Source: Morningstar 3Q2017 Variable Annuity Sales and Asset Survey, December 13, 2017
Fifteen Best-Selling Variable Annuity Contracts (3rd Quarter 2017)
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The Crypto-Capitalist and His Digital Tontine
An Irish entrepreneur based in Gibraltar wants to use cryptocurrency and tontines to disrupt the annuity industry in the way that Uber has disrupted the taxi business, Airbnb has disrupted the global lodging industry and Amazon has disrupted brick-and-mortar retail stores.
Dean McClelland, a 47-year-old former investment banker and self-described “crypto-capitalist,” isn’t the first to claim that tontines—a non-guaranteed, self-amortizing payout fund—can produce higher income for retirees than traditional annuities can deliver.
But he may be the first to market a financial product that weds the 17th century concept of tontines with the 21st century concepts of “blockchains”—the decentralized, encrypted, anonymous public ledgers—and the digital currencies in which blockchain transactions are conducted.
His company is called TontineTrust. This fall, McClelland has been assembling a management team, looking for hedge fund-type investors, and preparing an “initial coin offering” of a cryptocurrency he calls TON$. He spoke with RIJ recently from his office in the tiny British territory of Gibraltar, home of the famous limestone crag that guards the Atlantic entrance to the Mediterranean Sea.
‘What if we use a blockchain?’
McClelland, like quite a few people who are relatively new to retirement income, claims that his mother sparked his interest in the Boomer-aging opportunity.
“My mother was talking to me about the worries of the ladies and gents that she meets in her golf club,” he said. “Most of them have no clue about what rate they should be saving at today or about how much they can spend each year once they retire. In fact, whenever one of them dies, they wonder why they were saving at all.
“I did some research into the retirement income problem, and every solution had a serious flaw,” he added. “Then I started reading about tontines. I watched videos about them. They made perfect sense. Then I thought, ‘If you’re going to ask for people’s savings, but remove the insurance company from an annuity, you’d have to make it bulletproof.’ So we said, ‘What if we use the blockchain?’
This fall, McClelland (left) has been introducing himself to tontine and decumulation experts in North America like Jon Forman, Richard Fullmer, Gary Mettler, Michael Sabin and Moshe Milevsky.
“Dean is pretty far along,” said Forman, a law professor at the University of Oklahoma who has written about tontines. He calls them survivor funds. “Dean seems not to have a lot of regulatory hurdles in Gibraltar. And he probably has the ability to raise the money he will need to get tontine trusts off the ground.”
Richard Fullmer, an actuarial investment strategist who has co-authored a whitepaper for TontineTrust, told RIJ, “They’re at the pre-startup stage, trying to raise capital to create a real business. A lot of work has gone into putting together a prototype. It’s a marketing effort at this point.”
“[McClelland] has reached out to several people,” said Gary Mettler, a former Presidential Life executive specializing in income annuities. “Some have gone to Gibraltar and provided non-compensated support just because of the novelty of the effort. [TontineTrust] has a significant amount of money. They have legal support in Europe and product development support. They’re out front with it. It’s not under the radar.”
Like the ‘Hunger Games’
With annuity sales in the U.S. and the U.K. in a slump and Boomers’ need for lifetime income incompletely addressed, there’s both a need and an opportunity for new ideas around decumulation. Meanwhile, Bitcoin’s surging value this year has a lot of people pondering new uses for cryptocurrencies and the blockchain.
Like tontines, for example. If low payouts are the reason why near-retirees or retirees buy relatively few annuities, then tontines might be the answer. Since tontines don’t have lifetime guarantees (the participants share both the investment risk and the longevity risk), they don’t need life insurers to underwrite them. Forman and others estimate that 10% to 15% of the cost of a lifetime annuity goes to the life insurer (for insurance agent commissions, and for insurance company reserves, hedging, and profits).
Digitalization could make tontines even cheaper. By substituting the cloud-based blockchain for a traditional recordkeeper, investing the participants’ money in a global balanced exchange-traded fund (ETF), and capturing mortality credits more directly, a digital tontine could deliver as much as 40% more income per year to participants than an income annuity, McClelland said. He envisions an all-in fee of about 1% per year.
For those unfamiliar with life annuities or tontines, a definition of “mortality credit” may be in order. In a pure annuity or tontine, every participant’s money stays in the fund when they die and is credited to the surviving members. That’s the advantage of longevity risk pooling.
But annuities and tontines handle longevity pooling differently. In the annuity, an insurance company anticipates the future deaths and embeds a piece of the expected cash flows into the first and every subsequent fixed payment. In a tontine (although this design can vary), the payments climb significantly as the mortality rate of the members accelerates.
Tontines, like mutual funds, come in closed-end and open-end versions, and McClelland prefers the closed-end type. “I like the idea of, we get 10,000 people in the pool, all within two or three years of a certain age, and we position it like the ‘Hunger Games’: It’s your job to stay alive to win the ultimate reward. I think the competitive angle will appeal to people and help it sell.”
While the opportunity is huge, so are the challenges. McClelland imagines a globalized business, both retail and defined contribution. There are financing issues, asset management issues, actuarial issues, recordkeeping issues, regulatory and legal issues, marketing and distribution issues, and tax issues. How will TontineTrust deal with them?
For financing, McClelland will hold an initial coin offering. “We want to raise a ton of cash,” he told RIJ. “To do that we’ll issue 300 million tokens and sell them throughout the world. The management team will have some tokens. There will be some for recruiting and paying IARs (investment advisor representatives).”
In other words, he’ll be minting a new cryptocurrency, which he calls TON$, which can be traded like equity shares but also loaded onto debit cards for getting cash out of ATMs. “The tokens are traded on exchanges,” he said. “There is now $5 billion in bitcoin traded every day. There are new coins discovered all the time. Or you create them. We’ll do this instead of issuing equity or bonds.”
Asked to explain cryptocurrencies, McClelland offered an analogy. “Imagine that American Express came out and said, ‘From now on we are capping the number of rewards points we issue. If customers want to earn more points, they will have to buy them from other customers. You create a closed loop, which is a way of creating a market. That’s one way to think about digital currencies. There are cryptocurrency markets, and the tokens are the way we reference our transactions.”
Skin in the game
Distribution will be global, and TontineTrust will need an army of financial advisors to introduce the product to retail investors. He’ll promise them a five percent commission but spreads the risk by paying them in TON$, not their own local currency. “My feelings toward investment advisors are not the warmest. The conflicts of interest are just so massive,” McClelland said.
“But you can’t build a global distribution network without them. So you need to pay them. We can tell advisors, work with us, we’ll give you 5% of the money you bring in, by issuing you a tradable token. You can keep these tokens or sell them. They would help us get customers through the door.”
This business model requires advisors to put skin in the game by buying their own TON$ at the outset. In an interview, Gary Mettler told RIJ, “As I understand it, advisors can’t receive payments unless they also do a capital contribution of their own accord. If they plan do a $1 million in placements, for instance, they might have to put up $100,000 of their own accord. They’ll get paid in TON$. It’s as if I wanted to sell [an insurer’s] annuities and the insurer said, ‘Give us $25,000 in advance, and if the transaction screws up, they have cash.”
As for asset management, TontineTrust will invest in a low-cost, passively managed globally diversified balanced index fund. McClelland thinks it will be diversified enough not to need options-based risk management techniques, but he expects to hold a fair amount of cash to dampen volatility.
“We will smooth returns,” he told RIJ. “If we have a great return in one month, we’ll adjust the payout upward. If we have a bad month, we’ll adjust every future monthly payment downward. We will try to maintain as level a payout as possible until mortality credits kick in. I suggest that a significant amount of the assets will be in cash. Personally I feel more comfortable with that.”
Monthly payouts will be calculated by a robo-actuary or “smart actuary” and deposited as TON$ in the participants’ credit card or debit card accounts. “TontineTrust’s payouts would be better than a retail annuity even at the first payment. But they limit the amount paid out at the beginning,” Forman (pictured at left) said.
“They’re saying, we could pay $6,500 a year at the beginning by advancing some of the mortality credits and interest. But to make sure that we never have to cut payments in the future, we’ll just give them $5,500 and build up a cushion and then we’ll increase payments later on. You can play with it. In a traditional tontine, of course, the payouts would go up dramatically toward the end. Instead, Dean front-loads more of the payouts. The survivors will get more money, but they don’t want to get the bulk of it when they are too old to enjoy it.”
