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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.

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.

Vanguard and BlackRock/iShares dominate October fund flows

In October, investors put $27.6 billion into U.S. equity passive funds, more than doubling September’s $12.7 billion inflow. On the active front, investors pulled $18.8 billion out of U.S. equity funds compared with $18.5 billion in the previous month, according to Morningstar’s latest monthly asset flow report.

Highlights from the report include:

On the passive front, Vanguard was the top fund family, with inflows of $26.6 billion in October ($340.1 billion for one year), followed by BlackRock/iShares with inflows of $20.4 billion in October ($224.9 billion for one year). Gold-rated Vanguard 500 Index Fund attracted the highest flows of $9.0 billion and iShares Core S&P 500 ETF followed with $3.9 billion in flows.

The leaders in active flows among top U.S. fund families were J.P. Morgan with $4.6 billion and PIMCO with $3.5 billion. The active fund with the highest inflow was JPMorgan International Research Enhanced Equity Fund, with flows of $3.1 billion. Fidelity and Franklin Templeton suffered outflows from their active funds as they did in September; however, T. Rowe Price received inflows of $312.0 million.

Taxable bond remained the leading category group in October with $39.1 billion in flows overall, divided almost evenly between the passive and active side. International equity, which more than doubled to $22.2 billion in October from $9.8 billion in September, was the second leading category group.

Intermediate-term bond, foreign large blend, and large blend were the three Morningstar Categories with the highest inflows in October. The three Categories with the largest outflows were large value, large growth, and mid-cap value.

After announcing a fee increase in September, PIMCO Income, an actively managed bond fund with a Morningstar Analyst Rating of Silver, saw flows of $3.0 billion in October. On the passive front, Bronze-rated T. Rowe Price New Income suffered a $1.2 billion outflow in October, the largest outflow among active funds.

The passive fund with the largest outflow was Vanguard Institutional Index at $4.8 billion. iShares MSCI Spain Capped ETF experienced $571 million in outflows, following Catalonia’s declaration of independence from Spain.

Morningstar estimates net flow for mutual funds by computing the change in assets not explained by the performance of the fund and net flow for ETFs by computing the change in shares outstanding.

© 2017 Morningstar, Inc.

A Bitter Sandwich on Thanksgiving

Relatives of mine are experiencing a Dagwood-sized sandwich-generation moment that involves a large and unplanned expense for nursing or assisted-living care. We visited them over the Thanksgiving holiday in their comfortable, oak-forested suburban neighborhood. They weren’t feeling comfortable.

Until last September, their mother, a widow now past 80, was living independently in her Florida condo. Then she fell and struck her head. After surgery for sub-cranial bleeding, she needed physical therapy. She has lost weight, and now uses an aluminum walker with small black caster wheels. 

For her and many other older people, an injury from a fall often marks, at best, the beginning of dependency. For their adult children, it often marks the beginning of a period of logistical confusion, emotional turmoil and financial pressure.

I’ve seen many retirement income plans on computer screens. None of the colorful cash flow projections or illustrations has ever shown the sudden appearance of a $5,000 or $10,000 per month assisted living or nursing expense or any indication of how long that expense might last. Some of us know from experience that it could last for many years.

The $250,000 that this widow gained from the sale of her family home has long been spent. She and her late husband opted long ago for a single-life pension from his life-long public sector job, and they took Social Security early. Plans to buy long-term care insurance were drawn up 20 years ago but shelved. The proceeds from the sale of her West Palm Beach condo will cover no more than six months in a nursing home.

Her family can handle the five-figure cost of care for a while, but not for a decade. Her two sons are now weighing their options. Where they live, no services are cheap. Good assisted living arrangements cost $7,000 a month. Nursing home care costs $12,000 a month. They don’t plan to convert my friend’s basement to an age-in-place apartment with around-the-clock nursing care.

Just before Thanksgiving dinner, their mother arrived with her walker. A once-energetic woman, she moves hesitantly now. She had just enough strength to visit with her children and grandchildren for a few hours before returning to a rehab center, where Medicare coverage stops after 100 days.  

My relatives like to turn lemons into lemonade (or, better yet, a Tom Collins). So they’re taking this still-fluid situation as a wake-up call. They recognize that in 20 years or so, when they themselves turn thin and frail, their own children might face a similar predicament. The sandwich-generation dilemma is a bitter one, but it can remind us to prepare for what lies ahead.       

© 2017 RIJ Publishing LLC. All rights reserved.

Amid ‘Trump Bump,’ annuities go begging

Sustained low interest rates, a relentless bull market in equities and uncertainty over the regulation of annuity sales to IRA owners have all conspired to frustrate the annuity industry at the very moment in history when Baby Boomers should arguably be buying annuities for safe lifetime income. Go figure.

At $46.8 billion in the third quarter of 2017, total U.S. annuity sales were below the $50 billion mark for the first quarter since 2002, according to the LIMRA Secure Retirement Institute’s (SRI) quarterly retail annuity sales survey.

In the first nine months of 2017, overall annuity sales were $152.7 billion, 11% lower than in 2016. For seven straight quarters, fixed sales have outperformed variable annuity (VA) sales. That last happened nearly 25 years ago. The Institute predicts overall 2017 annuity sales to be around $200 billion.

Sales were down 13% from the same period in 2016, and fell for the sixth consecutive quarter. LIMRA expects VA sales to drop 10-15% in 2017, to below $100 billion. VA sales haven’t been below $100 billion since 1998. 

LIMRA SRI’s Annuity Research director, Todd Giesing, blamed the decline on the Department of Labor’s fiduciary rule, whose fate has been delayed until at least July 2019. “We are confident the initial implementation of the DOL’s fiduciary rule on June 9th had a negative effect on sales, particularly on IRA contracts,” he said in a release. “We expect the environment to improve in 2018.” 

For the first three-quarters of 2017, Jackson National was the top seller of VAs ($12.9 billion), New York Life was the top seller of fixed annuities ($8.5 billion) and AIG had the highest level of sales ($10.6 billion) among issuers with a balanced VA-FA offering. Allianz Life sold the most indexed annuities ($5.82 billion).

