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‘Growth Traps’ Outnumber ‘Value Traps’: GMO

Posted on May 26, 2022 by -

What do Netflix, Peloton Interactive, Coinbase, and Palantir Technologies have in common? I admit it isn’t a particularly challenging question. As anyone who has been following the US stock market in the last 10 months knows all too well, they are all US large cap growth stocks that have lost more than 50% of their value from their 2021 highs, actually well more than 50%.

[Note: This guest column is a condensed version of a longer article, available at the GMO site.]

 But I’d like to point out that they have something else in common that should be more broadly concerning for investors. They are all growth traps. Growth traps are a subset of the growth universe and get much less attention than their cousins, value traps, despite my attempt to call attention to them in the 2Q 2021 GMO Quarterly Letter, “Dispelling Myths in the Value vs. Growth Debate.” 

That is a shame, because investors would be well advised to recognize the damage growth traps can do to their portfolios. I’d like to offer a quick refresher on growth traps, why they are so painful, and why I believe they are probably going to continue to snap shut painfully on investors’ portfolios for some time yet to come. 

My Quarterly Letter last summer defined a trap as a company in either the value or growth universe that both disappointed on revenues in the last 12 months and saw its future revenue forecast decline as well. When it occurs to a stock in the value universe, it is a value trap. 

Investors seem to believe value traps teem in the portfolios of value managers and that those value traps cause massive damage to those portfolios when they appear. While I would love to tell you that the investors are dead wrong on those presumptions, sadly, they are pretty close to spot on. In a typical year, about 30% of stocks in the MSCI US Value index turn out to be value traps, and they underperform that index by 9% on average.

But what seems to be somewhat less well known is that growth traps are both more common and more painful than their value brethren, with a prevalence of about 37% of the MSCI US Growth index and an underperformance of 13% on average. 

The fact that growth traps are more painful than value traps is, in one sense, not really a surprise. Value stocks are already companies that investors don’t have particularly high hopes for. They trade at lower-than-average multiples by definition. The fact that a company trades at lower-than-average multiples certainly doesn’t mean it can’t fall when its fundamentals disappoint, but it does generally mean that the pain isn’t compounded too severely by falling valuations as well. 

For a growth stock, however, a disappointment in the performance of the company is extremely likely to result in a falling valuation multiple. After all, these are exactly the companies that the market has awarded higher-than-average multiples because of outsized expectations of their growth prospects. When those prospects deteriorate, valuations almost invariably fall significantly, often precipitously. 

Some of the pain was inflicted by a generic de-rating that hit the growth universe this year pretty indiscriminately. But a lot of it was driven by growth stocks that fundamentally underperformed investor expectations—growth traps. These growth traps actually had their worst showing on record relative to the growth universe. This fact should be of interest to market historians and, I will admit, it is also a source of some satisfaction for those investors who positioned their portfolios to be short growth stocks a year ago. 

But what should be of note to all investors whatever their positioning is that conditions today suggest that it is likely there will be more growth traps in the next year than there were in the last one and there is good reason to believe their underperformance will remain worse than usual until a full unwinding of the growth bubble occurs.

Ben Inker is co-head of GMO’s Asset Allocation team and a member of the GMO Board of Directors.

© 2022 GMO LLC.

Life/annuity insurers lead surge into private equity investments

Posted on May 26, 2022 by -

The value of US insurance companies’ investments in private equity products grew by 25.8% in 2021, to $117.4 billion, from $93.3 billion in 2020. It was the biggest year-over-year increase in PE investments in recent years, according to a new AM Best special report.

Life/annuity insurers, which account for three-quarters of the insurance industry’s private equity book adjusted/carrying value, are driving the new investments, realizing widespread book value gains, according to the report, “Strong Performance, New Investments Drive Private Equity Growth.” 

Of the $24.1 billion in year-over-year growth, $12.9 billion was from growth in book value from 2020 (net of disposals) and $11.2 billion from new investments. The overall annual increase follows strong growth of 14.8% in 2020 and 10.0% in 2019.

“Commitments for additional capital grew 13.1% in 2021—after growing over 10% in five of the six previous years—to roughly $55 billion, more than $31 billion of which are by L/A insurers,” the report said. 

“New investments in 2021 were concentrated in a few large organizations, with 10 insurers by book value accounting for roughly 60% of acquisitions for the year,” said Jason Hopper, associate director, industry research and analytics, in a release. 

Five large life/annuity companies accounted for more than half of the $73.9 billion in private equity investments of the 15 insurers with the largest PE investments, according to the report: MassMutual Group, with $11.9 billion, New York Life Group, Thrivent Financial, MetLife Group and John Hancock Life Group.

New York Life and MassMutual, both mutual insurance companies, were among the leading issuers of fixed annuities in the first quarter of 2022, according to LIMRA Secure Retirement Institute. New York Life was the top seller of fixed-rate deferred annuities, with sales of $2.78 billion.

MassMutual ranked third in that product category, with $1.62 billion in sales. MassMutual ranked sixth ($934 million) in fixed indexed annuity sales for the quarter and third ($272 million) in sales of payout annuities, according to LIMRA.

“Nearly a third of insurers had new investments totaling less than $5 million, signaling a more-cautious approach by most of the insurers that do not have significant scale or in-house expertise with this asset class,” Hopper said.

While PE investments made up only a tiny (3.7% on average) of the investments of the top 15 PE holders, they made up an average of 27.3% of the capital and surplus of those companies. Among the five insurance groups named above, the PE percentage of capital and surplus ranged from 65.9% (John Hancock Life) to 23.0% (New York Life).

Private equity investments span all stages of a company’s life cycle, each with its own unique sets of risks, the report said. Roughly 58% of the insurance industry’s exposure to private equity is through investments in leveraged buyout funds, although allocations vary by insurance segment. 

Venture capital accounts for another 29%, and mezzanine financing, the remainder. All three allocations grew, driven largely by life/annuity insurers, though mezzanine funds grew by double digits for all three insurance segments.

“Insurers are still seeking higher returns and opportunities to diversify their portfolios, and the performance of private equity investments has been strong with a low correlation to the public markets,” said Michael Lynch, associate analyst, AM Best.

Insurers use private equity to diversify investments and potentially achieve higher yields compared with other asset classes, but the small allocations as a percentage of invested assets point to more-conservative investment strategies and lower levels of risk tolerance.

Insurers have the smallest average allocations to private equity, as a percentage of total assets, of all the major types of institutional investors, the report said.

© 2022 RIJ Publishing LLC.

Breaking News

Posted on May 25, 2022 by -

iCapital buys SIMON, fusing two fintech firms

iCapital, a fintech platform through which asset managers and wealth managers can invest in alternative assets, has agreed to acquire SIMON, the online platform that distributes structured investments and indexed annuities, for an undisclosed sum.

SIMON brokered more than $48 billion in contract issuances in 2021, a release said. It served more than 50 product manufacturers, more than 50 broker dealers, private banks, and registered investment advisors, and more than 100,000 advisers. 

iCapital services more than $125 billion in platform assets and employs more than 800 people globally. In an interview, iCapital chairman and CEO Lawrence Calcano could not say whether the SIMON brand would be retained or not; there was no sign that it would be. 

According to the release, the acquisition “will significantly expand iCapital’s investment menu, and augment its technical capabilities, education offerings and support services for wealth managers.” SIMON offers a suite of digital tools, a library of on-demand educational resources for advisers, data and analytics, and life-cycle management. iCapital will also own SIMON Spectrum, a multi-dimensional allocation analysis and portfolio construction tool designed to evaluate how structured investments and/or annuities may fit into a portfolio.  

Under the agreement, Jason Broder, CEO of SIMON, will join iCapital as managing director, head of iCapital Solutions and member of the Operating Committee. He will oversee the combined platform’s integration, market development, and sales of iCapital’s technology offerings. iCapital said it will extend offers of employment to the nearly 200 SIMON team members.

Principal closes $25bn reinsurance deal 

Principal Financial Group (Nasdaq: PFG) announced May 25 that it has successfully closed its transaction to reinsure the company’s in-force US retail fixed annuity and universal life insurance with secondary guarantee blocks of business with an affiliate of Sixth Street and its insurance platform, Talcott Resolution. 

Under the agreement, the company has reinsured approximately $25 billion of in-force statutory reserves, and Talcott has engaged Principal to manage approximately $4 billion in commercial mortgage loans and private credit assets for the lifetime of the assets.

Principal expects deployable proceeds of approximately $800 million in 2022 from the closed transaction in combination with additional transactions designed to improve the capital efficiency of its in-force individual life insurance business. The proceeds are included in the company’s planned $2.0 billion-$2.3 billion of share repurchases for 2022.

This reinsurance transaction advances the company’s long-term strategy to focus on higher growth markets, improve capital efficiency, and will meaningfully enhance the company’s future financial profile:

  • Accretive to non-GAAP operating earnings per diluted share (EPS) starting in 2023;
  • Improving non-GAAP operating return on average equity (ROE) and affirming the company’s 15% target in 2023; and
  • Enhancing free capital flow conversion by approximately 10 percentage points annually; increasing the company’s target range to 75%-85% upon close.

