Archives: Articles

IssueM Articles

Bond Market Frets Over Treasury Supply

Posted on March 1, 2018 by Stephen Slifer -

Inflation fears sent the stock market into a tizzy in late January and early February. Those same fears rattled the bond market and boosted longterm interest rates. However, the fear of a sharp pickup in the inflation rate seems to have subsided and the stock market has recovered about half of what it lost. A rising inflation rate troubles the bond market as well, but its attention recently has shifted to larger budget deficits and increased Treasury supply in the years ahead. As a result, bond yields have jumped 0.5% since the end of last year.

Economists have been talking about escalating budget deficits for ages but, until now, the bond market has largely shrugged off any such concern. Politicians occasionally express some alarm, but they have been unwilling to do anything. Are rising bond yields an indication that budget deficits finally matter? Will our politicians in Washington be willing to do something? Our conclusion is that we are years away from any serious budget reform.

In late January the fear was that the economy was overheating, inflation was going to climb appreciably, and the Fed would be forced to raise rates more quickly than had been anticipated. The stock market swooned and registered its first “correction” in a couple of years. As is often the case the stock market overreacted. It still believes the economy has gathered momentum, inflation is headed higher, and the Fed may raise four times this year rather than three, but it now expects the interest rate ascent over time to be more gradual. As a result, the S&P 500 index has recovered about half of its earlier loss.

The bond market has not been so lucky. Bond yields have jumped 0.5% since the end of last year from 2.4% to 2.9%. While we thought that bond yields would rise in 2018, the runup has occurred much more quickly than we had anticipated. So, what’s bugging the bond market? Is it inflation, or is something else to blame? Our conclusion is that inflation has played a small role, but the bond market’s greatest fear currently is Treasury supply.

Long-term interest rates are closely tied to expectations of inflation. The measure of inflationary expectations we like the best is the implied inflation rate from the bond market. The Treasury has a nominal rate on the 10year note. It also has an inflationadjusted rate on the 10year note. The difference between the two represents an implied 10year inflation rate. It has risen in recent months but, at 2.1%, it can hardly be called troublesome and would not bother the Fed in the slightest.

First, tax cuts. The Congressional Budget Office initially estimated that they would add $1.5 trillion to budget deficits and debt outstanding during the next 10 years. Even if it tried to estimate the “dynamic” effects of the budget buts – i.e., tax cuts will stimulate GDP growth, generate more tax revenue, and partially offset some of the loss of tax revenue caused by the lower rates — the CBO still estimated that the deficit would increase by $1.0 trillion. While that estimate is still too high, the important point is that the recently enacted tax legislation will almost certainly boost budget deficits relative to the forecasts shown above – which were already problematical.

Second, President Trump and Congress agreed on a 20182019 budget deal which will increase both defense and nondefense spending. That additional spending will boost budget deficits for the next couple of years by an additional $300600 billion. No wonder the bond market is spooked. There is no longer any pretense of fiscal restraint.

Budget deficits matter because they add to the debt outstanding. If the government runs a $1.0 trillion budget deficit, the Treasury is forced to issue an additional $1.0 trillion of debt to finance that deficit. Debt as a percent of GDP today is 77%. It is expected to increase to 86% by 2026 and continue climbing to 125% of GDP within 20 years. And remember, these numbers were done prior to the tax cuts and prior to the increases in spending agreed upon over the next two years. They will go higher. Economists tend to believe that a debt to GDP ratio in excess of 90% can create problems.

Why? First, the ratings agencies may (once again) choose to downgrade Treasury debt which would increase the Treasury’s cost of borrowing. Second, the Fed will be reducing its holdings of U.S. Treasury bonds in the years ahead as it tries to shrink its balance sheet to a more sustainable level. Third, China and other foreign governments may be less willing to hold U.S. debt. They collectively own $6.3 trillion (or 42%) of the $14.8 billion such debt outstanding.

Foreign central banks cannot significantly reduce their holdings of U.S. Treasury debt because no other sovereign market is big enough to allow that to happen in any size. But they could at the margin cut back on their willingness to own U.S. Treasury debt and substitute euro or yendenominated debt instead. With Treasury debt poised to escalate any such marginal cutback would be bad news.

For purposes of comparison, the debt to GDP ratio for Greece is currently 180%. Prior to the recession the debt/GDP ratio in Greece was 103%. The recession boosted its budget deficits, triggered a crisis, and Greece had to be bailed out by its European Union partners. A recession in the U.S. at some point, which is inevitable, would exacerbate its debt woes. The U.S. may not be Greece, but there are lessons to be learned. Countries that do not prudently manage their government spending typically experience an unhappy ending.

Without wanting to be unduly alarmist, the U.S. has a problem. And the saddest part is that nobody in Washington seems willing to do anything about it. Because entitlement spending represents two-thirds of all government spending, the above situation is not going to be resolved without cutbacks in Social Security, Medicare, Medicaid, veterans’ benefits, and welfare benefits. And that is not going to change under this president. Any effort to reign in government spending is years down the road.

Homage to Andalusia

Posted on March 1, 2018 by Kerry Pechter -

In the tiny Pennsylvania borough where I live, you rarely see clusters of older people gathered outdoors in February—not unless it’s “$4 night” at our downtown movie house and a popular film is showing. Blockbuster, RedBox, Netflix and Amazon Prime have all failed to retire our 70-year-old Emmaus Theater.

But in Seville, Spain, where I spent part of January and February, you see lots of older people outside day and night. The sight of strolling elderly couples, of pensioners perched at pub tables outside the tapas bars, of matrons choosing bug-eyed langoustinos from beds of ice chips in La Mercado de Triana, made Seville seem like a convivial spot to grow old in.

Like illness, social isolation is a serious hazard of old age. In Pennsylvania, where cold weather can keep retirees housebound for months, the risk of a lonely old age feels very real. But no such problem seemed to exist in Andalusia, a sunny, arid region of southwestern Spain that has been ruled by successive waves of Tartessians, Carthaginians, Romans, Visigoths, and Moors before evolving into the Spain we know today.

It felt sometimes as if those foreign invaders never entirely left Seville, thanks to the palaces, churches and fortifications they left behind—and thanks to the ongoing invasion by tourists. Spain averages about 1.6 million tourists a week. Platoons of Chinese arrive by the busload. In the Barrio Santa Cruz, where the famous Alcazar Palace and Giralda Tower are located, the tourists (along with an army of attendant waiters, street musicians, gypsies selling rosemary sprigs, and drivers of horse-drawn carriages) generate a kind of manufactured buzz that amplifies the local buzz.

