ric] Edelman’s deal with Financial Engines as well as Envestnet’s deal with Yodlee. All three cases are efforts to pair a monetization engine with client-data fuel. The next question becomes: Who in the financial industry will do the matching deals with Facebook, Apple, Netflix, Google, etc.?”

An executive acquainted with the challenges of introducing income solutions into the define contribution space told RIJ, “The news release doesn’t say much beyond the fact that Fink and Nadella met and agree that there’s a retirement crisis and that by using investments and technology they might be able to solve for it. But there’s a bunch of tools out there already; the issue isn’t tools but utilization.

“Also, BlackRock doesn’t have a retirement platform, so I don’t know how they can get access to participants. If they want to partner with someone, it would have been better to partner with Intuit, which owns Mint.com. Microsoft got rid of Microsoft Money [in 2009]; if it wanted data it wouldn’t have done that. I’m not sure what the point of the press release was. Maybe just to cause distraction.”

*                        *                        *

BlackRock’s announcement could also be interpreted as a cry for help. The big DCIO [defined contribution investment-only] mutual fund and ETF firms are at risk of being marginalized out of the $27 trillion retirement income space. Their skills are getting automated and their fees are being compressed. In contrast to Vanguard, Fidelity and other full-service plan providers, they are razor blade makers without their own razor.

But, while they fit well into the pre-retirement space, they don’t line up as well against the post-retirement challenge. That’s because the asset managers are by nature risk sellers, and retirees, whether they know it or not, are inherent risk sellers too. They need a counterparty that will buy some of their risk.

The beauty of the asset management business is that the customer owns the risk. (This is not true for asset managers who also invest on their own behalf; that’s another business.) The asset managers can offer retirees products that diversify risks (balanced mutual funds), that carry smaller risks (bonds and bond ladders), that hedge risks (managed-volatility, dynamically-allocated funds), and that charge almost nothing for risk (exchange-traded funds).

But asset managers don’t buy risk. They can’t buy risk; it’s not how they make money. That hinders them in the retirement income space, where millions of mass-affluent retirees arguably need to sell some of their longevity risk. (The asset managers have, it’s true, entered the longevity game via variable annuities with living benefits. But the life insurers themselves have retreated from that game, preferring to wrap income riders around less volatile indexed annuities.)

Life insurers, on the other hand, are longevity risk buyers. They match up well with longevity risk sellers. Instead of upside potential, they offer mortality credits. So far, it’s mainly the mutual companies with career agent forces, like New York Life, that have a big appetite for the risk inherent in plain vanilla income annuities.

That reflects a difference in business models. Publicly held life insurers must sell products with bigger profit margins than conventional income annuities generate. Those same insurers also tend to distribute through third-parties, most of whom don’t earn enough on the sale of life annuities to take a big interest in selling them. But that’s fodder for another day.

In short, retirees need long-term counterparties who buy or share longevity risk. The DCIO asset managers like to date their clients, and even go steady. But they shy away from deep commitments. They’re not the marrying kind. The life insurers are better equipped to form long-term relationships with Boomers. Ironically, they have an even tougher time getting into the defined contribution space than asset managers do.

© 2018 RIJ Publishing LLC. All rights reserved.

New Jersey to establish auto-enrolled IRA for workers without plans

Posted on December 20, 2018 by -

The New Jersey Assembly on Dec. 17 passed a bill that would establish a state-run employment plan for private-sector employees whose employers have not offered a retirement plan in the preceding two years, NAPANet reported this week.

In a 52-24 vote, the Assembly approved A 4134, a bill that would establish the New Jersey Secure Choice Savings Program. A December 10 statement from Assembly Appropriations Committee described the program as “an automatic enrollment payroll deduction Individual Retirement Account for certain private sector employees.”

Like similar initiatives in California and Oregon, New Jersey’s plan requires employers who don’t currently offer a retirement plan to “establish a payroll deposit retirement savings arrangement to allow its employees to participate in the plan.” Employees are auto-enrolled but can opt-out of the plan.

States where Democrats control the legislatures have taken the lead in establishing these plans. Legislators there and in other states hope to address the problem that too many of their states’ workers don’t have access to a retirement savings. Those workers are at risk of under-saving for retirement and relying on public services in their old age.

The private retirement plan industry has been ambivalent about these plans. Some industry members expect mandates to drive employer adoption of private retirement plans. Others resist competition from a “public option” in the retirement plan space. Still others worry that such plans will produce a “patchwork” of retirement plans across the 50 states. But the Trump administration has abolished the Obama Administration’s MyRA national auto-enrolled IRA program.

“Open multiple employer plans,” which are the subject of legislation currently before Congress, are a private-sector alternative to the state plans. Some believe that these open MEPs could shrink the coverage gap that state plans are addressing. At any given time, only about half of U.S. workers have access to a retirement plan at work. Low-income and minority workers are especially likely to work at small firms that don’t offer retirement plans.

The New Jersey plan may offer a variety of to-be-determined investment options, the bill said, but the default investment will be a target-date “lifecycle” fund. Fees can’t exceed 75 basis points per year. Businesses less than two years old and businesses that have employed fewer than 25 people in the past calendar year don’t have to participate in the program but they can.

Further details about the program will be established by a New Jersey Secure Choice Savings Board and the finances of the program will be paid out of a New Jersey Secure Choice Administrative Fund.

The bill established penalties for covered employers who don’t help their employees participate in the program or who mishandle funds. The penalties start with a warning, and include a $100 fine for not enrolling employees who haven’t opted out, and become as severe as $5,000 for employers who collect employee contributions but don’t remit them to the savings fund.

The bill was introduced by Assembly members Roy Freiman (D-Hunterdon, Mercer, Middlesex and Somerset), Raj Mukherji (D-Hudson) and Carol Murphy (D-Burlington). The Assembly Financial Institutions and Insurance Committee reported A4134 favorably on Oct. 15, and the Assembly Appropriations Committee followed suit on Dec. 10.

The Senate version, S. 2891, was introduced on Aug. 27. The Labor Committee of the New Jersey Senate approved the bill on Dec. 3 and referred it to the Senate Budget and Appropriations Committee.

© 2018 RIJ Publishing LLC. All rights reserved.

Prudential surveys ethnic, gender finances

Posted on December 20, 2018 by -

Averages are of little or no use for demographic studies. They show you how many numbers are above or below a halfway line, but they don’t tell you anything about people. They can mask a dramatic situation. They can be used to mislead. Averages are more of a crime than a law.

Medians aren’t ideal for demographic analyses either, but they do take humans into account. They show you how many people are above or below a halfway line. In its new study of incomes of various ethnic and gender groups in the U.S., Prudential Financial uses median figures.

Prudential has just published “The Cut: Exploring Financial Wellness Across Diverse Populations,” a follow-up to its 2018 Financial Wellness Census. Both documents support Prudential’s recent emphasis on financial wellness programs in retirement plans.

All of the major retirement plan providers have jumped on the financial wellness bandwagon as a way to extend, integrate and make stickier their product offerings to plan participants, whose post-employment flow into rollover IRAs they’d like to slow or capture.

In “The Cut,” Prudential offers comparative survey data on six groups: Asian-Americans, Black Americans, Latino Americans, Women, members of the Lesbian-Bisexual Gay-Transgender community (LBGT), and Caregivers (people who are employed but who also provide care for an elderly, ill or disabled person at home). These groups are benchmarked against Prudential’s statistics on “the general population.”