Principal will release its second quarter 2022 financial results after market close on Monday, August 8, 2022. On Tuesday, August 9, 2022, Dan Houston, chairman, president, and chief executive officer, and Deanna Strable, executive vice president and chief financial officer, will discuss the results during a live conference call. 

The effective date of the reinsurance transaction is January 1, 2022. Second quarter financial results will include a true-up to transfer all associated revenue and earnings as of the beginning of the year to the counterparty. In addition, the company plans to provide a preliminary estimate of the transition adjustment related to its adoption of the FASB long-duration targeted improvements in 2023.

Securian Financial will be recordkeeper and PPP for WELLthBUILDER PEP

Strategic Retirement Partners (SRP), a retirement plan consulting services firm, has selected Securian Financial as the pooled plan provider and recordkeeper for its WELLthBUILDER Pooled Employer Plan (PEP).

Made possible by the federal SECURE Act, PEPs allow unrelated companies and organizations to enroll their employees in a single 401(k) retirement plan. Employers can offsource their retirement plan’s fiduciary and administrative responsibilities to PEP providers, who provide economies of scale unavailable to most small plans.

Securian Financial will serve as the pooled plan provider and ERISA 3(16) fiduciary, while Strategic Retirement Partners will provide ERISA 3(38) investment management and consulting services for the platform.

Securian Financial’s qualified retirement plan products are offered through a group variable annuity contract issued by Minnesota Life Insurance Company. Securian Financial is the marketing name for Securian Financial Group, Inc. and subsidiaries. Minnesota Life Insurance Company is a subsidiary of Securian Financial Group, Inc.

Nationwide is latest in New York’s purge of unlawful ‘replacement practices’

Nationwide Life Insurance Company has agreed to pay about $5.6 million in restitution and penalties for violating New York insurance regulations with respect to “deferred to immediate annuity replacement transactions,” the New York Department of Financial Services (DFS) announced this week. 

Under the agreement, contract owners will receive higher monthly payouts for the remainder of their contract terms, Superintendent of Financial Services Adrienne A. Harris said in a release. 

The settlement was the latest result in DFS’s industry-wide investigation into deferred to immediate annuity replacement practices in New York State. To date, the industry-wide investigation has resulted in settlements with 13 life insurance companies, totaling approximately $29 million in restitution and penalties.  

Regulators found that Nationwide failed to properly disclose to consumers income comparisons and suitability information, causing consumers to exchange more financially favorable deferred annuities with immediate annuities. 

Hundreds of New York consumers—primarily elderly individuals—received incomplete information regarding the replacement annuities, resulting in less income for identical or substantially similar payout options.  

Nationwide has also agreed to take corrective actions, including revising its disclosure statements to include side-by-side monthly income comparison information, and revising its disclosure, suitability, and training procedures to comply with New York regulations.

Riversource fined $5 million for ‘switching’

In the SEC’s first-ever enforcement proceeding under Section 11 of the Investment Company Act of 1940, the financial regulator has settled charges against RiverSource Distributors Inc. for improper switching or replacing of variable annuities.

Without admitting or denying the SEC’s findings, RiverSource consented to an order finding that it violated Section 11 of the Investment Company Act and imposing a cease-and-desist order, a censure and a $5 million civil penalty.

Section 11 of the Investment Company Act prohibits any principal underwriter from making or causing to be made an offer to exchange the securities of registered unit investment trusts (including variable annuities) unless the terms of the offer have been approved by the SEC or they fall within certain limited exceptions, none of which is applicable to RiverSource.

According to the SEC’s order, RiverSource offered and sold variable annuities to retail investors through an affiliated broker-dealer/investment adviser, Ameriprise Financial Services, LLC.

The order finds that certain employees of RiverSource developed and implemented a sales practice that caused exchange offers to be made to holders of variable annuities to switch from one variable annuity to another which had the effect of increasing sales commissions for RiverSource employees, while also increasing RiverSource’s variable annuity related revenues. 

According to the order, these types of transactions increased significantly from 2016 until 2018 when RiverSource’s compliance department put a stop to the sales practice abuses.

The SEC’s investigation was conducted by Jeff Leasure, Roger Landsman and James Murtha of the Complex Financial Instruments Unit under the supervision of Reid Muoio and with the assistance of Timothy Halloran of the Trial Unit. 

Without admitting or denying the SEC’s findings, RiverSource consented to an order finding that it violated Section 11 of the Investment Company Act and imposing a cease-and-desist order, a censure and a $5 million civil penalty.

“Congress enacted Section 11 to prohibit the improper ‘switching’ of investors from one investment product to another for the purpose of generating additional selling charges – precisely the conduct our order finds RiverSource to have engaged in,” said Sanjay Wadhwa, Deputy Director of the SEC’s Division of Enforcement. “Protecting retail investors from abusive sales practices is a mainstay of our enforcement program, and we remain committed to holding accountable those who engage in such conduct.”

Rockefeller Capital Management will be Empower’s investment fiduciary

Empower, the $1.4 trillion retirement plan provider, and Rockefeller Capital Management, a $95 billion financial advisory and services firm, are partnering on an fiduciary advice solution for retirement plan participants.

The joint offering is called Rockefeller Capital Management (RCM) Retirement Plan Fiduciary Manager. Rockefeller will serve as the ERISA “3(38)” investment manager to the plan. 

A press release offered few specifics other than that Rockefeller’s high-end advisory skills would be tied to a convenient digital platform giving participants a tool for accessing more than 7,000 investment funds offered by Empower.
Headquartered in metro Denver, Empower administers approximately $1.4 trillion in assets for more than 17 million retirement plan participants and is the nation’s second-largest retirement plan recordkeeper by total participants. 

Empower serves government 457 plans; small, mid-size and large corporate 401(k) clients; nonprofit 403(b) entities; private-label recordkeeping clients; and IRA customers. Its Personal Capital subsidiary provides robo-advice.
Rockefeller Capital Management advises wealthy individuals and families, institutions and corporations from 36 US locations. As of March 31, 2021, the firm was responsible for approximately $95 billion in client assets.

Turer to succeed Kroll at Lincoln Financial

Stephen Turer will succeed Brian Kroll as senior vice president and head of the annuity business at Lincoln Financial Group, effective July 1, 2022. He will report to Matthew Grove, who will join Lincoln Financial in July as head of Individual Life & Annuities and Lincoln Financial Network. Kroll is retiring.

Turer joined Lincoln Financial in 2005 as assistant vice president, Annuity Pricing. Most recently, he served as senior vice president, Annuity Product, Pricing and Valuation, leading pricing and business unit valuation for Lincoln Financial’s annuity products and the in-plan guaranteed solutions offered by the Retirement business. He is also the co-executive sponsor of Lincoln’s LGBTQ+ Business Resource Group (BRG).

Prior to joining Lincoln, Turer was an actuary with Travelers Life & Annuity. He earned a bachelor’s degree in Actuarial Science from Penn State University.

© 2022 RIJ Publishing LLC.

Fixed-Rate Annuities: First Quarter Favorites

Posted on May 25, 2022 by -

Amid falling bond and equity prices, investors sought the humble predictability of fixed rate deferred (FRD) annuities in the first quarter of 2022, according to the LIMRA’s latest report.

FRD sales were up 45% from the previous quarter, to $15.9 billion, as the average yield on the three-year product rose to 2.25%. Top-five FRD issuers were New York Life ($2.78bn), AIG ($1.82bn), MassMutual ($1.62bn), USAA ($1.21bn), Western Southern Group ($1.15bn) and Global Atlantic ($999m).

For more annuity sales data, see LIMRA’s Fact Tank. 

Todd Giesing

Overall, sales of fixed annuities (FRDs, fixed indexed, and payout) rose 14% from the prior quarter, to $35.2 billion. At $16.3 billion, FIA sales were down 2% from the previous quarter. Sales of deferred income annuities were down 15% and immediate annuities were down 12%.   but 21% higher than the first quarter of 2021. All fixed products except income annuities recording positive growth.

Relative to the first quarter of 2021, fixed-rate deferred annuity sales were up 9%. FIA sales were up 21% from the year-ago quarter. LIMRA expects FIA sales to grow as much as 10% and fixed-rate sales to grow as much as 7% in 2022.

“FIA and FRD sales benefited from rising interest rates and increased market volatility as investors sought protected growth options,” said Todd Giesing, assistant vice president, LIMRA Annuity Research, in a release.

Some carriers were apparently more nimble than others in incorporating rising rates into their products. “We’ve heard that some life/annuity companies are having challenges with rates moving so quickly, even though the rates are changing in their favor. Some carriers are changing rates only once a month, while others have the flexibility to change once a week,” Giesing told RIJ in a phone interview.

1Q2022 Annuity sales

Meanwhile, investors moved away from equity-linked annuities such as fixed indexed annuities (FIAs) and registered index-linked annuities (RILAs). RILA sales were down 7% from the prior quarter but were up 5% from the year-ago quarter. 