But the tourist trade doesn’t entirely explain the impression of an ongoing, entertaining circus of activity throughout the day and evening in Seville, a city of about 700,000. Across the Guadalquivir River (the name means “Big River” in transliterated Arabic) from the Barrio Santa Cruz, there’s a busy middle-class neighborhood called Triana. Local residents of all ages fill the pedestrian malls and the outdoor tables of sidewalk restaurants there. North of Barrio Santa Cruz, there’s a large open space called the Alameda de Hercules that’s lined with cafes. Outside one of them, a couple of dozen people in their 20s were swing-dancing to Big Band music. That was in the middle of a weekday.

Seville’s festivity doesn’t stop the inevitable consequences of old age, of course. While exploring one of the narrow stone-paved alleys (where old granite millwheels or “botarruedas” still reinforce the lower walls of villas, hostels and hotels), I saw a sign that said, Centro de Mayores, or Senior Center. Visible through a plate glass window was a group of pale, slow-moving, white-haired men and women in grey gowns. A few grasped the handles of walkers or slumped in wheelchairs. Their dayroom was clean and bright with garish fluorescent light. My request to enter and look around was politely denied.

A desire to research Spain’s retirement system for RIJ was my initial inspiration for visiting Seville. What I learned helped explain what I saw on the streets. For the past few decades at least, a typical male average-income worker in Spain could expect to retire at age 65 on a pension that replaces about 80% of his final or near-to-final income. After Greece, Spain has had the most generous national pension in the European Union.

The pension (along with the national health care system) is funded by a payroll tax of about 30%, of which employers pay 25%. This system isn’t quite as secure as it might sound: Housewives, as well as the owners and employees of Spain’s many small businesses, can fall outside of pension coverage. But the ample pension may explain the lack of anxiety that many people in Seville seemed to enjoy. As I reported a few weeks ago, however, the Spanish social security system is running an annual deficit of about $18 billion.

As for the young swing-dancers and buskers that made Seville’s streetscape so lively—their presence might have been a symptom Spain’s unemployment crisis. Nationally, the jobless rate is about 18%, down from about 25% during the Eurozone’s 2010 financial crisis. To achieve even an 18% rate, Spanish workers had to accept an across-the-board pay cut of up to 15%. Spain has succeeded in attracting tourists and foreign investment precisely because of that humbling “internal devaluation.”

A cynic might attribute Seville’s charms to a tourist’s illusions—a sunglasses-tinted view of a first-world society that is, frankly, enduring hard times. Still, the city’s residents radiated a modest, comforting joie de vivre (and an implicit desire to be in each other’s company) that I rarely feel back in Emmaus, Pa. It satisfied my inner hunger for the presence of lots of other people and the potential to know them. That, along with the reliable Andalusian sunshine, made me and my spouse think seriously about returning, if not retiring, to Seville.

Flight to passive funds continued in January: Morningstar

Posted on March 1, 2018 by Editorial Staff -

Investors started out the year by strongly declaring their preference for passive U.S. equity funds, which saw their largest monthly inflow since December 2016, according to “Morningstar Direct Asset Flows Commentary: United States,” which was released this week.

“Far from running away from the U.S. stock market, investors were eager to embrace it and its stable returns—but in the form of low-cost offerings only, it seems. ‘Returns,’ in this context, only refers to January and does not include February’s polar plunge, which saw the S&P 500 drop 7% through Feb. 12,” the report said.

According to the report:

Taxable-bonds front received a total inflow of $47.0 billion, almost equally distributed between active and passive. After raising short-term interest rates three times in 2017, the Federal Reserve decided to leave them unchanged at its first 2018 meeting on Jan. 30, which was also Janet Yellen’s last meeting as chairwoman.

International equity attracted $41.9 billion, with the majority of those flows going to passive funds.

Large blend was the overall top-flowing category in January despite a $7.3 billion outflow on the active side. Investors who switch to passive tend to prefer blend funds because they’re a good middle-of-the-road option between growth and value. Diversified emerging markets and foreign large blend were also in the top five but, unlike large blend, with positive flows on both the active and passive side. So was intermediate-term bond.

The trend of transferring assets to lower-cost, passive vehicles is continuing to expand to asset classes other than U.S. equity, where it started. Judging by flows, investors have given up on active management for U.S. equity, still find some value in it for international equity, and consider it highly valuable for fixed income.

High-yield bonds experienced outflows for the fourth consecutive month. The Tax Cuts and Jobs Act may have prompted some of the outflows, because it is limiting the tax-deductible amount of interest expenses.

High-yield debt companies will be negatively affected by this new provision because their interest expenses are much higher, and not being able to write them off will adversely affect profitability.

On the active side, American Funds rallied in January with a $7.9 billion inflow (all its funds are active). The two funds with the largest inflows were American Funds Tax Exempt Bond AFTEX and American Funds Europacific Growth AEPGX. Most of the top 10 companies enjoyed healthy flows in January. The few that did not do so well included Franklin Templeton and J.P. Morgan.

State Street enjoyed a second month of double-digit billion-dollar flows and almost caught up with Vanguard in terms of passive flows. Their flagship ETF, SPDR S&P 500 SPY, attracted the majority of the incoming money.

Ameriprise settles SEC claims that it over-charged retirement clients by $1.78 million

Posted on March 1, 2018 by Editorial Staff -

Ameriprise Financial Services Inc., the Minnesota-based broker-dealer and investment adviser, recommended and sold higher-fee mutual fund shares to retail retirement account customers and failed to provide sales charge waivers, the Securities and Exchange Commission announced this week.

Without admitting or denying the findings, Ameriprise consented to a cease-and-desist order, a censure, and a penalty of $230,000, the SEC said in a release. The SEC found that Ameriprise violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933.

Approximately 1,791 customer accounts paid a total of $1,778,592.31 in unnecessary up-front sales charges, contingent deferred sales charges, and higher ongoing fees and expenses as a result of Ameriprise’s practices, the SEC said.

Ameriprise “has cooperated with the Commission and voluntarily identified the affected accounts, issued payments including interest to the affected customers, and converted eligible customers to the mutual fund share class with the lowest expenses for which they are eligible, at no cost,” the SEC release added.

Ameriprise “disadvantaged certain retirement account customers by failing to ascertain their eligibility for less-expensive mutual fund share classes” and “recommended and sold these customers more expensive mutual fund share classes when less expensive share classes were available,” the release added.

Ameriprise also failed to disclose that it would receive greater compensation from the purchases and that the purchases would negatively impact the overall return on the customers’ investments, the SEC said.

‘Ameriprise generated greater revenue for itself but lower returns for its retirement account customers by recommending higher-fee share classes,” said Anthony S. Kelly, Co-Chief of the SEC Enforcement Division’s Asset Management Unit, in a prepared statement.

”As evidenced by our recently announced Share Class Selection Disclosure Initiative, pursuing these types of actions remains a priority for the Division as we seek to get money back in the hands of harmed investors.”

The SEC’s investigation was conducted by Salvatore Massa, Steven J. Meiner, and John Farinacci of the Asset Management Unit, and supervised by Jessica M. Weissman.