TontineTrust has reduced its regulation and compliance burdens by locating in Gibraltar, a business-friendly outpost of Britain. Almost twice as many companies as citizens are domiciled there. “My understanding is that they’ve received some kind of approval from Gibraltar’s regulatory agencies to create these products,” Fullmer told RIJ. “Places like Gibraltar are more on the forefront of innovation. That’s why Dean is there. Getting that approval is huge.”
As for overcoming the legal barriers to marketing a tontine in the US, where they’ve been more or less banned since a 1906 scandal, “You need a ruling that a tontine isn’t an insurance product,” Jon Forman told RIJ. “There are certain questions that need to be answered: Will a tontine violate the gambling or insurance laws of state X? Will the state tax the premiums? What will the reserves have to be? Another way to go is through ERISA?”
“This [retirement financing] problem needs to be solved,” McClelland told RIJ. With the fervor of a convert, he believes that cryptocurrencies, blockchain, smart contracts and tontines are the solution.
“Within two years, blockchain will be ubiquitous,” he said. “It’s close to being mainstream right now. It’s impossible to change the history of the blockchain. It creates a perfect audit trail. It’s like a triple entry accounting system. Madoff would never have happened if there’d been blockchain.”
© 2017 RIJ Publishing LLC. All rights reserved.
Surveying the Damage of Low Interest Rates
For years after the 2008 financial crisis, policymakers congratulated themselves for having averted a second Great Depression. They had responded to the global recession with the kind of Keynesian fiscal and monetary stimulus that the moment required.
But nine years have passed, and official interest rates are still hovering around zero, while growth has been mediocre. Since 2008, the European Union has grown at a dismal average annual rate of just 0.9%.
The broad Keynesian consensus that emerged immediately after the crisis has become today’s prevailing economic dogma: as long as growth remains substandard and annual inflation remains below 2%, more stimulus is deemed not just appropriate, but necessary.
The arguments underlying this dogma do not hold water. For starters, measures of inflation are so poor as to be arbitrary. As Harvard’s Martin Feldstein notes, governments have no good way to measure price inflation for services and new technologies, which account for an ever greater share of advanced economies’ GDP, because quality in these sectors varies substantially over time. Moreover, real estate and other assets are not even included in the accounting.
The dictate that inflation must rise at an annual rate of 2% is also arbitrary. Swedish economist Knut Wicksell’s century-old concept of a “natural” interest rate—at which real (inflation-adjusted) GDP growth follows a long-term average while inflation remains stable—makes sense.
But why should the inflation rate always be 2%? And why aren’t services, new technologies, or, say, Chinese manufactured goods excluded from the measure of core inflation, alongside energy and food?
Given these shortcomings, it is worth asking if central banks’ doctrine of “inflation targeting” will suffer the same fate as monetarism in the 1980s, when policymakers obsessed over the supply of money. As with inflation today, central bankers then had no credible way even to measure the quantity of money, let alone deliver desired monetary-policy outcomes.
We should consider the effects of large budget deficits as another dubious form of stimulus. In 2017, economic growth in the EU swung up to an annual rate of 2.3%, after member states had finally reduced their budget deficits to an average 1.5% of GDP, down from 6.4% of GDP in 2010. Apparently, the fiscal stimulus after the crisis was not all that stimulating. By contrast, tighter fiscal policies in recent years seem to have had a positive effect.
Usually, a financial crisis gives rise to major structural reforms. But neither the 2008 crisis nor the subsequent euro crisis, which was caused by excessive public debt, led to significant deleveraging or Schumpeterian creative destruction in the affected countries. Clearly, the flood of government spending alleviated the need for difficult reforms, and allowed incumbent enterprises to shore up their positions with cheap finance. Any chance at structural renewal was smothered in the crib.
Among EU countries, average public debt increased from 73% of GDP in 2009 to 86% of GDP in 2016, far above the ceiling of 60% of GDP set by the Maastricht criteria. In Southern Europe, public debts are so large that they will depress growth for years to come.
And yet the past decade of ultra-low interest rates will likely prove even more pernicious than the years of deficit spending. There is no telling when or where the next financial bubble will burst. But we would do well to heed the findings of economists such as the late Charles Kindleberger and Harvard’s Kenneth Rogoff and Carmen Reinhart, and tread carefully.
After all, one can spot potential bubbles all over the place. Real estate and other asset prices are at record highs in much of the world. And the value of bitcoin in circulation has increased tenfold just this year, to $170 billion, although the cryptocurrency’s underlying value remains dubious at best.
Ultra-low interest rates have also created such a scramble for higher yields that even a poor, mismanaged country like Tajikistan can sell Eurobonds. For Tajik President Emomali Rahmon, that certainly beats seeking help from the International Monetary Fund, which would demand substantial reforms. Thanks to low interest rates, Rahmon can continue to misrule his former Soviet republic as he sees fit.
The many other victims of ultra-low interest rates should be all too apparent. Middle-class savers have watched the real value of their bank deposits decline annually at a rate of about 2%, and many retirees have suffered a real decline in their pensions, which are invested in safe assets and thus yield minimal returns.
The same is also true for many forms of insurance. Insurers themselves seem to be doing fine, but that is because they have been cutting benefits to the point that their customers will soon wonder why they bothered to take out policies in the first place.
Even banks are beleaguered. In advanced economies, traditional lenders are now subject to such a mass of regulation that they have had to withdraw from foreign activities. Not surprisingly, less regulated intermediaries in the shadow banking system have stepped in to seize much of their business.
Traditionally, the banking business centered around attracting deposits and issuing loans. But as a result of “low-for-long” interest rates, that share of banking has become ever smaller, and banks have had to charge ever-higher fees for various other financial services.
Moreover, low interest rates have diverted money toward less transparent and more speculative financial institutions, such as private-equity and hedge funds. Such institutions thrive on cheap credit, which enjoys more favorable treatment than equity financing under most Western tax regimes.
The benefits of low interest rates have accrued not to the population at large, and certainly not to the middle class, but to billionaires—the top 0.1%. The global wealth gap has widened significantly in the past decade alone, and especially in the US, where billionaires pay little to nothing in taxes thanks to special rules such as “carried interest.” And under the new Republican tax plan, they will pay even less.
The question now is whether Western institutions are strong enough to contain the global plutocracy that low interest rates have wrought.
Anders Åslund is a senior fellow at the Atlantic Council in Washington, DC. He is the author of Ukraine: What Went Wrong and How to Fix It and, most recently, Europe’s Growth Challenge (with Simeon Djankov). He is currently writing a book on Russia’s crony capitalism.
© 2017 Project Syndicate.
Tontines: A New Threat to Annuities?
Insurance companies “don’t like the ‘t’ word,” one investment strategist told me. He meant tontines.
Just when life insurers and retirement providers thought they had weathered the interest rate nightmare, the robo nightmare, and the fiduciary nightmare, along comes a triple-edged nightmare: crypto-currencies, blockchain and tontines.
Just as global warming seems to bring stronger, more frequent hurricanes, the spread of digital technology seems to bring stronger, more frequent disruptions to the financial services industry.
The lead story in today’s issue of RIJ describes a Gibraltar-based startup, TontineTrust. Its founder, Dean McClelland, claims to be close to launching a tontine. It will be financed by a cryptocurrency offering, record-kept by blockchain, managed by a “smart actuary,” and represented on the web by one of those simple UX interfaces made famous by Betterment, et al.
First, what’s a tontine? It’s a fund that, like a life annuity, allows investors to pool their investment risk and longevity risk. In a life annuity, investors sell those risks outright to a life insurance company in return for a fixed guarantee lifetime income stream. In a tontine, investors retain some of the investment risk by accepting a variable income stream. And, by pooling instead of selling longevity risk, tontine participants can get bigger “mortality credits” for surviving.
Nothing is guaranteed, so no life insurer is needed. As York University finance professor and tontine historian Moshe Milevsky has written, that removes a lot of overhead and by itself significantly enhances the potential payout. Tontines can also hold riskier assets than an insurance company can, which implies bigger investment returns.
Opponents of conventional life annuities often claim that they’re no good because “when you die, you forfeit your money to the insurance company.” TontineTrust, in its whitepaper, says, “in a traditional annuity product, when a member passes away, their capital is in essence transferred to the shareholders of the life insurance company.”
Life insurers could do a better job of neutralizing this accusation, because it’s not exactly true. As Milevsky wrote to RIJ in an email:
“Any actuary will tell you that’s ridiculous. Rather, an assumption is made about the expected number of deaths in a particular year and then those who survive (lucky) are subsidized by those who don’t. Yes, there is some conservatism and profit baked-in into these assumptions, but it’s simply incorrect to say that money forfeited by the unfortunate is retained by the annuity company.”
