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Not All 401(k)s are Created Equal; Should They Be?

The other day I was interviewing an Irish crypto-currency entrepreneur and the topic of 401(k) plans came up. The 401(k) system appears to be a single, homogeneous, nationwide program when viewed from a distance, I said. Since every plan follows the same Labor Department rules, a casual observer might assume that all plans must be the same.

So he looked puzzled when I said that the quality of 401(k) plans can differ dramatically from one company to another. The differences are regressive: They amplify whatever economic inequalities already exist in the workplace. 

Good plans and good jobs tend to go together, and bad plans and bad jobs tend to go together. If you can afford to save a lot, and if your company offers a 401(k) with a generous match and maybe a voluntary tax-deferred contribution to your account, you’ll probably retire with an adequate nest egg.  

But if you work in a company that doesn’t offer a plan, or offers a plan with no “match” and high fees, or defaults you into a permanent contribution of 3% per year, or your job is low-paid and you change jobs frequently, or if you need to raid your 401(k) to cover an emergency expense, then your chance of retiring with enough money is a lot smaller. In fact, you might be better off contributing to your own private Roth IRA at a no-load fund supermarket.

For most of us, this arrangement makes sense. To get better pay and benefits, you compete for them. Inequality can be a good thing: It rewards effort and drives progress. Besides, Social Security helps buffer the inequalities in retirement by replacing a higher percentage of lower-paid workers’ earnings.

But this arrangement makes no sense at all to Teresa Ghilarducci, Ph.D., the progressive economist and 401(k) gadfly at the New School, where she directs the Retirement Equity Lab. She’s outraged by it. And she’s not willing to wait for proposed innovations like state-sponsored mandatory savings plans or private multi-employer plans (MEPs) to level the playing field.   

She’d like to replace 401(k)s with a universal mandatory defined contribution plan whose balance would automatically convert to a low-cost life annuity at retirement. This new system, she says, would distribute the benefits of the government’s 12-figure annual tax expenditure for retirement savings—the annual cost of tax deferral in terms of reduced tax receipts—more equally (though contribution levels would still vary) than the 401(k) system largely because it would cover all workers instead of just the 50% or so of workers that participate in 401(k) plans at any given time. 

In support of her idea, she and New School colleagues Andrew Webb, research director at the Schwartz Center for Economic Policy Analysis, and grad student Siavash Radpour, presented a paper at the American Economic Association’s annual meeting, held in Philadelphia a few weeks ago.

“We find that retirement wealth is highly unequally distributed. We also found that mean and median total retirement wealth, conditional on owning any wealth, changed little over the period 1992-2010 despite older workers needing more wealth. A shift from DB to DC was associated with an increase in retirement wealth inequality over the period from 1992 to 2010, reflecting the rise in share of older workers who have no retirement wealth.

“A DC system may have increased inequality by variation in wealth because of variation in financial returns, because of one’s age cohort, because one faces the risk of choosing a bad portfolio, or paying excessive fee risk, or having an employer who does not sponsor a plan or who chooses bad investment alternatives,” the paper said.

Because of Ghilarducci’s revolutionary views—her solution to retirement inequality would entail nothing less than a nationalization of the enormous private retirement industry in the U.S.—talk radio host Rush Limbaugh once called her “the most dangerous woman in America.”

But she has in recent years gained a mainstream ally in Blackstone COO Hamilton “Tony” James. Their book (Rescuing Retirement: A Plan to Guarantee Retirement Security for All Americans, Columbia Business School Publishing, 2017) has been endorsed by former New York mayor Michael Bloomberg and former Treasury Secretary Robert Rubin. Its second edition has just been published.

I think Ghilarducci’s voice needs to be heard. If competition drives progress, then we need to consider competing views about defined contribution plans. In fact, her idea isn’t much different from proposals in other countries for creating defined contribution plans that include retirement income components. (See today’s story in RIJ on the new Royal Mail “defined ambition” plan in the UK.)

But to gain more allies in the U.S., she’ll have to convince enough people that (a) tax deferral is a true federal expenditure and not just a deferral; that (b) luck plays a large role in human and corporate success and society needs to protect people who have the worst luck; and that (c) at a point, income inequality becomes economically counter-productive, even for the winners.

I don’t expect that to happen. In 2019, depending on how the mid-term elections affect the balance of power in Congress, we may begin to hear arguments from Speaker of the House Paul Ryan and others that Social Security costs America too much and needs to be cut. Not only is there very little political will to do what Ghilarducci recommends, there may not even be enough will to preserve Social Security as we know it.

© 2018 RIJ Publishing LLC. All rights reserved.

England’s first hybrid retirement plan gets a tentative start

After months of negotiations, Britain’s Royal Mail and the leadership of the Communications Workers Union (CWU) have agreed to create the United Kingdom’s first “collective defined contribution” (CDC) retirement plan. It will deliver non-guaranteed retirement income to participants.

The Royal’s defined benefit pension (RMPP) will stop accepting contributions on March 31, 2018. It will be replaced by CDC, a hybrid of defined contribution and defined benefit that has been dubbed “defined ambition” in the U.K.

But there’s a big hurdle left. Royal Mail and the CWU must lobby the British government to make legislative and regulatory changes so that they can establish their plan, IPE.com reported. CWU members must vote on the proposal and have been encouraged by the union to accept the deal.

Under an agreement made public this week, Royal Mail will contribute 13.6% of members’ pensionable pay to the new CDC plan and union members will contribute 6%. The plan would pay a target level of income in retirement, but the income level would not be guaranteed. 

A “defined benefit cash balance scheme” will exist alongside the CDC. It would fund the payment of guaranteed lump sums to members at retirement, with discretionary increases if investment performance allows. Until a CDC scheme is officially launched at Royal Mail, employees will save into the company’s existing defined contribution plan and the new cash balance fund.

Royal Mail said the new pension arrangement would cost roughly £400 million (€457 million or $563.65 million) per year. That’s comparable to the cost of its existing DB pension, but without the longevity risk or market risk. Last year, Royal Mail warned that its annual pension costs could reach £1bn (€1.124 billion) if the RMPP were not changed.

The new pension arrangement is “an affordable and sustainable solution that enables us to continue to innovate and grow and to meet the intense competition with confidence,” said Moya Greene, Royal Mail’s CEO, in a statement.

The birth of UK CDC

In 2015, the UK passed primary legislation to allow defined ambition plans, but the government abandoned the idea and has not yet introduced the secondary legislation required to make them possible. In November, the Work and Pensions Select Committee of the UK’s parliament launched an inquiry as to how the plans would work.

The Select Committee wants to “retain some of the best features of [defined benefit pensions] in a different age when employers are no longer willing or able to sustain the burden of final salary promises to employees, who could club together and pool the risk themselves,” Frank Field, chair of the committee, said this week. 

The committee’s call for evidence closed yesterday with 19 responses so far made public. Respondents include academics, consultants, trade bodies and pension funds, including master trust NEST and Dutch civil service scheme APG. 

© 2018 RIJ Publishing LLC. All rights reserved.

Managed accounts are a proxy for income options in DC plans: Cerulli

Despite strong annual growth, defined contribution (DC) managed accounts still represent only about 4% of total DC assets, according to Cerulli Associates, the global research consultant.

“Cost concerns, lack of participant understanding, and lack of qualified default investment alternative status” inhibit adoption of managed accounts in DC plans, said Jessica Sclafani, a director at Cerulli. Eight companies currently provide managed accounts to plan sponsors.

Plan sponsors offer managed accounts primarily because they “can be positioned as a retirement income solution,” Sclafani said in a release. “While the DC industry continues to wonder how best to structure in-plan retirement income solutions with guaranteed interest components, managed accounts are quietly making progress as a less controversial option for plan sponsors to offer participants.”      