Stock buybacks reach $113.4 billion in February: TrimTabs

Posted on March 1, 2018 by Editorial Staff -

Stock buyback announcements were high in February, suggesting that many corporate executives are using proceeds from the recent corporate income tax cut to support the stock prices on which much of their compensation is based, research firm TrimTabs reported this week.

New stock buybacks totaled $113.4 billion through February 22, which is already the highest volume in any month since April 2015. The largest announcements have been from:

Cisco Systems ($25.0 billion)
Wells Fargo ($22.7 billion)
AbbVie ($10.0 billion)
Amgen ($10.0 billion)
Google ($8.6 billion)
Visa ($7.5 billion)

Despite the $1,000 one-time bonus checks reportedly paid out to employees by various large employers subsequent to the passage of the new tax law, the buyback spurt indicates that the corporate tax cut may be helping business owners and investors even more.

At the same time, corporate liquidity flows have slowed amid the recent spike in equity volatility. Through Thursday, February 22, only $12.5 billion in cash had been committed to buy U.S. public companies in February. New equity issuance has slowed to $10.3 billion. Both of these volumes are among the lowest in the past year, TrimTabs reported.

U.S. ETF assets top $3.6 trillion: Cerulli

Posted on March 1, 2018 by Editorial Staff -

Investors added a net $51.3 billion into mutual funds in January, the highest monthly figure in over three years, according to the February 2018 issue of The Cerulli Edge–U.S. Monthly Product Trends Edition.

Total asset value grew 3.4%, to more than $15 trillion. ETF assets grew 6.1% month-over-month to more than $3.6 trillion, attracting net flows of more than $76.0 billion and 2.2% organic growth (growth achieved by internal investments of the firm as opposed to mergers or acquisitions).

In response to the steady migration to index funds and ETFs, “many asset managers are looking to multi-asset-class investments as a way to reestablish their competitive position,” Cerulli said in a release. Retail wealth management firms, like institutional asset managers, can address specific risks in investor portfolios by creating packaged multi-asset-class investments, Cerulli believes.

Most advisors (81%) agree that active management is ideal for certain asset classes, the release said. “Across all channels, advisors reported that actively managed ETFs make up 11% of their allocation across both active and passive products,” Cerulli said. “While this may be a small sleeve of advisor portfolios, this allocation persists among larger practices.”

If jobs were more flexible, seniors would work longer: NBER

Posted on March 1, 2018 by Editorial Staff -

There is a large, untapped pool of older Americans who have a strong desire to keep working, sometimes at wages significantly lower than the ones they earned previously, but only if they could have flexible work schedules.

That finding was expressed in “Older Americans Would Work Longer if Jobs Were Flexible,” an NBER Working Paper by John Ameriks, Joseph S. Briggs, Andrew Caplin, Minjoon Lee, Matthew D. Shapiro, and Christopher Tonetti. “About 40% of retirees surveyed were willing to return to work in a job like their previous one, but 60% would return if the schedule were flexible,” an NBER summary of the paper said.

The researchers’ primary data source was the Vanguard Research Initiative, a linked survey-administrative data panel drawn from account holders at The Vanguard Group, Inc. The researchers used the sample of 3,000 respondents who completed a survey related to later-in-life labor market activities. The survey focused on labor market participation and retirement, including a detailed history of employment, job search behavior, retirement paths, and employment in post-career “bridge” jobs.

About 40% of retirees—33% of those who did not have a bridge job and 44% of those who did—said they were willing to work if all the conditions were the same as in their last job, including wages and total hours, but 60% would be willing to return to work with a flexible schedule.

In addition, 20% of retirees would be willing to take an hourly wage reduction of 20% or more in return for more flexible hours.
Among those who had not held a post-career “bridge” job, the researchers found that only 11% had searched for a job opportunity after leaving their career job, but a third of them would be willing to work again in a job that had characteristics similar to their previous one.

The researchers concluded that demand-side factors play an important role in explaining later-life labor market behavior, writing that “older Americans’ labor force participation near and after normal retirement ages is limited more by a lack of acceptable job opportunities or low expectations about finding them, in particular jobs with part-time or flexible schedules, than by unwillingness to work longer.”

The share of Americans over 65 is projected to hit 40% by 2050, up from 20% in 2007. As the percentage of older Americans rises, concern is growing about the financial strains associated with a larger number of retirees being supported by each active worker. There’s also worry that some employers may face labor shortages, the paper’s authors found.

A possible response would be to enact or encourage policies that would allow older Americans to work beyond traditional retirement ages. Determining what sort of policies would encourage longer working lives is challenging because it is difficult to disentangle the roles of labor supply and labor demand in determining existing patterns of later-life labor market behavior, the NBER summary said.

Annuity Industry Sales Estimates

Posted on February 28, 2018 by Editorial Staff -

Source: LIMRA Secure Retirement Institute, Feb 21, 2018

Building a Personal Pension, a Month at a Time

Posted on February 22, 2018 by Kerry Pechter -

Prudential Financial intends to join a quiet but intriguing new trend in retirement income: The sale of multi-premium deferred income annuities more or less directly to the public through the Internet.

The new Prudential product is called Guaranteed Income for Tomorrow, or GIFT, and it will be “initially distributed through direct response solicitation through our Group Insurance business,” according to Prudential’s 10-K report for 2017, filed last Friday, February 16.

A Prudential Financial spokesperson declined to comment on the product, but it is described in a filing by Prudential Annuities Life Assurance Company with the Washington DC Department of Insurance and Securities Regulation (a local, not federal agency) last August 17.

Prudential’s GIFT will be marketed at first through Prudential’s group insurance business, which currently offers a guaranteed lifetime income benefit rider, called IncomeFlex, to participants in the full-service defined contribution plans that Prudential administers.

“It’s a DIA [deferred income annuity] with a minimum delay of 13 months,” said Tamiko Toland, head of annuity research at CANNEX, which provides annuity data to broker-dealers. “It’s marketed to group participants but it’s an individual contract. It’s a direct offer from Prudential to participants.”

“It doesn’t appear to be a replacement for IncomeFlex [Prudential’s 401(k) in-plan lifetime income offering], since it’s not offered through the [401(k)] plan itself,” Toland said. “It’s non-qualified so it’s not a QLAC [qualified longevity annuity contract]. This will be web-based and they are creating a platform specifically for that purpose. It requires a registration process and initially [contract owners] must receive all documentation electronically.”

Another industry source told RIJ, “It’s a payroll deduction program. [Prudential is] offering it as a part of the employee benefits options. The employee can have money put into their 401(k), into their medical benefits, and also into the GIFT annuity.” Foresters Financial offers a similar payroll-deduction annuity, the source added.