LIMRA 3rd Qtr 2017 annuity sales estimates

Variable annuities

Indeed, qualified VA sales dropped 24% in the third quarter, versus a 3% dip in non-qualified sales. Overall, third quarter variable annuity (VA) sales were $21.8 billion, down 16% from prior year. This is the 15th consecutive quarter of declines and the lowest level of quarterly VA sales in 20 years. Year-to-date, VA sales were $70.9 billion, 11% lower than in the first nine months of 2016. 

The momentum of structured (or “indexed”) variable annuities, which represent 8% of the total VA market, also flagged in the third quarter of 2017. Sales of these accumulation-focused products were $1.7 billion, up 15% from the third quarter 2016 but down 5% from the prior quarter.  

Fee-based VA product sales were $560 million in the third quarter, more than 50% higher than third quarter 2016, but a slight decline from the previous quarter.  Fee-based VA sales represent 2.5% of the total VA market.

Fixed annuities

Fixed annuity sales were not immune to the impact of the initial implementation of the DOL fiduciary rule. Third quarter sales were $25 billion, down 11% from 2016.  Year-to-date, fixed sales also fell 11% to $81.8 billion. 

Fixed indexed annuity (FIA) sales were $13.7 billion in the third quarter, 9% lower than in the third quarter 2016. In the first nine months of 2017, FIA sales were $42.9 billion, down 9% from prior year.

“A continued shift to accumulation focused-indexed products continues in the industry,” Giesing noted. “Sales of indexed annuities with a guaranteed living benefit (GLB) dropped significantly (27%) in the third quarter, compared with last year’s results; while sales without a GLB increased by 14%.”

The Institute is forecasting FIA sales to decline close to 10% in 2017, compared with 2016 sales results. In the third quarter, sales of fee-based indexed annuity products were $48 million, representing less than half of one percent of the indexed market.

“With nearly 60% of the FIA market sold through independent agents [who sell on commission], it is unlikely fee-based FIAs will experience significant growth unless regulations compel them,” the LIMRA release said.

Sales of fixed-rate deferred annuities (Book Value and MVA) fell 13% in the third quarter, to $7.4 billion. Year-to-date, fixed-rate deferred sales totaled $26.8 billion, down 14% from prior year.

Despite steady interest rates, SPIA sales fell 9% in the third quarter to $2 billion.  For the past several quarters, SPIA sales have stayed in the $2-$2.2 billion range. Year-to-date, SPIA sales fell by 14%, totaling $6.2 billion. Deferred income annuity (DIA) sales dropped 14% to $520 million in the third quarter. In the first three quarters of 2017, DIA sales totaled $1.67 billion, down 25% from prior year.

© 2017 RIJ Publishing LLC. All rights reserved.

DB-DC hybrid idea resurfaces in UK; launches in Germany on January 1

“Defined ambition,” a phrase used to describe “collective” defined contribution plans, was championed by Britain’s pension chief from 2012 to 2014. The concept is now making a tentative comeback in UK retirement policymaking circles.   

A bipartisan group of British politicians has opened a new inquiry into the “merits or otherwise” of defined ambition, which describes pension plans that are a hybrid of defined benefit plans and defined contribution plans (or “schemes” as Britons say).

For participants, these plans would provide less certainty in terms of retirement incomes than DB plans but more certainty than US-style DC plans. They would reduce the risks that employers face.

In essence, plan participants would agree to accept retirement incomes that fluctuate with market performance instead of expecting fixed payouts. Life insurance companies don’t play a role in defined ambition or CDC plans. Labor unions would need to play a role in representing participants. 

CDC schemes may be “the type of retirement saving plan with the potential to address some of the concerns that policymakers and the public have about the current pension ‘offer,’” said the Work and Pensions Committee (WPC) of the House of Commons, in an official statement this week.

The committee has asked for responses to its questions by January 8, 2018. It has posed questions about benefits to savers and the wider economy, converting defined benefit schemes to CDC, and how CDCs would be regulated. 

The politicians’ questions include:

  • Would CDC deliver tangible benefits to savers compared with other models?
  • How would a continental-style collective approach work alongside individual freedom and choice?
  • Could seriously underfunded DB pension schemes be resolved by changing their pension contract to CDC, along Dutch lines?
  • Is there appetite among employers and the UK pension industry to deliver CDC?
  • Would CDC funds have a clearer view towards investing for the long term?

“The select committee is aiming… to retain some of the best features of company schemes in a different age when employers are no longer willing or able to sustain the burden of final salary promises to employees, who could instead club together and pool the risk themselves,” said Frank Field, Labor Party member and chair of the WPC. The WPC is also inquiring into pension freedoms.

CDC is a potential source of longer- term investment in growing start-up companies, the lawmakers said. Unlocking such investment was one of the policy goals mentioned by Chancellor of the Exchequer Philip Hammond in his Budget statement this week.

Arguments made against CDC schemes, according to the committee, were that they could further fragment the pension landscape, suffer from lack of demand, or run counter to the trend towards greater individual freedom and choice in pensions.

Though common in the Netherlands and Denmark, CDC pension schemes are not allowed in the UK. But they will become possible in Germany in 2018, under certain conditions. In Germany, according to a recent Aon Hewitt report:

“Social partners [unions and employer associations] are urged to agree on an attractive and well balanced “Defined Contribution” approach. Employers who join such plans are released from any pension liability, which is transferred to the overarching pension fund. The pension fund, which is supervised and managed by the social partners, becomes responsible for the investment of pension assets and payment of pensions. The benefits are based on a “defined ambition approach” which allows for variations in the benefit levels depending on how well investment goals are achieved. Guarantees backed by insurance-type arrangements are not allowed. Further details, such as risk sharing and smoothing mechanisms between the plan participants, need to be agreed on by the social partners.”