“Managed account providers seeking to demonstrate how their services are worth the additional cost versus a traditional target-date fund should focus on the additional capabilities a managed account service offers,” she added.

While 68% of the top-25 DC recordkeepers (by 2016 record-kept assets) offer a proprietary target-date fund, Cerulli said, only 28% offer a proprietary managed account service.

“Recordkeeping is sometimes referred to as a commoditized business,” Sclafani said. “But there are higher-margin asset management opportunities, such as proprietary target-date or managed account solutions.”  

Cerulli’s latest report, U.S. Retirement Markets 2017: The Rise of Fiduciary Services, provides analysis of the U.S. retirement market; examines corporate defined benefit and DC assets, plans, and participants by plan asset and participant segment; and sizes the IRA market by assets and number of accounts.

© 2018 RIJ Publishing LLC. All rights reserved.

ADP and Financial Engines in financial advice deal

Financial Engines, which provides web-based advice and managed account services to millions of retirement plan participants, and ADP, the plan recordkeeping and administration giant, announced this week that ADP will begin offering Financial Engines to its clients as its exclusive advice option.

The Financial Engines advisory service offering, on the ADP platform, will launch in the summer of 2018. “It will broaden ADP’s financial wellness capabilities,” the two publicly-traded firms said in a release.  

“This will be the first time Financial Engines will build an automated service capable of on-boarding thousands of plans a year,” John Bunch, executive vice president and chief operating officer at Financial Engines, told RIJ in an email this week. “The partnership will also broaden ADP’s financial wellness capabilities that aim to help 401(k) participants better prepare for day-to-day expenses and broader financial challenges.”

Asked if the deal will open up new markets to Financial Engines, Bunch wrote, Our strategic relationship with ADP will enable us to help 1.7 million more Americans—including those who work at micro-, small and mid-size businesses—that might not otherwise have access to quality, independent and comprehensive financial advisory services that they need to live and retire well.”

FE will be a standard part of the ADP retirement services offering,” Bunch added. The offering will be available to retirement plan sponsors on the ADP Retirement Services platform. For sponsors offering Financial Engines, we are able to serve participants in their plans online, over the phone through our National Advisor Center, or in-person at 140-plus advisor center locations.”

ADP is also accepting Financial Engines as its exclusive advice provider. “With the new relationship, Financial Engines will be the only advice provider on the ADP recordkeeping platform,” Bunch said.

Financial Engines’ direct advisory services for participants include:

  • Online savings and investment advice and retirement income services for employees who want to manage their retirement themselves.
  • A discretionary managed account service for participants who want to delegate the management of their retirement accounts to a professional.
  • Income planning and Social Security claiming guidance via Financial Engines’ Social Security Planner.
  • Professional management for all participant accounts (401(k), IRA and taxable accounts) by a dedicated advisor.

Participants will also have access to Financial Engines’ non-commission-based Investment Advisor Representatives, as well as to independent online investment advice, and to ongoing financial wellness programs and education.

© 2108 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Lori Lucas to lead EBRI

Lori Lucas has been appointed president and CEO of the Employee Benefit Research Institute (EBRI), the non-profit source of data on corporate retirement and health plans. The former Callan Associates executive, who had been an EBRI board member, succeeds Harry Conaway.

In a release, EBRI said Lucas has 32 years of experience in the investment and benefits industry, most recently as an executive vice president at Callan, where she managed the Defined Contribution Consulting Team.  

Lucas “will be joining the organization at a pivotal time in our country’s economic history, including unprecedented challenges to American workers’ financial security” and “making EBRI’s research more widely accessible and relevant.”

Prior to working at Callan, Lucas was director of Retirement Research at Hewitt Associates, vice president at Ibbotson Associates, a consultant at the pension fund J.H. Ellwood & Associates, and an analyst and product head at Morningstar, Inc. She holds a B.A. from Indiana University and a masters degree from the University of Illinois.

A CFA Charterholder, Lucas is the immediate past chair of the Defined Contribution Institutional Investment Association. She is on the editorial advisory board of Benefits Quarterly and is a former columnist for Workforce Management magazine.

Prudential in $1.8 billion pension risk transfer deal with Scottish Widows Ltd

The Prudential Insurance Company of America, a Prudential Financial, Inc. company, has assumed the longevity risk for approximately $1.8 billion (£1.3 billion) of annuity liabilities held by Scottish Widows Limited, a unit of Lloyds Banking Group plc.

It was the first longevity risk transfer agreement between the two firms. The announcement was made by Michael Downie, the finance director, Annuities and Investment Strategy at Scottish Widows, and Amy Kessler, Prudential’s head of longevity reinsurance.

Prudential has executed more than $45 billion in international reinsurance transactions since 2011, including the largest longevity risk transfer transaction on record, a $27.7 billion transaction involving the BT Pension Scheme. Scottish Widows was founded in 1815 as Scotland’s first mutual life office.

DPL aims to bring no-commission insurance products to RIAs

DPL Financial Partners said a “growth capital investment” from Eldridge Industries and the addition of a half-dozen insurance consultants will further its effort “to bring low-cost, commission-free insurance products to registered investment advisors (RIAs) and their clients.”

DPL, which describes itself as an RIA insurance network that brings a full suite of low-cost, commission-free life and annuity products to RIA practices, will “bridge the gap” between registered investment advisors and insurance carriers, said CEO David Lau in a release. 

“The idea for DPL Financial Partners was born from decades of observing a total disconnect between insurance carriers and RIAs,” he said DPL CEO David Lau. “RIA clients need insurance…, yet their advisor cannot provide the products… because the overwhelming majority of insurance products are commission-driven.” 

Lau, formerly with Jefferson National and Telebank, added that the newly hired team, including six professionals to consult directly with advisors and their clients on insurance planning, along with senior support staff in technology and marketing, will expand DPL’s ability to serve RIAs across the U.S.

DPL aims to reinvent how insurance is delivered in the fee-only space. “DPL is an insurance network for RIAs. RIAs access our consultants to help find and implement low-cost, commission-free insurance products for their clients,” Mr. Lau explained. “At the same time, we create an effective way for carriers to reach this important market.”

The release said DPL will do this by serving RIAs as an agnostic consultant, consulting with insurance carriers to support and develop commission-free products, and bringing to market quality, low-cost, commission-free products that fit the RIA model.

Nuveen expands DCIO team

Nuveen, TIAA’s global asset management unit,  said it has appointed several executives to positions supporting its expanding Defined Contribution Investment Only (DCIO) enterprise. Nuveen re-positioned its DCIO business in 2015.

 “Our active and index target date strategies [are] seeing particularly high levels of inflows,” said Erin Donnelly, executive vice president and head of Nuveen’s DCIO business, in a release. “Our DCIO business grew nearly 40% in 2017.”

Additions to Nuveen’s DCIO team include:

Peter Whitman joined the firm as managing director for DCIO Strategic Accounts, reporting to Ms. Donnelly. He will oversee the firm’s retirement presence across recordkeeping, retirement intermediary and other third-party retirement platforms and relationships. Whitman will also focus on building Nuveen’s retirement sub-advisory business.

Greg Koleno joined the DCIO sales team reporting to Brendan McCarthy, DCIO National Sales Director. Based in Portland, Oregon, Koleno is responsible for DCIO sales in the Northwest. Previously, he was held a similar position at American Century Investments.

James Polito joined the DCIO sales team, also reporting to McCarthy. Based in Charlotte, North Carolina, Polito is responsible for DCIO sales in the Southeast. Most recently, he held a similar position at BNY Mellon.  

Nuveen also hired Jeff Eng as managing director responsible for retirement solutions, reporting to Martin Kremenstein, senior managing director and head of Nuveen’s retirement and ETF solutions business. Eng will lead new product initiatives. Previously, he was head of the custom defined contribution solutions business at AB.

