Archives: Articles

IssueM Articles

‘Rothification is a Stupid Idea’

Donald Trump’s tax cut plan, or rather a sketch for a draft of one, became public yesterday. It included a brief reassurance that tax incentives for retirement savings would not be sacrificed to pay for the cuts, but didn’t contain specifics on that topic.

Two days earlier, at the Insured Retirement Institute conference in Palm Beach on Monday, a panel of Washington veterans discussed the issues that preoccupy the thoughts of many of the annuity manufacturers and distributors who attended the meeting.

They worry that the administration might try to pay for tax relief for corporations and wealthy individuals by making the tax treatment of contributions to (and growth in) retirement plan accounts more like the treatment of Roth accounts. Income tax on contributions to traditional retirement accounts can be deferred until age 70½. Contributions to Roth accounts are taxable but withdrawals are generally not taxed.

The retirement industry opposes that shift, as did members of the panel at the IRI conference.

“Rothification is a stupid idea that will not die,” said Seth Harris, an ex-deputy Secretary of Labor in the Obama administration. “It’s bad policy that’s there just to fund a corporate tax cut. The tax cut will have to be paid for, and the other pay-fors are just as ugly. But the Roth 401(k) is a horrible idea.”

Another panelist, Sean Cassidy, vice president of federal government affairs for Voya Financial, described one possible scenario.

“We’re looking at the potential impact of Rothification. The Camp draft proposal (written by former House Ways and Means chairman Dave Camp, R-MI) of 2014 proposed a 50/50 model where the first $9,000 in contributions is tax-deferred and the next $9,000 is on a Roth basis. That idea is currently in play, but now they’re asking, ‘How low can we draw the tax-deferred line? At $3,500? $2,500?”

The retirement industry, which relies on tax deferral to incentivize plan participants to save, believes that a weakened form of tax deferral would hurt the industry and hurt retirees.

“My company is concerned about the behavioral response. Will people stop saving at the tax-deferred limit?” Cassidy said, noting that the retirees don’t necessarily feel commonality with the industry. “Politically, it’s sensitive. The voting public is shedding no rears for the life or annuity industry,” he added.   

A highly technical but important problem, Cassidy explained, is that tax deferral for retirement savings appears on the annual federal budget as a conspicuous twelve-figure expense, with no precise accounting for the income taxes that retirees will eventually pay when they withdraw the savings.

“Congress looks at tax deferral as an expenditure,” he said. “They put it on the same list as true deductions like the mortgage interest deduction. We’re saying, bring the money [the future income tax paid on withdrawals from 401(k)s and IRAs] into the 10-year budget window [where it would be netted against current expenditures].

The panelist, moderated by TV journalist Candy Crowley, also commented on the Obama Department of Labor’s fiduciary rule, with its requirement that advisors act in their clients’ best interests when handling retirement savings. It’s expected that the Trump administration will delay action on the rule until July 2019.

The annuity industry, assuming Hillary Clinton would be president and continue Obama retirement policies, has already done much to adapt to those policies, even as it continues to oppose them. It has spent tens of millions on new products, training, technology and compliance procedures—which may never be rolled back, regardless of what the Trump administration does.

“The battle over the best interest exemption is over,” Harris said. “The new battle will be over who is in charge. If Labor strikes down the DOL rule, then the SEC and the National Association of Insurance Commissioners will become important. Then the debate will be, ‘What is the enforcement policy?’

“But if you’re all breathing a sigh of relief over the 18-month delay, that would be a mistake,” he added. “It’s just breathing room. The SEC hasn’t produced a rule in seven years; it’s not going to produce one in 18 months. It will be up to the industry to push the SEC and DOL and NAIC into a room and give them clear guidance about what you want. But I think you’ll get a regime that’s more acceptable to industry than what we have now.”

But with so much uncertainty in the Labor department, where budgets are reportedly being slashed and no deputy Labor secretary for employee benefits has even been nominated, progress might be difficult. “There’s DOL fatigue on Capital Hill,” Cassidy said. “The legislative staff turns over and then the next wave needs to be educated about the issues. It’s like pushing string.”

All three panelists—former Oklahoma Republican congressman J.C. Watts was the third—agreed that confusion reigns in official Washington today, and that the main source of dysfunction is President Trump himself. “There’s no plan, no strategy. He just acquiesces to things and then backs away and gets outraged if he loses,” said Cassidy.

Watts agreed. “I don’t think there’s a strategy [behind what Trump does],” he said. “To him, people are just actors on a stage and he has to control the script. He will always position himself to lead the parade if he wins and blame somebody if he loses.”   

© 2017 RIJ Publishing LLC. All rights reserved.