In 2014 the UK government intended to alter pension law to make CDC plans legal, as part of a plan by then-pensions minister Sir Steve Webb for greater risk-sharing in pensions. They were even recognized as a distinct pension category in legislation created by the Conservative-Liberal Democrat coalition government. But efforts were shelved after the Tory victory in the 2015 general election.

At that time, the British government did not want to distract from other major reforms such as auto-enrolment and pension freedoms, according to Baroness Ros Altmann, Webb’s Conservative Party successor. Retirement industry representatives also opposed the CDC concept.   

© 2017 RIJ Publishing LLC. All rights reserved.

The Word of the Week Is: Thanks

We at Retirement Income Journal offer our thanks this holiday season to everyone who has contributed to our success over the past eight-plus years. Back in 2009, we saw that a new segment of the financial industry had formed in response to the Baby Boomer age wave, that this industry included annuities, investments, advice, distribution, and national borders, etc., and that it needed its own publication.

We built that publication, and the industry responded. Our newsletter audience includes executives and managers at life insurance, asset management firms and brokerages, financial advisors, insurance agents, consulting actuaries, academic economists, attorneys, and IT service providers. We have corporate, group and individual subscribers. Several of our readers and contributors are prominent authors in the field of retirement income and finance. At least one of our readers has won the Nobel Prize in economics. Thanks to all of you for your support.

We especially thank our long-standing and new corporate subscribers and advertisers, who include: Allianz Life, AXA, Cannex, CapGroup, Charles Schwab, DCF Exchange, Ernst & Young, Eversheds Sutherland, Fidelity Investments,    Great-West Life, Jackson National, John Hancock , LIMRA, MassMutual, MetLife, Milliman, Morningstar, Nationwide, New York Life, Prudential, The Principal, Protective Life, the Securities & Exchange Commission, Thrivent, TIAA, T. Rowe Price and Voya. 

In the past year, we successfully registered our brand name, Retirement Income Journal, with the U.S. Patent and Trademark Office. We have been working on a new website: in early 2018, expect to elevate an all-new WordPress website and a new payment system that will replace the Ruby-on-Rails and PayPal-based system that we’ve used since April 2009. We thought about splitting RIJ into two websites, one for manufacturers and one for distributors. But we decided to maintain a single website and dedicate a column of stories, clearly marked on the home page, to each of our major constituencies.

The retirement industry is constantly changing and RIJ will follow the changes as they emerge. We cover an eclectic range of topics within the retirement space, but our core mission has never changed. We believe that a combination of risk-free and risky products, working in tandem within a comprehensive individualized plan, offers retirees the best protection against the financial challenges they’ll face. Annuities may not be right for every retiree, but very few retirees, we believe, can afford not to become familiar with them.   

© 2017 RIJ Publishing LLC. All rights reserved.

Fixed annuity sales dipped sharply in 3Q2017

Annuities are experiencing a big chill, thanks to the Trump bull market, rising interest rates (which boosts competing sales of certificates of deposit), and possibly because of continuing uncertainty over the DOL fiduciary rule, whose provisions for indexed and variable annuity sales remain in limbo. 

The focus here and now is on fixed annuities. Sales of non-variable deferred annuity sales were over $20.2 billion in the third quarter of 2017, which was down 14.0% from the prior quarter, and 11.1% lower than in same period a year prior, according to the 81st quarterly edition of Wink’s Sales & Market Report.

The report is based on sales data from 57 fixed indexed annuity (FIA) providers, 53 traditional fixed annuity providers and 57 multi-year rate guaranteed annuity (MYGA) issuers.

Allianz Life led in non-variable deferred annuity sales, with a market share of 9.4% across all channels. The Minneapolis-based firm held an industry-leading 14.9% share of the FIA market. Its Allianz 222 Annuity, an FIA, was the top-selling non-variable deferred contract. It was also the top-selling FIA for the thirteen consecutive quarter.

WinkTable1 11232017

Other top non-variable fixed annuity sellers included New York Life, Global Atlantic Financial Group, Athene USA, and AIG, in that order. Within the FIA market alone, Nationwide, Athene USA, American Equity Companies, and Great American Insurance Group, in that order, trailed Allianz Life.

FIA sales for the third quarter were over $12.7 billion. That was down 12.6% from the previous quarter, and down 10.5% from the same period last year. Rising interest rates and rising equity prices were cause, according to Wink president and CEO Sheryl J. Moore.

“Rates have increased substantially on certificates of deposits from last quarter, and the [stock] market is on the rise,” said Moore, who is also president of Moore Market Intelligence. “There is typically an inverse relationship between CD rates and sales of fixed and indexed annuities.

“Likewise, whenever the market is on the rise, that hurts sales of these products. Despite the unfavorable market conditions for annuity sales, I still anticipate that fourth quarter will be strong,” she added. “The fourth quarter is always robust [for annuities].”

Traditional and MYGA annuities

Total sales of traditional fixed annuities, which offer a one-year guaranteed rate, were over $809.5 million in the third quarter. That was 20.7% lower than the previous quarter and 35.9% lower than the same period last year.  

Jackson National Life issued the most fixed annuities in the third quarter and held a market share of 16.5%. Modern Woodmen of America ranked second and was followed by Global Atlantic Financial Group, Reliance Standard, and Great American Insurance Group. Forethought Life’s ForeCare Fixed Annuity was the top-selling fixed annuity for the quarter, for all distribution channels combined.

Wink Table2 11232017

Sales of MYGAs, which offer a guaranteed rate for more than one year, were over $6.6 billion in the third quarter; 15.7% lower than the previous quarter and 7.9% lower than the same period last year. The top issuer was New York Life, with a market share of 25.1%, followed by Global Atlantic Financial Group, AIG, Security Benefit Life, and Delaware Life. Forethought’s SecureFore 5 Fixed Annuity was the top-selling MYGA for the quarter for all channels combined.

WinkTable3 11232017

Wink will begin reporting on sales indexed variable annuities beginning in the first quarter of 2018, the release said, and plans to report sales of immediate and variable annuities in the near future. Issuers of indexed variable annuities, a registered product, include Allianz Life, AXA, CUNA Mutual, MetLife and Voya.