If no annuity owner ever died, the life insurer’s payments would still contain mortality credits. If no tontine participant ever died, the participants would only get their fair share of the returns of the pool of assets. (The fact that a tontine requires human deaths in order to pay off may help explain why they’re not legal in the U.S.)
Sales of life annuities have always been low. If people don’t buy annuities because the payouts are too low, then tontines could replace annuities as retirement income tools. But what if that’s not the reason for low annuity sales? If Americans aren’t buying life annuities because a) they already own big inflation-adjusted life annuities in the form of Social Security or b) they want to keep savings liquid, or c) they want their children to inherit their money, then tontines will face similar marketing hurdles.
But in the hands of the right entrepreneurs, cryptocurrencies and blockchain (along with the Internet itself and newfangled APIs) could make tontines—or “survivor funds,” to use a less foreign and more upbeat term—a much bigger threat to insurance companies than they’ve been in the past.
Thanks to this year’s bull market in bitcoin, everybody’s talking about cryptocurrencies, smart contracts and blockchain, even if they don’t really understand it. Whether that enthusiasm will last, or whether it’s contagious enough to create enthusiasm for blockchain tontines, remains to be seen.
TontineTrust has an interesting marketing pitch. Imagine that you’re a contestant in the Hunger Games, McClelland says. You’re competing to stay alive, and the rewards for out-living everyone else are spectacular. (Tontines can be designed to make level payouts, but that would dilute the rewards for the few who live to 95 and beyond.)
Life insurers can take some comfort in believing that most older Americans will not hand over a big chunk of savings to a company they never heard of, especially one that uses a business model they don’t understand. Are Boomers going to give their money to a new company in Gibraltar or to a familiar old brand name that advertises during NFL and college basketball games?
But complacency would be a mistake. Life insurers like to say that they have a monopoly on longevity risk mediation. Digital tontines could prove them wrong.
© 2017 RIJ Publishing LLC. All rights reserved.
Sales of fee-based VAs and FIAs on rise in US: Cerulli
New research from Cerulli Associates, a global research and consulting firm, discusses how the Department of Labor (DOL) Conflict of Interest Rule has slowed development along the variable annuity (VA) product pipeline. However, many insurers were being proactive in 2016 as approximately 25 of the new product filings were I-share VAs (i.e., fee-based VAs).
“A clear priority for most VA carriers is to manage the risk of their guaranteed benefits,” explained Donnie Ethier, director at Cerulli. “Insurers we surveyed listed the cost of risk management and hedging as being an obstacle; 40% named it as their greatest obstacle in the space. This is followed by designing and distributing fee-based solutions as well as competing annuity designs such as fixed-indexed annuities (FIAs).
“While sales of fee-based VAs, or I-shares, were growing even before the DOL Rule was announced, they declined in 2016,” he added. “Sales surpassed $2.8 billion as of 2Q 2017 putting them on pace to post slight year-over-year annual growth. The share class is important as the insurance industry looks to address the DOL. However, the wealth management industry had already been transitioning toward the fee-based compensation model and the DOL Rule will have the effect of accelerating this process.”
Cerulli believes that regardless of what fiduciary standard is used, it will cause change in how advisors do business. And the steady migration to the fee-based compensation model will continue. Most industry observers expect annuity sales to be under pressure for the next few years, but hold out hope for the future. One bright spot for the industry has been FIAs.
“FIAs sold a record $60.1 billion in 2016, but sales faltered in 4Q 2016, when it was revealed that FIAs would be subject to the same standards as VAs under the DOL Rule,” Ethier said. “Sales seemed to rebound a bit when full implementation of the rule was delayed. More broker/dealers and advisors are beginning to warm up to the FIA concept. The products have come a long way in terms of transparency and acceptance; however, like the majority of surveyed insurers, Cerulli believes much of the surge in FIA sales is a result of an inadequate supply of attractive VA guarantees. Therefore, advisors are looking at new retirement income solutions.”
Cerulli’s latest report, U.S. Annuity Markets 2017: Guaranteed Retirement Income in a Fiduciary World, provides analysis of the U.S. annuities market, examines the impact of the DOL Rule, and projects annuity sales.
© 2017 Cerulli Associates.
VA sales drop in 3Q2017 despite equities rally
New variable annuity sales slipped 11.55% in the third quarter of 2017 to $20.6 billion from $23.3 billion in the second quarter. Sales were down 17.47% from the same quarter in 2016, according to Morningstar’s latest Variable Annuity Sales and Asset Survey.
Variable annuity assets under management (AUM) were $1.924 trillion in the third quarter, down about one percent (0.95%) from the second quarter but up about two percent (1.95%) from the third quarter a year ago.
Ameriprise Financial and Allianz, ranked eighth and ninth in quarterly sales, saw sales increases in 3Q2017. Thanks largely to its Index Advantage structured variable annuity, Allianz enjoyed a 26% increase in new sales from the previous quarter.
Index Advantage moved to 6th from 17th in new sales rank among VA contracts. The contract offers both buffered-crediting options or subaccount investment selections.
The remaining eight of the top 10 issuers experienced declines in new sales from second quarter 2017, however. Jackson National Life, TIAA, and AXA remained the top three issuing companies for new sales in the third quarter.
Jackson National posted new sales of $3.8 billion (18.89% market share); TIAA earned new sales of $2.6 billion (12.68% market share); and AXA generated $2.1 billion in new sales (10.28% market share). The top 10 issuers accounted for almost 81% of new sales.
Captive agents finished the third quarter in a near dead-heat with independent advisors in terms of VA market share. The captive channel, where TIAA, AXA and Ameriprise Financial dominate, accounted for 37.1% of sales. The independent channel, where Jackson National, Lincoln Financial and Prudential Financial stand out, accounted for 37.0%. Other channels represent less than 10% of the market with declines from second quarter results of one percent or less.
© 2017 RIJ Publishing LLC. All rights reserved.
Home equity and purchases of long-term care services
Retirees spend more on home health care and use more unpaid informal care when the value of their homes (and access to home equity) rises. But their use of nursing home care doesn’t appear to be correlated with home equity, according to a study from the National Bureau of Economic Research.
In “Access to Long-Term Care After a Wealth Shock” (NBER Working Paper No.23781), Joan Costa Font, Richard Frank, and Katherine Swartz look at how changes in wealth, specifically housing wealth, affect decision-making around the three above-mentioned types of long-term care services.
“Housing assets represent 67% of the median per capita net worth of adults over the age of 66, and home equity is the primary self-funding mechanism for those who require long-term care,” they write. Their finding adds new evidence to the theory that retirees rely on their housing wealth to finance some types of long-term care services but offers no evidence that they use it to pay for nursing home care specifically.
The researchers analyzed the impact of variations in housing prices from 1996 through 2010–a turbulent period for real estate–on the use of long-term care services. Between 1998 and 2006, housing prices (and thus housing wealth) rose significantly; then it dropped more than 20% on average between 2006 and 2010, according to data from the Health and Retirement Study and the Federal Housing Finance Agency.
Spikes in house prices significantly increased homeowners’ use of both paid home health care and unpaid informal care but did not increase the use of nursing home care, the researchers found.
For instance, a $3,149 increase in wealth increased the probability that a homeowner would use paid home health care services by 0.25 percentage points. It was also associated with a 3% to 4% increase in the probability that a homeowner will use unpaid, informal care. In contrast, renters did not change their usage of long-term care services in response to changing local housing prices.
Half of adults who live to the age of 65 will eventually require long-term care services. Among those who do, these services will cost $133,700 per year in 2015 dollars, on average. For 5% of men and 12% of women, the total lifetime cost of long-term care will exceed $250,000. Medicaid covers about 35% of these costs. Elderly Americans and their families bear about half the cost of long-term care directly.
© 2017 RIJ Publishing LLC. All rights reserved.
Vanguard uses blockchain to share index data
In a pilot program, Vanguard, the Center for Research in Security Prices (CRSP), and Symbiont are cooperating to use blockchain technology to “simplify the index data sharing process,” Vanguard announced this week. Index data will move instantly between index providers and market participants over one decentralized database.
“Investment managers will be able to instantly distribute, receive, and process index data, resulting in better benchmark tracking and significant cost savings,” said Warren Pennington, a principal in Vanguard’s Investment Management Group, in a release.
For several months, CRSP has distributed daily index data to Vanguard in a testing environment through Symbiont’s blockchain platform. Delivering the data via a blockchain and automating workflows with smart contracts has served to expedite data delivery, eliminate the need for manual updates, and reduce risks.
Currently, index data transmission, which is essential to many operations within the financial services industry, including portfolio construction and strategy execution, relies on multiple parties and distribution channels to reach investment professionals.