At $16.3 billion, first-quarter FIA sales were down 2% from 4Q2021 but up 21% from 1Q2021. Top-five FIA issuers were Athene Annuity & Life ($2.23bn), Allianz Life of North America ($1.74bn), AIG ($1.45bn), Sammons Financial Group (and $1.02bn) and Fidelity & Guaranty Life ($962m). 

“FIA and RILA sales were both slightly down from the prior quarter. That might reflect some investor uneasiness about equity index-linked products. But fixed-rate sales went to $16 billion in first quarter of 2022 from $11 billion in the fourth quarter of 2021,” Giesing said. LIMRA’s quarterly annuity sales survey represents 91% of the total market.

Overall US annuity sales were up 1% from the fourth quarter of 2021 in the first quarter of 2022 and up 4% from the year-ago quarter, according to LIMRA’s US Individual Annuity Sales Survey. 

The top five sellers of annuities in 1Q2022, of any type, were AIG Companies ($5.0bn), New York Life ($4.47bn), Jackson National Life ($4.25bn), Equitable Financial ($3.71bn) and Allianz Life of North America ($3.25bn).

1Q2022 Annuity Sales

Immediate income annuity sales were $1.5 billion in the first three months of 2022, equal the results from prior year. Deferred income annuity sales totaled $365 million in the first quarter, down 14% year-over-year. With higher interest rates expected this year, LIMRA has forecast as much as 15% growth collectively for immediate and deferred income annuity sales.

Total variable annuity sales fell 6% in the first quarter, to $28.1 billion. Registered index-linked annuity (RILA) sales grew 5% to $9.6 billion in the first quarter. Traditional variable annuity (VA) sales were $18.5 billion in the first quarter, down 11% year-over-year.  

The top five variable annuity issuers in 1Q2022 were Jackson National Life ($4.19bn), Equitable Financial ($3.71bn), Lincoln Financial Group ($2.39bn), TIAA (1.89bn) and Brighthouse Financial ($1.81bn). By the end of 2022, LIMRA has predicted traditional VA sales to grow by as much as 8%. LIMRA expects RILA sales to increase as high as 30% by year-end 2022. 

© 2022 RIJ Publishing LLC.

Fortitude Re’s expansion continues

Posted on May 19, 2022 by -

Fortitude Re, the Bermuda-based reinsurer that was born when the Carlyle Group and other investors purchased AIG’s reinsurance business in 2019, in January established a Bermuda multi-line reinsurer and acquired a US life insurer, according to an announcement that RIJ overlooked at the time. 

Fortitude Re’s subsidiary, Fortitude Reinsurance Company Ltd., Bermuda’s largest multi-line reinsurer, obtained approval to operate as a Reciprocal Jurisdiction Reinsurer, the first such approval to be granted by the Texas Department of Insurance. “Fortitude Re can now offer the flexibility to transact through multiple entities and structures to help its clients achieve their objectives,” a release said.

Fortitude Re also acquired two U.S.-domiciled third party administrators from American International Group, Inc. and acquired Prudential Annuities Life Assurance Corporation and its in-force legacy variable annuity block from Prudential Financial, Inc.

Fortitude Re and Prudential

Last September, Prudential Financial, Inc., and Fortitude Group Holdings, LLC announced that Prudential would sell a portion of its in-force legacy variable annuity block to Fortitude Re for a total transaction value of $2.2 billion.

Under the agreement, Prudential sold one of its stand-alone legal entity subsidiaries, Prudential Annuities Life Assurance Corporation (PALAC), including PALAC’s in-force annuity contracts, to Fortitude Re, for an all-cash purchase price of $1.5 billion, subject to certain adjustments at closing, plus a capital release to Prudential and an expected tax benefit.

The PALAC block primarily consisted of non-New York traditional variable annuities with guaranteed living benefits that were issued prior to 2011, which constitute approximately $31 billion or 17% of Prudential’s total in-force individual annuity account values as of June 30, 2021. 

“PALAC complements Fortitude Re’s market-leading capabilities in designing tailored solutions for leading insurers that enhance capital efficiency and address strategic priorities. Prudential will continue to service and administer all contracts in the PALAC block following the transaction to ensure a consistent experience for customers. Prudential does not expect there to be any direct impact to employee head count as a result of the transaction,” a release said.

Since January 1, 2022, Fortitude International Reinsurance Ltd [FIRL] has operated as a Class 4 and Class E reinsurer, licensed by the Bermuda Monetary Authority. FIRL will complement Fortitude Re’s other operating entities and focus on reinsurance solutions for insurers domiciled outside the US.

On January 3, 2022, Fortitude Re completed its acquisition of Rx Life Insurance Company (to be renamed Fortitude US Reinsurance Company) from Heritage Life Insurance Company. Fortitude Re US, which will serve as a US reinsurance platform for Fortitude Re, is an Arizona domiciled life and annuity insurer widely licensed in the US. This acquisition will enable Fortitude Re to offer clients a US domiciled reinsurance option.

Reciprocal jurisdiction reinsurer status

Effective January 1, 2022, the TDI granted FRL authority to operate as a Reciprocal Jurisdiction Reinsurer. FRL expects to seek similar status in other selected US jurisdictions in the near future.

FRL’s Reciprocal Jurisdiction Reinsurer status allows US ceding companies to take full statutory credit for reinsurance ceded to FRL without any regulatory prescribed collateral requirements, effectively treating FRL for these purposes as a US domiciled reinsurer. FRL is among the first reinsurers to obtain such status in the US.

The transactions and regulatory approval represent an important step in the evolution and expansion of the capabilities Fortitude Re is able to offer to clients to solve their most complex challenges. 

“With the establishment of FIRL, we expect to grow our international reinsurance business in Asia and the UK and European markets,” said James Bracken, Fortitude Re CEO.

PALAC is in the process of changing its name to Fortitude Life Insurance & Annuity Company and Rx is in the process of changing its name to Fortitude US Reinsurance Company. Variable annuities are distributed by Prudential Annuities Distributors, Inc. , Shelton, CT. 

Reinsurance transactions are entered into by PALAC, Rx, Fortitude Reinsurance Company Ltd (“FRL”) and Fortitude International Reinsurance Ltd (“FIRL”). FRL and FIRL are both located in Hamilton, Bermuda. Fortitude Re is the marketing name for FGH Parent, LP and its subsidiaries, including PALAC, Rx, FRL and FIRL. Each subsidiary is responsible for its own financial and contractual obligations. These subsidiaries are not licensed to do business in New York.

© 2022 RIJ Publishing LLC.

Church-affiliated retirement plan adopts Pacific Life longevity annuity

Posted on May 19, 2022 by -

Pacific Life today announced a new collaboration with Wespath Benefits and Investments and WTW (formerly Willis Towers Watson) to provide the qualifying longevity annuity contract (QLAC) option in Wespath’s enhanced LifeStage Retirement Income program.

The program provides participants with a new interactive retirement income modeling tool, an optional Social Security “bridge,” and an optional QLAC.

People using the bridge strategy would delay filing for Social Security benefits until age 70 and finance their expenses, if necessary, during the period between their retirement date and age 70 with defined contribution plan savings.

A QLAC is a deferred income annuity that can be purchased with tax-deferred savings, for income starting after age 72, without violating rules governing required minimum distributions. Wespath’s Pacific Life QLAC allows a 70% continuation payment for surviving spouses.

“We believe that the unique solution Wespath developed will provide enhanced lifetime income security for participants in retirement,” said Paul Hance, senior vice president and head of the Customer Solutions Group for Pacific Life’s Institutional Division, in a release.

“The LifeStage Retirement Income program provides features that few, if any, financial services firms offer in a packaged manner,” said Martin Bauer, senior managing director, Wespath Benefit Plans. “We’re particularly pleased to partner with WTW in the development of the new program features and with Pacific Life in offering the longevity income protection annuity.”

The optional longevity income protection feature helps protect participants against the risk of outliving their savings. With Pacific Life’s QLAC, participants are guaranteed a retirement income stream starting at age 80, regardless of how long the participant and, if applicable, their spouse lives. In addition, the QLAC will reduce required minimum distributions providing additional tax planning options.

“We are honored to be selected as the provider for the QLAC portion of the LifeStage Retirement Income program,” said Ruth Schau, senior director of Pension Solutions for Pacific Life.

Wespath Benefits and Investments (Wespath) is a not-for-profit agency serving The United Methodist Church (UMC). It administers benefit plans and, with its subsidiaries, including Wespath Institutional Investments, invests over $29 billion in assets on behalf of over 100,000 participants and over 100 United Methodist-affiliated institutions (as of December 31, 2021). 

Wespath invests in a sustainable manner that seeks to achieve positive financial, social, and environmental impact while upholding the values of the UMC. Wespath maintains the largest reporting faith-based pension fund in the world. 

© 2022 RIJ Publishing LLC. 

Private Equity and Accounting Firms

Posted on May 19, 2022 by -

My threshold for surprise is fairly high. 

Many years ago, the telephone rang at my desk in the smoky Billings Gazette newsroom. A drug dealer offered crocodile condolences: A man with whom I’d had lunch in a cafe in Red Lodge the previous day was dead. The dead man had been a witness in the dealer’s criminal trial.

That set my benchmark for surprise.