© 2017 RIJ Publishing LLC. All rights reserved.

 

How to succeed in the DC investment-only market

John Hancock Financial Services, Principal Funds, Nationwide, Charles Schwab Investment Management and Wells Fargo have stronger brand presence in the DCIO market than in the broader retail advisory market, partly because they specialize in target date funds and retirement income products.

That and other findings are included in the Retirement Plan Advisor Trends study by Market Strategies International, publisher of Cogent Reports.

The companies mentioned above showed higher brand equity scores in the research firm’s Retirement Plan Advisor Trends study than in the firm’s retail Advisor Brandscape study.   

While John Hancock, Principal and Nationwide respectively rank 13th, 23rd and 28th in brand equity in the mutual fund retail market, they rank in the top 10 among DC advisors. Charles Schwab and Wells Fargo were ranked 26th and 24th, respectively, in brand equity in the retail market but 13th and 15th among DC advisors.

“These five firms are doing an excellent job playing to their strengths and offering competitive solutions for the workplace retirement market,” said Sonia Sharigian, product director at Market Strategies and author of the Retirement Plan Advisor Trends report, in a press release. “[They] are carving out a distinct advantage within the target date funds and retirement income categories.”

The report found that only a few firms are able to differentiate themselves beyond actively managed mutual funds and target date funds to earn broader product consideration.

To produce the Retirement Plan Advisor Trends report, Cogent Reports conducted an online survey of a representative cross section of 514 plan advisors in July through August 2017. Survey participants are required to have an active book of business of at least $5 million and be actively managing DC plans.

© 2017 RIJ Publishing LLC. All rights reserved.

As Bitcoin price soars, TOBAM launches the first Bitcoin mutual fund

TOBAM, the French asset management firm, intends to raise money from institutional investors for Europe’s first mutual fund investing in Bitcoin, according to a report in IPE.com.

The firm, a specialist in smart beta strategies, has developed an in-house team focused on cryptocurrency research. It said cryptocurrencies had “the potential to become durable standards in financial and saving markets.” The market value of a single Bitcoin rose more than 1,000% in dollar terms in the past 12 months, to $8,263 from $748, according to Coindesk.

“The mutual fund’s launch follows approval from the Autorité des Marchés Financiers, one of the country’s top financial regulators,” according to a report in the Financial Times. “PwC will perform auditing services while Caceis, the asset servicing banking group of France-based Crédit Agricole, will custody the bitcoins tied to the fund.”

Bitcoin is a “highly diversifying asset,” said TOBAM president Yves Choueifaty, adding that his company has already conducted research into the digital currency “from a technical, financial, economic and regulatory point of view” for a year. 

The fund is available via private placements into an unregulated alternative investment fund domiciled in France.

Choueifaty told the Financial Times that he expects investors to put as much as $400 million into the institutional Bitcoin mutual fund within the next few years.

In a prepared statement, TOBAM said its fund would allow institutional investors to access the cryptocurrency “in a more convenient and safer vehicle… Bitcoin is prone to significant risks, including a very high level of volatility, [but] it also provides diversification benefits.” 

TOBAM said it had “developed cybersecurity systems” and other capabilities over the past 12 years, including the management of “forks,” which occur when a change or update is made to the algorithm behind Bitcoin.

© 2017 RIJ Publishing LLC. All rights reserved.

 

ICI releases first-half 2017 participant behavior data

Americans continued to save for retirement through defined contribution (DC) plans during the first half of this year, according to the Investment Company Institute’s “Defined Contribution Plan Participants’ Activities, First Half 2017.” 

The study tracks contributions, withdrawals, and other activity, based on DC plan recordkeeper data covering more than 30 million participant accounts in employer-based DC plans.

The latest recordkeeper data indicate that nearly all plan participants continued contributing to their plans in the first half of 2017. Only 1.6% of DC plan participants stopped contributing during this period. 

Other findings include:

  • Most DC plan participants left their asset allocations unchanged. In the first half of 2017, only 6.8% of DC plan participants changed the asset allocation of their account balances, and only 4.3% changed the asset allocation of their contributions.  
  • Withdrawals from DC plans remained low in the first half of 2017, as in 2016. In the first half of 2017, 2.2% of DC plan participants took withdrawals, about the same share as in the first half of 2016. Only 0.9% of DC plan participants took hardship withdrawals during the first half of the year, similar to the first half of 2016.
  • DC plan participants’ loan activity was little changed at the end of the first half of 2017. At the end of June 2017, 16.7% of DC plan participants had loans outstanding, compared with 16.6% at the end of the first quarter of 2017. Loan activity continues to remain higher than at the end of 2008, when 15.3% of DC plan participants had loans outstanding.

© 2017 RIJ Publishing LLC. All rights reserved. 

eMoney Advisor adds integration partners

eMoney Advisor has announced that it plans to integrate with OpenView Gateway, the integration platform from Schwab Advisor Services (including Schwab Advisor Center), Envestnet | Tamarac, and cloud content management leader Box.

The integration with Schwab is planned for the last quarter of 2017. The Envestnet and Box integrations are scheduled to go live in 2018, according to a release this week from eMoney, a unit of Fidelity Investments.

When all three integration are complete, 20 integrations will be available on eMoney’s financial planning platform. Its nearly 50,000 users will be able to “transition between sites, securely accessing shared data and streamlining their planning processes,” the release said.
In the first quarter of 2018, eMoney’s integrations with Envestnet | Tamarac and Box will offer these functions:

  • Envestnet |Tamarac – Investors and their advisors benefit from bi-directional, single sign-on access between both the advisor and client portals of eMoney and Tamarac. 
  • Box – The Box integration meets the criteria required in SEC ruling 17a-4 (aka WORM: Write Once, Read Many) and helps broker-dealers comply with FINRA and SEC rules. Users will be able to access their Box content from the eMoney Vault, allowing the safe transfer of sensitive information. 

eMoney announced in April that the firm will integrate with CapitalRock’s RightBRIDGE product recommendation software in 2018. Earlier this year, eMoney launched integrations with Wealthbox and Black Diamond and enhanced integrations with Orion, Riskalyze, Envestnet and Fidelity Wealthscape.   