To increase sales of active funds, bundle them with passive: Cerulli

Asset managers need to better align their product development plans with the processes that financial advisors use when constructing portfolios out of various funds, investment vehicles and assets classes, according to new research from Cerulli Associates.  

“Asset managers are looking to provide asset allocation to differentiate themselves,” said Brendan Powers, senior analyst at Cerulli, in a release. “Asset managers must be able to shift and reshape as the industry does. As advisors’ needs are changing, so must the product lines.”

With product commoditization and platform consolidation is making it tougher for standalone products to compete, 58% of asset managers are offering asset allocations that consist entirely of their own underlying strategies, Cerulli found. Firms with multi-asset-class capabilities may want to combine active and passive funds within quantitative or strategic beta strategies as way to increase sales.

“These capabilities can be offered at a lower cost compared to active, with upside potential over the index,” the release said.
Asset managers need to recognize where active management has advantages over passive (e.g., municipal bond, emerging markets equity), and where passive management holds an advantage (e.g., U.S. equity), Cerulli noted.

Cerulli’s latest report, U.S. Product Development 2017: Advisor Product Demand in a Model-Driven Environment, provides tactical data for understanding advisor product use, continued coverage of active versus passive, and advisors’ increased reliance on investment models.

© 2017 RIJ Publishing LLC. All rights reserved.

As risk premium shrinks, so does investors’ risk appetite

Experienced investors understand that the risk premium isn’t a constant, and that it gets smaller as price/earnings ratios rise. That may help explain recent investor behavior. 

In August, investors put $8.5 billion into U.S. equity passive funds, down from $10.8 billion in July 2017. On the active front, investors pulled $23.0 billion out of U.S. equity funds, compared with $19.6 billion in July, according to Morningstar’s latest monthly asset flow report.

(Morningstar estimates net mutual fund flow by the change in assets not explained by performance and net ETF flow by the change in shares outstanding.)

The report for August said:

  • Taxable bond was the lead fund category, with $27.5 billion in net flows. For the first time since May, active taxable-bond flows surpassed passive, by $14.1 billion to $13.3 billion.
  • The four Morningstar Categories with the highest inflows in August were: Intermediate-term bond, foreign large blend, multi-sector bond, and diversified emerging markets. Large blend did not make the top five categories, as interest in U.S. equities waned.  
  • PIMCO led in active flows with $4.1 billion, followed by Vanguard with $1.4 billion.
  • The two active funds with the highest inflows were the same in August as they were in July: PIMCO Income, with flows of $3.1 billion, followed by Oakmark International with $911.0 million in flows.
  • On the passive front, Vanguard was the top fund family, with inflows of $19.3 billion, followed by BlackRock/iShares, with inflows of $9.9 billion, and Fidelity, who is benefiting from multiple rounds of fee cuts.
  • The passive funds with the highest inflows were Vanguard Total Stock Market Index Fund ($6.2 billion) and Vanguard Total International Stock Index Fund ($2.5 billion).  
  • BlackRock High Yield Bond had the highest outflows in August of $1.4 billion.
  • Growth funds from Fidelity, T. Rowe Price, and American Funds also suffered large outflows as investors kept avoiding U.S. equity and growth stocks.

To view the complete report, please click here.

© 2017 Morningstar, Inc.

 

How wholesalers should adapt to disruption: DST

At the Insured Retirement Institute annual conference in Florida this week, one of the break-out sessions was dedicated to the future of the annuity wholesaling. Called “Evolution or Extinction,” it focused on disruptions in the advisor world that, in turn, are disrupting the wholesaling world. 

A new series of reports from DST Research, Analytics and Consulting, coincidentally looks at investment product distribution, which faces some of the same challenges. The series, “Prevailing in a Changing Distribution Landscape,” includes material that:

  • Examines the imbalance of asset managers’ current business models and the industry trends challenging them
  • Provides a framework to assess the firms’ preparedness
  • Outlines steps to modernize sales team structures and compensation programs

“Increased regulatory scrutiny and fee compression have forced the industry to consolidate to achieve better economics,” said Steven Miyao, head of DST Research, Analytics and Consulting, in a release. “The largest distributors are overhauling their platforms to put potentially more than $3 trillion of assets in motion.”

Because advisors make investment decisions on only 36% of all broker-dealer AUM (research analysts and algorithms govern the other 64%), distribution teams should:

  • Work with their firms’ business intelligence teams to identify and avoid advisors who outsource their investment decisions.
  • Use segmentation to identify advisors who can be influenced, and whose needs for products and services align with the asset manager’s capabilities and goals. 