Matt Carey of Blueprint Income, a direct-sale online platform that currently sells multi-premium DIAs from several life insurers, told RIJ this week, “It’s great to see more insurers get into this market and we think highly of the Prudential team working on it. The future of the annuity market is digital. And the low minimum subscription DIA is the right way to re-imagine what an annuity should be—simple, low barrier-to-entry and built exclusively to provide income. We think what Prudential’s doing is further validation of that.”

Contract owners would presumably buy a chunk of future income every time they make an automatic payment from their bank account or payroll deferral. In theory, buying a pension could become as easy and as painless as paying a monthly Netflix bill or making any other type of automatic payment.

How much would it cost to buy a personal pension on a monthly installment plan? According to the calculator on Blueprint Income’s website, at today’s rates, a 40-year-old male could get an income of $1,000 per month for life starting at age 65 by making an initial purchase payment of $5,000 and subsequent monthly contributions of $127 per month (rising 10% per year for 25 years) or $233 per month (rising 5% per year).

A similar calculator offered on Nationwide’s GRIN (Guaranteed Retirement Income from Nationwide) website shows that a 35-year-old male contributing $300 per month for 30 years would receive $1,118 a month for life starting at age 65. (For more on GRIN, see below.)

According to the Washington, DC, filing, Prudential is leaving open the possibility that it may market the product through advisors as well as online and that it may accept tax-deferred as well as post-tax money. At present, the offering is for single-life contracts only. Contract owners will be able to change their income start date at least once. The minimum contribution is $100. The latest income start age is 84.

GIFT “will be marketed through direct response solicitation to consumers,” the filing said. “We intend to collect the information needed to issue the annuity via a secure online process described in the attached Appendix A. In the future, we may offer the submitted annuity through traditional channels including advisor-sold channels.”

Like most deferred income annuities, GIFT will have no cash value. But a death benefit equal to the paid-in premium (adjusted for taxes and fees) will be paid if the contract owner dies before income payments begin. An installment refund equal to un-disbursed premium will be paid to the beneficiaries if the contract owner dies before the entire premium has been paid out.

“Annuity income payments from this contract will be in the form of payments for life with an installment refund. Annuity income payments under this contract may not be accelerated, advanced or commuted. The contract has no cash surrender value and surrender/withdrawals are not permitted. A death benefit, equal to the purchase payment(s) adjusted for any premium taxes, is payable upon death before annuity income payments begin,” the DC filing said.

Americans arguably need vehicles for buying retirement income with incremental contributions to a deferred annuity over their lifetimes. Defined contribution plans typically do not and cannot easily offer such a service (TIAA’s 403(b) plan is an exception), although MetLife attempted to introduce an in-plan multi-premium personal pensions with its unrealized SponsorMatch venture before the financial crisis.

So far, mutual insurers New York Life and Guardian offer multi-premium deferred income annuities direct to consumers (with the mediation of insurance-licensed agents) through the Blueprint Income (formerly Abaris.com) website, Blueprint Income’s Carey said.

Nationwide has been testing the same concept, which it calls GRIN, within the state of Arizona. “With GRIN, we’re selling a DIA on a stand-alone basis” rather than as a part of a comprehensive retirement plan, Eric Henderson, Nationwide’s senior vice president for annuities, told RIJ last November. “We’re relying on the simplicity of the offer: ‘You give us $100 a month today and we’ll pay you $210 a month in retirement,’ for instance.”

GRIN’s target market is middle-class people in mid-life who do not have 401(k)s and do not work with financial advisors. “If you look at it mathematically, the DIA makes a lot of sense,” Henderson said. “If you look at it emotionally, it can be a hard sell because there’s no immediate gratification. So it becomes a matter of how you position it and how you talk about it.”

Annuity Sales Declined in 2017: LIMRA

Posted on February 22, 2018 by Editorial Staff -

In 2017, total annuity sales decreased 8% to $203.5 billion compared with 2016, according to LIMRA Secure Retirement Institute’s Fourth Quarter 2017 U.S. Individual Annuity Sales Survey.

After six consecutive quarters of decline, the fourth quarter results for total annuity sales were flat, compared to this quarter last year, at $50.8 billion. This is a 9% rebound from the 16-year low in the third quarter of 2017.

“The implementation of the DOL fiduciary rule in 2017 had a significant impact on the individual annuity market,” said Todd Giesing, director, Annuity Research, LIMRA Secure Retirement Institute. “The impact to IRA annuity sales was much more pronounced than nonqualified annuity sales.”

U.S. variable annuity (VA) sales were $24.7 billion in the fourth quarter, down two percent compared with prior year results. Total VA sales for 2017 were $95.6 billion—nine percent lower than 2016. This marks the first time in almost 20 years annual VA sales have fallen below $100 billion.

Structured annuities were one of the bright spots in the annuity market in 2017. Structured annuity sales leveled off in the fourth quarter, but were up 10% compared to fourth quarter 2016. For the year, structured annuity sales were up 25% to $9.2 billion compared to 2016. “Structured annuity sales continue to attract individuals looking for a balance between investment return and downside protection”, Giesing noted. “Structured annuity sales saw impressive growth through Independent BD’s in 2017.”

Total fixed annuity sales increased in the fourth quarter, up two percent to $26.1 billion. For the year, fixed annuity sales fell 8% to $107.9 billion. Despite this decline, annual fixed annuity sales surpassed $100 billion for the third consecutive year. Based on Institute research, this is the first time this has occurred.

Fourth quarter indexed annuity sales totaled $14.7 billion, a 7% rebound from prior quarter and a 5% increase, compared with fourth quarter 2016 results. For the year, fixed annuity sales fell 5% to $57.6 billion, compared with prior year. This is the first year since 2009 where annual indexed annuity sales declined.

Fixed rate deferred annuities (Book Value and MVA) sales dropped 4% in the fourth quarter to $7.4 billion. Full year fixed-rate deferred annuity sales for 2017 were $34.2 billion, 12% lower compared to 2016 results.

“Sales of these products generally align with the 10-year treasury rate yet that didn’t occur again this quarter,” Giesing said. “People just seem to be looking for shorter-term investments anticipating increases in interest rates in 2018.”

Immediate income annuity sales rose 5 percent in the fourth quarter to $2.1 billion. For the year, income annuity sales dropped 10%, to $8.3 billion. In contrast, deferred income annuity (DIA) dropped 5% to $550 million in the fourth quarter.

The fourth quarter 2017 Annuities Industry Estimates can be found in LIMRA’s Data Bank. To view variable, fixed and total annuity sales over the past 10 years, please visit Annuity Sales 2008-2017.

IRI Presents its Lobbying Goals for 2018

Posted on February 22, 2018 by Kerry Pechter -

During the Obama administration, the lobbyists at Insured Retirement Institute faced a wind tunnel’s worth of political headwinds. Obama’s Labor Department appointees, especially Phyllis Borzi at the Employee Benefits Security Administration (EBSA), were skeptical if not hostile to the variable and indexed annuities that IRI’s members manufacture and distribute.