© 2017 RIJ Publishing LLC. All rights reserved.

The Ambiguity of Tax Deferral

When you look at your 401(k) or 403(b) or rollover IRA, what do you see? Do you see a two-sleeve account, where you contributed about 80% and the federal government contributed about 20%? Or do you feel like the account contains only your money, with no help from your Uncle Sam?

To economist Steve Zeldes of Columbia University, it’s obvious that Uncle Sam contributed part of your balance. But advisors who manage brokerage IRAs tend to believe that the money is all yours. Similarly, many affluent retirees over age 70½ wonder why the IRS requires them to withdraw three or four percent of their tax-deferred savings each year and pay ordinary income taxes on it. 

Just as there’s more than one way to look at the image that illustrates this article, there may be more than one way to think about tax deferral. Indeed, our national arguments over the Department of Labor’s (DOL) fiduciary rule, the potential “Rothification” of defined contribution plans, and the need for a harmonized DOL-SEC fiduciary rule, may stem from the fact that we don’t all think about it the same way.

An academic view

At the annual academic forum of the Defined Contribution Institutional Investors Association (DCIIA) in New York a few weeks ago, Zeldes presented a research paper he’s been refining for a year or so. The paper (available on SSRN at http://ssrn.com/abstract=3046077 ) asserts that our “Traditional” 401(k) system, in which contributions are tax-deductible today but taxed at withdrawal, leads to a U.S. government subsidy to the private asset management industry of about $13.5 billion relative to a pure Roth system in which all contributions are made with after-tax money and never taxed again.

Zeldes explained that when 401(k) plan participants defer $1,000 a month into their plans, they contribute about $800 and the government contributes about $200. By excluding $1,000 from their gross paycheck, they reduce their tax withholding by about $200 (assuming they are in the 20% tax bracket). The $1,000 contribution to the plan cost them only $800. The other $200 came from Uncle Sam, and results in a boost to the size of the 401(k). But it’s not a permanent boost; the government will collect it back when the participant withdraws the funds later in life and pays taxes on the principal and gains.

When you consider that the asset management industry charges retail (not institutional) fees on the assets purchased with that money, you wind up with a subsidy, reasoned Zeldes and his co-author, Mattia Landoni. They assumed that of the $14.4 trillion in tax-deferred accounts today (excluding defined benefit plans) the government’s contribution is worth about $2.9 trillion.

The two economists then assumed that asset managers and other financial intermediaries charge about 72 basis points (50 bps for investment management and 22 bps for trading costs) a year on that $2.9 trillion and that, as corporations, they pay taxes on profits at the rate of 35%, so that the overall fee would be 0.72% x (1 – .35) = 0.47% or about $13.5 billion a year. Forty-seven basis points, the reasoning went, is perhaps ten times as much as a big institutional investor like Uncle Sam should have to pay.   

“The government could achieve savings equivalent to $13.5 billion per year by forcing the conversion of all existing tax-deferred retirement accounts into Roth accounts,” Zeldes and Landoni wrote in their paper. This $13.5 billion, a cost to the government, is an annual subsidy to the asset management industry.”  

A $200 gain or $800 loss?

The several hundred executives from asset management and related industries listened calmly and impassively to Zeldes’ presentation. Presumably, they do not think of themselves or their industry as partially underwritten by the federal government. No one in the audience seemed to register surprise or offense at the implications of the paper. (Zeldes told RIJ afterwards that it was only a coincidence that he was presenting the paper at the same that Congress was wondering—in the face of massive resistance from the financial services industry—whether to “Rothify” the retirement system by making contributions taxable and withdrawals tax-free.)

It’s possible that few or none of them accepted Zeldes’ assumption that 20% of the money in tax-deferred accounts came from the government. It’s possible that plan participants do not perceive that a benevolent government simultaneously enhances their retirement account by $200 and charges them $200 less in taxes (per $1,000 contribution).

Perhaps plan participants believe that they put $1,000 into their tax-deferred accounts, and that the government took $200 less in taxes in their paychecks—which they spent on groceries and so forth—without enjoying a sense of extra wealth. Perhaps they felt the pain of an $800 drop in their take-home pain without feeling any pleasure that it didn’t drop by $1,000. 

Skin or no skin

Anecdotal evidence suggests that most people regard the money in tax-deferred accounts as theirs and their alone, with no government “skin” in their “game.” This question came up at a conference for asset managers a few years ago, when that industry was excited about capturing rollovers from 401(k) plans. Asset managers looked forward to charging retail fees, rather than the relative lower fees charged in 401(k) plans, on trillions of dollars in rollover assets.

A speaker at the conference asked members of the audience if they saw any difference between qualified money and other money. Only one person raised his hand to answer. “Yes. It’s tax deferred,” he said. Brokerage firms and advisors don’t seem to regard Uncle Sam as a minority partner in brokerage rollover IRAs either.  

An official in a retirement trade group, when asked about this question, saw no government skin in the game either. Describing the difference between a Roth 401(k), a traditional 401(k) and a conventional taxable savings account, he said, “It’s just a matter of whether somebody wants to pay their taxes up front or later.” His view may be based the fact that traditional and Roth accounts produce the same amount of after-tax income in retirement, if the saver has the same tax rate at the time of contribution and the time of withdrawal).

As for retirees who must take taxable required minimum distributions (RMDs) from their 401(k)s or IRAs starting at age 70½, anecdotal evidence suggests that they don’t understand why, if they didn’t need the withdrawal for current expenses, the IRS forces them to take a withdrawal and pay taxes on it.

Even if their tax rate in retirement is lower than their tax rate during their working years, they don’t seem to feel the difference, let alone take pleasure in it. When asked, they don’t appear to recognize that RMDs are the only way that the government can make sure that tax-deferral achieves its public policy goal of producing retirement income.   