The success of this initial pilot will enable automation of CRSP index data delivery and intra-day updates over the private blockchain network in early 2018. Vanguard, Symbiont, and CRSP will also use the results of this initiative to influence future blockchain efforts.
© 2017 RIJ Publishing LLC. All rights reserved.
Honorable Mention
Fujitsu settles excessive fee case for $14 million
In the settlement of a class action lawsuit over excessive retirement plan fees, Fujitsu Technology and Business of America, Inc., has agreed to pay $14 million to the participants of the Fujitsu Group Defined Contribution and 401(k) Plan. The settlement equals about $600 per class member and about one percent of plan assets, NAPA Net reported this week.
In addition to the payout, Fujitsu agreed to undertake a request for proposal (RFP) process “to reduce the amount of recordkeeping expenses paid by the Plan and already has voluntarily taken steps to reduce the amount of investment management fees paid by the Plan.”
In the suit, filed in 2016 in the U.S. District Court for the Northern District of California plaintiffs claimed that in 2013, total fees amounted to approximately 0.88% of plan assets (about $11,400,000), and that in 2014, total fees amounted to approximately 0.90% of plan assets (about $11,900,000) – fees that they claimed were almost three times higher than the average for plans of similar size – and that the suit alleged made it one of the five most expensive defined contribution plans out of approximately 650 plans with assets of more than $1 billion.
Holland ponders the effect of raising its pension age
If the Dutch government raised the country’s state pension age in line with life expectancy, it would mean that if people were to live till 110, they would have to work past their 90th birthday, according to the Netherlands Bureau for Economic Policy Analysis, or CPB.
The director of the CPB, Laura van Geest, called such an increase “unrealistic.” The Dutch government has already decided to increase the retirement age to 67 in 2020. One year later, the AOW age will increase again by another three months.
In a new report on working longer, the government’s accountants have warned that low-paid workers and the fast-growing group of self-employed workers (known as zzp’ers in the Netherlands) could face serious problems if the state pension (AOW) age keeps rising.
The government opted for this solution as a way of keeping the state pension affordable, with state finances under pressure since the financial crisis. Van Geest proposed a more gradual increase of the AOW age – for example an annual rise of three months – to enable the current generation of older workers to prepare for working longer.
According to Van Geest, such a slowdown of the rising retirement age would cost the government €1.1bn in 2021, but would be almost budget-neutral in the longer term.
The CPB also said that many self-employed hardly saved for their pension and that most of them had no short-term disability insurance, in contrast to full-time employees. This meant zzp’ers lacked a social safety net if they couldn’t work any longer before retirement age. Van Geest also suggested that the government should assess whether self-employed workers could be persuaded or forced to insure themselves.
“Although the government has made different choices for zzp’ers, research has shown that people don’t think properly about their future and don’t expect to get ill,” she said. “If they do get ill, it is too late to arrange something.”
If the retirement age rises, it would be cost-effective for the government to help people take better care of themselves, she added. Life expectancies of lower-educated workers was at least four years less than that of higher-educated employees because of higher rates of smoking, drinking, eating unhealthy food and not exercising, van Geest said.
T. Rowe Price offers cash flow management tool to participants
To enhance its “financial wellness” services for plan sponsors and participants, T. Rowe Price Retirement Plan Services has integrated a third-party online cash flow management tool, DoubleNet Pay, into its Workplace Retirement website.
Participants can use DoubleNet Pay to manage their “competing financial priorities by automating their spending and saving for short- and long-term goals,” according to a T. Rowe Price release.
With more plan sponsors becoming aware of the adverse impact of financial anxiety and retirement un-readiness on productivity and workforce management, major plan providers have been adding these types of functionalities to their menus of online participant services. Such tools are increasingly perceived as competitive necessities for plan providers.
Users of DoubleNet Pay can set up regular deductions from their bank accounts to pay bills, manage debt and fund an emergency savings account. “Each month the identified dollar amounts will be automatically deducted from an individual’s paycheck so they can clearly see and understand their disposable income,” the release said.
“DoubleNet Pay was created to help people easily pay their bills on time and to start a savings fund before spending their money on discretionary items,” “The tool is significant because individuals are able to enroll in the service annually for less than the cost of a bounced check or the late fee on a credit card,” said Brian Cosgray, DoubleNet Pay’s founder and CEO, in the release.
Quebec raises contribution, replacement rates of DC plans
TowersWatson, the benefits consulting firm, issued a report last week on a recently proposed Canadian law that would raise mandatory contributions to the Quebec Pension Plan (QPP), an earnings-related pension program within the Canadian social security system.
Bill 149, introduced in November, would increase benefits and employer/employee contributions gradually over a seven-year period starting January 1, 2019. It will also amend the Supplemental Pension Plans Act (SPPA), which applies to employer-provided plans in Quebec.
The proposed enhancements mirror those enacted by the federal government in December 2016 for the Canada Pension Plan (CPP), which applies to workers in the other Canadian provinces. Bill 149 calls for these changes to the QPP:
- From 2019 to 2023, the income-replacement rate at retirement for a Quebec worker will increase in stages from 25% to 33.33% of pay, up to the year’s maximum pensionable earnings (YMPE).
- From 2019 to 2023, a 2% increase in contributions (1% by employers and 1% by workers) up to the YMPE will be phased in to fund the above benefit enhancements.
- Covered earnings for determining benefits and contributions under the QPP will be extended by 7% of the YMPE in each of 2024 and 2025, resulting in a final ceiling of 114% of the YMPE.
- The resulting increased benefits will be funded, from 2025, by an 8% contribution (4% by employers and 4% by workers) on pay above the YMPE.
Bill 149 would also enact changes to the SPPA, affecting employer-provided pension plans registered in Quebec, notably the following:
- Contributions made to reduce a letter of credit will be accounted for in the employee reserve maintained by the employer.
- The appropriation and allocation of surplus assets during the life of a pension plan would become increasingly flexible, according to rules that differ from the current default provided under the SPPA.
“Employers and pension plan sponsors will be able to analyze how these changes impact costs, their labor forces’ retirement preparations and the goals they set for their pension programs,” a TowersWatson release said.
Quebec Bill 149 received its first reading on November 2, 2017; however, with the planned changes to the CPP coming into effect in 2019, it is expected that the QPP will be amended to follow suit, TowersWatson said.
U.S. collective investment trust assets reach $2.8 trillion in 2016
Assets in collective investment trusts (CITs) grew to roughly $2.8 trillion as of year-end 2016, representing a year-over-year growth of approximately 11.6%, according to Cerulli Associates, the global research and consulting firm.
The increase reflects the “increasing demand for lower-cost vehicles among institutions,” said Christopher Mason, senior analyst at Cerulli, in a release. “CITs can often be priced lower than mutual funds.”
“Nearly 95% of plan sponsors value the cost savings compared to mutual funds as one of the most important attributes of CITs. Similarly, roughly 90% of consultants feel that the cost savings compared to mutual funds is a very important attribute of CITs.”
“Managers that do not offer CITs should consider doing so, particularly for asset classes or strategies in which cost savings can be passed on to the end-investor,” says Mason.
Cerulli’s latest report, “North American Institutional Markets 2017: Strategies for Implementing Customized Services Across Client Segments,” provides coverage of the rise of institutional custom solutions, particularly liability-driven investing among corporate defined benefit plans, the increased use and adoption of CITs, and the ongoing influence of investment consultants.
Savers want safety and freedom in retirement: Wells Fargo
The Wells Fargo/Gallup Investor and Retirement Optimism Index held steady in the fourth quarter at +140, statistically unchanged from +138 in the third quarter. The index is near its September 2000 high of +147.
Three-quarters of non-retired investors in the survey have a 401(k) plan, and 57% say the most valued feature of their plan is the “match contribution from their employer.” The next most valued feature is the tax deferral on the money they contribute, which was noted by 33%.
Forty-six% say they would “save less” or “stop saving” in their 401(k) if the tax deferred status of their plan was taken away, whereas 42% say they would “save the same amount.” The survey was conducted by telephone with 1,015 U.S. investors Nov. 1–5, 2017, 67% of whom are non-retired and 33% of whom are retired.
Nearly all non-retired investors agree that “it is important to have a guaranteed income stream in retirement, in addition to Social Security,” but about half of investors are unsure about what products offer guaranteed income throughout retirement.
Six in ten (61%) want a guaranteed monthly income stream that lasts as long as they need it, even if that meant “giving up access to some of their money.” But 75% of non-retired investors also want the freedom to spend their money as they wish in retirement, even if that means they may run out of money “too soon.”