Nuveen describes itself as the fourth largest investment manager of defined contribution assets in the United States and the sixth largest manager of target date fund assets. Its DCIO team works in consultation with plan sponsors, consultants and retirement plan advisors.

The DCIO team offers fixed income and equity mutual funds as well as environmental, social and governance (ESG) equity and fixed income funds, including the TIAA-CREF Social Choice Bond Fund (TSBIX). The team also offers active and passive target date funds such as TIAA-CREF Lifecycle 2040 (TCIOX) and TIAA-CREF Lifecycle Index 2040 (TIZLX), asset allocation strategies that can act as the qualified default investment alternative (QDIA) of defined contribution plans.

Anthem adds $58 million to employees’ retirement accounts

Anthem, Inc., whose health plans serve some 40 million Americans, said this week that it will contribute $1,000 to the 401(k) accounts for each of its more than 58,000 associates and recent retirees, or about $58 million, as a response to the recent revisions to the U.S. tax code.  

 In total, Anthem will contribute more than $58 million to the program which helps Anthem associates plan for their retirement and the needs of their families in the future. In addition to the Anthem 401(k) program, the company is investing savings from the changes in the tax code in other efforts to reduce the cost of healthcare and benefit customers and shareholders.

Anthem’s full-time, part-time, temporary associates and recent retirees are eligible to receive the 401(k) contributions. For eligible associates who have not previously participated in Anthem’s 401(k), the company will automatically establish a 401(k) account and make the $1,000 investment.

Associates will receive the contribution on March 29 and have the ability to select how the money is invested by choosing from the 15 investment options that are offered through Anthem’s 401(k) program.

© 2018 RIJ Publishing LLC. All rights reserved.

Tax Cut Will Drive Global Growth: Chao

Eight years after the end of the financial crisis, the global economy is much healthier and now growing in sync for the first time since 2010.  The superb performance in equities/risk assets globally reflects the positive business and consumer sentiments, increased economic activities and more employment.

New tax law. The new U.S. tax law passed in December is not popular with those who are deficit hawks or who believe that the late-stage organic growth of the economy does not require pro-cyclical fiscal policy. 

However, the law’s business-focused tax cuts and preferences for foreign asset repatriation have given a turbo boost to the economy for 2018, and their positive impact is rippling through the rest of the global economy. IMF credits 50% of the global economic upward revision to the impact of the U.S. tax bill.

Employment. Unemployment (U3) is at 4.1% and 8.1% for the broader U6 measure and we expect the U3 to be in the mid 3% range by the end of 2018 with a sub 8% U6.

Gross Domestic Product. The advance estimate of 2.6% for fourth-quarter GDP came in below the consensus estimate of 2.9%, and 2017 ended at 2.5%, which is at the upper range of the post-financial crisis era. With the new tax cut, we expect the GDP for 2018 to be at the 3% level.

Inflation. Inflation has been the missing ingredient, and indicators are showing its return. Some of the improvements in inflation may be statistical (i.e. a change in value from a very low starting point), but much will be “pushed” to our economy under a lower US dollar, increased and sustained energy prices, and other commodities regime. When wage inflation picks up, overall inflation will likely be “pulled” as well.

Interest rates. The 2017 FOMC has been signaling three interest-rate hikes in 2018. We expect four hikes under the new FOMC due to pro-cyclical effects from the new tax bill. Our projection is also due to a possible upside surprise in inflation expectation. The likelihood of an inverted yield curve in 2018 has been reduced, so the likelihood of a recession has been pushed out further into 2020 and beyond.

Securities markets. The seeming parallel universe that we have been traveling in (i.e. risk assets continue to advance despite geopolitical and other systemic risks) will continue, and as such, we are constructive/positive on equities globally.

Due to FOMC rate normalization (bad for short end), possible inflation surprises and the less attractiveness of U.S. long yields as other yields begin to move higher, fixed income will likely be delivering a lower to no return in 2018. Commodities have performed well, as they typically do at the late stage of an economic cycle.

Risks. Downside risks remain: geopolitical risks from rogue states, findings from the Mueller’s investigation into Russia’s meddling in the 2016 election and the possible Trump campaign’s collusion, and the mid-term 2018 U.S. election outcome.

© Philip Chao. Reprinted with permission of the author.

Why Bruce Springsteen Is America’s Most-Likely Income Annuity Buyer

New Jersey, though far from the most populous U.S. state, boasts the most income annuity sales. The Garden State is also home to folk-blues rocker Bruce Springsteen who, at age 68, has just recently surpassed the average age (67.5) for the purchase of an income annuity.

We know these facts—about annuities, not about the Boss (below right)—because Cannex has released its annual survey of single-premium immediate annuities (SPIAs), deferred income annuities (DIAs) and qualified deferred longevity annuity contracts (QLACs)  sold in 2017 through distribution platforms that rely on Cannex’s carrier-approved contract pricing data. For survey pdfs, click here and here

Perhaps the most notable statistic in the data set was that nearly 40% of the contracts sold included a cash refund option. (This option, which refunds unpaid-out premia to beneficiaries upon the death of all annuitants, reduces the contract owners’ annual income.) An additional 41% were either life-only (26%) contracts or life with 10 years certain (15%) contracts.Bruce Springsteen

The client is using part of the premium to, in effect, buy enough life insurance to cover the risk that he might die before getting all of his premium back. Annuity purists would say that it’s inefficient to buy mortality and longevity protection from the insurance carrier at the same time—just as it would be inefficient to press the gas pedal and the brake pedal simultaneously.  

Curiously, the report also shows that when advisors asked for Cannex to quote the income for a specific premium or the premium necessary for a specific income level, they often used income or premium amounts well in excess of the income or premium reported for contracts actually sold.

Cannex president Gary Baker said the reason for that wasn’t entirely clear. “The size of the average premium has always been somewhat of a mystery at CANNEX since we started this report five plus years ago,” he told RIJ in an email this week.

“Our hypothesis is either: a) for mass affluent/high net worth clients, the advisor is typically working with a bigger premium amount (e.g., 20% of a $1 million portfolio), but will split the purchase amongst two carriers to diversify crediting risk and match the state guarantee limit (@ around $100,000).

“Or, b) for middle-market/smaller savers, the advisor is looking to see how much of a guarantee a large portion (or all) of a nest egg could generate, and then dial back based on compliance requirements (i.e., some firms require that the advisor leave a certain percentage liquid in a client’s portfolio).”

The Cannex data represents much of the U.S. market. According to its report, 1,143,698 income annuity contracts were sold in the U.S. in 2017. Almost exactly two-thirds were immediate contracts and one-third were deferred. Single-life was the most popular (58%), followed by joint life (31%) and period certain only (11%).

Though the data doesn’t contain an average purchase premium, but the following statistics may help in imagining the most common types of contracts:

  • 25% of the contracts (where the premium was given) had a premium of between $75,000 and $100,000.
  • 17% had a premium of $100,000 to $200,000.
  • Those contracts represented 42% of the total and almost half of the contracts where the premium was provided.
  • 40,000 QLACs were purchased.
  • 61% of contracts were non-qualified.
  • Close to 60% of the contracts were purchased by people between the ages of 55 and 69, with 25% between ages 60 and 64.
  • 65% of primary annuitants were male and 85% of the joint annuitants were female.
  • Almost all (94%) of the joint contracts were non-reducing on the death of the primary annuitant. Where payments were reduced, they were most often reduced by 50%.

My biggest takeaway from the Cannex data is that older people are clearly ready to concede a big chunk of the income from an income annuity just to be certain that if they are struck by a bus—that rogue bus that pursues annuity contract owners as ruthlessly as tornados target trailer parks in Kansas—the day after the free-look period ends.  