Today, with a pro-business President in the Oval Office, a Republican-dominated Congress and Preston Rutledge, a longtime retirement industry ally, running EBSA, the IRI would appear to have the wind at its back for the first time since it was born in October 2008 as a successor to the old National Association for Variable Annuities.

But the mood at yesterday’s IRI press conference, which was held to announce IRI’s lobbying agenda for 2018, was not especially upbeat or confident. Perhaps that’s because IRI has already had a year to witness how difficult it can be to pass any new retirement legislation or change any regulation in our nation’s divided and dysfunctional capital city, even with a pro-business administration in power.

The year was not a disaster, of course—the benefit of tax-deferral for contributions to retirement plans survived the tax overhaul. But now we’ve entered a tumultuous mid-term election year when legislators are likely to be distracted.

It’s not as if IRI is calling for anything new and unfamiliar. Its 2018 Retirement Security Blueprint agenda includes several items that asset managers and life insurance companies have desired for several years. Nor is “retirement security” a very controversial issue; the details can be politically contentious, but in normal times it attracts bipartisan support. Unfortunately, the times aren’t normal.

New wish list

What’s on the IRI agenda? You can find it in the IRI’s own words below. It asks (as it has before) for the creation of a regulatory “safe harbor” that would exempt plan sponsors from liability in case their conscientiously selected provider of an in-plan annuity (a life insurer) should fail. The lack of such a safe harbor has kept life insurers out of the 401(k) market.

The IRI also hopes to see legislative or regulatory changes that would allow for the creation of so-called Open MEPs, or multi-employer plans. Under current law, unrelated small companies can’t band together to buy a 401(k) plan, nor are MEP members currently protected from collective responsibility for the misdeeds of one of the companies in the plan. The lack of these changes prevents large asset managers and retirement plan providers from serving the small-company market economically.

In addition, the IRI wants a rollback of the sections of the DOL’s 2017 fiduciary rule that make it more difficult for advisors or agents to sell variable and indexed annuities—the most commonly-sold annuities—than to sell fixed deferred annuities or income annuities. Partly as a result of the rule, sales of all annuities were down in 2017 versus 2016, according to the LIMRA Secure Retirement Institute. A revised “best interest standard” would help solve this problem.

Here’s the official IRI list:

Maintain and Enhance the Current Tax Treatment for Retirement Savings:

Congress recognized the vital role tax deferred retirement savings plays in spurring America’s economic growth and prosperity in the “Tax Cuts and Jobs Act enacted in 2017. Congress should:

1) Maintain and promote the use of tax deferral for retirement savings.
2) Protect and preserve the distinct types of retirement plans.
3) Create tax incentives to encourage greater usage of guaranteed lifetime income products.

Expand Opportunities for Retirement Savings:

Congress should enact legislation which:

1) Generally requires all but the smallest employers to automatically enroll their employees in a 401(k) plan maintained by the employer and eliminate the barriers which discourage employers from offering these plans.
2) Removes the regulatory and legal obstacles to facilitate small businesses use of multiple employer plans (Open MEPs).
3) Increases auto-enrollment and auto-escalation default rates.
4) Improves and enhances access to the start-up retirement credit for small business employer-sponsored retirement plans.

Increase Access to Lifetime Income Products:

Congress or the Department of Labor should clarify employer fiduciary responsibility in the annuity selection safe-harbor. Congress should enact legislation which:

1) Enables annuity portability.
2) Reduces the age requirement for in-service rollovers to purchase lifetime income products.
3) Updates required minimum distribution (RMD) rules to reflect longer life-spans
4) Authorizes the Department of Treasury to enhance and reform the rules governing the use of QLACs.
5) Directs the Department of Labor or another appropriate federal department to revise Qualified Default Investment Alternatives (QDIAs) rules to allow broader use of lifetime income products as default investment options.

Help Savers Make Decisions about their Finances:

IRI is calling for federal and state legislators and regulators to work constructively and collaboratively to develop a clear, consistent and workable best interest standard to avoid the creation of potentially duplicative, conflicting, or incompatible rules. Congress should enact legislation which:

1) Requires lifetime income estimates on workers’ benefit statements.
2) Permits electronic disclosure for retirement plans. The Securities and Exchange Commission should adopt a variable annuity summary prospectus and annual update. The President should implement the national insurance licensing clearinghouse.

Provide More Resources to Protect Older Americans from Financial Exploitation:Congress should enact legislation to:

1) Enable financial advisors to report suspected financial abuse protect their clients from financial abuse.
2) Increase the amounts appropriated to support currently underfunded federal programs supporting state Adult Protective Service agencies.

Legislation ready to go

Covington said that 11 pieces of legislation have already been proposed that would give the IRI most of what it wants. Many of the items on the IRI wish list are already included, for instance, in the Retirement Enhancement and Savings Act of 2016. RESA was approved by the Senate Finance Committee but never introduced in the Senate. It was produced by Sen. Orrin Hatch’s office (and reportedly written by his then-aide Preston Rutledge). But Hatch is retiring at the end of the current congressional session, and the future of the bill is unclear.

According to reports from the American Retirement Association, Rep. Richie Neal (MA), the ranking Democrat on the House Ways & Means Committee, introduced two separate retirement bills in December 2017. These were the Retirement Plan Simplification and Enhancement Act of 2017 (RPSEA) and the Automatic Retirement Plan Act of 2017 (ARPA).

The ARPA and RPSEA seek to implement automatic 401(k)s and simplify administration and improve retirement savings opportunities across the spectrum of plans, including both DB and DC plans. Moreover, the RPSEA pulls together many of the bipartisan pieces of legislation that have been stalled on Capitol Hill for the last several years, including several provisions from Sen. Hatch’s RESA bill.

In addition, Reps. Ron Kind (D-WI) and Dave Reichert (R-WA), senior members of the House Ways & Means Committee, reintroduced their Small Businesses Add Value for Employees (SAVE) Act (H.R. 4637) on Dec. 13.

H.R. 4637 would make changes to existing SIMPLE IRA and SIMPLE 401(k) retirement plans, allow for open multiple-employer plans (MEPs) and ease other requirements to make it easier for small businesses to offer plans to their employees. The SAVE Act also includes similar provisions in Rep. Neal’s RPSEA and Sen. Hatch’s RESA legislation.

IRI’s job in 2018 will be to generate support for at least some of these bills on Capitol Hill. Getting legislators’ attention at a time when many of them are preparing for the mid-term elections is a lot to ask. IRI itself is undergoing a transition; it is looking for a new CEO to replace the retiring Cathy Weatherford.