Asian-Americans

While Asian-Americans represented only about one in 20 American in 2015, Prudential’s 2017 survey found that they had the highest median incomes of any ethnic group. The median household income for Asians was about $81,000, or 19% above the median for non-Latino whites.

Foreign-born Asian-Americans were concentrated at the high end of this group, possibly due to “foreign-born Asians skewing older as well as immigration regulations favoring highly-skilled immigrants.” Immigrants from India, the Philippines and Japan had the highest household incomes. Immigrants from Bangladesh, Nepal and Burma had the lowest, according to Pew Research Center data cited by Prudential.

Asian-Americans are the biggest savers, the most likely to send money to relatives overseas and the most likely to act as caregivers. Foreign-born members of this group save or invest 47% of their monthly income in accounts marked for growth or retirement, and are the group most likely to use a workplace retirement savings plan.

For U.S.-born Asians, the percentage was 36%. For the general population, the figure was just 10%. “Asian-Americans spend only about 20% of their monthly income on necessities, while the general population spends 46% on average,” Prudential said.

African-Americans

Despite the palpably high representation of African-Americans in television commercials for financial services and luxury goods, Black Americans, along with Latino Americans, lag behind the general population in savings and preparation for retirement, Prudential’s survey showed. But there was an indication that conditions for Black Americans are changing.

“Nearly half of higher-income black households surveyed [those with incomes above $60,000 a year] are Gen X, for example, while less than one in five are Baby Boomers,” Prudential found. “Among the general population, the reverse is true: Boomers accounted for 42% of higher-income households and Millennials only 24%.”

About 60% of Black Americans have incomes below $50,000, while about 10% have incomes over $100,000, according to charts in The Cut. Those with incomes over $60,000 have an average of about $54,000 saved for retirement compared with an average of $276,400 for the general population that has income over $60,000.

Caregivers

People of color are more likely to be caregivers, Prudential found. While more than 30% of Black, Asian, and Latinos reported providing caregiving services, only 22% of white Americans did. Thirty-eight percent of caregivers said they don’t think they would ever be able to retire, for example, versus only 25% of non-caregivers.

The circumstances of caregivers depended in part on whom they cared for. “Those caring for someone other than a parent, spouse or child are more likely than other caregivers (28% versus about 21%) to have household incomes under $30,000 per year, and are notable exceptions. Those caring for spouses tended to be older and have slightly higher incomes than other caregivers.

Income data for Latino-American and LBGT households was lower than that of the general population, in part because those groups skew younger than the general population and are not as advanced in careers. More than half of LBGT women have children, versus 17% of LBGT men.

“The average annual income for women in our sample was $52,521, compared with $84,006 for men—a difference of 37%,” Prudential said. “Women are earning about 63 cents for every dollar earned by men. Lower incomes mean less money available today for saving and investing, and lower Social Security benefits tomorrow for retirement—a double whammy for women after they leave the workforce.”

© 2018 RIJ Publishing LLC. All rights reserved.

 

Honorable Mention

Posted on December 20, 2018 by -

Fed raises benchmark rate by 25 basis points

The Federal Reserve raised its benchmark interest rate on Wednesday and signaled that it expects additional rate increases next year in a display of measured confidence in the economy that came despite financial market worries and political pressure to suspend rate increases, the New York Times reported.

Jerome H. Powell, the Fed’s chairman, emphasized the continued strength of economic growth at a news conference after the announcement. He acknowledged new strains in recent months, including weaker growth in Europe and China and a downturn in stock prices, and he said the Fed expects slightly slower domestic growth and fewer rate increases next year.

But he defended the Fed’s decision to increase rates. “We think this move was appropriate for what is a very healthy economy,” Mr. Powell said. Mr. Powell’s remarks were described by one analyst as a dose of “tough love” for financial markets.

Mr. Powell insisted on the wisdom of the Fed’s plans to raise borrowing costs while investors dumped their holdings. Stock prices fell when the Fed released its policy statement at 2 p.m., and dropped again as Mr. Powell spoke. The S&P 500 was down 1.5% on the day and is now down 6% on the year.

The decision to raise rates for the fifth consecutive quarter, by a unanimous vote of the Federal Open Market Committee, amounted to a rejection of the view that the Fed should continue to stimulate the economy in the hope of increasing employment and wage gains. The benchmark rate will now sit in a range from 2.25% to 2.5%, abutting the lower end of what Fed officials consider the neutral zone: the region in which rates would neither stimulate nor restrain the economy.

“Policy at this point does not need to be accommodative,” Mr. Powell said of that milestone.

A.M. Best affirms the ‘A’ ratings of AXA Equitable Life

A.M. Best has removed from under review with developing implications and has affirmed the Financial Strength Rating (FSR) of A and the Long-Term Issuer Credit Rating (Long-Term ICR) of “a+” of AXA Equitable Life Insurance Company.

In March 2018, the ratings of AXA Financial, Inc. and its life insurance subsidiaries were placed under review with developing implications following AXA S.A.’s announcement that the group had entered into an agreement to acquire 100% of XL Group Ltd (XL) for a cash consideration of $15.3 billion (EUR 12.4 billion).

In May 2018, AXA S.A. executed a partial IPO of AXA Equitable Holdings, Inc., a new U.S. holding company with and into which the former AXA Financial, Inc. was merged.

AXA S.A. completed this partial IPO of the U.S. operations on September 12, 2018 and made a secondary offering of AXA Equitable Holdings, Inc. common stock in November 2018, allowing A.M. Best to conclude its assessment of the impact of these events.

Regarding AXA Equitable Holdings’ variable annuity business, A.M. Best said:

While AXA Equitable intends to maintain its very strong risk-adjusted capital profile going forward, it remains exposed to equity market pressures on both sides of the balance sheet.

These pressures emanate from its investment in AB and through its variable insurance products with guaranteed benefits, as well as potential volatility in revenue from asset fees as a result of market value changes in its large separate account book of business and derivative activity.

A.M. Best notes that the exposure from VA guarantees is managed effectively through reinsurance and hedging programs. In recent years, AXA Equitable has developed and introduced new and innovative products with the objective of offering a more balanced and diversified product portfolio while reducing product design risk. More recently, the company is looking to expand its product offering with product solutions tailored to the employee benefits marketplace.

According to A.M. Best, the new ratings reflect AXA Equitable’s balance sheet strength, which A.M. Best categorizes as very strong, as well as its strong operating performance, favorable business profile and appropriate enterprise risk management (ERM).

AXA Equitable’s rating affirmations are attributable to its very strong and improved risk-adjusted capitalization, strong financial flexibility, sophisticated risk management practices and its position as a leading variable annuity (VA) and universal life writer and global asset manager.

A.M. Best notes that in advance of AXA Equitable Holdings, Inc.’s partial IPO earlier this year, AXA S.A. made a capital contribution of more than $2 billion to the U.S. operations, resulting in a material improvement in its stand-alone risk-adjusted capital position.

AXA Equitable also benefits from a diversified and productive distribution model, which includes a recently increased ownership stake in AllianceBernstein (AB), a large publicly traded global investment management firm.

Also, AXA Equitable post-IPO continues to maintain an appropriate ERM framework with a focus on hedging strategies to protect its statutory and economic capital.

In anticipation of being a stand-alone U.S. entity, the company has updated its economic capital model to be more U.S.-centric by shifting away from Solvency II framework to a U.S. economic and risk-based capital/contingent tail expectation-centric capital model.