About half of non-retired investors (53%) have a savings “number” in mind for retirement. Non-retired investors with a specific number in mind say $1 million (median) is the right objective, although 29% say $500,000 or less.
Forty-one percent of non-retired investors have a specific savings number in mind and can also estimate what that sum will generate annually in retirement, but many of these estimates are unrealistic.
Nineteen percent of non-retired investors have a savings goal in mind and a somewhat realistic assumption of withdrawing up 1 to 5% of their savings every year throughout retirement. The rest are unsure about what their annual draw down would be, or they estimate more than a 5% annual withdrawal rate.
Wells Fargo Asset Management estimates that a five percent inflation-adjusted annual distribution carries a 20%–30% risk of running out of money in retirement, assuming a well-diversified investment portfolio.
Investors who say they need to save $1 million or more expect to draw 5% per year, on average, while those who say they need to save less than $1 million expect to draw an average of 7% per year.
© 2017 RIJ Publishing LLC. All rights reserved.
Differences in contribution rates to retirement plans, by income and gender
Source: 2017 MassMutual Retirement Savings & Household Income Study. *Includes only participants in plans where an employer match is offered.
Cannex Launches Annuity Comparison Tools
“Apple-to-apples” comparisons between annuity contracts or between different types of annuities have always been difficult to make. If it were easier for advisors to determine which contracts are the most “suitable” or in the “best interest” of a client, more of them might recommend annuities.
Cannex Financial Exchanges, the Toronto-based data company that serves the annuity industry in the U.S., and Canada, wants to remove that barrier to sales. The company has for many years offered a wizard for comparing SPIAs (single premium immediate annuities). It now offers tools for evaluating the relative merits of variable annuities (VAs) and fixed indexed annuities (FIAs).
The tools are called Cannex VA Analysis and Cannex FIA Analysis. Besides helping individual advisors match the right annuity contract or annuity rider with the right client, the product is designed to help brokerages and insurance marketing organizations pick contracts for their shelves and enable life insurers to perform competitive benchmarking.
Cannex, which serves more than 300 broker-dealers, banks, IMOs and other institutions employing some 350,000 advisors or agents, aggregates data on an estimated 50 SPIAs and DIA contracts, 100 multi-year guaranteed-rate (MYGA) fixed deferred annuity contracts, 200 FIAs and t 200 VAs from some 30 issuers who represent an estimated 85% of total sales. The firm receives almost four million requests for quotes on SPIAs each year.
“This has been about seven years in the making,” Cannex president Gary Baker told RIJ. “When I joined Cannex in 2010, the first thing that certain clients asked me was, ‘I like what Cannex does with income annuities. Could you please do that with the other annuity products?
“It was difficult for advisors or firms to pull apart the structure of these bundled contracts to assess the income benefits and the death benefits. So there was pent-up demand for transparency. But it was not until we bought the QWeMA business from Moshe Milevsky that we had the elements to do that.”
The biggest demand for these tools should come from advisors who hope to use the so-called living benefits (lifetime income riders) and death benefits of VAs and FIAs in retirement planning. These riders have turned VAs and FIAs, which once were mainly used as tax-deferred investment vehicles, into popular retirement income vehicles.
Advisors can use the tools to rank the living benefits of various contracts by their minimum monthly payment, average monthly payment (based on Monte Carlo projections of future performance), average income benefit over a lifetime (based on mortality tables) average death benefit and average “total economic benefit” (which combines living and death benefits).
To calculate those amounts, Cannex uses the S&P 500 Index whenever analyzing FIA rider values and a 60/40 stock/bond mix when analyzing VA rider values. “We’re running the same ‘electric current’ through every contract,” Baker told RIJ. “We’ve found that even if you vary the asset allocation to 50/50 or 70/30, it doesn’t seem to change a product’s score or its ranking. Some products do have ceilings on the equity allocation when a rider is chosen, and we’re in the process of adding that to the software.” The tools can compare contracts within or across product categories.
“We’ll also be able to create a heat map with 100 cells where the advisor can see the performance of a living benefit in various deferral periods. That’s in development right now,” Baker said. For example, the map could help advisors see the optimal number of years that a client should wait before “turning on” an income rider. The heat map could also show how a client’s age at purchase might affect the relative strengths of different products.
“For the first release [of the VA Analysis and FIA analysis tools] through our platform, we decided that the simplest approach would be to look at new annuity sales [rather than exchanges of one annuity contract for another]. We do support transfers off-platform, either for a back-end compliance group that wants to evaluate a transaction, or at the point of sale,” he added.
Cannex expects brokerages and advisors to rely on its tool as evidence of their efforts to establish the suitability (under FINRA rules) or “best interest” (under the Department of Labor’s BICE or Best Interest Contract Exemption) of a contract, and as an indication of due-diligence. To that end, it has obtained a letter from the Wagner Group, the Boston-based employee benefits law firm, testifying to its applicability to that purpose.
“In our view,” the Wagner letter said, “the Cannex Methodology annuity analysis and evaluation software would qualify as an analysis and evaluation tool that registered investment advisors and their IARs [investment advisor representatives] would be able to utilize in accordance with their duty to act with the care, skill, prudence and diligence of a prudent person under (i) the BICE’s best interest standard of care as applicable to rollover advice provided to Retirement Account clients and (ii) ERISA’s Prudent Man Standard of Care as applicable to non-rollover advice provided to Retirement Account clients subject to Title I of ERISA.”
But “even if there were no DOL rule, there would still be demand for this product,” Baker told RIJ. “The demand for this predates the DOL rule. We’ve shown the new tool to FINRA, and they gave us some feedback on how it can be used to establish the suitability of an annuity sale. A lot of companies are positioning their tools as “DOL” tools, but that’s not our position.”
© 2017 RIJ Publishing LLC. All rights reserved.
Bitcoin is a Bubble. Blockchain is a Breakthrough
Bitcoin is new and exciting. But bitcoin was developed in secrecy by a person or group of people whose identity remains unknown. Its whole purpose is to evade regulation which makes it particularly appealing to the darker side of society—drug dealers, arm sales, terrorists, sex traffickers—which gives it a close link to tax evasion and organized crime.
While it is being billed as “money,” it is not. It is neither a medium of exchange nor a store of value. Bitcoin purchasers today are doing so solely because they seek the anonymity or because they believe the value of a bitcoin will be higher tomorrow. Thus, it seems to us that bitcoin is more like a tulip than money and does not serve any socially useful economic function.
Having said that, the underlying technology on which it is based is revolutionary and could make identity theft by hackers far more difficult, and eventually eliminate the 2-3% transaction fee typically charged today on credit card transactions. It is important to distinguish between bitcoins and the technological advancement that was used to create it. One is useful, one is not.
The origination of the bitcoin is shrouded in secrecy. It was developed in 2008 by some person or a group of people, using a pseudonym—Satoshi Nakamoto—whose identity remains unknown. That is hardly a confidence-boosting start.
Bitcoins are being billed as a new form of “money.” But money is supposed to be a “medium of exchange” which means that it is a widely accepted means of payment. However, few legitimate businesses today accept bitcoin as a means of payment. Money is also supposed to be a “store of value”. But the value of a bitcoin is wildly unstable and its value can change by 10% or more in a single day. It is hard to imagine any investor choosing to park a large portion of his or her assets in bitcoins given this extreme volatility. Thus, bitcoins do not fit any conventional definition of “money”.
The appeal of bitcoin is that the technology on which it is based makes transactions largely anonymous which explains bitcoin’s appeal to the darker side of society. Most illegal activities from drug and gun sales to prostitution and the sex trade are done in cash. But money laundering is challenging, and bitcoins offer the perfect opportunity to convert a mountain of cash into a useable form without alerting authorities.
But the illegal nature of these transactions is sure to encourage regulators to keep a watchful eye on the market and could lead them to impose regulations which would dampen its appeal. It is also going to attract the attention of crime-busters like the FBI. Silk Road was an online black market best known as a platform for selling illegal drugs. It was shut down by the FBI in 2013 but, unfortunately, many Silk Road look-alikes have emerged.
While recognizing the downside of bitcoin, the blockchain technology on which it is based is revolutionary. In today’s world transactions are cleared by banks which verify that the purchaser has the funds available and transfer the proceeds to someone else’s account. Thus, transactions are controlled by banks. But blockchain can be thought of as a giant private sector database that performs those transactions without the bank or any other central authority.
Once a transaction is recorded the bitcoin network it is encrypted by a formula that can supposedly be unlocked only through a trial-and-error process and eventually the bitcoin proceeds find their way to the seller. The transaction is both anonymous and cost-less. Those are powerful advantages.