They either don’t understand the principle behind longevity risk-pooling (highly possible) or they can’t sleep at night for worrying about the Stephen King-possessed bus and its effect on their heirs (also possible) or the advisor/agent who sells them the contract is hedging his or her risk of facing outraged beneficiaries in the future.

© 2018 RIJ Publishing LLC. All rights reserved.

‘Missing’ group annuitants give MetLife a share shock

MetLife’s share price dropped by as much as 12% this week, to $48.48 on Wednesday from $55.15 on Monday, after the diversified insurance company, ranked 42nd on the Fortune 500, after the firm announced that it would increase its reserves by as much as $575 million and take an earnings hit as high as $195 million.

This week MetLife said it would delay its fourth-quarter and year-end 2017 earnings report and conference call to February 14 and would release its 2017 10-K on March 1. The earnings call had originally been scheduled for yesterday and today.

MetLife nonetheless reported preliminary fourth quarter 2017 results of $2 billion to $2.1 billion in net income, “including an after-tax benefit of $1.2 billion related to the impact of U.S. tax reform, which includes a negative impact to adjusted earnings of approximately $300 million.”

Investor concerns about MetLife are linked to “certain Retirement and Income Solutions group annuitants who have been unresponsive or missing over time,” MetLife revealed on its Dec. 15, 2017, Investor Outlook Call. The $50 billion company said it “was undertaking a review of practices and procedures used to estimate its reserves.”   

In short, thousands of group annuitants hadn’t been sent or hadn’t received their pension checks because MetLife lost track of them through error or because they could not be located.  “It’s not just embarrassing, it could cost MetLife future business,” wrote Canadian pension blogger Leo Kolivakis, referring to the business of pension risk transfer, or swapping group annuities for corporate defined benefit plan assets and liabilities.

News reports didn’t say which group annuity’s annuitants could not be found. Payouts to annuitants can last for decades, during which time some may relocate.

In the December statement, MetLife that it believed the group missing out on the payments represented less than 5% of about 600,000 people who receive a type of annuity benefit from the company via its retirement business. Those affected generally have average benefits of less than $150 a month, MetLife said.

“We are deeply disappointed that we fell short of our own high standards,” MetLife said. “Our customers deserve better. We are committed to making this right for our customers. We found the issue, we self-reported it, and we are committed to doing better.”

In its January 29 release, MetLife said “Management of the company has determined the prior release of group annuity reserves resulted from a material weakness in internal control over financial reporting. MetLife expects to increase reserves in total between $525 million and $575 million pre-tax, to adjust for reserves previously released, as well as accrued interest and other related liabilities.

“The total amount expected to impact fourth quarter 2017 net income is between $135 million and $165 million pre-tax, the majority of which represents a current period strengthening of reserves and will be reflected in Adjusted Earnings (formerly known as Operating Earnings). We expect the full year 2017 net income impact to be between $165 million and $195 million pre-tax,” the release added.

“To date, MetLife is not aware of any intentional wrongdoing in connection with this matter,” the company also said. Plaintiff’s attorneys responded immediately. Faruqi & Faruqi, LLP, for one, said it began investigating potential claims against MetLife, Inc.

In its release, MetLife said it “had previously informed its primary state regulator, the New York Department of Financial Services, about this matter and is responding to questions from them and other state regulators. The U.S. Securities and Exchange Commission enforcement staff has also made an inquiry regarding this matter and MetLife is responding to its questions.

A.M. Best issued a release affirming MetLife’s A+ (Superior) strength rating. “The Credit Ratings (ratings) of MetLife, Inc. and its insurance subsidiaries remain unchanged following the announcement that it will increase group annuity reserves,” the release said.

“MetLife has sufficient earnings capacity to absorb this charge, which is not expected to have a material impact on reported risk-adjusted capitalization ratios. While the charge has resulted in disclosure of a material weakness in MetLife’s internal control framework, A.M. Best believes this issue is confined to its PRT business segment only and not indicative of broader control risks throughout other business lines.

“Therefore, its ratings will remain unchanged at present. However, future disclosures relating to broader material weakness in its internal controls could result in a negative rating action, as would additional charges that materially impact MetLife’s level of risk-adjusted capitalization.”

© 2018 RIJ Publishing LLC. All rights reserved.

Prudential plays the ‘index card’

Prudential Annuities, best known for its huge $161 billion book of variable annuity business, became an issuer of fixed indexed annuities for the first time this week with the announcement of PruSecure single-premium fixed indexed annuity (FIA) for accumulation, not retirement income, purposes.   

Prudential is going after money on the sidelines, as FIA issuers characteristically do. The announcement noted that “investors fearful of down-market loss now hold $12 trillion in cash, CD and money market positions that offer little growth opportunity.” FIAs are also inexpensive for carriers to issue, since they present less risk and require less reserve capital than variable annuities.

In PruSecure FIA, earned interest can be linked to the performance of the S&P 500, MSCI EAFE, Dow Jones U.S. Real Estate Index or Bloomberg Commodity Index. PruSecure offers one-, three-, and five-year index term options. Initial cap rates provide “up to a 32% return” based on the chosen index, credit term, and surrender period.

The 32% figure refers to the cap on the interest that can be earned on a five-year term contract linked to the MSCI EAFE Index with a purchase premium of $100,000 or more, according to the latest rate chartPruSecure Rate Chart

Clients can mix and match indexes and crediting terms. Surviving beneficiaries will receive the current account value plus a portion of any growth earned before the end of the crediting term. There’s a single crediting strategy—point to point—for simplicity of understanding. There’s a choice of either a five-year or seven-year surrender period.

The fixed indexed annuity market has been dominated by Allianz Life, which currently accounts for about 15% of the market. Nationwide, Athene USA, American Equity Companies, and Great American Insurance Group are the closest followers, in that order, according to Wink.

In the past, the big publicly-held domestic life insurance companies, such as Prudential, MetLife and Lincoln Financial, have focused on the variable annuity market, which traditionally involved the broker-dealer distribution channel, rather than the FIA market, which for a long time involved primarily the independent agent channel.

But as FIAs have become more mainstream, both for manufacturers and distributors, they have attracted a wider range of issuers and distributors. Although the DOL fiduciary rule, in its original Obama administration form, could make it more complicated for fiduciary intermediaries to sell FIAs, that aspect of the rule is currently under review by the Trump administration.

FIA tend to sell well in low interest rate environments because their indirect exposure to the equity markets, through investments in equity index options, gives them more potential return than certificates of deposit. They also appeal to investors who want to reduce but not entirely eliminate their equity exposure. In short, they appeal to people who might otherwise just hold cash.

“Many investors remember the 2008 financial crisis and continue to be concerned about market risk,” said Dianne Bogoian, head of product for Prudential Annuities. “Fixed-indexed annuities like PruSecure offer downside protection plus upside opportunity—you don’t have to choose one or the other.”

© 2018 RIJ Publishing LLC. All rights reserved.

 

High demand for bond mutual funds is ‘concerning’: TrimTabs

Demand for bond funds has exploded in January after moderating in November and December. Bond funds had negative returns in four of the past five months, and their popularity amid lackluster performance should concern contrarians, according to a release from TrimTabs, the investment research firm.

The inflow of $38.2 billion into bond mutual funds (MFs) and ETFs this month through Thursday, January 25 is on track to be the highest since October 2009, driven by an estimated inflow of $32.3 billion into bond MFs. 

Global equity funds also saw dramatically accelerated inflows. The inflow of $33.4 billion into global equity MFs and ETFs in January is on track to be the most since April 2015. As with bond funds, retail investors have been driving much of the buying. The estimated inflow of $15.8 billion into global equity MFs this month is set to be the most since July 2015.