This week, I spotted a headline on the Accounting Today website. It said, “Private Equity in Accounting.” The accompanying podcast transcript also contained the word “annuity.” The needle on my internal surprise-meter didn’t red-line, but it quivered.  

For his podcast, the magazine’s editor had interviewed a business broker about the excess of “dry powder” the private equity firms had received from clients, and how the PE firms were inclined to use it to buy accounting firms for the accountants’ “recurring revenue”—their “annuity of tax and audit” services. 

“One of the more interesting developments in the past couple years has been the entry of private equity into the accounting space, with PE firms taking stakes and creating ventures with major accounting firms,” the broker told the editor. 

“I’d like to call this the ‘private equity invasion.’ So with rock and roll, it was the British invasion. You know, the Beatles and the Rolling Stones. This is going to be huge,” the broker said.

Given years of low yields on publicly-traded debt and a scarcity of bargains in public equities, institutional investors have, in their search for higher yield, pressed hundreds of billions of dollars on asset management firms for astute investment in custom-made, relatively illiquid private equity and credit instruments.  

As RIJ has reported in our series on the “Bermuda Triangle” phenomenon, some private equity firms have applied some of that dry powder to the purchase of life/annuity companies or blocks of annuity business. This gives them new money—annuity premiums—to manage and to invest in the private credit instruments they create. Retail annuity contract owners—mom and pop—are less sophisticated and demanding than institutional investors but just as yield-hungry.

The idea that the larger and larger private equity firms would own larger and larger accounting firms was introduced in the Accounting Today article. 

“The big question everyone has is, ‘Who is private equity gonna sell to when they have that liquidity event?’ And it’s our belief that it will either be another private equity firm that’s doing the same thing, and big will become bigger, or rather gigantic,” the broker said, or “it may be another CPA firm, or it may be another party that’s totally uninvolved in the business of public accounting.” 

When impatient, yield-starved investors throw money at asset managers, the performance incentives can become huge. The process can be hard to stop. It’s like the well-known folk tale of Rumpelstiltskin, in which the miller’s daughter, unable to spin straw into gold though her life depends on it, comes to rely on a troll who knows how. 

That tale ends more happily than the story about Allianz Global Investors US, which broke this week when the Securities & Exchange Commission accused the asset manager and three of its advisers—who admitted to the charges—with taking a lot of straw from institutional investors and lying to them before and after the COVID-related market crash of 2020 ruined its flawed formula for turning the straw into gold. 

The incentives were huge, and ultimately turned perverse. AGI US paid the advisers—whose individual base salaries were no more than $300,000—some $101 million in bonuses from 2016 to 2020, according to the SEC. The business was so lucrative for AGI US and the advisers that, when it melted down—as a result of un-fiduciary risk management and a black swan event—the incentive to hide the truth was evidently overwhelming.

So what happened back at the cafe in small-town Montana all those years ago?

Two middle-aged West Coast outlaws, their two young street-dealing accomplices and a femme fatale were lying low and dealing pot and meth out of a house at the foot of the snowy Beartooth Mountains. They believed that contributions to local law officers would allow them to distribute their products in peace.

As out-of-towners from the big city, the five never foresaw that rural gossips would instantly notice them. Soon there were FBI stake-outs, a messy raid and, before long, an indictment by the county attorney and a stunt-filled trial in a Victorian-era courthouse with portraits of bearded old jurists on the walls. 

One witness, a deputy sheriff aware of both the crimes and the corruption, fatally sat down to lunch one day with the reporter covering the trial. Since Red Lodge boasted only one good cafe, their table and their Monte Cristo sandwiches were in full view of all the other principals in the case. 

The next day, I received that surprise phone call.

© 2022 RIJ Publishing LLC. All rights reserved. 

The Coming Stagflation

Posted on May 19, 2022 by -

For most investors, the word of the year for 2022 is “inflation.”  

Runaway inflation has the Fed playing catch up. It is taking an aggressive, hawkish stance towards rate hikes. This has wreaked havoc in the asset market, beating down both stocks and bonds. Growth equities, which have valuations driven primarily by easy capital from exuberant investors, have seen prices cut by 50% to 80%. 

The million-dollar question is whether the end is near? Or is there more yet to come? The key to answering this question is in the Fed’s ability to contain skyrocketing inflation, which now stands at 8%.  

Let us examine the two geopolitical events at the core of this inflation. The first core issue is record-high energy and food prices driven by the conflict in Ukraine. Russia is one of the world’s biggest energy exporters and both Russia and Ukraine are two of the biggest fertilizer and food producers. A war between these two countries – combined with global trade sanctions against Russia – are driving up the cost of food, manufactured goods, and shipping around the world.

The second core issue is the draconian Covid lockdown in China. This has substantially disrupted both manufacturing and shipping at the world’s de facto factory. Although these two core disruptors are temporary, the impact of the Ukraine war and China’s lockdowns could persist a long time.

For example, some say the US is committed to fighting Putin so long as the last Ukrainian is standing. But Putin will not back down either. Ukraine has a real chance of becoming a Russian quagmire akin to Afghanistan. That means price increases driven by energy and food will not ease in the near-term.

And unfortunately, the Covid lockdown in China seems poised to extend into Q3 if not Q4 of 2022, as China’s XJP has doubled down on his zero Covid policy. This means massive supply chain disruptions will continue indefinitely, impacting the manufacture of both final consumer products and key components. The port congestion outside China has further increased logistical costs that will, inevitably, be reflected in end consumer prices here in the United States. 

Crude has gone from $20 a barrel to $100. Bulk container shipping cost has gone from $2,000 to $18,000. The increase in cost associated with critical production and transportation factors must eventually transmit to higher final prices in your Amazon shopping cart. The fact that prices have not gone up more aggressively is a testament to the skill in cost hedging and inventory management practiced by the different key players in the global supply chain. The Fed ought not be taking credit for that.  

It’s hard to say which of these two cores – the Ukraine conflict or China’s lockdown – is the “primary” driver of US inflation. But I can say for certain that the Fed’s hawkish tone and rate hikes will have exactly zero impact on either of these two drivers of price inflation.  What we have is cost-driven inflation rather than demand-pulled inflation. 

Thus, for the foreseeable future, inflation will remain intransigent and the Fed’s efforts will be futile. Slowing demand by hiking interest rates will have little impact on the high prices. It doesn’t matter how much demand is slowing. So long as the cost of inputs remain high, prices on the shelves will remain high; no one is in the business of selling for a loss. In the meantime, we will all experience the unintended consequences of continued rate hikes.   

Asset prices will decline automatically as discount rates rise. This will create a meaningful negative wealth shock, which we have already seen. The high cost of capital also means less investment while we are already facing insufficient production. We already have a global slowdown driven by war and Covid; to further compound the shock with higher capital costs and reduced liquidity only adds insult to injury.

Worse yet, the impact of rate hikes on inflation will be more muted than people expect for the reasons already explained above. All of this points to the risk of the market losing confidence in the Fed as it claims mastery over inflation only to lose the fight against a cost-pushed price increase. There is an added risk that the Fed will double-down on its rate hike, pressured by populist politicians who watched a YouTube on the right way to beat inflation. A Volcker-esque approach will surely exacerbate what is already unnecessary self-harming. It is hard to predict how much damage could be inflicted before the Fed and the politicians breathing down its neck pursue an alternative route.

For certain, there is some justifiable populist anger with the low interest rate environment created by the Fed, which has led to record real estate prices and record stock prices; this policy has benefitted the wealthy while meaningfully disadvantaging less affluent families and retirees, who depend on interest income from bank deposits. However, lower rates and easy liquidity, while the root cause of many silly bubbles now blowing up in our face, is not at the heart of our current rising prices. Japan, which has been engaged in the world’s longest and biggest money printing experiment, has decidedly pledged to not raise rates to deal with the very same cost-push inflation that it also faces. Let us not be quick to assume that Japanese central bankers are dumber than our Fed. Japan might know a few things we can learn from.  

The forthcoming global stagflation, where growth stalls and inflation is high, will be a “never-market” condition that is unprecedented for this generation of US investors and policymakers. You’re damned if you hike rates and you’re damned if you don’t. So, what does all this mean? It means a prolonged period in the United States of policy bickering and finger-pointing. Our politicians and central bankers have not dealt with this before. They don’t have the right answer even if they have to promise a quick solution for the sake of politics. The result will be economic molasses.

This may sound pessimistic, but the impact on you personally will depend on your time horizon and the overall diversification of your portfolio.  Do you have a globally diversified portfolio that will withstand policy missteps here in the US? Or are you all-in the US because it has been the best performing market in the last 10 years? Or perhaps are you aggressively buying on the dip the battered tech darlings, as they make new lows (because they have to come back, right)? 

It would be hubris to assume that our democracy must always lead to a world-beating outcome for our stock market. We are quick to criticize others’ regulatory and fiscal missteps, but it would be foolish to imagine the US Federal Reserve and our other institutions are not similarly capable of self-harm—out of ignorance, hubris or politics. It’s impossible to predict what will happen next. But I hazard to guess the worst is not yet over in the United States.