To my mind, it’s also difficult to imagine Congress addressing retirement savings in a piecemeal fashion; ideally, a retirement policy overhaul should be coordinated with much-needed revisions to Social Security. Recognition of all these facts may explain the absence of buoyancy at the IRI press conference this week.

Brighthouse offers new VA rider

Posted on February 22, 2018 by Editorial Staff -

Brighthouse Financial (Nasdaq: BHF) has announced a new version of its FlexChoice variable annuity living benefit rider. The optional new rider, FlexChoice Access, offers 50 investment options and an income option that lets contract owners receive more income during the early years of retirement.

For a product brochure, click here.

FlexChoice Access offers a 5% compounded annual deferral bonus for the first 10 contract years. Contract owners can choose to receive level payments for life or to access higher withdrawals early in retirement. If a contract holder decides he or she no longer needs lifetime income, the rider provides options for cancellation.

Prospective clients do not need to choose single or joint lifetime income options at issue. This feature removes at least one of the decisions that can slow down the commitment to purchase an annuity. Additionally, income is based on the age of the older owner, so married clients can potentially get more income sooner through a higher withdrawal rate.

Brighthouse manages the risk of the contract in part by offering a lower payout rate if and when the account value is exhausted and benefits are paid directly from the insurer’s general fund.

The launch of FlexChoice Access is the latest update to the company’s annuity portfolio following the expansion of its flagship Shield Level suite in August 2017. In its fourth quarter 2017 financial results, Brighthouse Financial reported a 26% increase in annuity sales in the fourth quarter of 2017, compared to the fourth quarter of 2016.

Poland unveils retirement system overhaul

Posted on February 22, 2018 by Editorial Staff -

Poland prime minister Mateusz Morawiecki, elected just last December, has released draft legislation to overhaul the nation’s retirement system. Morawiecki first proposed a new kind of employee pension plan (“PPK” or Employee Capital Plan) two years ago when he was Poland’s economic development minister.

Under the proposal, employers (except those companies with an existing employer-paid pension with a minimum total contribution of 3.5%) would be obligated to contribute at least 2% of pay to employee accounts, with an option to contribute 2% more.

Employees would contribute at least 1.5% but no more than 2.5%. As planned, the PPKs will be voluntary for employees. Workers ages 55 years and younger will have three months to opt out of the proposed auto-enrollment system. Older workers, of up to 70 years, will have to opt in.

Poland’s pension system has three so-called “pillars.” The first pillar is the state pension, ZUS, which corresponds to our Social Security. The second pillar consists of mandatory defined contribution plans funded by part of the ZUS tax, with investments in “open pension funds” called OFEs run by private banks, insurers, and asset managers. A third pillar consists of Occupational Pension Funds (PPEs) that employers could set up voluntarily. The new PPKs would replace the second (OFE) pillar plans.

One point of controversy: The proposal excludes private banks, insurers and asset managers that have been running OFEs from managing any of the plan assets. Asset management will be restricted to Polish investment fund companies (TFIs) registered for at least three years, and coordinated by the state-run Polish Development Fund. The Fund, which also runs a TFI, will administer the PPK portal.

The proposal is intended to address a retirement savings crisis in Poland that the OFEs and PPEs couldn’t solve. Many Polish workers stopped directing part of their ZUS contributions to the OFEs. Only about 400,000 workers were covered by PPEs (Poland has a population of 38 million). PPE assets were just 0.10% of GDP.

The PPK plan aims to use auto-enrollment bring 11.4 million workers (75% of the working population) into employer-based pension plans over the next two year and to bring pension assets closer to the average among EU countries of 24% of GDP, according to the European Insurance and Occupational Pensions Authority (EIOPA).

The government will add PLN240 (€58) per year to each individual account, along with a one-off welcome bonus of PLN250 after three months of enrolment, until the end of 2020. The program will be implemented in six-month stages, starting in January 2019.

The first stage will involve companies with more than 250 employees, a group that will encompass about 3.3 million people. The final stage, scheduled for July 2020, will cover companies with between one and 19 workers, as well as budget-financed entities such as state schools. This last category includes about 5.1 million of the total projected 11.4 million workers covered.

The draft caps annual management fees at 0.50% of net assets, with a further 0.10% allowed as a performance fee. To prevent market concentration, any investment fund company (including its subsidiaries) with PPK assets exceeding 15% of the market total will not receive any fees on the excess.

Principal’s Mexico retirement business acquires MetLife’s

Posted on February 22, 2018 by Editorial Staff -

Principal Financial Group has completed its acquisition of MetLife, Inc.’s pension fund management business in Mexico, Afore, S.A. de C.V., attaining full regulatory approval for the deal, the insurance and retirement firm said this week.

Afore is an acronym that in Mexico stands for Administrator of Funds for Retirement. After merging MetLife’s Afore with Principal’s, Principal Afore, S.A. de C.V. will be Mexico’s fifth largest Afore, with a more than seven percent market share.

After the purchase, Principal in Mexico will manage around 3.4 million individual accounts for retirement with the equivalent of US$12.3 billion of assets under management at the current exchange rate of Mex$18.65 to US$1.

“Mexico is a growing and important market for Principal,” said Luis Valdes, president of Principal International, the global pension business of Principal Financial Group, in a release. Unless MetLife Afore clients request a transfer of their individual accounts to another Afore, they will become clients of Principal Afore over the next 90 days.

Western & Southern reports $337 million in PRT business

Posted on February 22, 2018 by Editorial Staff -

Western & Southern Financial Group, Inc., generated more than $337 million in pension risk transfer (PRT) premium in 2017, up from $15 million in premium in 2015 and 2016 combined.

PRT is offered through Western & Southern’s institutional markets business unit. In September 2017, the business unit was established to expand Western & Southern capabilities with corporate and business clients. The unit also offers bank-owned life insurance solutions and a cobranded direct-to-consumer digital insurance platform built specifically for banks, wealth management firms and finance companies. The business unit is also evaluating opportunities to create retirement and protection solutions for small and medium-sized enterprises (SMEs).

Western & Southern serves pension risk transfer needs with a guaranteed single-premium group annuity called PensionAssist from subsidiary Western-Southern Life Assurance Company (Western & Southern Life). PensionAssist, launched in 2015, allows plan sponsors to replace pension benefits paid to pension participants with annuity payments from Western & Southern Life.

LIMRA Ad

Posted on February 22, 2018 by Editorial Staff -

Retirement Industry Conference Ad

Net Percentage of Asset Allocators Reporting Overweight in Equities Surpasses Previous Spikes

Posted on February 19, 2018 by Editorial Staff -

Source: BofA Merrill Lynch Global Fund Manager Survey, via Financial Advisor magazine.

Spain Looks for New Ways to Save

Posted on February 15, 2018 by Kerry Pechter -

“To go to America,” sighed the smartly dressed young assistant in a Sotheby’s real estate office on Plaza Nueva in Seville, Spain, where tourists from richer countries come to see flamenco, eat tapas and relax in the sun. “That is my dream. Everything here is work, work, work.”