U.S. equity ETFs are drawing huge inflows for a fourth consecutive month. This month’s inflow has reached $30.0 billion. It is on track to be the most since December 2016. The inflow from October to January of $112.0 billion is on track to be the second-highest four-month inflow on record. 

Buying of U.S. equity ETFs this month has been offset by redemptions of $22.2 billion from U.S. equity MFs, which are suffering a thirty-fifth consecutive monthly outflow.

© 2018 RIJ Publishing LLC. All rights reserved.

Outsourcing will persist in management of insurer general account assets: Cerulli

Insurance general accounts remains “a strong, growing institutional asset management segment,” despite a pause in the allocation of assets to nonaffiliated third-party asset managers.

That’s according to the first quarter 2018 issue of The Cerulli Edge – U.S. Institutional Edition, which examines the recent hiatus and an anticipated increase in growth of insurance general accounts and investment outsourcing.

Between 2015 and 2016, the growth rate for the placement of assets with nonaffiliated managers largely flattened out,” said Cerulli director Alexi Maravel in a release. In that period, the percentage of total assets entrusted to nonaffiliated managers changed 0.3%, following a 1.0% change between 2014 and 2015, according to Cerulli’s calculations.

But stronger growth will resume in the next few years, Cerulli predicts, because asset managers will pursue it. “According to a 2017 survey by Cerulli, insurance offers the second-longest client relationship, after public DB plans, at 6.6 years,” Maravel said. “The attractiveness of the business and the potential for gaining long-term client assets should encourage institutional asset managers to attempt to engage insurance chief investment officers for many years to come.”

Nonetheless, “insurance-related merger and acquisition transactions in the asset management industry will likely cool in the near term,” she said. Respondents to a Cerulli survey of insurance asset managers showed that 81% plan to grow their insurance capabilities organically in the next 12 months and 82% report that they are unlikely to do an acquisition soon.

Cerulli believes that while the overall institutional asset management industry expects insurance client assets to grow, managers are pausing to “take stock of their investments, deepen client relationships, employ strategic hiring, and showcase strategies and capabilities that might be new to insurance companies.”

© 2018 RIJ Publishing LLC. All rights reserved.

ISO seeks to support opportunities of aging

A recently formed International Organization for Standardization (ISO) technical committee (ISO/TC 314, Ageing Societies) aims to develop standards and solutions “to tackle the challenges posed as well as harness the opportunities that ageing populations bring,” an ISO press release said.

Dementia, preventative care, ageing workforces, technologies and accessibility are just some of the areas of standardization that the committee proposes to work on, said ISO/TC 314 Secretary Nele Zgavc from BSI, ISO’s member for the UK, in the release.

“Ageing societies have global implications,” she said. “Governments and service providers need to effectively cater to the needs of their populations as they age for the benefit of society as a whole. There is a crucial need for standards to support this.”  

ISO/TC 314 is currently composed of experts from 30 different countries. Its creation follows the development of International Workshop Agreement IWA 18, Framework for integrated community-based life-long health and care services in aged societies, and the ISO Strategic Advisory Group (SAG) on Ageing Societies.

“In 2017, the number of people aged 60 years or over worldwide was more than twice as big as in 1980, and it is expected to double again by 2050 to reach nearly 2.1 billion,” the release said. “The changing demographics of our society brings with it pressures and challenges ranging from everything to healthcare to the local bus.”

© 2018 RIJ Publishing LLC. All rights reserved.

A ‘Blueprint’ to Sell Income Annuities Direct

Blueprint Income is the new name of what was Abaris Financial, a firm created in 2014 in Philadelphia to sell immediate and deferred income annuities via licensed phone reps to do-it-yourself Gen-Xers and others over the Internet.

Abaris stalled, but the new platform looks more viable. It has a friendly interface and a mission to sell not just single premium products but also multi-premium income annuities, or “personal pensions,” to people five or more years from retirement. It also boasts more than dozen carrier partners (including Nationwide, which has been running its own experiments with Internet-sold multi-premium income annuities in the Arizona market.)

Matt Carey, a co-founder of Abaris with Wharton School credentials, told RIJ this week that the company, whose website now indicates a Manhattan address, is delaying publicity until a hard launch of its new brand in a few weeks.

“We’re releasing a bunch of new tech in the next couple weeks, along with a funding announcement, so we’ve decided to hold off on talking to media outlets until then,” Carey said in an email. On its website, the company promises, “We put the customer first by taking lower commissions from insurance companies to offer you the highest possible rates.” 

Recognizing the tainted image of annuities in the public mind, Blueprint Income has distanced itself from the most widely-sold products, even distinguishing between what it calls “good” annuities (income annuities, qualified longevity annuity contracts, plain-vanilla fixed deferred annuities) and “bad” annuities (indexed and variable annuities) on its website.

Virtually all of the major income annuity issuers are represented on Blueprint Financial’s quote engine. An RIJ request entered at the site for bids on a $100,000 deferred income annuity (DIA) for a 66-year-old male with a deferral to age 80 elicited monthly payout offers between $1,224 and $1,434 from New York Life, MassMutual, Guardian, Mutual of Omaha, Lincoln Financial, Principal, Pacific Life, Symetra, and AIG.

Mutual of Omaha offering the highest monthly payout. (See chart on RIJ homepage). Along with those quotes, the website indicated that it had information about additional contracts from USAA, Integrity Life, Nationwide, Americo and Foresters Financial.

The initial quote list from Blueprint Income did not give details about the contract structures. A comparable request sent to immediateannuities.com returned an average payout of $1,502 a month for a life-with-cash-refund DIA and $1,933 a month for a life-only DIA.

A January 5 post on the Blueprint Financial website said, “Frankly, the decision to update our name and brand has been an easy one. Abaris never clicked with users, investors or even us. Abaris, in Greek mythology, advised Apollo on important decisions. But not everyone knew that. And not everyone pronounced it the same way. We love how Blueprint Income gives us a way to talk about what we do and how we do it in a simple and emotive way.”Insurers on the Blueprint Income platform

In past statements, Carey and co-founders Adam Colombo and Nimish Shukla have said they’re focusing on the self-reliant Gen-X market and female markets, with an emphasis on transparency and integrity and a website that follows the airy, colorful, simple, utterly unambiguous user-interface style that has for at least three years been the standard in the fintech world and beyond.

A just-published report on insurance fintech from Aite said Abaris/Blueprint Income said:

“Abaris is providing a great tool for consumers in the market for annuities to buy without guidance or solicitation. It is perfect for the do-it-yourself buyers who know what they want. Its extensive online application helps to complete the transactions online without additional carrier contact. Carriers are obviously comfortable with its approach, given the breadth of quality annuity providers brokering through its platform.”

“Abaris is convinced that purchasing annuities online will become the preferred annuity purchase method going forward. In fact, Abaris is so convinced of this approach that it is launching a companion website called Blueprint Income. Blueprint Income will focus on delivering what it calls “personal pensions” online and will target Generation Xers (people born roughly between 1965 and 1981).”

Back in 2014, Carey told RIJ:

“We have two business lines. First, we represent a new sales channel for insurers. We act as an insurance producer and work on a commission basis.  We have relationships with seven insurance carriers in this market.  As the largest fixed annuity underwriters (such as New York Life, MassMutual, and Northwestern Mutual) unveil their QLAC [qualified longevity annuity contracts] products later this year, we hope they will also join our platform.

“Our second business line is analytics. We’re building out a data-driven platform that will enable carriers to make more informed underwriting, marketing and new product development decisions. You glean a lot more about potential customers when they are researching and getting quotes online than when they are being sold a product offline.  We think this shift to online research and purchasing represents an exciting opportunity for the carriers to harness data to make better decisions.”