Jason Hsu is founder of and chief investment officer of Rayliant Global Advisors. This article first appeared as a post on LinkedIn.

Desperately Seeking Alpha (and Getting Caught)

Posted on May 19, 2022 by -

A major asset manager has admitted that for five years its fund advisers hid the flaws of their complex options strategies—flaws that would cost pension funds, family offices and other institutional investors an estimated $5 billion.

The Securities & Exchange Commission (SEC) has ordered Allianz Global Investors US (AGI US), a subsidiary of Munich-based Allianz SE, and three then-advisers of AGI US’s Structured Alpha funds, to “disgorge” over $100 million in bonuses that the SEC’s May 17 civil complaint called “ill-gotten.” The Structured Alpha funds held as much as $11 billion in assets, on which AGI earned some $550 million in fees, the complaint said.

No institutional investors were identified in the SEC complaint. There were 17 Structured Alpha funds, with 114 institutional investors in the US and other countries. The funds took in almost $3 billion more than their pre-established $9 billion capacity. As of December 31, 2020, AGI US managed $148.8 billion.

AGI US—which Allianz SE sold this week to Voya Investment Management (see below)—admitted that its conduct from 2016 to 2020 violated federal securities laws. It agreed to a cease-and-desist order, a censure and payment of $315.2 million in disgorgement, $34 million in prejudgment interest, and a $675 million civil penalty, a portion of which will be distributed to certain investors, the SEC release said. 

In addition, the US Attorney’s Office for the Southern District of New York this week announced related criminal charges against AGI US and the three advisers: Gregoire P. Tournant, Trevor L. Taylor, and Stephen G. Bond-Nelson. AGI US, Taylor and Bond-Nelson have agreed to guilty pleas. 

In an apparent response to the negative news, Allianz SE separated itself from AGI. The German firm has already arranged to sell AGI to Voya Investment Management (Voya IM). After its guilty plea, AGI US was automatically and immediately disqualified from providing advisory services to US registered investment funds for the next ten years. AGI US will transfer teams managing about $120 billion in “income and growth, fundamental equities and private placements” assets to Voya IM, whose assets under management will grow to about $370 billion. Allianz will own 24% of Voya IM. It was not immediately clear if the service ban will follow the AGI US teams or affect the disposition of their AUM after they transition to Voya IM.

In its release this week, the SEC emphasized that the crime was not victimless. “The victims of this misconduct include teachers, clergy, bus drivers, and engineers, whose pensions are invested in institutional funds to support their retirement. This case once again demonstrates that even the most sophisticated institutional investors, like pension funds, can become victims of wrongdoing,” said SEC Commissioner Gary Gensler, in a release.

The AGI advisers admitted to deceiving institutional investors about the risk management techniques in the fund and then trying to cover up its activity by lying to its customers and, later, to the SEC. 

The complaint painted a picture in which low interest rates and investor demand for yield, plus high-tech financial engineering, plus immense financial incentives to hide bad news from clients, plus a black swan event in the financial markets in March 2020 (when the Structured Alpha funds suffered massive losses), provided the ingredients for a multi-level disaster.  

According to the complaint, the fund advisers saved money by buying less expensive but riskier options, using less effective hedging strategies than they led their clients to believe, and accepting investor money in excess of the capacity of the fund.

“Structured Alpha was a complex options trading strategy designed to generate profits by using a portfolio of debt or equity securities as collateral to purchase and sell options, primarily on the S&P 500 Index,” the complaint said.

“Structured Alpha’s options trading strategy had three components: range-bound spreads, directional spreads, and hedging positions,” the complaint continued. “Range-bound spreads and directional spreads were designed to generate profits by collecting premiums from selling put and call options that expired out-of-the-money. Hedging positions were designed to protect against short-term market crashes.”

Judging by their bonuses, disclosed in the SEC complaint, the AGI advisers were highly incentivized to grow the Structured Alpha business, to retain clients and attract new investments, and to hide difficulties. 

Over five years, Tournant and Taylor each received almost $50 million in bonuses on top of $300,000 annual base salaries. Bond-Nelson received $10.775 million in bonuses on top of a $250,000 base salary. Together, they received just under $114.66 million across the five-year period relevant to the complaint.

From 5/17/2022 SEC complaint against AGI US, p. 46.

allianz gi complaint 5-17-2022 SEC

The SEC’s investigation was conducted by Jonathan C. Shapiro and James F. Murtha, and supervised by Reid A. Muoio of the Complex Financial Instruments Unit. The litigation will be led by Timothy K. Halloran under the supervision of Melissa J. Armstrong. 

© 2022 RIJ Publishing LLC. All rights reserved.

Envestnet and Kestra co-launch platform for plan advisers

Posted on May 12, 2022 by -

Envestnet Retirement Solutions and Kestra Financial, a wealth management platform, are partners in launching Retirement Plan Enterprise, a service for advisers who sell retirement plans and provide investment menu advice to plan sponsors.

“RPE provides a comprehensive retirement plan practice management platform through single sign-on capability within Kestra Financial’s proprietary technology platform, at no additional cost to associated financial professionals,” a Kestra release said.

The platform includes these retirement plan tools:

Plan management dashboard. Designed to help financial professionals set and manage business retention and goals, the dashboard provides aggregate views of plans, AUM and scorecards, among other key metrics. The dashboard also assists financial professionals with asset and trend monitoring by fund and record keeper.

Investment analytics, fund research and monitoring reports. The platform will enable financial professionals to analyze and compare existing funds with recommended lineups, provide access to RPE’s proprietary analytics module, scoring criteria, and weightings as well as generate self-branded reports, including market commentary, asset allocation, plan-level performance, fund monitoring, due diligence, fee benchmarking, and more.

RFP and vendor search tools. The program is built to automate, streamline, customize, and manage the proposal and search process. It can help financial professionals monitor, track, review, and compare vendor responses.

The platform is also designed to ensure that the financial professional’s recommendations are in the client’s best interest by accounting for evolving regulatory requirements and fiduciary standards, the release said.

Kestra Financial, headquartered in Austin, Texas, is a division of Kestra Holdings. It includes the Kestra-branded broker-dealer and investment advisers. The firm supports more than 1,800 independent financial professionals.  

Envestnet refers to the family of operating subsidiaries of the public holding company, Envestnet, Inc. (NYSE: ENV). Its cloud-based platform supports more than 108,000 advisors and more than 6,000 companies—including 18 of the 20 largest US banks, 47 of the 50 largest wealth management and brokerage firms, over 500 of the largest RIAs, and hundreds of fintech companies. 

© 2022 RIJ Publishing LLC.

Annuity providers report 1Q2022 performance

Posted on May 12, 2022 by -

Jackson National Life, Equitable, and Brighthouse Financial recently reported their earnings for the first quarter of 2022. Excerpts from their news releases can be found below.

Jackson National Life

Jackson National Life reported $199 million in sales of Registered Index-Linked Annuities (RILAs) in the first quarter, after launching the product in the fourth quarter of 2021. RILA sales offset a 2% decline in variable annuity sales. 

Jackson’s retail annuities business reported pretax adjusted operating earnings of $406 million in the first quarter of 2022 compared to $568 million in the first quarter of 2021. 

Total annuity sales of $4.8 billion were up 2% from the first quarter of 2021. Jackson reported $19.3 billion in annuity considerations received for all of 2021, according to its annual statutory statement, filed in Michigan.

Jackson also reported these financial highlights:

  • Net income of $2,025 million, or $22.51 per diluted share, including the impact of non-economic hedging results under GAAP accounting
  • Adjusted operating earnings of $354 million, or $3.94 per diluted share
  • Total annuity account value of $242 billion increased 2% from the first quarter of 2021, primarily as a result of positive separate account performance
  • Returned $192 million to shareholders through $140 million of share repurchases and $52 million in dividends, in-line with full-year capital return target of $425-$525 million
  • Estimated Adjusted Risk Based Capital (RBC) ratio was within the target range of 500-525% at the end of the quarter
  • Cash and cash equivalents at the holding company of nearly $1 billion at the end of the quarter, above Jackson’s minimum liquidity buffer

“In total, annuity sales without lifetime benefit guarantees represented 33% of total annuity sales, up from 31% in the first quarter of 2021. We continue to generate fee-based sales, with current quarter advisory annuity sales of $207 million, compared to $267 million in the first quarter of 2021,” Jackson’s release said.

Equitable

Equitable reported total assets under management of $856 billion as of March 31, 2022, “a year-over-year increase of 4.1% driven by net inflows and market performance over the prior twelve months,” according to a release.

Net income attributable to holdings for the first quarter of 2022 was $573 million compared to net loss of $1.5 billion in the first quarter of 2021 driven primarily by non-economic market impacts from hedging under US GAAP accounting.

Non-GAAP operating earnings in the first quarter of 2022 was $548 million compared to $600 million in the first quarter of 2021. Excluding notable items5 of $67 million, first quarter 2022 Non-GAAP operating earnings were $615 million or $1.53 per share.

As of March 31, 2022, book value per common share, including accumulated other comprehensive income (“AOCI”), was $16.64. Book value per common share, excluding AOCI, was $21.29.