As a result, central banks around the world are working feverishly to determine whether adoption of blockchain technology could make it harder for hackers to engage in identity theft. Furthermore, in today’s world a merchant pays a 2-3% fee when a purchaser uses a credit card. Bitcoin technology could eliminate these fees to the middleman. Thus, bitcoin technology offers the opportunity to advance the financial payments mechanism into the 21st century.
As we see it, bitcoins have no socially useful economic function. They are not money and they facilitate the ability of drug dealers, gun sellers, sex traffickers, and terrorists to finance their operations. Bitcoins are only useful to speculators—hedge funds and high-speed trading firms in particular. For these reasons, in our opinion, bitcoin has limited appeal. But the blockchain technology on which it is based is revolutionary and will both enhance cyber-security and make the current payment mechanism far more efficient.
© 2017 NumberNomics.
Where Defined Contribution Falls Short
Owning stocks and bonds is the most reliable way to achieve retirement security over the long run. That’s what we’re told and that’s more or less what history has demonstrated. But what percentage of Americans actually holds a retirement-worthy portfolio? The percentage is surprising low.
A few days ago, I received a new research paper by economist Edward Wolff of New York University. According to his review of surveys of U.S. household wealth and income, stock ownership is broad but not deep. About half of Americans own stocks but a small minority owns almost all of it.
Age explains part of the story, but not all of it. Ownership of investments appears to increase with age, as expected. In 2007, pension accounts, corporate stock, financial securities, mutual funds and personal trusts represented just 10.2% of household wealth for those under age 35 but rose to 33.4% for those ages 65 to 74, according to the paper.
Defined contribution plans deserve much of the credit for that increase. Since the appearance of 401(k) plans in the early 1980s, financial assets have played a bigger role overall in personal wealth. The percent of households owning pension accounts, bonds, corporate stocks and mutual funds was just 14.7% in 1983. In 2016, it was 30.7%. Most of that increase (1.5% to 16.5%) came from the growth of defined contribution (DC) plans and IRAs. The share of all households with a DC plan more than doubled from 24% in 1989 to 53% percent in 2007.
“Among younger households, the share rose from 31% to 50%, and among middle-aged households it went from 28 to 64%,” Wolff writes. “The average value of DC plans shot up more than seven-fold from $10,600 to $76,800 (all figures are in 2007 dollars). Among younger households, DC wealth rose by a factor of 3.3. Among middle-aged households, the average value of DC plans mushroomed by a factor of 6.5.”
Unequal equity ownership
But only a minority of Americans has become wealthy as a result. Between 1983 and 2013, the top one percent received 45% of the total growth in net worth, while the top 20% got close to 100%. The share of income held by the top 20% rose to 61.8% in 2013 from 51.9% in 1982. The share of wealth held by the top 20% rose to 88.9% in 2013 to 81.3% in 1983.
The reality is that relatively few U.S. households today have a significant stake in the stock market. In 2016, only 36.8% had total stock holdings worth $5,000 or more, down from 40.1% in 2001; 32.0% owned $10,000 or more of stock, down from 35.1% in 2001; and only 24.6% had $25,000 or more of stocks, down from 27.1% 15 years earlier (all in 1995 dollars). Wolff’s data isn’t entirely consistent, but it all points to almost negligible average equity ownership among a solid majority of American households.
Ownership of stock is much more extensive and intensive at the high end of the wealth spectrum. According to Wolff, 94% of the top one percent of wealth holders own stock and 93% of households in the top 5.2% of income recipients ($250,000 or more) owned stock in 2016.
The top one percent of households (by income) still owns 40% of all stocks. The top five percent owns 71%, the top 10% owns 84% and the top 20% owns 93%. The paper notes that households earning $75,000 or more (the richest 35%) own 91% of all stocks and households earning $50,000 or more own 96%. In other words, only about half of households have any stocks at all.
What conclusions can we draw from this data? You might say, “So what?” Beauty contests and stock car races always have winners and runner-ups; for every population and every metric, there will be a top 20%, a middle 60% and a bottom 20%. Outside of Lake Wobegon, Minn., not every household can squeeze into the top quintile.
Alternately, you might invoke the 80:20 “Pareto” principle as a law of nature. This rule-of-thumb suggests that, in any population, 20% will account for 80% of performance. Or you might interpret the lop-sided data as evidence that the market justly rewards risk-takers. You could even argue that it’s all relative: Even the poor in America are much richer than most people in the developing world.
But it’s still a mystery why, even though DC plans have been available for 35 years, ownership of stock (even indirectly) remains so concentrated. My hunch is that the existing defined contribution system, despite its standardized designs, regulations and contribution limits, reproduces (and may amplify) the economic disparities in the workforce it covers (or fails to cover). If that’s true, DC may not be the ideal path to broader retirement security.
© 2017 RIJ Publishing LLC. All rights reserved.
Integrity Life enhances Indextra FIAs
Integrity Life has added the J.P. Morgan Strategic Balanced Index as an index option on its Indextra Series fixed indexed annuity (FIA), according to an announcement this week by W&S Financial Group, the distributor of insurance products for Western & Southern Financial Group, Integrity Life’s parent.
Sales of the Indextra series exceeded $1.5 billion as of November 30, 2017, according to the release. Launched Sept. 29, 2014, Indextra had strongest first-year sales in W&S Financial Group Distributors’ product history, the release said.
The new index option, which is available in one-, two- and three-year crediting period, is designed to maintain “a stable level of risk no matter the economic cycle,” according to a W&S release. According to W&S product literature, the J.P. Morgan Strategic Balanced Index targets a 6% volatility by investing partly in high-dividend stocks through ownership of the Power Shares S&P 500 High Dividend Low Volatility exchange traded fund (ETF) and partly in the J.P. Morgan Total Return Index, which uses ETFs to get exposure to four classes of bonds.
With this arrangement, the amount of interest that a contract owner can earn over the crediting period has no cap (which places a ceiling on earned interest) or spread (which gives the issuer the initial earnings up to a certain point, and gives the investor the yield above that), but it does participation rate. A new participation rate is declared at the beginning of each new crediting period. The owner is guarantee at least 10% of the index returns.
This type of FIA/index combination would appeal most to investors who like the assurance of three layers of risk protection. The diversification of the index into stocks and bonds provides one layer and J.P. Morgan’s risk-management techniques provide a second layer.
A third layer is provided by the insurance carrier, who guarantees against any loss of principal (if the client holds the product to end of its seven-year surrender period). Less risk-averse investors could get sufficient risk reduction by investing directly in a balanced index fund, which could cost as little as $19 per $10,000 per year (19 basis points) to own.
The product also offers an optional living benefit rider for a fee of 95 basis points per year for clients under age 80. The minimum premium is $10,000.
© 2017 RIJ Publishing LLC. All rights reserved.
Over one-third of U.S. households own IRAs: ICI
A new study from the Investment Company Institute, “The Role of IRAs in US Households’ Saving for Retirement, 2017,” examines contribution, withdrawal, and retirement planning activities by the 27.8% (35.1 million) of U.S. households that own traditional IRAs.
Roth IRAs were the second most common type of IRA, held by 19.7% of US households. Employer-sponsored IRAs, including SEP IRAs, SAR-SEP IRAs, and SIMPLE IRAs, were held by 6.0% of US households.
Among traditional IRA-owning households, 77% held their traditional IRAs through full-service brokerages, financial planning firms, banks and savings institutions, or insurance companies. Thirty percent held them directly through mutual fund companies like Vanguard and Fidelity and discount brokers like E*Trade and Charles Schwab.
In mid-2017, 57% of traditional IRA-owning households, or about 20 million, said their accounts contained rollovers from employer-sponsored retirement plans. Regarding their most recent rollover, most said they transferred the entire plan account balance. The most common reasons for executing a rollover were to:
- Avoid leaving assets at a former employer (63%)
- Keep the savings tax-deferred (59%)
- Consolidate assets at one institution (58%)
- Get more investment options (49%)
Traditional IRA-owning households rarely take withdrawals before retirement and often wait until they reach age 70½, when annual withdrawals are required. Among the 9.1 million households that took withdrawals for tax year 2016, 71% used the required minimum distribution (RMD) rule to calculate them. About two-thirds (64%) asked a financial adviser to calculate their withdrawal. Eighty-one percent of households that made withdrawals were retired.
“The Role of IRAs in US Households’ Saving for Retirement, 2017” reports information from two separate ICI household surveys. ICI’s 2017 IRA Owners Survey was conducted in June 2017. It is based on a representative sample of 3,205 US households owning traditional IRAs or Roth IRAs.