The online income annuity sales landscape is by no means crowded—U.S. sales of immediate and deferred income annuities were just $7.9 billion in the first three-quarters of 2017, according to LIMRA. It has always been a bit complicated by the fact that the big mutual insurers, which are the main issuers of income annuities, have their own agents and don’t want to cannibalize that channel. But New York Life, for instance, has said it would like to stimulate third-party sales.

Blueprint Income enters an online annuity marketplace field populated with Fidelity’s income annuity platform, Kelli Hueler’s Income Solutions platform, and Hersh Stern’s incomeannuities.com.

In the past year, Nationwide has been testing direct online sales of multi-premium income annuities with a pilot program limited to the Arizona market. Stan “the Annuity Man” Haithcock, a champion of insurance-only annuities, has also announced a venture in direct income annuity sales.

Each of these firms has its own business model. Many if not most of the purchases on Fidelity’s platform are driven by Fidelity clients whose Fidelity-affiliated advisors recommend them. Income Solutions serves individuals and advisors, but its primary mission has been to serve people who are retiring from large 401(k) plans, including those of Boeing, GM and IBM, and all Vanguard-administered plans. Nationwide’s platform will be proprietary. Stern’s business is independent.

All of these platforms provide competitive bids from competing insurers. That gives consumers an informational advantage that they don’t have when buying from a captive agent who presents only his or her company’s product. Cannex, the Canadian-American annuity quote and price comparison site, is the biggest provider of real-time annuity quotes to the platforms (with the exception of Income Solutions).

Direct-selling annuities to consumers challenges the conventional wisdom that annuities are sold, not spontaneously bought, by the investing public. There’s also the obvious issue with regulation; sales of annuities require the intermediation of a licensed insurance agent, and fixed annuity issuers, sold online or not, have historically paid a one-time fee of 2% to 3% to independent agents. The purchaser doesn’t see that fee; it’s baked into the monthly payment. 

But consumer habits have changed. It’s now assumed that not just Millennials but Americans of all ages have become accustomed to and may even prefer online financial transactions. Research has suggested that consumers feel more “in control” of the process when they buy online, where there’s little or no sales pressure and they may have an informational advantage.  

© 2018 RIJ Publishing LLC. All rights reserved.

Flat Rich: How Airbnb Saved the Quinteros’ Retirement

The Baby Boomer retirement wave, the damage done to global social security systems by the financial crisis, and the exponential growth of Airbnb’s online lodging network, have more or less coincided over past ten years. If that convergence is an accident, it doesn’t quack like one.

For Jesus Quintero Alvarez, a 61-year-old topographical engineer in Seville, Spain, those three trends are the story of his life. Mr. Quintero was born midway into the post-WWII fertility boom, in 1955. As he and his wife neared retirement age, Spain reduced the generosity of its state pension. And he salvaged his retirement by becoming an Airbnb entrepreneur.    

Mr. Quintero, his wife Rita, and his son Paulo, 35, a mechanical engineer, sat down at the dining room table in one of their two Airbnb apartments in Seville recently to tell their story. It’s a story about weakening social safety nets, personal resourcefulness and Airbnb, which, in a sense, has usurped life insurers as a provider of lifetime income for retirees worldwide.

You’re fired!

Mr. Quintero worked for 35 years at a multinational construction company that built homes, apartment complexes, roads and bridges. Only 52 years old when the eurozone’s financial crisis erupted in 2008, he survived several rounds of layoffs and expected to work until he reached full pension age at 65.

Spain’s social security pension is generous, to a fault. Its 80% initial replacement rate is twice the median replacement rate of Social Security in the U.S. It’s funded (or rather, underfunded; it’s running a government-financed deficit €18 billion a year) by a payroll tax of about 30% (25% from the employer and 5% from the employee). 

But two years ago, Mr. Quintero’s employer, fired him without specific cause, leaving him five years short of full pension age. Unemployment benefits (which, like the pension, are richer in Spain than most other EU countries) helped ease the pain. As for severance pay, but he had to go to court to force his company to pay him the 30% (€43,000, or $53,340 at today’s exchange rate). 

Calle Mateos Gago Sevilla  

His involuntary early retirement would reduce his annual pension by 7.5%, he said. That shortfall alone might not sound crushing, but under Spain’s recent financial reforms, pensions are no longer indexed to inflation. By capping annual increases at 0.50%, Spain hopes to inflate away a chunk of its pension burden. The Quinteros would also be without a 401(k) type savings plan or a “spousal benefit” for Sra. Quintero; Spain has neither.

The Quinteros held a family meeting to decide what to do next. They didn’t need to worry about health care; it’s universal. But they still faced a future of steady declining purchasing power unless they found a source of supplemental income. But how to get it? Since they live in tourist-heavy Seville, the answer was rather obvious.

Spain’s tourism boom

Spain in general and Seville in particular have been major tourist destinations since tourism was born in the 19th century. But in recent years, Spain’s tourism industry has mushroomed. That’s a dividend, ironically, of the eurozone’s financial crisis, which hit Spain (along with Greece, Italy and Portugal) especially hard. 

After Spain’s real estate bust in 2008, its citizens, banks, and government all woke up to a hangover of hundreds of billions of euros in external debt that it could never pay back. Bound to the euro, Spain couldn’t devalue its currency (and thereby revive its export competitiveness). So the whole country took a pay-cut of up to 15%. This “internal devaluation” sparked booms in manufacturing and tourism. In 2016, Spain, a country of 46.5 million, received 75.6 million foreign visitors. In July 2017, 10.8 million people visited Spain, setting a single-month record.

Tourists in general are using organized packages less often and switching to DIY travel. In Spain, one result has been that while hotel traffic grew only 4.1% from 2015 to 2016, the use of short-term apartments grew 23.2% (albeit from a smaller base). The number of Airbnb properties has been doubling every year. The online service now accounts for a reported 54.2% of all available vacation rentals in Spain.

At their family meeting, the Quinteros decided to enter the Airbnb business, and to do it seriously, not as a hobby.  They are now among the 37% of Seville’s Airbnb hosts who have been with Airbnb for two years or more, the 69% who solicit bookings “regularly,” and the 36% with two listings, according to a University of Seville survey of 100 Airbnb hosts.

Bosch appliances, marble baths

With caution, the Quinteros crunched the numbers. First, they calculated their net income needs. Then they imagined the type of property that could generate enough top-line revenue to produce a satisfactory bottom line–after the considerable cost of a mortgage, utilities, maintenance, management and a 20% municipal lodging tax.

They needed a safe investment—a premium property that could maintain a reliable year-round occupancy rate in the face of competition with other Airbnb properties and with Seville’s bouquet of boutique hotels, which offer luxury rooms for $100 to $200 a night in winter and $200 to $350 a night in summer.

So they bought two flats in a strategic neighborhood. Seville is a 2,000-year-old city of about 700,000 people 120 miles north of Mediterranean beaches. Ornamented with Roman, Moorish and Spanish Imperial architecture, Seville’s oldest, quaintest section is Barrio Santa Cruz, a labyrinth of narrow alleys surrounding Seville’s landmark Giralda bell tower and Cathedral of Santa Maria de la Sede. 

The epicenter of dining and lodging in the barrio is Calle Mateos Gago (pictured above), a cobblestone lane lined with orange trees and bistros, called tapas bars. There the Quinteros found an old building that had been gutted and converted into contemporary apartments, each with a small living room/dining room, a galley kitchen with a Bosch stove and dishwasher and two marble baths. If the apartment sold in line with prices of comparable properties, the Quinteros paid about €250,000 (about $300,000) for each. 

Borrowing to buy two apartments was a big gamble to take late in life. But the Quinteros saw it as a multi-generational investment. The three of them handle all the chores. They charge $190 per night (discounted to $3,200 per month). By attending to detail (professional-grade photos for their Airbnb webpage; in-person welcomes; chocolate truffles for new arrivals), they’ve earned a five-star, 9.8 Airbnb rating from guests. Perfect user ratings are a key to success in the Airbnb game.