Additionally, asset risk consists of a well-diversified portfolio of invested assets, which are considered to be well managed.

A.M. Best notes that a deviation of methodology applies to the determination of the ratings of the following four subsidiaries of AXA Equitable. These subsidiaries were afforded rating enhancement from AXA Equitable despite the fact that it is not currently the lead rating unit as defined by Best’s Credit Rating Methodology (BCRM).

AXA S.A. (the ultimate parent), which is currently the lead rating unit for the group, has publicly made its intention clear to divest its majority interest in the U.S. operations over the near term, at which point it is A.M. Best’s expectation that AXA Equitable will become the lead rating unit, enabling it to afford rating enhancement to these four subsidiaries as per BCRM:

  • The FSR of A (Excellent) and the Long-Term ICR of “a” have been affirmed and assigned a stable outlook for MONY Life Insurance Company of America (Phoenix, AZ), another subsidiary of AXA Equitable.
  • The FSR of B+ (Good) and the Long-Term ICR of “bbb-” have been affirmed and assigned a stable outlook for AXA Corporate Solutions Life Reinsurance Company (Delaware).
  • The FSR of A (Excellent) and the Long-Term ICR of “a” have been affirmed and a stable outlook assigned for U.S. Financial Life Insurance Company (Cincinnati, OH).
  • The ratings have been removed from under review with developing implications and the FSR has been downgraded to B++ (Good) from A- (Excellent) and the Long-Term ICR downgraded to “bbb” from “a-” and assigned a stable outlook for AXA Equitable Life and Annuity Company (Denver, CO).
DPL Financial’s insurance platform for RIAs to offer no-commission Security Benefit annuity

DPL Financial Partners, the insurance product sales platform for registered investment advisors (RIAs), has agreed to begin offering a four-year version of Security Benefit’s Advanced Choice fixed-rate annuity to RIAs nationwide.

Advanced Choice is Security Benefit’s multi-year guarantee rate annuity (“MYGA”) product and the four-year guarantee period version is being offered commission-free exclusively through DPL, a release by the two companies said.

Security Benefit’s Advanced Choice Annuity can be purchased as an IRA, Roth IRA, 403(b) rollover or non-qualified contract. The product is available now through DPL.

Contaminated baby powder could lead to ERISA suit against Johnson & Johnson

Zamansky LLC, a Manhattan-based law firm specializing in securities and investment fraud, is investigating Johnson & Johnson Inc. for potential violations of the federal Employee Retirement Income Security Act (“ERISA”) related to the recent lawsuit filed against Johnson & Johnson over possible asbestos contamination of its iconic baby powder.

The firm wants to find out if Johnson & Johnson failed in its ERISA-mandated fiduciary duties by continuing to offer J&J stock as an investment option to the participants in the J&J Retirement Savings plan while it knew of liability exposure related to the powder.

On December 14, 2018, Reuters reported that internal Johnson & Johnson documents produced in a lawsuit involving cancer-causing asbestos found in baby powder reflect that company senior officers and lawyers knew for many years about the contaminated talc.

The documents showed that raw talc and finished powders sometimes tested positive for asbestos, and company executives, line managers, scientists, doctors and lawyers fretted over the problem and how to address it while failing to disclose the problem to regulators or the public while discussing it internally. These revelations caused Johnson & Johnson stock to fall by 10% in mid-December.

BNY Mellon to buy back more shares

BNY Mellon has received approval from the Federal Reserve and its board of directors to immediately increase its repurchase program of common stock by up to an additional  $830 million through the second quarter of 2019. These repurchases augment the company’s repurchase of $2.4 billion of common stock previously announced on June 28, 2018.

As of September 30, 2018, BNY Mellon had $34.5 trillion in assets under custody and/or administration, and $1.8 trillion in assets under management. BNY Mellon can act as a single point of contact for clients looking to create, trade, hold, manage, service, distribute or restructure investments. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation (NYSE: BK).

Single retirees need retirement advice: LIMRA SRI

The clichéd images of white-haired couples combing beaches together or canoodling in his-and-hers Adirondack chairs don’t apply to the millions of single retirees, but those soloists need just as much help from advisors as couples do, according to LIMRA Secure Retirement Institute.

There are 7.6 million single pre-retiree and retiree households (aged 55 and over) with assets of $100,000 dollars or more, according to LIMRA SRI. In total, U.S. post-retirees have about $6 trillion in savings. Only 38% of single retiree households work with an advisor.

Single retirees require special attention in retirement planning, a LIMRA release said. As a group, they are measurably less confident than married retirees. Only about two-thirds (64%) are confident that they “can live the lifestyle they want” in retirement, compared with 71% of retirees in couples.

Four in ten single retirees believe their savings won’t last if they live to age 90, but only about one third of married or partnered retirees feel the same way, the release said. Just 57% of single retirees are living the retirement they pictured, compared with almost 70% of married retirees.

© 2018 RIJ Publishing LLC. All rights reserved.

Life/annuity industry upgraded to stable from negative by A.M. Best

Posted on December 13, 2018 by -

A.M. Best has revised its market segment outlook for the U.S. life/annuity (L/A) industry to stable from negative for 2019, citing increased profitability, improved regulatory and tax environments and a strengthening U.S. economy, along with overall reduced balance sheet risk due to a proactive approach taken by companies in recent years.

A series of Best’s Market Segment Reports includes a discussion of A.M. Best’s outlook revision and views on the entire L/A industry, as well as the individual life insurance and annuity segments. Overall, the stable outlook reflects the improved risk-adjusted capitalization and liquidity of L/A industry participants.

Although volatility ratcheted up in the second half of 2018, A.M. Best expects the equity markets and interest rate movements to be net positives for operating performance. Business profiles in general are stronger, as companies continue to focus on core business lines and make use of alternative risk transfer mechanisms to shed risk. Enterprise risk management programs also continue to evolve to further identify and manage current and evolving risks.

The market segment reports outline other factors that are driving the outlook revision, including the following:

Products such as indexed universal life, which offer higher potential crediting rates under favorable equity market conditions, and other protection-based products continue to sell well despite overall flat premium trends in the life insurance segment.

Individual annuity sales increased 11% through third-quarter 2018, following three years of declines. A.M. Best views the impact of the SEC’s proposed “best interest” legislation as likely to be limited given the industry’s progress in preparing for the changes previously proposed under the vacated U.S. Department of Labor’s fiduciary rule.

Lower effective tax rates going forward will improve U.S. L/A insurers’ earnings, albeit partly countered by a decline in deductibility for absolute tax reserves.

Modestly rising interest rates, coupled with a relatively benign credit environment for the coming year, should bolster portfolio returns, which should restore investment spreads to equilibrium as new money yields gradually approach existing portfolio returns.

Insurers continue to take on greater risk in their investment portfolios, through either higher credit risk or lower liquidity, but many have done so by employing a barbell strategy. A.M. Best believes this approach works in a modest economic downturn but could have a greater negative impact on surplus if a more recessionary environment unfolds.

The divide between technologically superior companies and much smaller, less tech-savvy companies is getting wider. However, insurers overall acknowledge their shortcomings with respect to innovation. A.M. Best believes companies that take a measured, methodical approach to identifying where innovation can best help them now and in the future will compete effectively.

© 2018 RIJ Publishing LLC. All rights reserved.

Survey shows how advisors generate income for clients

Posted on December 13, 2018 by -

Over 70% of financial advisors believe it will take a significant correction in the equity markets to wake all investors up to the portfolio benefits of fixed income investing, according to a new survey released today by Incapital LLC, an underwriter and distributor of fixed income securities.