Equitable’s business segment highlights included:

Individual Retirement reported first quarter net inflows of $52 million, the highest quarter since the Equitable’s IPO and separation from AXA. The Structured Capital Strategies buffered annuity product achieved its highest month of sales ever in March and $2 billion in first-year premium for the quarter.

Group Retirement generated first quarter net inflows of $523 million primarily driven by secure income inflows associated with AB’s Lifetime Income product.

Investment Management and Research (AllianceBernstein) reported over $11 billion in net inflows in the quarter, with fee rate expansion of 1% and annualized organic growth of 6% year-over-year.

Protection Solutions gross written premiums up 36% year-over-year driven by shift to less interested-sensitive VUL; excess mortality continues to be within COVID guidance.

Brighthouse Financial

Annuity sales decreased 3% quarter-over-quarter and 12% sequentially. Life sales decreased 13% quarter-over-quarter and 43% sequentially. Overall, sales results were impacted by the recent macroeconomic headwinds.

During the first quarter of 2022, the company repurchased $127 million of its common stock, with an additional $53 million of its common stock repurchased, on a trade date basis, through May 5, 2022.

The company reported net income available to shareholders of $613 million in the first quarter of 2022, or $7.91 per diluted share, compared with a net loss available to shareholders of $610 million in the first quarter of 2021. During the quarter, as a result of market performance, the value of our hedges increased, as expected.

Due to being accounted for as insurance liabilities as required under US GAAP accounting, certain corresponding liabilities are less sensitive to market movements and, therefore, did not fully offset the increase in the value of our hedges.

The company ended the first quarter of 2022 with common stockholders’ equity (book value) of $11.1 billion, or $146.64 per common share, and book value, excluding accumulated other comprehensive income (AOCI) of $10.8 billion, or $141.85 per common share.

For the first quarter of 2022, the company reported adjusted earnings of $294 million, or $3.79 per diluted share, compared with adjusted earnings of $385 million, or $4.36 per diluted share, in the first quarter of 2021.

© 2022 RIJ Publishing LLC. 

Fed’s stability report assesses life insurers

Posted on May 12, 2022 by -

The Federal Reserve’s Board of Governors released its annual Financial Stability Report this month. Portions of the 72-page document were devoted to statistics on the financial health of the US life insurance industry, which includes the annuity industry. 

The report noted an overall increase in the liquidity of the industry’s liabilities and a trend toward holding less liquid assets—a potential cause of difficulty. Rising interest rates, the report said, could make life insurers more profitable, but also more susceptible to surrenders.

According to the report:

  • Leverage at life insurers remained near its highest level of the past two decades. Life insurers continued to invest heavily in corporate bonds, collateralized loan obligations (CLOs), and commercial real estate (CRE) debt, which leaves their capital positions vulnerable to sudden drops in the value of these risky assets.
  • Gradually rising interest rates improve the profitability outlook of life insurers, as their liabilities generally have longer effective durations than their assets, and higher interest rates may reduce life insurers’ incentives to invest in riskier assets. 

  • However, a large and unexpected increase in interest rates could induce policyholders to surrender their contracts at a higher-than-expected rate. 
  • If the increase in surrenders is substantial enough, it could put downward pressure on life insurers’ financial performance. 
  • Over the past decade, the liquidity of life insurers’ assets declined and the liquidity of their liabilities increased, potentially making it more difficult for life insurers to meet a sudden rise in withdrawals and other claims. 
  • On the asset side, life insurers increased the share of risky, illiquid assets—including CRE loans, less liquid corporate debt, and alternative investments—on their balance sheets.

  • Life insurers increasingly relied on nontraditional liabilities, such as funding-agreement-backed securities, Federal Home Loan Bank advances, and cash received through repurchase agreements and securities lending transactions. 
  • These liabilities, which are generally more vulnerable to rapid withdrawals than most policyholder liabilities, have grown steadily in recent years.

© 2022 RIJ Publishing LLC. All rights reserved.

Social Security’s Political Problems

Posted on May 12, 2022 by -

Social Security’s problems have always been more political than economic. We can expect Washington to make inconsistent stabs at refinancing the program, depending on the politics of the moment. 

Today, even the moderates can’t get in synch.  

Having praised Rep. John B. Larson’s 2019 “Social Security 2100 Act,” which raised payroll taxes on the wealthy, the non-partisan Committee for a Responsible Federal Budget (CRFB) has panned the bill’s latest iteration, which doesn’t. 

“The previous version of Social Security 2100…would generate enough new revenue to restore solvency and expand benefits,” the committee said last week. “The legislation would subject earnings over $400,000 to the payroll tax while also gradually raising the payroll tax rate from 12.4% to 14.8%. In addition to closing the program’s financial shortfall, the funds would finance a stronger minimum benefit, larger cost-of-living adjustments, and reduced taxation of benefits.”

Larson (D-CT) replaced that bill last October, however, with a new bill (H.R. 5723, or “Social Security 2100, A Sacred Trust”). It disappoints the CRFB.  

“The new legislation removes nearly half of the solvency-improving revenue from the original bill, while dramatically expanding new spending—but making that spending temporary to cover up the costs… The new legislation removes adjustments to the payroll tax rate—which were responsible for closing two-thirds of the solvency gap — while adding eight new benefit expansions that would further increase benefits for disabled workers, spouses, young adults, and the very old.”

In revising the bill, Rep. Larson may have wanted to replace deal-killing tax hikes with sweeteners in order to gain more support for its passage from the left and right. But the revision appears to have offended the middle, as represented by the CFRB. 

Meanwhile, we get closer to Social Security’s 2034 political reckoning, whose outcome may hinge on the results of the 2028 presidential election. Which is to say, very soon.  

Most of the news about Social Security tends to be characterized either by sensationalist cliff-hanging for its own sake or reductive name-calling (“Ponzi scheme”) by those who would replace our pay-as-you-go national pension with a defined contribution system.  

Social Security’s actual economic situation is not so dire. Even facing demographic headwinds (rising life expectancies and falling fertility rates), 75% of all promised benefits can continue to be paid after 2034, regardless of whether the program crosses into technical “insolvency.”

Social Security doesn’t face failure. It faces the question: Do we value it enough, as the most efficient way to manage the longevity risk of the tens of millions of American elderly, to pay a bit more for it—so that we can get what we’ve already been promised?

Social Security is not a giant burden to the US economy. Every year, $1 trillion that would have gone into the bank accounts of workers goes into the bank accounts of retirees. They spend it into the economy. Workers receive incremental credits toward a guaranteed life-contingent pension.

The banking system—the economy—enjoys the same amount of reserves either way, and can lend just as much to businesses. High-income managers, professionals and business owners continue to contribute the maximum to their 401(k) accounts. 

Critics of Social Security say it should be pre-funded. It has been. Starting in the late 1980s, pre-Boomers and Boomers paid trillions of dollars more in Social Security taxes than flowed out as benefits. The trust fund—still more than $2 trillion—reflects the pre-funding. 

It is said that Social Security is a bum deal for high earners, because it replaces relatively less of their pre-retirement income than of low earners’ pre-retirement income. But high earners receive much larger benefits than low income earners. And because they are healthier, on average, they tend to collect longer. 

A dual-income professional couple who waited to claim the maximum benefit at age 70 would receive as much as $4,200 a month each in 2022 from Social Security. That benefit is protected from market risk, inflation risk, sequence risk, and longevity risk. A comparably safe single premium immediate retail annuity would cost a man about $700,000 and a woman about $750,000, according to immediateannuities.com. 

Those who recommend that we replace Social Security with a national defined contribution (DC) retirement system underestimate the difficult of switching from social insurance to investment-driven retirement savings, judging by other countries’ experience. 

National DC typically calls for large mandatory contributions from employers, a centrally managed pension fund with illiquid individual accounts, a means-tested minimum benefit for those who’ve never worked, a “smoothing” mechanism so that market volatility doesn’t create winners and losers, and often a requirement for at least partial annuitization. You can’t just throw a lever and divert half of the payroll tax to target-date funds.

The politics of designing and implementing such a system in the US would be even more difficult and time-consuming than fixing Social Security, which needs only a few  fiscal tweaks. It would take many years to pilot a new DC system through our contentious, erratic, lobbied and game-able legislative process. 

We don’t have many years. 

© 2022 RIJ Publishing LLC. All rights reserved.

Who Has ‘Three Legs at Evening’? (The Elderly)

Posted on May 12, 2022 by -

The red granite Sphinx of Ramses II, all 13 tons of it, used to recline on its lion-haunches in the Egyptian gallery at the Penn Museum in Philadelphia. The Wharton School’s Pension Research Council (PRC) once punctuated its Spring Symposiums with a white tablecloth supper there.

The PRC has hosted the two-day symposium since 1994. Selected from pension academics all over the world, six or eight authors offer slide-presentations of some of their latest research to an audience of several dozen representatives of universities, policy groups, and companies in the retirement industry. 

This year, for the third year in a row, the symposium happened on Zoom, on April 28 and 29. There was no elegant dinner, no live face-time with pension specialists (or, unfortunately, with a sphinx, whose lethal question, ‘What goes on four legs, then two, then three?’ refers to the stages of aging). [Penn’s sphinx has since been moved to a new gallery at the museum.]