No coincidence

This story began with the question: Is it an accident that Boomer retirement, the damage inflicted on public pensions by the financial crisis, and the rise of the global Airbnb phenomenon have all occurred within more or less the same time period? Probably not.

Airbnb is in the right place at the right time. Almost as soon as the service appeared, older people and empty nesters with spare bedrooms or apartments recognized that rental income could cover their savings gaps. At the same time, Boomers with an itch for international travel in retirement recognized in Airbnb a way to see the world on the cheap. Four million properties in 191 countries now use the platform.

That doesn’t mean that hosting is easy. Once Airbnb’s potential for monetizing surplus real estate became clear, it was inevitable that entrepreneurs would turn it from an amateur endeavor to a cutthroat professional one. Airbnb’s low barrier to entry also makes it ruthlessly price-competitive and, inevitably, reduces the odds of success. The Quinteros say they understand the risks, and they’re ready to do what it takes to reap the rewards. 

© 2018 RIJ Publishing LLC. All rights reserved.

The World’s Priciest Stock Market

The level of stock markets differs widely across countries. And right now, the United States is leading the world. What everyone wants to know is why – and whether its stock market’s current level is justified.

We can get a simple intuitive measure of the differences between countries by looking at price-earnings ratios. I have long advocated the cyclically adjusted price-earnings (CAPE) ratio that John Campbell (now at Harvard University) and I developed 30 years ago.

The CAPE ratio is the real (inflation-adjusted) price of a share divided by a ten-year average of real earnings per share. Barclays Bank in London compiles the CAPE ratios for 26 countries (I consult for Barclays on its products related to the CAPE ratio). As of December 29, the CAPE ratio is highest for the US.

Let’s consider what these ratios mean. Ownership of stock represents a long-term claim on a company’s earnings, which the company can pay to the owners of shares as dividends or reinvest to provide the shareholders more dividends in the future. A share in a company is not just a claim on next year’s earnings, or on earnings the year after that. Successful companies last for decades, even centuries.

So, to arrive at a valuation for a country’s stock market, we need to forecast the growth rate of earnings and dividends for an interval considerably longer than a year. We really want to know what the earnings will do over the next ten or 20 years. But how can one be confident of long-term forecasts of earnings growth across countries?

In pricing stock markets, people don’t seem to be relying on any good forecast of the next ten years’ earnings. They just seem to look at the past ten years, which are already done and gone, but also known and tangible. But when Campbell and I studied earnings growth in the US with long historical data, we found that it has not been very amenable to extrapolation. Since 1881, the correlation of the past decade’s real earnings growth with the price-earnings ratio is a positive 0.32.

But there is zero correlation between the CAPE ratio and the next ten years’ real earnings growth. And real earnings growth per share for the S&P Composite Stock Price Index over the previous ten years was negatively correlated (-17% since 1881) with real earnings growth over the subsequent ten years. That’s the opposite of momentum. It means that good news about earnings growth in the past decade is (slightly) bad news about earnings growth in the future.

Essentially the same sort of thing happens with US inflation and the bond market. One might think that long-term interest rates tend to be high when there is evidence that there will be higher inflation over the life of the bond, to compensate investors for the expected decline in the dollar’s purchasing power. Using data since 1913, when the consumer price index computed by the US Bureau of Labor Statistics starts, we find that the there is almost no correlation between long-term interest rates and ten-year inflation rates over succeeding decades. While positive, the correlation between one decade’s total inflation and the next decade’s total inflation is only 2%.

But bond markets act as if they think inflation can be extrapolated. Long-term interest rates tend to be high when the last decade’s inflation was high. US long-term bond yields, such as the 10-year Treasury yield, are highly positively correlated (70% since 1913) with the previous ten years’ inflation. But the correlation between the Treasury yield and the inflation rate over the next ten years is only 28%.

How can we square investors’ behavior with the famous assertion that it is hard to beat the market? Why haven’t growing reliance on data analytics and aggressive trading meant that, as markets become more efficient over time, all remaining opportunities to secure abnormal profits are competed away?

Economic theory, as exemplified by the work of Andrei Shleifer at Harvard and Robert Vishny of the University of Chicago, offers ample reason to expect that long-term investment opportunities will never be eliminated from markets, even when there are a lot of very smart people trading.

This brings us back to the mystery of what’s driving the US stock market higher than all others. It’s not the “Trump effect,” or the effect of the recent cut in the US corporate tax rate. After all, the US has pretty much had the world’s highest CAPE ratio ever since President Barack Obama’s second term began in 2013. Nor is extrapolation of rapid earnings growth a significant factor, given that the latest real earnings per share for the S&P index are only 6% above their peak about ten years earlier, before the 2008 financial crisis erupted.

Part of the reason for America’s world-beating CAPE ratio may be its higher rate of share repurchases, though share repurchases have become a global phenomenon. Higher CAPE ratios in the US may also reflect a stronger psychology of fear about the replacement of jobs by machines. The flip side of that fear, as I argued in the third edition of my book Irrational Exuberance, is a stronger desire to own capital in a free-market country with an association with computers.

The truth is that it is impossible to pin down the full cause of the high price of the US stock market. The lack of any clear justification for its high CAPE ratio should remind all investors of the importance of diversification, and that the overall US stock market should not be given too much weight in a portfolio. 

The Fragility of VA Living Benefit Guarantees

There’s a potboiler waiting to be written about the boom and bust of the variable annuity market from the mid-1990s to the mid 2010s. Of that I have no doubt. In the meantime, two economists, Ralph Koijen of NYU’s Stern School and Motohiro Yogo of Princeton, have published a technical post-mortem of the VA debacle of a decade ago.

The equation-rich article, “The Fragility of Market Risk Insurance” (NBER Working Paper 24182, January 2018), isn’t an easy read for the non-economist, even on multiple readings. But it adds some accessible details to the history of VAs—a history that we need to study or risk repeating.

For their part, the authors claim to provide “a more complete theory of the supply side of insurance markets that explains pricing, contract characteristics, and the degree of market incompleteness.” I took that to mean: Why some VA issuers had to drop out of the business.

Check out the scatter charts

VA industry veterans won’t be surprised at some of the authors’ conclusions. Rich roll-up rates fueled demand for VAs with guaranteed lifetime withdrawal benefits (GLWBs) and rising fees depressed it. After the stock market and interest rates dropped in 2008, declines in the valuation of the reserves behind VA guarantees.

These declines led to shrinkages in supply, as issuers with too much “financial friction” (the difference between earnings from capital and the cost of capital) and less “market power” (the ability to raise fees and stay competitive) reduced their sales or fled the space entirely.

For the reader who wants information about specific companies, the most relevant aspect of the report may be two scatter charts in the appendix. Both charts populated by the names of VA issuers (though some names are unfortunately obscured by others in this version of the paper).

The first chart (below) shows the issuer-by-issuer relationship between VA sales growth and changes in reserve valuations (I took this as an indication of the decline in the value of assets supporting liabilities) between 2007 and 2010. Note the negative correlation between the two, and note the outliers.

Koijen Chart 1

AXA and Genworth had the biggest changes in reserve valuations and saw some of the biggest percentage drops in sales growth. Jackson and Prudential, during the same period, enjoyed the biggest increases in sales growth and saw some of the smallest increases in reserve valuations. Little mystery that they could keep selling VAs in volume after 2010. Note also that MetLife, AEGON and Sun Life experienced almost no change in sales growth even as they absorbed a fairly high increase in reserve valuation. 

The second chart (below) shows the positive correlation between the percent of reserves reinsured and the changes in reserve valuations over that three-year period.