The survey of 200 financial advisors found that investors generate income primarily from dividend-paying stocks and equity income mutual funds.

The average asset allocation among the clients served by the advisors surveyed was:

  • Equities: 46%
  • Fixed income: 27%
  • Cash: 14%
  • Alternatives: 9%
  • Other: 4%

Half of the surveyed advisors expect their clients to increase allocations to fixed income or cash over the next 12 months; 29% expect an increase in equities. Principal protection has become a top priority for their clients, according to 76% of the advisors surveyed.

“With increased volatility in the market, we believe investors will now be far more receptive to assessing some of the potential benefits that are typically associated with fixed income. This is especially true among investors who have taken equity risk for income, and those who now may be focused on principal protection and a fixed and predictable stream of income,” said Paul Mottola, managing director and head of capital markets at Incapital, in a release.

Advisors surveyed seek three top benefits from fixed income investing for clients:

  • A predictable rate of income: 53%
  • Portfolio diversification: 51%
  • Return of principal at maturity: 38%

Eighty percent of advisors surveyed said they were bullish on bond ladders as an aid to managing interest rate risk. The risk of rising rates was the advisors’ top-ranked concern with fixed income investing, followed by finding attractive yields and generating income without adding portfolio risk.

Almost two-thirds (64%) of advisors said that bond ETFs (exchange-traded funds) have changed the definition of fixed income investing away from predictable income and return of principal to fixed income exposure. But bond ETFs do not provide all of the benefits of individual bonds, Mottola said.

“Most bond ETFs provide many important benefits, such as portfolio diversification and market liquidity. However, their income is generally not fixed, and in many cases their interest rate sensitivity remains constant over time, unlike a bond, which declines over time as the maturity date grows closer. This is an important consideration, especially given the risk of rising interest rates,” he said.

Among the investments typically used by advisors to generate income for clients, dividend-paying stocks led the way at 51%. Individual bonds were used 38% of the time.

  • Dividend-paying stocks (51%)
  • Equity income mutual funds (43%)
  • Annuities (43%)
  • Bonds (38%)
  • Bond mutual funds (39%)
  • Bond ETFs (29%)

Asked what would get them to use more individual bonds in their clients’ portfolios, 38% of advisors surveyed said “a rate increase.” They also want:

  • A simplified process to access bonds (32%)
  • Access to better online tools for evaluating bonds (28%)
  • Better education on bond investing (24%)

Almost two-thirds of the advisors surveyed (63%) believe that the bull market in bonds is over, or will be within 12 months.

Q8 Research LLC conducted the online survey for Incapital. A total of 200 financial advisors across channels completed the survey between September 20 and October 1, 2018. Advisors from wire houses, regional dealers, independent dealers, banks and registered investment advisors were surveyed. All respondents had three or more years’ tenure as financial advisors and were involved in portfolio construction decision-making with clients.

© 2018 RIJ Publishing LLC. All rights reserved.

The Newest Retirement Income Fintech

Posted on December 13, 2018 by -

It’s not unusual for male founders of retirement-oriented fintech companies to say that their entrepreneurial inspiration came from watching their pension-less mothers or grandmothers struggle with the complexities of retirement income planning.

Rhian Horgan, a former managing director at J.P. Morgan in New York, told RIJ that she was inspired to start her retirement oriented fintech firm, Kindur, after watching her father struggle with his transition into what, in industry jargon, we sometimes call the decumulation stage.

“My father is 69. He was part of the Boomer generation who delayed their retirements because of the 2008 financial crisis,” said Horgan, who received $9 million in venture funding this week, and plans to open for business in January 2019. When she talked to her father about his finances, she discovered that his problem wasn’t a savings shortfall but a complexity surplus.

Her parents owned about eight different retirement and brokerage accounts, all custodied in different institutions, she said. Her dad kept track of them all in his head. Her mother, silo-ed in traditional domestic affairs, knew little about the couple’s finances.

Rhian Horgan

Horgan, who joined J.P. Morgan in 1999 from William & Mary College, eventually rising to head of alternative investment strategies in the asset management division, looked for applicable solutions but found no online tools that fit. “Most of the talk in the fintech world was about saving—about getting people to retirement,” she told RIJ. “My dad’s problem was happening later in the process.”

So she decided to start her own fintech company, calling it Kindur (with a short i). Over the past two years she assembled a 16-member team not of young coders but of people with experience building asset allocation models or trading exchange-traded funds at firms like Fidelity Investment, Capital One, and J.P. Morgan. Other team members came from Earnest, which refinances student loans, and Seamless, the food delivery app. Kindur’s offices are in Manhattan’s Flatiron district, not far from Betterment, the accumulation-oriented fintech that started about four years ago—an eternity in fintech time.

Kindur, by contrast, is designed for people who are about to retire or have recently retired. It will help them generate steady retirement paychecks from savings of $500,000 to $2 million. About 25% of Boomer households, excluding the wealthiest one percent, have accumulated savings in that range, Horgan said.

A press release this week called Kindur “a new kind of financial services company designed to help baby boomers navigate their complex financial lives. Through straightforward digital advice and its signature retirement paycheck, Kindur makes sense of savings, insurance, social security and healthcare costs so users can focus on enjoying a hard-earned retirement with confidence.”

Kindur is a registered investment advisor with insurance licensing, and the paychecks will come partly from annuity payouts and partly from flexible withdrawals from an investment portfolio. Horgan is withholding details about her life insurance partner and the type of annuity she’ll offer until January. But she described the contract as a fixed annuity—not fixed indexed or fixed income—with an income option that clients can turn on when they want to. It sounds like a guaranteed lifetime withdrawal benefit, but she wouldn’t confirm that.

Clients can get occasional help from a Kindur “coach” but they’ll deal mainly with a self-service, algorithm-driven advice engine. “This is not going to be a customized financial planning service,” Horgan said. “But a coach is there to help answer questions about Social Security, for instance.” Horgan’s research shows that her target market hangs out on Facebook, her research shows, so Kindur plans to use the (increasingly controversial) social media giant to reach it.

As for Kindur’s revenue model, “We don’t generate any revenue from sales of specific investments. Instead, we align our interests with our customers by charging fees on an assets-under-management basis,” Horgan told RIJ. The specific fee levels will be available at launch in 2019, she added. “You can expect to see an offering which allows our customers to save versus their current fund fees and enables them to use these additional savings to keep funding their retirement.”
On December 12, Kindur announced the close of a $9 million Series A round of financing, including investments from Anthemis, Point72 Ventures and Clocktower. Anthemis has made previous investments in Betterment and many highly specialized fintech startups in banking, insurance, payments, and wealth management. Point72 Ventures has investments in, among many other start-ups, the “micro-investing” app Acorns.

A Series A round is typically a company’s first significant round of venture capital financing. The name refers to the class of preferred stocks sold to those investors. It is usually the first series of stock after the common stock and stock options issued to founders, friends, family and angel investors.

© 2018 RIJ Publishing LLC. All rights reserved.

FIA sales will exceed VA sales by end of 2021: Cerulli

Posted on December 13, 2018 by -

Fixed-indexed annuities (FIAs) and structured annuities are expected to see improved sales growth over the next few years, according to new research from Cerulli Associates.

“This finding could create new growth for insurance carriers looking for new opportunities to innovate their product offerings. Today, only 22% of surveyed carriers offer structured products,” a Cerulli release said.