“Real World Shocks and Retirement System Resiliency” was the theme of the 2022 Symposium. The papers looked at forces at work in the economy today—the entry of the Millennial generation into the workforce, COVID, the ever-rising costs of health care, and the growth in financial inequality—and their potential effects on retirement systems.

The conference dealt mainly with the public-policy side of retirement. On the private sector side, everyone asks: Will workers save enough? Will their investments perform well? Will they buy stocks, bonds, annuities, long-term care insurance, or reverse mortgages? 

On the public-sector side of retirement, the fate of the less-affluent 50% of American retirees tends to occupy much of the discussion. Their future well-being depends largely on whether social insurance—what the private sector calls entitlements—remains funded at current levels or not.  

Do the young face a tougher old age?

On average, Millennials (ages 26 to 41) aren’t doing the wealth-aggregating things, like marrying and buying homes, as much as their Boomer parents (ages 57 to 75) did at the same ages, according to Richard W. Johnson and Karen E. Smith of the Urban Institute.  

Since marriage and homeownership lead to (or are markers for) wealth accumulation over a lifetime, Millennials are less likely to be on track to replace at least 75% of their peak earnings in retirement as were Americans born in the early 1960s (68% on track) or the early 1940s (74%) on track.

But individual outcomes depend on lots of factors other than “generation.” On the plus side, Millennials are more likely to be college-educated, which correlates with higher earnings. Millennial women are more likely than their mothers to have jobs outside the home, and they’re more likely to keep working as they age. These are the Millennials most likely to have a secure retirement.

Those with only high school degrees and/or people of color will tend to fare less favorably, Johnson and Smith found. They have will have the most to lose if—as many of them fear—there’s no Social Security (or a Social Security with only 75% of today’s benefits) to cushion their retirements.

Less income, more illness at older ages

In their paper, “Retirement Security and Health Costs,” Glenn Follette of the Federal Reserve Board and Louise Sheiner of the Brookings Institution assemble a mountain of data to figure out the future growth of health care costs, the degree to which it will fall on the individuals of different wealth levels, the implications for federal policy and the potential impact on the national debt. 

“Health care spending by the elderly is a much higher fraction of their income than it is for the population in general,” they found. That’s not surprising, given that the elderly usually don’t have earned income and have more health problems than younger people. The situation has improved, however. The poorest elderly spent an average of 45% of their income on premiums, co-pays and deductibles in 1996. By 2016, that group was paying less than 10% on average. 

The data also reflects a reduction in the growth of Medicare spending. “Total Medicare spending rose at a much slower pace than anticipated before the enactment of the ACA, with lower reimbursement rates the main driver, but lower utilization rates, and much lower spending on drugs were also important… Regardless of whether expressed in nominal dollars or as a share of GDP, by 2019, Medicare spending was about 20% lower than projected in 2009. This saved the federal government roughly $1 trillion from 2010 to 2019.”

Ready (or not) for retirement

Financial “inequality” is said to have been growing in the US and around the world. Some people consider that a big mystery. But after a 40-year bull market in stocks and bonds, the world seems clearly divided into those with investments (the richest 20% owns about 80% of equities) and those without (50% of Americans own few or no securities). 

Inequality inevitably affects retirement policy, because people without adequate savings will retire in poverty and rely more or less on social insurance, on local public services, and on informal care. So how is the increase in inequality affecting America’s overall “readiness” for retirement? 

That turns out to be a very hard question to answer. “Two researchers with very different retirement wealth adequacy yardsticks can look at the same wealth distributions and come to very different conclusions about the number of people facing retirement shortfalls, and how large those shortfalls might be,” according to John Sabelhaus of the University of Michigan and the Brookings Institution and Alice Henriques Volz, principal economist at the Federal Reserve. 

The data varies, but a young/old divide seems to exist. The Boomers and their parents, after all, enjoyed a bull market for much of their working years. 

“A large majority of the growth in average comprehensive wealth between 1995 and 2016 occurred at older ages,” Sabelhaus and Volz found. “Adjusting the wealth measure for expected social security funding shortfalls makes the age differentials even larger, especially for the bottom half of the wealth distribution. In fact, average comprehensive wealth is estimated to be lower in 2019 than it was in 1995 for younger individuals in the bottom 50% of their wealth distribution.” 

The young/old divide—on average—will be even more striking if younger people face weak markets and they lose Social Security. The retirement preparedness levels of the wealthiest 10% of Americans won’t change if Social Security benefits drop 25% across the board after 2034, Sabelhaus and Volz concluded. But such a cut in benefits would devastate the poorest of the Millennials.

© 2022 RIJ Publishing LLC. All rights reserved.

In the UK, private equity finds a NEST-ing ground

Posted on May 5, 2022 by -

NEST, the UK “master trust” that has expanded the availability of defined contribution savings plans to millions of middle-class British workers, will add private equity to its members’ portfolios. 

Schroders Capital will be NEST’s manager for the asset class, according to a report at IPE.com. A master trust in the UK is roughly comparable to a Pooled Employer Plan (PEP) in the US. PEPs were made possible by the SECURE Act of 2019.

NEST estimates it will have at least £1.5bn ($1.8bn) invested in private equity by early 2025. The master trust currently has assets of £24bn and gains more than £400m a month in new contributions. 

Many observers doubted that NEST would be able to find a private equity manager to work for the low expense ratio that NEST offered. NEST has been at the forefront of UK’s auto-enrolled master trusts expansion into illiquid assets. 

Fee constraints imposed by a manager charge-cap and stiff competition in the market have made it difficult for defined contribution (DC) schemes to add these more expensive strategies. But Schroders Capital was willing, and its emphasis on environmental, social and governance (ESG) companies aligned with NEST’s.

In the long run, NEST intends its centrally managed investment portfolio to allocate about 5% to private equity, on top of the 15% it already devotes to alternative assets such as real estate, private credit and infrastructure debt. NEST participates have notional accounts in the portfolio and do not manage their own assets.

Initially the private equity allocation will be for the early “foundation phase” of the NEST’s accumulation strategies which is accessed by the master trust’s youngest members as well as the subsequent “growth phase.” At age 55, as part of a glidepath toward lower volatility, NEST would transfer the private equity positions to younger participants’ accounts.

© 2022 RIJ Publishing LLC.

The ‘Retirement Income Consortium’ is Born

Posted on May 5, 2022 by -

A group of life insurers and asset managers has created a new industry group:  the Retirement Income Consortium (RIC). The founding members are AllianceBernstein, Allianz, BlackRock, Income America, Nationwide, Principal Financial Group, Prudential Financial and TIAA-Nuveen.

RIC’s overall goal is to “accelerate adoption of guaranteed income solutions in retirement plans,” according to a release this week. More specifically, it plans to  “develop a vetted due diligence framework for retirement income solution selection and monitoring.”

Broadridge, a fintech firm would provide some of the infrastructure for 401(k) income options,  provided a platform for RIC-related information on its website. Cannex, fi360 (a Broadridge company), Endeavor Retirement LLC (Lake Oswego, OR), and Michelle Richter, founder of Fiduciary Insurance Services LLC, are facilitators of the consortium. Richter is also executive director of IRIC, the Institutional Retirement Income Council.

The American Retirement Association, which encompasses the National Association of Plan Advisors (NAPA) and the Plan Sponsor Council of America (PSCA), has also joined the Consortium. It has “an independent initiative to create a curriculum for a new retirement income certification program,” the release said. 

Those who want to hear about RICs plans can join a 30-minute webinar on May 19, 2022 at 1 pm Eastern, titled “Introducing the Retirement Income Consortium.” Registration is free and open to the public. Register for the webinar here.

Nouns and verbs

A clear process by which defined contribution plan participants can convert all or part of their tax-deferred savings into a guaranteed revenue stream at retirement has long been a feature in non-profit 403(b) plans; TIAA pioneered it. But Department of Labor-regulated 401(k) plans, sponsored by for-profit companies, rarely offer them to active participants prior to retirement.

That’s partly because a clear legal and business process by which employers can evaluate, select, design and monitor so-called “in-plan” annuities for their participants hasn’t existed. While the SECURE Act of 2019 helped clarify the applicable labor law around annuities in 401(k) plans, it didn’t create a specific guide to conducting due diligence on income tools and providers.  

RIC’s goal is to formalize such a process. It will educate plan sponsors about income tools while remaining agnostic to the various types of tools and annuity products that its member-companies want to distribute to participants through retirement plans. 

Richter told RIJ that there’s an implicit barrier to retrofitting 401(k)s for income. On the one hand, plan sponsors are used to hiring financial professionals to give them advice on creating an investment menu for participants. 

But there is no training for financial professionals who can give plan sponsors advice on annuities, she said. And while the Alliance for Lifetime Income promotes income solutions to individuals, no one is advocating income solutions to plan sponsors.