In the United Kingdom, the government emphasizes its role in tax-deferred savings. On one government website, a diagram explicitly shows savers that their tax-deferred accounts have three sleeves: their own contributions, Her Majesty’s contribution, and their employers’ contributions. In the U.S., the government makes no similar effort to frame the discussion.

The meaning of tax deferral

You might ask if it matters how we think about tax deferral. I think the consequences run into billions of dollars and years of time spent inefficiently if not wasted.

The huge, expensive, drawn-out conflict over the Department of Labor (DOL) fiduciary rule, and the current debate over “harmonization” of fiduciary standards between the DOL and the SEC, and the fight over whether to Rothify 401(k) were arguably all created, or at least exacerbated, by a failure to agree on the way we think about tax-deferred accounts, and whether the government has a stake in them. 

Brokerages fighting against the fiduciary rule can accuse the DOL of regulatory “overreach” because they don’t believe that there’s government money in rollover IRAs. The DOL can argue that there is government money in those accounts. Or it can argue that the government has an interest in those accounts merely because the accounts remain tax-deferred. That is: the money remains government-subsidized pension money, just as it was in 401(k)s. The DOL can even claim that it has an obligation to regulate it.  

The inability to resolve the difference in our perception of tax deferral is creating delays and indecision not just for the DOL fiduciary rule but also in the current battle over tax reform. If we knew, for instance, whether 401(k) participants actually regard tax deferral as important incentive to save, the debate might have more clarity. Similarly, agreement on the significance of tax deferral might also illuminate the debate over whether there should or shouldn’t be a higher fiduciary standard for brokerage IRAs than for taxable accounts.

Instead of addressing these issues directly and openly, different sides have taken rigid positions without first agreeing on important facts. The facts, unfortunately, can be ambiguous—as in the case of the picture at the top of this article. We could be so engrossed in the ambiguity between the newspaper and the landscape that we don’t realize that we’re looking at a portrait of the famous Abbey St. Michel in Normandy, France.   

© 2017 RIJ Publishing LLC. All rights reserved.

A Debt Straitjacket? Or a Misdiagnosed Disease?

A straitjacket, yes, but debt defines its features poorly. Debt is merely one symptom of a disease that has vastly restricted the ability of developed nations to respond to new needs, emergencies, opportunities, and voter interests. 

The disease: the extraordinary degree to which past policymakers have attempted to control the future—building automatic growth or growing public expectations into existing spending and tax subsidy programs while refusing to collect the corresponding revenues required to pay for them. 

In Dead Men Ruling, I show how this leads to a “decline in fiscal democracy”—the sense by officials and voters alike that they have lost control over their fiscal destiny. Though the degree and nature of the problem varies by type of government and culture, research so far in the U.S. and Germany, two countries with greater fiscal space than most other developed countries, confirms this historic shift.

We must understand how we got here if we ever expect to get a cure, since defining the problem by the debt symptom has led mainly to periodic deficit-cutting that leaves the same long-term bind, frustrating voters and officials alike while increasing the appeal of anarchists and populists.

For most of history, nations with even modest economic growth wore no long-term fiscal straitjacket. Even with the debt levels left at the end of World War II, economic growth led to rising revenues, while most spending grew only through newly legislated programs or features added to programs.

Typically, existing programs were expected to decline in cost, e.g., as a defense need was met or construction was completed. Until recent decades, budget offices did no long-term projection. If they had, they would have revealed massive future surpluses over time even when a current year revealed an excessive deficit. Year-after-year profligacy was still a danger, but it wasn’t built into what in the U.S. is referred to as “current law.”

Today, rising spending expectations are built into the law through features such as retirement benefits that rise with wages, expectations that health care spending will automatically pay for new innovations, and failure to adjust for declining birth rates and the corresponding hit on spending, employment and revenues. At the same time, officials fail to raise the revenues required to meet, much less fund, those laws or voter expectations. 

A rising debt level relative to GDP is merely one symptom. Reduced ability to respond to the next recession or emergency is another, while the increasing share of government spending on consumption and interest crimps programs oriented toward work, investment, saving, human capital formation, and mobility. Politically the chief budget job of elected officials turns from giveaways (to avoid growing surpluses) to takeaways (that renege on what the public believes is promised to them).

Economic populists, fiscal hawks and doves alike, don’t help when their fights over short-run austerity ignore the fundamental long-term disease. The bottom line: flexibility, not merely sustainable debt, is required for any institution—business, household, or government—to thrive. 

The full range of responses given by other economists to the question of debt can be found here

© 2017 The Urban Institute.

The Turmoil inside TIAA

TIAA, as you probably know, was recently the subject of a couple of major man-bites-dog stories in the New York Times. TIAA is the hundred-year-old provider of 403(b) plans to universities, colleges and other non-profit institutions of higher learning. It hasn’t been a non-profit entity itself since 1998. But it still has a cooperative, not a corporate, structure that it touts as non-conflictive with the professors and administrators who participate in its plans.   

Unlike 401(k) firms, it serves multiple plan sponsors, so that teachers can switch colleges without leaving the plan. It is also primarily an annuity provider. Participants can invest in mutual funds through a deferred variable or fixed annuity during the accumulation period. When they retire, they can take income via systematic withdrawals or through a fixed life annuity that offers bonuses when investment returns are good. 

Despite TIAA’s carefully tended reputation for absolute probity, two Times reporters asserted, the company isn’t as free of conflicts-of-interest as it presents itself. In possible violation of the Department of Labor’s best interest rule, the Times said, TIAA has begun incentivizing its financial advisors to steer clients into relatively expensive products.

After the Times stories appeared, RIJ reached out to former TIAA executives about the story. Two were willing to comment on the condition of anonymity. Both thought the Times October 22 story was unfair to TIAA. But they also confirmed many of the points that were made. Their portrait of TIAA differs mainly in its emphasis. They focus on the organizational and financial stresses that TIAA has come under as a result of the maturity of the higher-ed market, the stress of acquiring an asset management firm and a bank, and the heat of competition from giant 401(k) plan providers like Vanguard and Fidelity.