Cerulli projects that FIAs will grow to 40% of total annuity production by 2023, which would put them on track to exceed sales of traditional variable annuities (VAs) by year-end 2021. Insurers continue to develop and enrich FIAs as many believe they offer advantages in almost any market environment: if interest rates rise, insurers can raise crediting rates; if rates are low, clients can focus more on index strategies, knowing they have downside protection.

“Indexed and structured annuities will likely fuel overall annuity industry sales growth over the coming years, although a rebound to the record years of 2007 and 2008 is unlikely to come any time soon,” said Donnie Ethier, director at Cerulli, in the release.

“As already seen to an extent in 2018, rising interest rates will add to the value proposition of traditional fixed annuities and income annuities. Any market downturn would also help FIAs continue to outpace VA sales.”

Total annuity industry sales were down in 2017, as a result of downward pressure from the Department of Labor Conflict of Interest Rule. However, the delayed implementation and subsequent repeal of the rule fueled a sales recovery, specifically for FIAs and VAs. Now insurers need to watch potential state-specific decisions.

“Cerulli forecasts that annuity sales will become more balanced across the major product types over the next five years,” explains Ethier. “Indexed annuity sales are expected to grow steadily and outpace traditional VA sales by 2021.” Ethier said, “Although a few VA carriers have increased the attractiveness of their optional guarantees, Cerulli does not see the sales trend reversing unless a greater number of VAs follow.”

Cerulli’s latest report, “U.S. Annuity Markets 2018: Remaining Well Capitalized and Adaptive,” analyzes the U.S. annuities marketplace, including distribution, product development, and asset management opportunities.

FIA sales, VA assets hit record highs in 3Q2018: IRI

Fixed index annuity sales ($18 billion) and variable annuity assets ($2 trillion) hit record quarterly highs in the third quarter of 2018, according to the Insured Retirement Institute (IRI), Beacon Research and Morningstar, Inc.

“While sales dipped a bit in the third quarter, we believe annuity sales will continue to improve given the reduction in disruption and uncertainty following the demise of the DOL fiduciary rule last spring,” said IRI President and CEO Cathy Weatherford, in a release. “We expect fourth quarter sales to remain strong and continue into 2019.”

For the entire fixed annuity market, there were approximately $17.9 billion in qualified sales and $13.9 billion in non-qualified sales during the 2018 third quarter.

“We expect all fixed annuity product types to continue showing robust growth in 2019 in an investment environment that is likely to be marked by higher interest rates and increased market volatility,” said Beacon Research CEO Jeremy Alexander.

Variable annuity net assets rose in the third quarter as the bull market in equities continued to drive higher valuations in subaccount assets, according to Morningstar. Assets reached $2.0 trillion, up 1.9% from the second quarter and up 2.4% from the year-ago third quarter. Net asset flows in variable annuities were again in negative territory, at -$19.4 billion in the third quarter, but that was an 8.1% improvement over -$21.1 billion in the second quarter of 2018.

Within the variable annuity market, there were $14.9 billion in qualified sales and $8.1 billion in non-qualified sales during the third quarter of 2018. Qualified sales fell 3.7 % from second quarter sales of $15.5 billion, while sales of non-qualified variable annuities were down 5.5 % from second quarter non-qualified sales of $8.6 billion.

“Strong market performance pushed assets under management past [a record] $2 trillion,” said Michael Manetta, Senior Quantitative Analyst at Morningstar. “While we still see weakness in VA sales, levels are recovering from record lows reached last year, and sales should continue to improve in 2019 as rising interest rates have a positive effect on lifetime income benefit features and insurer risk capacity.”

Total annuity sales
  • $54.9 billion. Industry-wide annuity sales in the third quarter of 2018
  • 0% decrease from sales of $56.0 billion during the second quarter of 2018
  • 20% higher versus third quarter of 2017 sales of $45.8 billion
  • $159.3 billion. Year-to-date total annuity sales
  • Up 7.1% from 2017 third quarter year-to-date sales of $148.8 billion
Fixed annuity sales
  • $31.8 billion in 2018 third quarter fixed annuity sales; flat compared to second quarter
  • Up 40.9% from 2017 third quarter sales of $22.6 billion
Variable annuity sales
  • $23.0 billion in 2018 third quarter variable annuity total sales
  • Down 4.4% from 2017 second quarter sales of $24.1 billion
  • 1% higher than 2017 third quarter VA sales of $20.9 billion
Fixed indexed annuity sales
  • $18.0 billion in 2018 third quarter sales, a record
  • 1% increase versus 2018 second quarter sales of $17.6 billion
  • 7% higher versus 2017 third quarter sales of $13.0 billion
  • At $7.0 billion, book value annuities sales were virtually flat in 2018 third quarter
  • 2018 third quarter sales 56.4% higher versus 2017 third quarter sales of $4.4 billion
  • $4.1 billion in market value adjusted (MVA) annuities sales, down 4.3% from 2018 second quarter sales of $4.3 billion
  • Up 53.3% from third quarter 2017 sales of $2.7 billion
Income annuity sales
  • 8% decrease from 2018 second quarter income annuity sales of $2.9 billion
  • 3% higher than 2017 third quarter income annuity sales of $2.5 billion

© 2018 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on December 13, 2018 by -

A.M. Best affirms Ohio National’s A+ rating, despite lawsuits

A.M. Best has left the financial strength rating of A+ (Superior) and the long-term issuer credit ratings of “aa-ˮ of The Ohio National Life Insurance Company and its wholly owned subsidiary, Ohio National Life Assurance Corporation unchanged following a series of recent developments, including litigation initiated by certain distributors related to the company’s recent exit from the annuity market, as well as three notable senior management changes.

The stable outlook of these Credit Ratings (ratings) is also unchanged. Both companies are domiciled in Cincinnati, OH.

In September, the company stopped accepting applications for the purchase of annuity products to focus its resources on its core life insurance and disability income businesses. Subsequently at the end of September, the company announced that it was terminating payments of trail commissions on certain of its variable annuity products.

During this time, three members of senior management left the company, including the recently elected president and chief operating officer.A.M. Best said it has met with the chairman and the current senior management team to discuss these recent events and evaluate any potential impact to the group’s current ratings.

Recent events are not expected to have a meaningful near-term impact on A.M. Best’s view of the credit profile of the Ohio National Life Group, the ratings firm said, adding that it will monitor the impact of those and any future developments and take any necessary actions.

$24 million settlement in BB&T Bank excessive fee case

On November 30, BB&T Bank, the defendant, and participants in its 401(k) plan, the plaintiffs, have reached a $24 million settlement after three years of litigation in the U.S. District Court for the Middle District of North Carolina. Plan participants had accused the bank of charging plan participants excessive fees.

Under the terms of the preliminary settlement, BB&T Corp. will create a $24 million to reimburse plaintiffs, along with non-monetary relief. BB&T admitted no wrongdoing or liability. Law firms Schlichter Bogard & Denton; Nichols Kaster; and Puryear & Lingle represented the plaintiffs.

In the case, Robert Sims, et al v. BB&T Corporation, et al., employees and retirees of BB&T sued for alleged breach of fiduciary duty under the Employee Retirement Income Security Act (ERISA).

In the initial complaint, filed on September 4, 2015 in the Court of Judge Catherine C. Eagles, plaintiffs claimed that BB&T selected and retained in the plan high cost and poor performing investments, incurred unreasonable administrative expenses, engaged in prohibited transactions with both fiduciaries and parties in interest, and failed to monitor and remedy the breaches of other plan fiduciaries.