“There’s been no centralized advocacy group for the income solution providers,” she said. “They’ve been on their own in wholesaling to the plan sponsor community. The Retirement Income Consortium will level the playing field for those of us who believe that we can deliver insurance in a way that supports fiduciaries. ERISA says you must have a prudent, well-documented process or you could be sued.” 

One of the barriers to annuities in 401(k) plans involves cost. Plan sponsors are sensitive about adding new fees to their plans; they’ve fought many lawsuits over the level of fees that their retirement plan providers charge participants. A new insurance product such as an annuity would add a potentially expensive new option to 401(k) plans. 

Michelle Richter

Plan sponsors need a framework for reconciling the expense of an annuity with the best interests of plan participants, said Richter. Her firm, Fiduciary Insurance Services LLC, is a provider of services that would be available within such a framework.

Today, “Insurance products are still perceived as expensive assets and not as efficient providers of liability management,” Richter said. We live in a regulatory regime where investment advisory services are “verbs” and insurance products are “nouns,” she explained. “There is a framework of verb sales to the left [asset] side of an individual’s persona balance sheet, but no framework of verb sales to the right [liability] side of the balance sheet.” 

This type of framework is a necessary but not sufficient condition for the distribution of annuities through 401(k) plans. Even if a framework for comparing income products is standardized, plan sponsors would find no standardized income solution. 

They will still face a bewildering landscape of variable, fixed, indexed, deferred, and immediate annuities—and possibly even tontines. These products are difficult to compare. They entail certain trade-offs that can’t easily be resolved by giving plan sponsors more information.  

By most accounts, plan sponsors won’t import annuities into their plans unless the products are “liquid.” That implies a variable or fixed indexed annuity with a “guaranteed lifetime withdrawal benefit” rider.

But those products are typically fee-heavy, complex, or both. At the same time, annuity issuers are striving to have their products bundled into QDIAs (Qualified Default Investment Alternatives) so that participants can be defaulted into them. Managed accounts and target-date funds are the prevalent QDIAs.

Without more demand from participants for income solutions, plan sponsors might hesitate to climb a daunting new learning curve. Demand for in-plan communities comes mainly from companies like the RIC members, who are looking for ways to capture 401(k) assets that will otherwise be rolled over to brokerage IRAs and lost to them. 

Most plan advisers are investment advisers, and they share a conviction that risk can be efficiently managed on the investment side alone, either through diversification of risky assets or by allocating more or less of a client’s portfolio to cash equivalents or TIPS. 

The idea that an investor or plan participant should pay an insurance company to haul away their risk, like asking 1-800-Got-Junk to empty their basement, is foreign to them. RIC will try to teach plan advisors and sponsors that removing longevity risk and market risk by purchasing an annuity or a guaranteed lifetime withdrawal rider should be a participant’s first step toward putting his or her retirement house in order.   

Jack Towarnicky, former executive director of the PSCA, remains skeptical of the demand or the need for in-plan income solutions.

“In my past plan sponsor roles, I did not encounter any financial organization that provided an in-plan guaranteed income solution which would appeal to more than a minimal number of my plan participants—if only because of tenure trends, where only a small minority of my plan participants actually retired upon leaving my firm,” Towarnicky told RIJ in an email. 

“Perhaps the consortium can focus on demonstrating why/how an in plan guaranteed income option would be superior to a choice of individual marketplace products so as to overcome the cost to implement/administer and the fiduciary risk in selection and monitoring.”

In the coming months, the Consortium will present a free educational webinar series covering the essentials of in-plan retirement income, starting with “Retirement Income: Why Now?” Registration is free and continuing education credits are available. Registration and replays will be available through the Consortium website.

© 2022 RIJ Publishing LLC. All rights reserved.

Why RIJ Obsesses over the ‘Bermuda Triangle’

Posted on May 5, 2022 by -

As an RIJ reader, you might have wondered why we spend so much editorial space on the ‘Bermuda Triangle’ phenomenon. There are three main reasons. 

First, the obvious. The annuity business is our wheelhouse. Annuities (and life insurance, to a lesser extent) are an essential ingredient of the Bermuda Triangle strategy.

Second, if the insurance business is a black box, the Bermuda Triangle is a black box within a black box. Outsiders—competitors, regulators, investors—want to know what’s happening inside of it.

Third, the Bermuda Triangle strategy contains echoes of the home mortgage crisis of 2008. It just may contain the seeds of another financial disaster.

Private equity is no longer a sideshow in the annuity industry. Its involvement is now the main event. But we know too little about its growing role in this space.

Let’s unpack those points of interest one by one. [Newcomers can find a definition of the Bermuda Triangle strategy in the last section of this article.] 

A problematic foundation 

Yield-hungry individual investors bought some $63 billion worth of fixed indexed annuities (FIAs) and $53 billion worth of fixed-rate annuities in 2021. FIAs are complex and opaque products, but people typically buy them (often without understanding them) because they yield more than bonds—and because selling agents are highly incentivized and aggressive. But those factors are not new. 

What’s new is that there’s more supply than ever: Life insurers that once ignored FIAs  now sell them because they’re less capital-intensive than other types of annuities. What’s also new is the degree to which sales are driven by the requirements of the private equity companies that manage an increasing share of life insurer general account assets.

Private equity firms love FIA premiums because they’re a source of long-dated and illiquid deposits (“sticky”or “permanent” capital, in industry jargon) that the firms can lend at relatively high rates of interest to high-risk borrowers. They bundle the loans, securitize them, create tranches of varied risk levels, and sell the tranches to life insurers and other yield-starved investors worldwide. 

Does this dynamic encourage suitable sales of commission-driven FIAs? Is the commission-driven FIA the right product on which to build the future of the life/annuity business? My impression is that buyers of long-dated FIAs are over-paying for the protection and/or upside potential they get—too much in terms of opportunity costs, if not in fees—without knowing it. 

Too much privacy, too little transparency

Transparency is a sine qua non of trust, and not much about the Bermuda Triangle strategy is transparent. Private assets exist outside the public markets. The newest custom indexes that drive the returns of FIAs are hard to understand. 

When one holding company controls all three partners in a Bermuda Triangle strategy—the annuity issuer, the reinsurer and the asset manager—no one can see whether or not transactions between affiliates are as fairly priced as they would be between unrelated counter-parties.

Ratings agencies say they can see the assets held by reinsurers in Bermuda, but the exact nature of those assets are not available for public review. The “modified coinsurance” and “funds withheld” forms of reinsurance that characterize most Bermuda Triangle reinsurance transactions are not widely understood, and have been described by academics as “shadow insurance.” Financial shadows call for sunlight. 

Participants in the Bermuda Triangle strategy tell me that the current regulatory and legislative regimes governing their business are adequate. But regulators don’t necessarily agree. The NAIC has convened new task forces to address questions about the Bermuda Triangle strategy (without using that moniker). 

The Senate Banking Committee chairman has asked for a formal briefing from the NAIC and the Federal Insurance Office on private equity involvement in the life/annuity business. There are many unanswered questions.

Seeds of crisis

Before the home mortgage crisis of 2008, houses were considered the safest of investments. Investors in mortgage-backed securities took comfort in the idea that there had never been a meltdown in housing prices. You hear the same about the life/annuity industry: It has a history of stability.

But in the housing crisis, banks lost their incentive not to lend to high-risk borrowers. They were writing mortgages and selling them to FannieMae and FreddieMac. Something similar may be happening in annuities. Issuers increasingly send the liabilities to reinsurers and the assets to asset managers. The asset managers repackage the investment risk and sell it to third-party investors. The issuers bear less risk and require less capital.  

A so-called “capital light” fee-based business may be more profitable, but it also has less skin in the game. Is it even still an insurance company, let alone one that people will entrust with their retirement savings for periods of up to 30 years? Or has it become a mere storefront for annuity sales?

An annuity-fueled crisis wouldn’t necessarily start with the large firms that pioneered the Bermuda Triangle strategy. It could start with the failure of small or hastily assembled copycats of the pioneers’ business models. In classical fashion, it could start after the insurers and asset managers have accepted in-flows far in excess of the availability of worthwhile investment targets. We’ve seen that movie before.

A bit of background 

What RIJ calls “the Bermuda Triangle” is a synergistic, much-varied business model involving a kind of triple accounting play between: 

  • A US domiciled life insurer that issues fixed-rate or fixed indexed annuities
  • An asset manager with global reach and expertise in alternative assets and origination of high-yield loans
  • A reinsurer in a jurisdiction (e.g., Bermuda, Cayman Islands, Vermont) that permits the valuation of annuity liabilities according to Generally Accepted Accounting Principles (GAAP) along with or instead of the more conservative Statutory Accounting Principles required of all US life insurers 

In the Bermuda Triangle’s purest form, all three players belong to the same holding company. They may also have some overlapping ownership, or may be strategic partners. Life insurers who employ all or part of the Bermuda Triangle strategy include leading FA and/or FIA sellers like Athene Annuity & Life, Global Atlantic, AIG, MassMutual, and others. Together, Bermuda Triangle companies accounted for about half of the $116.8 billion in 2021 fixed-rate/fixed indexed annuity sales reported by LIMRA’s Secure Retirement Institute.

© 2022 RIJ Publishing LLC. All rights reserved.