Their answers to our questions can be found below. One is identified as a “former executive,” and another as “the second executive.” They depict a company under pressure on several fronts. A formal response to RIJ from a TIAA spokesperson can be found at the end of the article. (Full disclosure: TIAA is a group subscriber to Retirement Income Journal. My spouse is a TIAA plan participant, and we’ve received financial advice from a TIAA advisor.) 

What about the allegations of conflicted sales practices?

“If what they’re questioning are the sales practices—I was involved in discussions about advisor compensation,” said one former executive. “We agreed: You don’t get paid more money for recommending TIAA products. There’s nothing in the compensation scheme that rewards people for that. We make fund recommendations using a third-party provider. Ibbotson runs the model. There are lots of safeguards. There may have been differential compensation based on the complexity of the transaction, and that [compensation] might have been correlated with certain products. But [we did that] so [the advisors] would be willing to take the time to sell those products.

“If a client says, ‘I want to learn more about managed accounts,’ we will show them. But within those transactions there’s no bias toward TIAA. These are allegations. The Times ignored certain things. [Gregtchen Morgenstern] ot certain facts wrong. She said we opposed the fiduciary rule. We didn’t. There was no lawsuit; there was a whistleblower filing with the SEC. I don’t know what her motivation was. We welcome the regulators coming in. If they find stuff we’ll clean it up. They won’t find a lot. The reporter had a story she wanted to write. I believe TIAA is wearing the white hat here. It might have some dust on it. It has 15,000 employees. We’re not just another profit mongering financial services company. That’s not the company I know.”

“TIAA makes the most money on its annuitization outcome,” a second executive said. “There’s no mystery there. But obviously as they ramped up their individual financial planning enterprise, which now has 850 or 900 planners, there was a question of how those people were compensated. Absolutely, there was a degree of incentive to open managed accounts. But was there as much incentive as you’d see at a wirehouse? No.

“It’s funny that the Times article took that approach—‘TIAA is incentivizing planners to open managed accounts.’ A managed account is actually a good outcome for investors with money. It was a reasoned approach. But that’s not even where TIAA makes the most money. What’s best for TIAA—and for the investor, in my opinion—is their annuitization outcome. They have a strong annuity product. It’s the TIAA equivalent of a defined benefit outcome.”

“TIAA has three silos. There’s asset management, which includes the old TIAA funds plus the Nuveen funds. Then there’s the individual side, which means Everbank, which was another challenging acquisition. That’s a different culture. That’s where the individual planners are. They’re the only people who could put someone in a managed account. The planners see people who have $500,000 or more. People with $50,000 will not get a call from a planner. The third division is the traditional TIAA 403(b) business, which includes hundreds of relationship managers. That group struggles with questions like, ‘What do our fees need to be if Fidelity comes in with much lower fees and TIAA’s costs are higher?’”

Was there a link between the layoffs and the whistle-blower complaint?

“Before 2003, TIAA had never had a layoff,” the second executive said. “They had their first layoff that year and have had them regularly since then. That’s an indicator of how they think about business. [Previous layoffs have had a mix of people from different levels of the company], but one layoff last fall didn’t focus on low-level people. It focused on high-level people. This is pure speculation, but one could make the interpretation that when you lay off high-level people who have incredible knowledge and have made big contributions to the organization, a small percentage of them might be unhappy.

“There’s been a lot of turnover among the advisors in the wealth management business—probably more there than anywhere else in the company. They have had a lot of goals and quotas. TIAA’s core business was trying to retain assets and gather more share of the wallet of participants, but how long can that last? Once you’ve combed through current customers, at some point you have to look elsewhere.

“The layoffs started in earnest in June of 2016. That’s when they really got under way. They ramped up toward the end of last year and have continued. From my vantage point, the layoffs of high-level people peaked toward the early part of this year, and they are still continuing. There were two reasons. TIAA had a substantial amount of right-sizing to do. They recognized it. I don’t think they’re quite there yet. They have more to do. But they’re doing it in a very quiet manner. You won’t read a press release about it.

“Do I see a link between layoffs and whistle-blowing? Yes. That’s the short answer. I put that in the ‘human nature’ category. Anytime you are terminating people, even if you are trying to do it fairly and congenially, you will eventually awaken a sleeping giant or poke the wrong bear. But when it comes time to react you have to react on a bigger scale.

“The company was not the right size to move forward in the interest rate environment that we’re in. Think of it in these terms: Before the election—and by the way there weren’t too many people, especially in Manhattan, who thought Trump was going to win—there were lots of very credible forecasts saying that the 10-year Treasury would be at 2.5% going forward. At the time, TIAA was considering whether they were or weren’t right-sized. But then the ten-year rate keeps going down, and down. Say that you’re an insurer thinking that the 10-year will be 2.5% or even 3%, and you’re considering whether you’re right-sized or not. If it goes down to 1.5% or lower, you know that you’re not even close to being right-sized. A little panic sets in. TIAA may have to lay off a thousand more people. It’s an economic issue.”

“Are there disgruntled people at TIAA?” the first executive said. “Find me a company with 15,000 employees, with five to ten percent turnover every year, that doesn’t have them.” 

What’s the larger context for these accusations?

“There’s a big picture and a little picture,” he added. “The little picture is that employees have leaked internal presentations and talked about pressure to sell and put people into higher-profit products. The big picture is that TIAA used to be a co-op. As a co-op, TIAA traditionally charged every client, regardless of the size, the same amount, with only slight differences. Since everyone got charged the same, it meant that people with high account balances paid more than it cost to maintain those accounts.

“Their cost per dollar invested was higher. It was the same with the institutions. The University of Michigan, with 60,000 employees, is cheaper to serve per person than a small liberal arts college. So you had cross-subsidies. That was so participants could move from one institution to another and still pay the same fees. It was for the good of the whole.