As a part of the settlement, BB&T agreed to, among other reforms, engage a consulting firm to conduct a request for proposal for investment consulting firms that are unaffiliated with BB&T and an independent consultant to provide consulting services to the plan. BB&T will also conduct a request for proposal for recordkeeping services.

During the two-year period following final approval of the settlement BB&T will rebate to plan participants any 12b-1 fees, sub-transfer agent fees, or other monetary compensation that any mutual fund company pays or extends to the plan’s recordkeeper based on the plan’s investments.

Schlichter Bogard & Denton, has filed over 30 such complaints and secured 14 settlements on behalf of employees since 2006. In 2009, the firm won the first full trial of a 401(k) excessive fee case against ABB. On May 18, 2015, the firm won a 9-0 decision at the U.S. Supreme Court in Tibble v. Edison, the only 401(k) excessive fee case to be argued in the high court.

AIG names new chief financial officer

American International Group has appointed Mark D. Lyons to the role of executive vice president and chief financial officer (CFO). He succeeds Sid Sankaran, who will remain at AIG in an advisory capacity through the year-end reporting process for fiscal year 2018.

Lyons will serve on the AIG Executive Leadership Team and will report directly to Brian Duperreault, President and Chief Executive Officer of AIG. Lyons will remain Chief Actuary, General Insurance, until a successor is named.

Lyons joined AIG in 2018 from Arch Capital Group, Ltd., where he served as executive vice president, CFO and treasurer since 2012. Prior to joining Arch, Mr. Lyons held various positions at Zurich U.S., Berkshire Hathaway and AIG.

Lyons holds a B.S. in mathematics from Elizabethtown College, and completed the Executive Program at the Kellogg School of Management of Northwestern University. He is a Member of the American Academy of Actuaries and is an Associate of the Casualty Actuarial Society.

E*Trade offers online investing tool

E*TRADE Financial Corporation has announced a new educational tool that allows self-directed investors to choose from three exchange-traded fund (ETF) or three mutual fund portfolios, based on the investor’s self-identified risk tolerance, time horizon, and preference for active or passive investing. Highlights include:

  • Three non-proprietary ETF or mutual fund bundles categorized as either conservative, moderate, or aggressive.
  • A selection of commission-free, low-expense-ratio ETFs or no-load, no-transaction-fee mutual funds in each portfolio.
  • Jargon-free descriptions that highlight recognizable company names to make investing quick and easy to understand.

Portfolios can be selected and purchased with a $2,500 minimum for ETF portfolios and a $1,000 minimum for mutual fund portfolios.

Cigna expands its financial wellness program

Cigna, the global health service giant, is expanding the My Secure Advantage (MSA) financial wellness program to group insurance customers effective January 1, 2019. The program includes “money coaching,” identity theft protection and resolution services, and resources for preparing wills and other legal documents, according to a release this week.

The MSA program will now be standard for most Cigna Group Insurance customers with life, accident, disability, accidental injury, critical illness and hospital care insurance policies. At no additional cost, group customers and household members can use these services:

  • Thirty days of money coaching from an experienced financial professional with the option to continue the relationship on a self-pay basis.
  • Online tools and educational webinars to assist with financial planning.
  • Resources and templates to create and execute state-specific wills, powers of attorney and a variety of other important legal documents.
  • A 30-minute complimentary legal consultation with a licensed practicing attorney, and discounted attorney fees if additional time is desired.
  • Discounts on tax planning and preparation services.
  • Identity theft services including consultation with a fraud resolution professional.

The MSA program is made available through Cigna’s relationship with CLC Inc., a provider of legal and financial programs with a national network of more than 20,000 attorneys, mediators and financial professionals. CLC, Inc. is solely responsible for their products and services.

The program is not insurance and does not provide reimbursement for financial losses. The program is not currently available under policies insured by Cigna Life Insurance Company of New York.

Reinsurance deal with Athene will fund Lincoln share repurchases

Lincoln Financial Group has agreed with a subsidiary of Athene Holding Ltd. to reinsure approximately $7.7 billion of Lincoln Financial’s in-force fixed and fixed indexed annuity products, according to a news release this week.

The transaction was dated December 7, 2018 and is effective as of October 1, 2018. The agreement is structured as a modified coinsurance treaty with counterparty protections around investment guidelines and overcollateralization established to meet Lincoln Financial’s risk management objectives.

Lincoln will use most of the capital released from the transaction, including a ceding commission paid by Athene, to buy back $500 million worth of shares through an accelerated share repurchase program. The transaction is expected to be accretive to Lincoln Financial’s earnings per share in 2019.

Lincoln Financial will retain account administration and recordkeeping of the annuity policies. The transaction will not affect Lincoln Financial’s relationships or commitments to distribution partners and policyholders.

Goldman Sachs & Co. LLC acted as financial advisor to Lincoln Financial.

Empower finds appetite for open multiple employer plans

Sixty-six percent of small business owners who do not offer a retirement plan today are likely to consider an open Multiple Employer Plan (MEP), according to a new survey from Empower Retirement.

Open MEPs are defined contribution plans created by a plan service provider and offered to more than one unrelated employer. Two separate proposals, one in the U.S. House and one in the Senate, would broaden the scope of open MEPs by allowing service providers to offer multiple employers to join a single plan.

Almost all of the business owners who expressed interest in open MEPs said the biggest advantage in offering their employees a retirement plan is “it’s the right thing to do.” Additionally, 59% of employers interested in open MEPs said other advantages to offering retirement plans would be employee retention and attracting talent.

However, among the top reasons why small businesses don’t offer a retirement plan to employees is because their company is too small, survey respondents said.

Empower’s survey also reveals that 50% of small businesses associate open MEPs as coming with help from financial professionals.

A new paper by the Empower Institute “Open MEPs: A promising way to narrow the coverage gap” lays out more details from the survey.

Under the legislative proposals, open MEPs would allow unaffiliated small employers without the ability to administer their own plans to enroll their employees into professionally managed workplace plans that offer the economies of scale found in the plans large companies offer.

The impact of plan access on projected income replacement at retirement is significant. Participants who are eligible for a defined contribution plan and actively contribute have a median income replacement percentage of 79% compared to 45% for those without access.

At small businesses in the U.S. with fewer than 100 employees, less than half of workers have access to a defined contribution retirement plan, such as a 401(k). But according to the Empower survey,1 employees are interested in workplace retirement savings plans. Among the small businesses where owners are interested in open MEPs, 39% said employees expressed interest in having a workplace retirement plan.

© 2018 RIJ Publishing LLC. All rights reserved.

Send Pensioners Back to Work?

Posted on December 13, 2018 by -

In most developed countries, a retirement of leisure is one of the great socioeconomic innovations of the past century. But it is quickly becoming a luxury that few countries can afford, particularly in Europe. The retirees enjoying a second youth may not want to hear it, but it is past time that governments made public pensions partly conditional on community work.

Overly generous pension benefits are destabilizing public finances, compromising the intergenerational social contract, and fueling support for far-right populist movements. Across Europe, potential debt obligations due to unfunded pensions range from 90-360% of GDP. In Italy, some retirees receive pensions that are 2-3 times higher than their working-age contributions would entail. And across the European Union, the median income of people over 63 is almost as high as the median income earned by active workers.