Koijen chart 2

In this case, Jackson National and AXA again appear as outliers at opposite ends of the chart. “AXA increased the share of variable annuity reserves reinsured by 64 percentage points as its reserve valuation increased by 12 percentage points from 2007 to 2010,” the paper said. Jackson National, with a slight drop in reserve valuation, reduced its reinsured reserves by about 45%. A half decade later, Jackson would become the VA sales leader.

Cautionary note

Are sales of VAs with GLWBs down in recent years because of declining supply or because of declining demand? Are they too expensive for most life insurers to offer or too expensive for advisors to recommend to investors? Koijen and Yogo appear to offer evidence for either interpretation.

 “The increase in fees during the financial crisis coincides with the decline in sales, suggesting an important role for a supply shock,” they write, while adding a page later: “Higher fees and lower rollup rates make variable annuities less attractive to investors, explaining the decline in sales.”

The authors conclude their article with two observations about the VA industry: First, that VA liabilities now represent a significant 34% of all life insurance company liabilities; second, that the reliance on VAs has made life insurers “more like pension fund managers because they have risky assets and guaranteed liabilities.”

Koijen and Yogo tack on a cautionary note at the end: “The persistent under-funding of pension funds may foreshadow similar problems for life insurers in the future. The fact that [some] life insurers are publicly-traded and subject to market discipline could lead to additional challenges that are not present for under-funded pension funds.”

© 2018 RIJ Publishing LLC. All rights reserved.

What’s in the latest issue of Journal of Retirement?

The Journal of Retirement has released its Winter 2018 edition (Vol. 5, No. 3). As usual, the scholarly journal, published by Institutional Investor Journals and edited by George A. (Sandy) Mackenzie, contains a half-dozen or so authoritative articles by some of the most prominent academics and policy experts in the retirement field.

The latest issue features a mix of articles by familiar authors, including Mark Warshawsky, David Blanchette, John Turner, Michael Kitces, and others. Topics include safe savings rates during accumulation, safe withdrawal rates during decumulation, using term life to protect the purchasing power of a surviving spouse, comparative studies of pension systems in Hong Kong and Australia, reverse mortgages and others.  

The contents of the Winter 2018 edition of the JoR are:

“Retire on the House: The Possible Use of Reverse Mortgages to Enhance Retirement Security,” by Mark J. Warshawsky. This study asks whether reverse mortgages can be used to fill at least some of this gap. He finds that 12%–14% of all retired households are suitable for, and might sensibly use, an HECM. He concludes with proposals to lower costs, increase demand for, and encourage the use of reverse mortgages. 

“The Value of a Gamma-Efficient Portfolio,” by David Blanchett and Paul D. Kaplan. In 2014, the authors introduced gamma, a new metric designed to quantify the value of working with a financial advisor. Here, they find that the “average” investor is likely to benefit from working with an advisor who provides “comprehensive, high-quality portfolio services for a reasonable fee.” The actual benefits, they caution, will vary by investor.

“Maximum Withdrawal Rates: An Empirical and Global Perspective,” by Javier Estrada. The author evaluates different retirement strategies through a historical analysis of maximum withdrawal rates in 21 countries over 115 years with 11 asset allocations ranging from 100% stocks to 100% bonds.   

“Optimal Longevity Risk Management in the Retirement Stage of the Life Cycle,” by Koray D. Simsek, Min Jeong Kim, Woo Chang Kim and John M. Mulvey. The authors look for the optimal asset allocation for a retired couple with uncertain life expectancy using term life insurance to protect against a drop in pension income for a surviving spouse. The solution depends on the couple’s longevity risks, the relative price of insurance and the size of any cut in pension benefits.

“Blending Growth, Income, and Protection to Create Default Post-Retirement Solutions for Australia and Hong Kong,” by Lesley-Ann Morgan, Paul Marsden, Clement Yong and Sean Markowicz. After looking at case studies of pensioners in Australia and Hong Kong, two countries that have reformed their social security systems, the authors conclude that retirees need a combination of protection and growth to produce enough income for a comfortable retirement.

“Life-Cycle Earnings Curves and Safe Savings Rates,” by Derek T. Tharp and Michael E. Kitces. By assuming smooth lifetime earnings growth for workers, analysts have overstated successful retirement rates (SSRs) for lower-income households and older households while understating SSRs for higher-income households and younger households, the authors say. Using more realistic earnings curves and Social Security benefits, the authors claim that only the highest-income households need to save more than 10% per year.

“Regulating Financial Advice: The Conflicted Role of Record Keepers in Pension Rollovers,” by John A. Turner. The recordkeepers of 401(k) plans manage roughly 40% of assets rolled over to IRAs. In this article, the author shows that recordkeepers can easily reword their communications to avoid the appearance of non-fiduciary advice while still effectively influencing participants to use the recordkeeper’s IRA rollover service.

Review of The Nation’s Retirement System: A Comprehensive Re-evaluation Is Needed to Better Promote Future Retirement Security, by George A. (Sandy) Mackenzie. The editor of the Journal of Retirement assesses the 174-page study issued in October 2017 by the Government Accountability Office, which was based on the input of a panel of 15 retirement policy experts. 

© 2018 RIJ Publishing LLC. All rights reserved.

2017 was another big year for Vanguard funds: Cerulli

Favorable market conditions and advisor sentiment about active management could lead to another year of positive active net flows, especially for strategies in which passive funds are not as competitive, according to The Cerulli Edge – U.S. Monthly Product Trends Edition for January.

Vanguard, in Bill McNabb’s final year as CEO, continued to dominate flows for all of 2017. Vanguard’s total flows for year were over $207 billion (DFA was second with $31 billion). The coming year will be Vanguard’s first under long-time heir-apparent Mortimer “Tim” Buckley.

Six out of seven of the funds with the most flows were Vanguard index funds (Total Stock Market, 500 Index, Total International Stock Market, Total Bond Market, Total Bond Market II, and Total International Bond Market).

In their first year of positive net flows since 2014, actively managed mutual funds and ETFs added net flows of $19.1 billion in 2017. Of that, $3.7 billion came from mutual funds and $15.4 billion from ETFs.

Flows into active ETFs equate to organic growth of 53%, helping boost assets to $45.2 billion at EOY 2017. On the passive side, assets closed the year above $6.6 trillion, with $3.3 trillion in mutual funds and $3.4 trillion in ETFs. Passive ETFs brought in more than $447.0 billion in 2017, up from $279.7 in 2016.

Cerulli said it expects assets managers “to continue to be selective in their product development efforts.” Here are a few more of Cerulli’s comments on various sectors of the fund market:

ESG criteria. An area of focus will be to build out new vehicle capabilities. Additionally, incorporation of environmental, social, and corporate governance factors/criteria into investment products and processes and development of strategic beta or quantitative capabilities will also be likely areas of focus.

Mutual funds. Mutual fund assets experienced growth of more than 18% during 2017, closing the year at greater than $14.6 trillion. Mutual funds reaped net flows of $249.7 billion for 2017, with taxable bond mutual funds collectively receiving the most flows of any asset class in 2017.

Exchange-traded funds. ETFs had another banner year in 2017, with assets improving 35% to more than $3.4 trillion. Net flows into the vehicle were a robust $463.2 billion, representing organic growth of 18.3%.

Liquid alternatives. The number of new open-end liquid alternative mutual fund product launches in 2017 was essentially on par with 2016. Options-based strategies led new product development activity, with 18 products launched in 2017.

Quantamentals. Within the multi-alternative and long/short equity category, there has been a growing trend of product development of quantitative strategies (factor-based with portfolio manager discretion). These strategies, often referred to as “quantamental,” attempt to combine the strength of fundamental research with quantitative investing.

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