Spain is still working its way out of its 2010-2011 financial crisis. Tourism (82 million people visited this nation of 45 million in 2017) has been a blessing but also a symptom of the country’s bargain prices—which stem from lingering unemployment and depressed wages.

Because of those conditions, most Spaniards are too caught up in day-to-day financial worries to think much about the future. But, like the US, Spain is aging. And a retirement income crisis is coming. The Spanish government intends to all but eliminate future cost-of-living increases to the national pension, so future retirees will need other sources of savings to offset their reduced purchasing power.

Therein lies the tension. Spain’s defined contribution (aka “second pillar”) system is under-developed. That’s partly because so many Spaniards work in small independent businesses. In addition, payroll taxes are already high (employers pay 24% of pay) and the public pension replaces more than 80% of the €27,000 median salary. By 2050, however, the average replacement rate is expected to shrink to 50%.

“Not many private plans have been implemented in Spain, because the statutory scheme has been so good,” Rosa Di Capua, a partner at Mercer (right), told RIJ. “People don’t think private plans are necessary, but it’s clear that there will be a need them in the future.”

Similarities and differences

Spain has only 1,290 employer-sponsored retirement plans, according to Inverco, a pension trade group here. Only about 7% of Spanish workers are covered by such plans, according to the European Trade Union Institute. “Occupational pension schemes have very limited coverage in actuality. Almost only large-sized companies tend to provide occupational pension benefits (usually defined contribution schemes),” according to the ETUI.

The amount of money in private retirement savings plans is growing, however. In 2016, according to OECD (Organization of Economic Cooperation and Development) estimates, fund assets in Spain were $164.2 billion or 14% of GDP, up from US $116.4 billion, or 7.8% of GDP in 2011. (For comparison, private retirement savings are worth 72% of GDP in the US and 136% of GDP in the Netherlands).

Defined contribution “has not expanded because companies think that for us this is a new cost, an increase in salary cost. And it’s not something that unions are fighting for,” Di Capua said. “Also, salaries in the last decade have been so low due to the crisis, that deferring more of the salary isn’t realistic.”

“The second pillar is quite low,” said Diego Valero (below left), CEO of Novaster, a Spanish pension consultancy, in an interview with RIJ. “Not many companies have developed an occupational pension for their employees. Big companies or the multinational companies have some pension schemes. In Spain, 90% of the labor force works in medium and small companies, and most of them don’t have any complementary savings plans.”

If and when DC plans flower in Spain, they will be both similar and dissimilar to US-style DC. Like US plans, they will be tax-deferred, voluntary (Spain’s constitution forbids mandatory DC), employer-based, and open to lump sum, systematic or guaranteed distribution at retirement.

But DC in Spain would also have a European flavor. Spanish DC plans would be co-designed by unions and management. An employer match would likely be expected. There would be less liquidity: No counterpart to the rollover IRA exists in Spain, and only this month did the government begin allowing penalty-free, non-hardship access to qualified savings after a 10-year holding period.

One investment option for all

Unlike DC plan participants in the US, Spain’s participants can’t build their own portfolios. “One of the huge differences between
defined contribution in the US and Spain is in the investment policies,” Di Capua told RIJ. Aside from the fact that participants over age 50 must invest 100% in fixed income, all participants in Spanish DC plans invest in the same collective fund.

All of the money is managed by a single investment manager for all participants, with the fund manager typically working for one of the major banks, such as CaixaBank, BBVA or Santander. To break into the Spanish institutional market, a US asset manager like Vanguard or BlackRock would have to manage a tranche of that fund.

“Today the law makes it impossible to have a US or UK type plan where individuals can choose different strategies, mutual funds, and create their own personal portfolio,” said Alvaro Molina, (below right) director of institutional investments for Aon Hewitt in Spain.

So far only Endesa, the electrical and gas utility that is 70% owned by the Italian company ENEL, has looked to hire best-in-class fund managers on an a la carte basis, Molina said, and three or four other DC plans have target date funds. Unions tend to be leery of target date funds—union leaders think pension professionals can manage money better than rank-and-file workers.

Winning hearts and minds

“We are trying to offer the market more possibilities for developing DC plans,” Novaster’s Valero told RIJ. “Otherwise the future looks terrible. I am a strong proponent of models like NEST in the UK; I like [Shlomo Benartzi’s] ‘Save More Tomorrow’ idea. We are trying to introduce principles of behavioral economics to the pension industry here. We’re trying help companies understand what this means, and how to set up an auto-enrollment scheme. This is our goal.

“Asset managers think the DC market will grow; the question is, ‘What is the best way to grow?’ Most of the industry thinks it’s necessary to increase tax incentives [for retirement savings]. But, from my point of view, that’s clearly not enough. We need other points of view to reach the companies.”

The government is not necessarily helping stimulate tax-deferred savings. It has reduced the limit on deductible contributions to retirement to the lower of €8,000 or 30% of earnings (reduced from €10,000) , compared to $18,000 ($24,000 for those over 50) in the US. Although new regulations also reduced the limit on average commissions on pension funds, a May 2017 press report said that investment costs are kept high in Spain by the handful of major banks that control most of the market.

“Everyone knows that the public pension’s average replacement rate will drop to 50% over the next 30 years, but there’s a present bias,” Valero told RIJ. “There are no new incentives by the government and no new models, so unfortunately we are in a very bad situation for the immediate future.”

One possibility that Aon Hewitt’s Molina suggested: Create an ad hoc DC plan by making it easy for workers to contribute to personal pensions through their payroll systems at work. Several Spanish banks offer IRA-type individual savings vehicles. Banco Mediolanum, for instance, offers a pension-supplement savings program and life insurance that can converts to a life annuity. Investment options tend to be more flexible in these personal pensions than in DC plans.

The Lessons of Black Monday

Posted on February 15, 2018 by Barry Eichengreen -

US President Donald Trump has regularly pointed to the stock market as a source of validation of his administration’s economic program. But, while the Dow Jones Industrial Average (DJIA) has risen by roughly 30% since Trump’s inauguration, the extent to which the market’s rise was due to the president’s policies is uncertain. What is certain, as we have recently been reminded, is that what goes up can come down.

When interpreting sharp drops in stock prices and their impact, many will think back to 2008 and the market turbulence surrounding Lehman Brothers’ bankruptcy filing. But a better historical precedent for current conditions is Black Monday: October 19, 1987.

Black Monday was a big deal: the 22.6% price collapse is still the largest one-day percentage drop in the DJIA on record. The equivalent today would be – wait for it – 6,000 points on the Dow.