Moreover, as a result of early-retirement policies, around 30 million pensioners across the EU are under 65 years old, which is to say that about 25% of all European retirees are not old at all. Making matters worse, the official retirement age has not been adjusted to account for longer life spans. When German Chancellor Otto von Bismarck introduced the world’s first public pension system in 1870, the eligibility age was 70 and the average life expectancy was 45. Today, the average European retires at 65 and lives until he or she is at least 80.

The standard way to fix this problem is to raise the retirement age or cut pension benefits. But each of these measures comes at a cost. The longer that older workers remain in the labor force, the more exposed they are to technological unemployment. From an employer’s perspective, older workers simply do not have the skills to compete with fresh graduates or younger colleagues. Greece’s experience during the euro crisis showed that cutting benefits can force retirees to reduce their consumption, causing recessionary pressures.

Lastly, the purely technocratic approach is a recipe for pushing older voters into the arms of populists. After appealing to retirees in the election earlier this year, Italy’s populist governing coalition is now trying to dismantle a technocratic pension-reform package that former Prime Minister Mario Monti pushed through in 2011. If they succeed, they will have undermined the stability of the system, all but ensuring that pensioners collect fewer benefits in the future.

A policy of mandatory active retirement would avoid some of the pitfalls of the standard approach. Although most seniors are ill-suited for today’s fast-changing labor market, they still have the skills, wisdom, and experience to contribute to society. As such, governments should start treating them as a segment of the workforce, rather than as a burden on public spending and economic growth.

With able-bodied retirees “working” for a pension, consumption patterns among the elderly need not decline, and governments would have more fiscal space to support the most vulnerable. Better yet, society as a whole would benefit from older citizens’ more active day-to-day engagement.

Contributions from the elderly could take many forms. As a first step, governments should survey pensioners to determine their competencies and the kind of community work they would like to perform. The focus should be on filling roles in education, social services, and health care that would otherwise require hiring public sector employees. Whatever is paid out in pensions would be at least partly offset by reduced public-sector wage costs. Alternatively, pensioners could serve as labor market reservists whom the government could call upon when the need arises.

Needless to say, the active-retirement condition would apply only to those who are physically and mentally fit to contribute, and the commitment to work would decline with age. At the same time, governments could impose financial penalties on those who refuse to contribute—particularly those who do not even remotely qualify as “elderly.”

Pensioners would instinctively resist any such reform, arguing that they earned their benefits in full, and that they already provide unpaid services such as child care within the home. In 2012, when Lord Bichard, a former head of the British Benefits Agency, suggested that retirees could make a “useful contribution to civil society,” pensioners-rights campaigners reacted angrily.

But community work would have benefits for pensioners, too. Studies show that idle retirement leads to a sharp decline in one’s cognitive skills, whereas a policy of active retirement would encourage older people to pursue fulfilling new challenges.

At the end of the day, conditioning retirement benefits on work represents a fair compromise between the self-defeating technocratic approach and the unsustainable populist approach. Asking governments to cut pensions at a time of rising job insecurity is a political nonstarter, whereas continuously promising more benefits is financially suicidal.

Enlightened politicians should appeal to older voters’ sense of fairness. Younger generations are being asked to contribute to a system that will pay out ever-smaller returns over time. If younger workers are to remain committed to the current system, they will need to see a display of reciprocity from their elders.

Idle retirement is a remarkable socioeconomic experiment that has been rendered unsustainable by current economic and demographic trends. It is time to put it out to pasture and try something new.

© 2018 RIJ Publishing LLC. All rights reserved.

Steve Vernon’s Guide to Retirement Success

Posted on December 13, 2018 by -

Steve Vernon, the Boomer, actuary, research scholar at the Stanford Center on Longevity, and co-author with the esteemed Wade Pfau and Joe Tomlinson of a 2017 Society of Actuaries paper called “Optimizing Retirement Income,” has published a new book for consumers about retirement income planning.

Called Retirement Game-Changers (Rest-of-Life Communications, 2018), the book promises to show near-retirees how to “generate recession-proof retirement income” for life, “enhance your health and longevity,” “protect yourself against ruinous medical and long-term care costs,” and “lead a fulfilling and socially connected life.”

That’s a big promise—the kind that perhaps only a sun-soaked Californian like Vernon can confidently make—but one that a host of well-known reviewers, including Christine Benz of Morningstar, Boomer zeitgeist guru Ken Dychtwald, and a host of newspaper columnists, say that Vernon delivers.

We’ll focus here on Vernon’s advice about retirement income generation. Consistent with his previous writing, Vernon recommends the purchase of single-premium immediate annuities (SPIAs) for people who have a gap between other safe income sources they may have—such as Social Security and pensions—and their minimum monthly spending needs.

Vernon doesn’t dive into any specifics about how SPIAs work; he doesn’t mention mortality credits, for instance. (I like to explain the SPIA concept by saying that it can let retirees safely spend up to 50% more per month in retirement than they can with the 4% “safe withdrawal” rule, given the same nest egg.) But Vernon already wrote a book that goes into more detail on annuities. It’s called Money for Life: Turn Your IRA and 401(k) or IRA in a Lifetime Retirement Paycheck.

The core of Vernon’s philosophy is captured in what he calls the “Spend Safely in Retirement Strategy,” which is distilled from a research project at the Stanford Center on Longevity and the Society of Actuaries. Its component steps include:

  • Delaying Social Security benefits (until age 70, if possible)
  • Creating a bucket of stable, liquid investments when you’re within five years of retirement (to protect against sequence risk or finance the Social Security delay)
  • Using investments as a Retirement Income Generator (spending required minimum distributions from qualified accounts, for instance)
  • Developing a cash side-fund for emergencies.

Vernon devotes considerable attention to reverse mortgages, which can provide annuity-like income later in life or can be used to set up a line of credit for emergency cash during retirement or for assisted living or nursing home expenses. The reputation of the reverse mortgage industry has been tainted by the dominance of sales by late-night infomercial hucksters, but the fact that so much Boomer net worth resides in home equity makes it virtually inevitable that these products will see greater use in the future.

Besides advice about generating retirement income, Vernon’s book contains lots of useful information about health, health care and health insurance. Vernon seems to favor Medigap insurance over those tempting zero-monthly payment Medicare Advantage plans—a sentiment that I share.

This is not a book for financial advisors, per se. If anything, it urges readers interested in annuities to turn to direct providers like Income Solutions, Immediateannuities.com, Fidelity, Vanguard, and Schwab. But I could easily see a fee-only advisor (members of the National Association of Personal Financial Advisors) giving this book to new middle-class (or “mass affluent”) clients as a way to save time.

This book is written by an expert from a consumer’s perspective; it focuses on minimizing investment expenses and maximizing freedom from anxiety about money. Vernon is one of the many career financial specialists whose professional and personal interests in retirement planning merged as they approached retirement, and who feel inspired to share what they’ve learned with fellow retirees and near-retirees.

© 2018 RIJ Publishing LLC. All rights reserved.

Allianz Life to nurture tech startups

Posted on December 6, 2018 by -

Allianz Life Ventures, part of Allianz Life Insurance Company of North America, has announced a multi-year strategic partnership with SixThirty, a St. Louis-based venture fund that specializes in investing in and scaling up fintech and insurtech startups.

Allianz Life Ventures will “mentor SixThirty portfolio companies, build networking opportunities and help startups with strategic planning,” according to a news release this week. The startups will “leverage Allianz Life Venture’s expertise, financial resources and global network of partners.”