“And for a long time, that was OK. But with the advent of competition from firms like Fidelity and Vanguard, there was pressure to add more products and services. Not too long ago, we didn’t even have a money market account. There started to be pressure to cut deals with big institutions. Fidelity and Vanguard were going after the biggest accounts, and offering to charge them lower prices. Those bigger institutions then came to TIAA and said, ‘We want a better deal.’”

“TIAA struggles with the average cost of servicing a plan,” the second executive said. “They tried to better match the fees with the amount of work that had to be done. In the case of the bigger institutions, which were large enough to have their own CFOs and a team of sophisticated assistants, TIAA didn’t have to work as hard. So they tried to reduce the prices to the large institutions and raise the fees of the smaller ones. At smaller institutions, TIAA was their retirement office, so they involved more work. But there wasn’t as much price-raising as you might expect. The idea was to get more competitive and you don’t get more competitive by raising prices.

“What had also happened was that the higher education business became mature,” the first executive said. “TIAA grew tremendously in the 1980s and 1990s because of changes in the pension law. The real competition in the old days came from the public retirement plans in higher education. For instance, North Carolina might have a state retirement plan for university workers. We competed. A lot of those state plans [closed] and TIAA got a lot of new business. We were an option everywhere outside of California. 

“But then that business became mature. TIAA faced a situation where the core pension business was flat to declining. At the same time, we had a big group of participants who had come into the plan in the 1960s. They were retiring and taking their money out. In the late 1990s we were facing changes in the cooperative structure and a shift in demographics. So TIAA went into new businesses.

“TIAA also wanted to hang onto the business that they have. Our participants typically contributed a total of 10% to 15% of their pay to their 403(b) retirement accounts, if you include employer contributions. The all-in contribution rate to 401(k)s is typically only 7.5%. So there are some high account balances, and competitors looked at them as potential rollovers. So TIAA started a wealth management group to give those [high account-balance participants] more services. It was a defensive move. TIAA doesn’t want money moving to Wall Street. So, combined with these other pressures—the nature of being a co-op and the flattening growth—that’s the big picture.  

“We wanted to start the wealth management business to retain assets and to get more of the [non-TIAA] assets of the people we already served. That’s where you saw the pressure. The core retirement business isn’t growing. They have to cut deals with the big university plans. There was intense competition there. They lost Notre Dame and Stanford. Fidelity took over Stanford. It’s no longer this one-happy-family co-op that it used to be, though there are still vestiges of that.

“As you stop being so much of a co-op, you have to cut prices to your biggest customers and raise prices on smaller customers. They did some of that, but then you need new revenue streams. That would come from managed accounts, the institutional asset management business, and from Nuveen.”

When did the culture at TIAA start to change?

“It started with Herb Allison. He came in from Merrill Lynch in 2001 or 2002. Starting with the top leadership, he brought in a new head of sales, a new head of marketing, new public relations people. There were more outsiders, and that continued under [current CEO] Roger Ferguson [who had been vice chair of the Federal Reserve and was a McKinsey veteran],” the first executive said.

“Now only one of the top senior leadership team is homegrown. They noticed all of the problems I’ve been talking about, and they knew they needed to do something different. You have to understand that TIAA didn’t get big enough to break even until the 1950s. Until then it got infusions from the Carnegie Foundation, which was always there to write another check.

“Unequivocally, the culture has changed. When you’re running a mutual or a not-for-profit for decades and along comes Herb Allison from Merrill Lynch, the culture will definitely change. And they needed some of that change. It had gotten too sleepy. So a lot of that [cultural change] needed to happen. The cultural changes continued under Roger Ferguson, but he’s not like Allison. He’s a McKinsey guy, not a Wall Street guy. The Nuveen acquisition definitely changed the culture, and I don’t think that was all positive. Nuveen had a really different culture. TIAA is still trying to wrap their arms around that.”

“TIAA is a different company than it was four years ago,” the second executive said. “A lot of the cultural change came from the Nuveen acquisition. That absolutely changed the culture of the asset management side at TIAA, and not all for the better. TIAA made those acquisitions because they wanted a bigger asset base. They wanted a cushion against the annuitization business, which was in trouble.”

“We bought Nuveen and Everbank because we thought they were good investments that would generate higher returns on the general account,” the first executive said. “In the case of Everbank, we wanted to be able to serve our clients’ needs up to and through retirement. Part of the reason was to make TIAA relevant to a younger generation and part was to provide in-house services to retirees. On the Nuveen side, we wanted to get assets under management up to scale, to be more profitable, and to provide more investment options. The subsidiaries are for-profit and they will continue to act like for-profit entities. But their profits still get dividend-ed up to the general account.”

TIAA’s response

TIAA’s vice president for media relations, Chad Peterson, sent RIJ the following prepared statement in response to our inquiries:

“Because TIAA does not have public shareholders, all of our earnings are returned to participants or are invested in our business. TIAA focuses exclusively on meeting our clients’ long-term financial needs. We always put our clients first and operate in a highly transparent and ethical way.

“Our financial advisor compensation practices are designed to put our clients first. They are paid a salary plus an annual variable bonus that is not based on the profit any product may deliver. Our advisors do not have product-specific targets.

“Financial advisors rely on a Centralized Advice Group to develop tailored client financial plans. Unlike many other firms, our advisors are not responsible for choosing the underlying funds in managed accounts or any other investment solution. In addition, all recommendations are reviewed by a separate review team to ensure they are appropriate and in the client’s interest. We are transparent about how we compensate our financial advisors. 

“Ninety-five percent of participants responding to surveys agreed/strongly agreed that TIAA’s Wealth Management Advisors considered their interests first, based on our Customer Insights Scorecard as of December 31, 2016.

“[Regarding] our managed account offer: We believe our managed account offer is strong and competitively priced. A team of skilled investment management professionals manages the asset allocation, investment selection, daily portfolio review and rebalancing, as needed. Additionally, all managed account clients have a dedicated advisor who assists with professional oversight. Our offers also take into account tax sensitivities, where appropriate.”

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