In addition, the 1987 crash occurred against the backdrop of monetary-policy tightening by the US Federal Reserve. Between January and October 1987, the Fed pushed up the effective federal funds rate by nearly 100 basis points, making it more expensive to borrow and purchase shares. In the run-up to October 2008, by contrast, interest rates fell sharply, reflecting a deteriorating economy. That is hardly the case now, of course, which makes 1987 the better analogy.

The 1987 crash also occurred in a period of dollar weakness. Late in the preceding week, Treasury Secretary James Baker made some remarks that were interpreted as a threat to devalue the dollar. Like current Treasury Secretary Steven Mnuchin at Davos this year, Baker could complain that his comments were taken out of context. But it is revealing that the sell-off on Black Monday began overseas, in countries likely to be adversely affected by a weak dollar, before spreading to the US.

Finally, algorithmic trading played a role. The algorithms in question, developed at the University of California, Berkeley, were known as “portfolio insurance.” Using computer modeling to optimize stock-to-cash ratios, portfolio insurance told investors to reduce the weight on stocks in falling markets as a way of limiting downside risk. These models thus encouraged investors to sell into a weak market, amplifying price swings.

Although the role of portfolio insurance is disputed, it’s hard to see how the market could have fallen by such a large amount without its influence. Twenty-first-century algorithmic trading may be more complex, but it, too, has unintended consequences, and it, too, can amplify volatility.

Despite all the drama on Wall Street in 1987, the impact on economic activity was muted. Consumer spending dropped sharply in October, owing to negative wealth effects and heightened uncertainty, but it quickly stabilized and recovered, while investment spending remained essentially unchanged.

What accounted for the limited fallout? First, the Fed, under its brand-new chairman, Alan Greenspan, loosened monetary policy, reassuring investors that the crash would not create serious liquidity problems. Market volatility declined, as did the associated uncertainty, buttressing consumer confidence.

Second, the crash did not destabilize systemically important financial institutions. The big money-center banks had used the five years since the outbreak of the Latin American debt crisis to strengthen their balance sheets. Although the Savings & Loan crisis continued to simmer, S&Ls were too small, even as a group, for their troubles to impact the economy significantly.

What, then, would be the effects of an analogous crash today? Currently, the US banking system looks sufficiently robust to absorb the strain. But we know that banks that are healthy when the market is rising can quickly fall sick when it reverses. Congressional moves to weaken the Dodd-Frank Act, relieving many banks of the requirement to undergo regular stress testing, suggest that this robust health shouldn’t be taken for granted.

Moreover, there is less room to cut interest rates today than in 1987, when the fed funds rate exceeded 6% and the prime rate charged by big banks was above 9%. To be sure, if the market fell sharply, the Fed would activate the “Greenspan-Bernanke Put,” providing large amounts of liquidity to distressed intermediaries. But whether Jay Powell’s Fed would respond as creatively as Bernanke’s in 2008 – providing “back-to-back” loans to non-member banks in distress, for example – is an open question.

Much will hinge, finally, on the president’s reaction. Will Trump respond like FDR in 1933, reassuring the public that the only thing we have to fear is fear itself? Or will he look for someone to blame for the collapse in his favorite economic indicator and lash out at the Democrats, foreign governments, and the Fed? A president who plays the blame game would only further aggravate the problem.

Barry Eichengreen is professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His latest book is Hall of Mirrors: The Great Depression, the Great Recession, and the Uses – and Misuses – of History.

Two ‘Santas’ Can Be Worse Than One

Posted on February 15, 2018 by Eugene Steuerle -

Politicians love to claim that they have given us something. “We want to give you, the American people, a giant tax cut for Christmas. And when I say giant, I mean giant.” So proclaimed President Trump, with words echoed by many Congressional leaders.

There were only two problems with the statement. The tax cut wasn’t giant and the President and Congress didn’t give us anything

Not that Republicans stand alone in their claims of generosity. Democrats claimed they gave millions of Americans health insurance when they passed the 2010 Affordable Care Act. But while Congress and the President credit themselves for giving us something, they really are transferring public resources to some of us from others. In aggregate and over time, we must pay for anything they claim to give.

I find it easiest to divide the two sides of the balance sheet required for new legislation into giveaways and takeaways. Giveaways generally come in the form of tax cuts and spending increases, takeaways in the form of spending cuts and tax increases. Just as sources of funds must equal uses of funds for the budget as a whole, so also for new legislation must the sum of new giveaways be balanced by new takeaways.

Of course, some of the takeaways can be deferred through borrowing. Politicians never count those costs when announcing the amount they claim to have given us.

In a 1976 column in the journal National Observer, entitled “Taxes and the Two Santa Claus Theory,” conservative columnist and editor Jude Wanniski argued that Republicans needed be the party of tax cuts the way he asserted that Democrats played Santa Claus when they increased spending for social programs or passed redistributionist tax legislation.

At that time, Republicans had long been a minority party, particularly in the House of Representatives. Wanniski argued that they would never gain power as long as they simply opposed Santa-like spending increases or promoted raising taxes to pay for them.
In some ways, he got what he wanted. In the first years of the Republican presidencies of Ronald Reagan, George W. Bush, and Donald Trump, Congress passed tax cuts. Trump’s description of the Tax Cuts and Jobs Act (TCJA) as a Christmas gift lends full credence to the belief that political parties try to retain power by acting as Santa.

What Wanniski hadn’t fully anticipated was how far we have gone toward having two Santas acting at the same time, with scheduled spending increases being matched by new tax cuts that make the whole federal fiscal system increasingly unsustainable.
I’m not arguing the relative merits of tax cuts versus new spending. Government can—and should—shift resources in ways it believes will provide a future return to society. But that is different from saying that the money is free, like a gift from Santa.

For instance, Republicans believe shifting resources to business in the form of tax cuts in the TCJA will generate an economic return just as families believe they would generate a return by shifting money to pay for their children’s education. But neither Congress nor families can claim that the transaction is free, just because the money came from additional borrowing on our public or family credit card.

While both government and personal debt tempt us to live for today, only with government debt can Santa leave an IOU for Americans not yet identified and in some cases not yet born. The two competing Santas explain better than anything why borrowing in the U.S. has increased extraordinarily in recent decades, continually rising to new all-time highs outside of a World War II peak that was scheduled to decline quickly once war spending ended.

While analysts at the Tax Policy Center and Joint Committee on Taxation can determine which income and other classes will be affected by specified changes in the law—for instance, who benefits from higher child tax credits—they can’t identify the future losers. Thus, the distributional tables, just like claims that our elected officials have given us something, are often incomplete and in some ways misleading.

While these analysts can and do at times examine implications such as how tax cuts or spending increases might eventually be financed, those analyses get much less press attention than the explicit listing of today’s known “winners” and “losers.” The damage to good budget policy is obvious. It will always have trouble getting traction as long as we fail to recognize that we, not the President or Congress, are the ones who pay for what they claim to give away.

Data Connection

Lists*