Brian Muench, vice president of investment management at Allianz Life, will join the organization’s investment committee, which evaluates the investment pipeline and selects startups that SixThirty invests in. To date, SixThirty has invested in 44 startups.

Started in 2013, SixThirty invests in eight to 12 early-stage startups each year from around the world. In addition to receiving funding, the selected companies also participate in the SixThirty go-to-market program that offers mentorship, collaboration and networking with some of the leading incumbents in the financial services industry.

© 2018 RIJ Publishing LLC. All rights reserved.

Latinos fall behind in saving even as their numbers surge ahead

Posted on December 6, 2018 by -

Only 31% of all working age Latinos participate in employer-sponsored workplace retirement plans, resulting in a median retirement account balance equal to zero, according to the National Institute of Retirement Security and UnidosUS.

“Most Americans are far off-track when it comes to preparing for retirement, and this report offers an even grimmer outlook for Latinos. The retirement divide can begin to close if more Latinos have access to retirement plans and are eligible to participate,” said Diane Oakley, NIRS executive director.

“State-sponsored retirement plans that are taking hold across the nation also can play a big role in improving the retirement outlook for Latinos. Such plans target working Americans who lack access to employer-sponsored retirement plans, and less than half of Latino employees in the private sector have access to such plans,” Oakley added.

The research finds that:

  • Access and eligibility to an employer-sponsored retirement remains the largest hurdle to Latino retirement security.
  • The retirement plan participation rate for Latino workers (30.9%) is about 22 percentage points lower than participation rate of White workers (53%).
  • When a Latino has access and is eligible to participate in a plan, they show slightly higher take-up rates when compared to others races and ethnicities.

For working Latinos who are saving, their average savings in a retirement account is less than one-third of the average retirement savings of white workers. Overall, less than one percent of Latinos have retirement accounts equal to or greater than their annual income.

The report indicates that policy options that would greatly benefit Latinos are as follows:

Expand Plan Eligibility for Part-Time Workers. Given that top reason that Latinos did not have retirement savings was that they worked part-time. Allowing part-time workers the ability to participate in employer-sponsored retirement plans would greatly increase the number of Latinos that could save in a retirement plan.

Promote the Saver’s Credit. The Saver’s Credit is a non-refundable income tax credit for taxpayers with adjusted gross incomes of less than $31,500 for single filers and $63,000 for joint filers. Given that the median household income for Latinos was $46,882 in 2016, a large number of Latino households would qualify for the Federal Saver’s credit if they saved for retirement. By further promoting the credit, many more Latino households could be rewarded for saving for retirement.

Promote and Further Develop State Retirement Savings Plans. In 2014, an estimated 103 million Americans between 21 and 64 did not have access to an employer-sponsored retirement account. In response to this gap, a number of states have enacted state-sponsored retirement savings programs that automatically enroll individuals into a plan if they are not covered by an employer-sponsored plan. For Latinos, these plans are especially important. State retirement savings plan can assist with providing low-cost retirement products to working Latinos who are not covered by a workplace retirement plan, helping to alleviate the current retirement savings crisis that Latinos face.

Latinos lead population growth in United States, accounting for 17.8% of the total U.S. population and numbering over 57.5%. As the largest minority group in the U.S workforce, Latinos comprised 16.8% of the labor force in 2016.

The U.S. Census Bureau estimates that by 2060, the Latino population will number 119 million and will account for approximately 28.6% of the nation’s population. The U.S. Administration on Aging predicts the Latino population that is age 65 and older will number 21.5 million and will comprise 21.55% of the population by 2060.

This report updates and expands upon a 2013 report, Race and Retirement Insecurity in the United States, and is based on an analysis of the 2014 Survey of Income and Program Participation (SIPP) Social Security Administration (SSA) Supplement data from the U.S. Census Bureau. The report examines the disparities in retirement readiness between working Latinos aged 21 to 64 and other racial and ethnic groups.

© 2018 RIJ Publishing LLC. All rights reserved.

How to Save Social Security Systems

Posted on December 6, 2018 by -

Every society faces the difficult task of providing support for older people who are no longer working. In an earlier era, retirees lived with their adult children, providing childcare and helping around the house. But those days are largely gone. Retirees and their adult children alike prefer living independently.
In a rational economic world, individuals would save during their working years, accumulating enough to purchase an annuity that finances a comfortable standard of living when they retire. But that is not what most people do, either because of their shortsightedness or because of the incentives created by the government social security programs.

European governments since Otto von Bismarck and US governments since Franklin Roosevelt have therefore maintained pay-as-you-go (PAYG) retirement pension systems. More recently, Japan has adopted such a system.

But providing benefits to support a comfortable standard of living for retirees with just a modest rate of tax on the working population depends on there being a small number of pensioners relative to the number of taxpayers. That was true in these programs’ early years, but maintaining benefit levels became more difficult as more workers lived long enough to retire and longer after retirement, which increased the ratio of retirees to the taxpaying population.

Life expectancy [at birth] in the United States, for example, has increased from 63 years in 1940, when the US Social Security program began, to 78 years in 2017. In 1960, there were five workers per retiree; today, there are only three. Looking ahead, the Social Security Administration’s actuaries forecast that the number of workers per retiree will decline to two by 2030. That implies that the tax rate needed to achieve the current benefit structure would have to rise from 12% today to 18% in 2030. Other major countries face a similar problem.

If it is not politically possible to raise the tax rate to support future retirees with the current structure of benefits, there are only two options to avoid a collapse of the entire system. One option is to slow the future growth of benefits so that they can be financed without a substantial tax increase. The other is to shift from a pure PAYG system to a mixed system that supplements fixed benefits with returns from financial investments.

A US example shows how slowing the growth of benefits might work in a politically acceptable way. In 1983, the age at which one became eligible to receive full Social Security benefits was raised from 65 to 67. This effective benefit reduction was politically possible because the change began only after a substantial delay and has since been phased in over several decades. Moreover, individuals are still eligible to receive benefits as early as age 62 with an actuarial adjustment.

Since that change was enacted, the life expectancy of someone in their mid-sixties has increased by about three years, continuing a pattern of one-year-per-decade increases in longevity for someone of that age. Some economists, including me, now advocate raising the age for full benefits by another three years, to 70, and then indexing the future age for full benefits to keep the life expectancy of beneficiaries unchanged.

Consider the second option: combining the PAYG system with financial investments. Pension systems operated by private companies achieve benefits at a lower cost by investing in portfolios of stocks and bonds. A typical US private pension has 60% of its assets in equities and the remaining 40% in high quality bonds, providing a real (inflation-adjusted) rate of return of about 5.5% over long periods of time. In contrast, taxes collected for a PAYG system produce a real rate of return of about 2% without investing in financial assets, because real wages and the number of taxpayers rise.

It would be possible to replace the existing PAYG systems gradually with a pure investment-based system that produces the same expected level of benefits with a much lower tax rate. Unfortunately, the benefits produced by that contribution rate would entail significant risk that the benefits would be substantially below the expected level.

Research that I and others have conducted shows that a mixed system that combines the existing PAYG system with a small investment-based component can achieve a higher expected level of benefits with little risk of lower benefit levels.

The current structure of pension systems in most developed countries cannot be sustained without cutting benefit levels substantially or introducing much higher taxes. A shift to a mixed system that combines the stability of the PAYG benefits with the higher return of market-based investments would permit countries to avoid that choice altogether.

© 2018 Project-Syndicate.