The 2017 ICI Annual Mutual Fund Shareholder Tracking Survey was conducted from May to July 2017. It is based on a sample of 5,000 randomly selected US households, of which 34.8% owned IRAs.
© 2017 RIJ Publishing LLC. All rights reserved.
Researchers weigh impact of various Social Security solvency cures
The Social Security Trust Fund is currently projected to deplete its surplus in 2034, and policymakers know a reckoning is coming. How they respond is the hard part. To restore solvency, Congress can either cut Social Security’s pension benefits or increase the payroll taxes deducted from workers’ pay.
Both policies would affect the amount that households can spend. A new study from the Center for Retirement Research at Boston College finds that benefit reductions would have a much larger annual impact on retirees than would the higher taxes on workers. But the taxes would be spread over a longer time period.
The new study looks at four specific policies, two that cut retirement benefits and two that raise taxes. All four would have an equally beneficial effect on Social Security’s finances.
To gauge the likely effects, researchers used a model for predicting workers’ behavior. Some workers might be inclined to retire earlier if more taxes are being taken out of their paychecks. But if they knew their future benefits would be trimmed, they might decide to work longer to increase the size of their monthly checks.
The options
One option for reducing Social Security payouts would be to delay the full retirement age (FRA) (the age at which retirees are eligible to collect “full” benefits). A two-year increase in the FRA, to 69, would reduce annual consumption in retirement by 5.6% for low-income, 4% for middle-income, and 2.2% for high-income retirees.
A second option would be to trim Social Security’s annual cost-of-living (COLA) increases. The impact of COLA reductions, small at first, would compound over time. For people who live to age 90, the COLA cut would mean sharply lower consumption—10.5% less for low-income, 8% for middle-income, and 4% less for high-income retirees.
To increase the revenues going into Social Security, Congress could either raise the payroll tax rate or the dollar ceiling on workers’ earnings that are taxed. The researchers looked at the impact of increasing the payroll tax to 7.75% from the current 6.2%.
This would reduce consumption during people’s working lives by 1.55 percentage points per year. Raising the earnings amount subject to the payroll tax—to $270,000 from $127,200 currently—would have a smaller impact, decreasing consumption by 1% on Americans with very high income.
© 2017 The Center for Retirement Research at Boston College.
Top 20 Sellers of Fixed Indexed Annuities, 3rd Quarter YTD, 2017 (Sales in $millions)
Source: LIMRA Secure Retirement Institute, November 29, 2017
Research Roundup
A new batch of retirement research papers arrives here every week. Some of the articles fall into our wheelhouse—retirement financing. Periodically we glean them for insights and then condense them for our audience of advisors, plan providers, academics, insurers, asset managers and marketers.
Our latest Research Roundup includes summaries of five recent research articles. Two of the articles, “The Sustainability of U.S. Household Finances” and “The Great Debt Boom: 1949-2013”, help explain why most Americans, including the affluent, aren’t well prepared for retirement.
A third article, “Living Below the Line: Economic Insecurity and Older Americans in the States, 2016,” helps define and quantify “basic” and “essential” expenses in retirement. The last two articles address the topics of “rainy day funds” (a part of financial wellness programs) and “Rothification,” a federal revenue-generating idea that most 401(k) industry lobbyists despise.
Sustainable consumption in retirement
The finances of almost half of American households are unsustainable, if sustainability means that a household can consume at its current rate through its remaining working and retirement years without running out of money, according to research by Steven M. Fazzari of Washington University and two Federal Reserve economists, Daniel H. Cooper and Barry Z. Cynamon.
Baby Boomers, as a group, appear to be at very high risk. In a presentation at the Tipping Points II Conference in New York last June, the authors showed that more than 90% of Baby Boomer-led households were financially sustainable in the early 1980s. But that percentage dropped steadily over the next 30 years, to 31% in 2012.
Their study showed a decline in consumption sustainability over the life cycle for even the higher-income households, except for the highest one percent. Indeed, between 1983 and 2013, those in the 91st to 99th income percentile saw the largest drop in percentage of sustainable households, to 47% from 81%.
The economists created a metric they called Consumption at Risk (CAR). It is the percent of current consumption that households would have to cut in order to live within their means—that is, if they were forced to consume at a sustainable rate. Among financially unsustainable houses, the CAR in 2012 was just over 30%.
The researchers expect that many Boomer householders will have to work in retirement if they want to consume at current rates. “For the sustainability share in 2012 to be the same as in 1988, households that planned to smooth their consumption through retirement in 1988 would need to plan to cut their retirement consumption in half by 2012,” they wrote in an October 2016 paper, “The Sustainability of U.S. Household Finances.”
From Levittown to McMansions, a story of debt
Even the rich in America, on average, are borrowing and spending at a rate that they won’t be able to sustain for their entire lives, according to “The Great American Debt Boom 1949-2013,” a September 2017 paper by three German economists. Almost all of us are over-borrowed and, ipso facto, under-saved.
The personal debt load carried by Americans has grown more than six-fold since 1949, from 15% of GDP to 100% of GDP, write Moritz Kuhn, Moritz Schularick and Ulrike Steins of the University of Bonn. Generally, the upper-middle class has over-borrowed on real estate, the middle-class for tuition and the lower-middle class just to make ends meet.
The big story is in real estate. From 1949 to the 1970s, during what might be called the Levittown boom, broader home ownership drove the rise in household debt, as the parents of Boomers eschewed urban apartments for sheetrock homes on half-acre tracts in the suburbs.
Later, as interest rates fell and the stock market rose, lending practices loosened. The McMansion boom arrived. Members of the upper middle class were able to finance much larger homes and take on unprecedented debt. Except for the subprime lending phase, this was a period of “intensive” rather than “extensive” borrowing.
People born between 1915 and 1924 tended to start deleveraging at about age 45, but younger people have not “reduced their indebtedness as they grew older,” the authors write. For Boomers born between 1945 and 1964, “mean debt-to-income ratios even increased with age.” That may be the essence of our looming “retirement crisis.”
‘Basic’ expenses in retirement? About $40,000
When estimating your retirement cost-of-living, can you draw a line between “essential” and “discretionary” expenses? Advisors often ask that question and most people have difficult answering it.
At the Gerontology Institute at UMass Boston, economists have created a benchmark called the Elder Economic Security Index Standard, which they claim represents the amount of monthly and annual cost of basic expenses in retirement for singles and couples over age 65.
They put the basic required income for a single person over age 65 at $20,000 to $31,000 a year ($1,700 to $2,600 a month) and for a couple at $31,000 to $41,000 a year ($2,500 to $3,500 a month). Homeowners with mortgages have the highest expenses, followed by renters and homeowners without mortgages. Spending on entertainment, travel, restaurant meals, or the cost of anything else beyond essential needs is not included.
These figures are published in “Living Below the Line: Economic Insecurity and Older Americans in the States, 2016,” by Jan Mutchler, Yang Li, and Ping Xu of the Center for Social and Demographic Research on Aging, Gerontological Institute, McCormack Graduate School of Policy and Global Studies, University of Massachusetts-Boston.
One interesting artifact of the study: Very few retired couples are truly poor, by federal poverty standards. They’re roughly half as likely as single people to be economically insecure. Very few retired couples—no more than 6.2% (in Mississippi) and only 2.6% in Vermont—have incomes below the official U.S. poverty line.
The forecast for “rainy day” accounts
Proposals for “financial wellness” programs within 401(k) plans sometimes include an emergency fund or “rainy day” fund. If participants had a source of ready cash, the theory goes, they wouldn’t need to take hardship withdrawals or to borrow from their accounts. It would be easier for them to keep their savings “on track.”
The details, however, can be devilish. The obstacles and uncertainties that face plan sponsors or plan providers who contemplate adding a rainy day fund are explored in an October 2017 research paper aptly called, “Building Emergency Savings Through Employer-Sponsored Rainy Day Accounts.”
The paper was produced by A-list retirement researchers: John Beshears, David Laibson and Brigitte Madrian of Harvard, James Choi of Yale, and the duo of Mark Iwry and David John, who co-created the “auto-IRA” model on which state-sponsored workplace IRA plans in California and Oregon are based.
The researchers considered three potential designs for a rainy day fund: an after-tax employee contribution account within a 401(k) plan; a Roth IRA inside a 401(k) plan (aka a “deemed” Roth IRA); and an account that would live at a bank or credit union and would, if regulations allow, feed excess emergency savings back into a 401(k) plan.
Clearly, many uncertainties still exist. The paper focuses on the many questions that would face the sponsor of such a program–about how to invest the contributions, how large the fund should be, how to make sure the accounts are enhancing long-term retirement savings instead of cannibalizing them, and so forth.
The data points to a huge need for rainy day funds. “Forty-six percent of U.S. adults report that they either could not come up with $400 to cover an emergency expense” without borrowing or selling something, the authors write. “Among households whose head is age 61-70, median liquid net worth is $6,213, while the 25th percentile is $1.”
The case against ‘Rothification’
The Center for Retirement Research (CRR) at Boston College opposes “Rothification” of 401(k) plans. Its economists consider the idea, only recently shelved by Congress, to be a revenue-generating “gimmick” rather than a good-faith attempt to improve the retirement system.
“Many better options exist if Congress wants to focus on improving the retirement system,” write CRR director Alicia Munnell and staff economist Gal Wettstein in a brief entitled, “Dodged a Bullet? ‘Rothification’ Likely to Reduce Retirement Saving.”
A switch to Roth 401(k)s would reverse the current system, in which contributions are tax-deductible and withdrawals in retirement are taxed as ordinary income. Eliminating the tax deduction for contributions to 401(k) plans, Munnell and Wettstein claim, might have unpleasant unintended consequences, like eliminating an important incentive to save.
For the present, Congress has dropped its original Rothification proposal, which would have cannibalized the 401(k) system for near-term tax revenue in order to pay for the large corporate tax cuts. But that’s not very comforting, since it means that they don’t intend to update the flawed 401(k) system, which covers only about half the U.S. workforce at any given time and has no provision for income-generation in retirement.
Munnell and Wettstein recommend making auto-enrollment and auto-escalation of the default contribution rate mandatory. “Changes are also required on the draw-down side so that retirees do not either spend their money too quickly and outlive their savings or spend it too slowly and deprive themselves of necessities,” they write. “And expansion of coverage is needed for the half of private sector workers who have no employer-sponsored retirement plan at work.”
© 2017 RIJ Publishing LLC. All rights reserved.
Department of Labor Declares 18-Month ‘Transition Period’ for BICE
The DOL finalized its proposed 18-month extension—from January 1, 2018 to July 1, 2019—of the Transition Period for the Best Interest Contract Exemption (“BICE”), Principal Transactions Exemption and PTE 84-24 (collectively, the “Fiduciary Compensation Exemptions” or “Exemptions”). The formal notice of DOL action was published in the Federal Register on November 29, 2017.
The DOL action leaves in place the Fiduciary Rule (which became effective as of June 9, 2017), including the revised definitions of fiduciary and “investment advice” that applies to ERISA plans and IRAs (and similar accounts). The DOL’s action continues the current status for the Exemptions. Financial services firms and others can rely on the BICE and the Principal Transactions Exemption as long as they satisfy the Impartial Conduct Standards.
PTE 84-24 will continue to be available for both fixed and variable annuities as long as the Impartial Conduct Standards are satisfied (along with the conditions in effect before the Fiduciary Rule was proposed). In short, financial advisors, broker-dealers and other financial institutions that are already in compliance with the Impartial Conduct Standards with respect to their ERISA and IRA clients do not need to take additional steps in order to comply with the Exemptions (until the DOL announces new changes). The DOL indicated that it will both complete its review and propose alternative or amended exemptions before July 1, 2019.
DOL agrees with comments supporting fixed 18-Month extension
In announcing the extension, the DOL stated that a delay was necessary to allow the DOL to complete its examination of the Fiduciary Rule and the Exemptions, to propose changes to the Exemptions and/or propose alternate exemptions, and to coordinate with the SEC and other regulators such as FINRA and the National Association of Insurance Commissions (“NAIC”).
Notably, the DOL stated that it anticipates that it will propose in the near future a new streamlined class exemption. The DOL received numerous comments both for and against an extended Transition Period. Although many commenters expressed concern that extending the Transition Period would result in economic harm to investors and would not prompt financial services firms to comply with the Impartial Conduct Standards, the DOL stated that it “believes that many financial institutions are using the compliance infrastructure to ensure that they are currently meeting the requirements of the impartial conduct standards” and that there are adequate enforcement mechanisms in place to protect investors during an extended transition.
The DOL also agreed that a delay was necessary to give the financial services industry certainty regarding its compliance obligations and to avoid confusion or unnecessary restrictions on retirement investors that might occur if the original January 1, 2018 date was unchanged.
Current enforcement position extended
The DOL also extended the enforcement position articulated in FAB 2017-02 to July 1, 2019. FAB 2017-02 provided that the DOL would not pursue claims against investment advice fiduciaries who were working diligently and in good faith to comply with their fiduciary duties and meet the conditions of the Exemptions. The DOL stated that it was in the interest of plans, plan fiduciaries, plan participants and beneficiaries, IRAs and IRA owners to continue this approach.
The DOL emphasized, however, that diligent and good faith efforts were in fact required and that “the basic norms and standards of fair dealing” still applied during the Transition Period. The DOL further stated that as it reviews compliance efforts during the Transition Period, it will focus on the “affirmative steps” that firms have taken to comply with the Impartial Conduct Standards and reduce the scope and severity of conflicts that could lead to violations.
The DOL noted that although there is some flexibility in how to safeguard compliance with the Impartial Conduct Standards, financial services firms may look to the specific provisions of the Exemptions for compliance guidance. The DOL specifically noted that limitations on an advisor’s investment recommendations to proprietary products or investments that generate third-party payments could be structured to comply with the Impartial Conduct Standards under the BICE.
Based on this statement, it appears that reliance on other compliance principles articulated or implicit in the Exemptions can be used to demonstrate compliance with the Impartial Conduct Standards during the Transition Period ending on July 1, 2019.
Compliance during the extended transition period
Although the extended Transition Period will help financial services firms by allowing the DOL to conclude its review of the Fiduciary Rule and the Exemptions without imposing new or interim compliance obligations, the DOL release does not provide clear compliance obligations in the short term.
To the extent that financial institutions and financial advisors have already implemented policies and procedures designed to demonstrate compliance with the Impartial Conduct Standards, those policies and procedures should remain in effect. To the extent that such policies and procedures have not been adopted, financial institutions should seriously consider doing so.
Even though the DOL has stated that its enforcement posture will continue to be focused on compliance assistance, private litigants will not be and, depending on the facts, the DOL may conclude that certain compensation systems or other fact patterns are simply inconsistent with the Impartial Conduct Standards.
With respect to any additional compliance steps, the DOL has clearly signaled that firms may look to certain principles and provisions of the BICE or the other Exemptions for guidance. In a prior Alert, which can be read here, we provided a non-exhaustive list of steps that can be taken, though no single step is required by law or regulation. Note that the DOL has stated that it is broadly available to discuss compliance approaches that have been adopted or may be adopted.
© 2017 The Wagner Law Group.
AIG launches New York’s first fixed annuity with GLWB
New Yorkers can now buy a fixed deferred annuity with a living benefit rider, but the rider will differ in an important way from versions of the product that are sold in most other states.
American International Group, Inc. (AIG) announced this week that one of its subsidiaries, The United States Life Insurance Company in the City of New York, has issued what it described as “the first fixed annuity with a guaranteed lifetime income benefit in New York State.
The product, “Assured Edge Income Builder-NY,” was issued in other states in 2016, AIG said in a release. New York Life’s Clear Income fixed deferred annuity with a guaranteed lifetime withdrawal benefit (GLWB) is not offered in New York State, California, Delaware or Guam.
American General Life, also a unit of AIG, sells a version of the Assured Edge product. That version also has a GLWB priced at 0.95% per year. But where the non-New York product offers a 7.5% increase in the benefit base for every year withdrawals are delayed, the New York version offers a quarter of a percentage point (0.25%) increase in the withdrawal percentage.
“We modified the design to comply with the NY requirements, which meant that we needed to have the guaranteed income amount be tied to the account value upon first lifetime withdrawal rather than tied to the annuity premium,” an AIG spokesperson told RIJ.
“We therefore constructed the income levels and the annual income increases (0.25% as mentioned) to be as equivalent as possible with our non-NY feature, subject to also accounting for other differences in the NY product.”
All deferred annuities offer owners the right to convert the contract value to a lifetime income stream–a largely irrevocable process known as annuitization. When a GLWB rider is attached to a deferred annuity, the owners have a combination of liquidity and guaranteed income that will last until he/she/they die. GLWBs can be found on variable, indexed and fixed annuities.
The guaranteed lifetime withdrawal benefit is automatically included in the contract issue with no annual rider fee. Assured Edge Income Builder-NY is available only in New York. A suite of annuity products is available in all other states issued by American General Life Insurance Company (AGL).
© 2017 RIJ Publishing LLC. All rights reserved.