Team and territory structures

As advisor business models evolve (45% of advisors plan to conduct more fee-based business in 2017), advisors are becoming harder to reach (in-person meetings are down 16% and call volume is down 27% since 2011). In terms of sophistication and skills, it’s more important than ever to match the right wholesaler with the right advisor. 

Compensation models

Compensation models for distributors must become more aligned with the asset managers’ business strategies. Variable commissions based on gross sales, which represented 35% to 49% of total compensation for external salespeople in 2016, don’t necessarily drive the metrics, such as holding period, that determine profitability.

Relationship management

As much as $3.3 trillion in actively managed assets are in funds with Morningstar Ratings of 1, 2, or 3 stars. These underperformers are most at risk for being eliminated from product shelves. This will demand the services of a dedicated relationship manager who can focus on retention activities.

For more information on DST’s “Prevailing in a Changing Distribution Landscape” research, contact Myra Bartalos, head of Marketing for DST Research, Analytics and Consulting, at mbartalos@dstsystems.com.

Economic conditions lift interest in retirement plans: Nationwide

Amid the nation’s ongoing debate about whether states should offer public-option workplace savings plans or if all employers should be required to offer access to such plans, a new survey by Nationwide suggests that small business owners want to promote retirement readiness among their employees.

According to Nationwide’s third annual survey of more than 1,000 business owners across the country with up to 299 employees, a tight labor market, competition for good employees and confidence about the economy are causing more business owners to start offering retirement plans or enhance the ones they have.

Half of business owners who offer a 401(k) plan intend to increase retirement plan contributions, with 55% percent of them citing rising sales or revenue as the reason. Of business owners who currently don’t offer a plan but intend to offer one in the near future, 36% say it’s because they expect sales revenue to increase in the next 12 to 24 months. Additionally, 30% of business owners plan to introduce retirement benefits as a result of continued economic improvement.

Among business owners who offer retirement benefits, 85% of Millennials plan to increase contributions to their employees’ 401(k) plans, compared to 31% of Boomers and 49% of Gen X business owners.  Millennial business owners are also more likely to feel they should provide retirement benefits, with 70% of them stating agreement versus 47% for all business owners. Only 39% of business owners believe their employees are on track to retire, and 72% of business owners surveyed think the U.S. is facing a retirement readiness crisis.  

Nationwide commissioned a 20-minute, online survey by Edelman Intelligence among a sample of 1,069 U.S. small business owners in May 2017. Small business owners are defined as having between 1-299 employees, 18 years or older and self-reported being a sole or partial owner of their business.    

© 2017 RIJ Publishing LLC. All rights reserved.

‘Tell Ken Fisher To Stuff It’

A highlight reel of the Insured Retirement Institute conference in Palm Beach, Fla., this week would surely feature Julius Caesar “J.C.” Watts, the former Oklahoma Sooners quarterback who in 1995 became the first black U.S. congressman elected south of the Mason-Dixon Line since Reconstruction.  

Appearing on a panel discussion about politics, Watts recalled how, weeks after he was elected, his car was stopped for no apparent reason in Norman, Okla., and blocked by six police cruisers. After making his point, he deftly ended the story on a note more patriotic than angry and drew an explosion of applause from the audience of annuity industry executives.

Racial themes rarely intrude at annuity conferences, but we live in interesting times. TV journalist Candy Crowley, the panel moderator, had asked Watt to assess the furor over Donald Trump’s remarks (“Get the SOBs off the field”) about NFL players who kneel for the national anthem. Watts took the question and ran for daylight—lifting a ready-made anecdote about racial profiling from his own 2016 memoir, “Dig Deep.”

Suitably enough, this year’s IRI conference was held at The Breakers in Palm Beach, not far from the president’s own exclusive Mar-a-Lago club. It marked the 25th anniversary of the organization, which began as a trade group called the National Association of Variable Annuities. CEO Cathy Weatherford has been its leader since 2008. At the conference, she announced her intention to retire at the end of 2018 after a ten-year run.

Regulatory limbo

The DOL rule, tax reform, and the tribulations of the annuity business were the main topics of conversation during the panel discussions, breakout sessions and cocktail receptions, as executives from major life insurance companies and brokerages mingled among the palms on the very sand bar and in the very hotel where the Florida real estate boom reached its 1920s peak.   

Despite their outward deference to the spirit of the Obama DOL rule, many of these executives are “angry,” I heard anecdotally, both at the Obama administration’s attack on their annuity sales model and at the Trump administration’s apparent inability to work out the controversies over the rule in a timely manner.

Anger is understandable; the industry has been whipsawed by the federal government. They spent tens of millions of dollars and thousands of hours on internal changes to comply with the rule—only to find that many changes may turn out to be unnecessary. Meanwhile, uncertainty over the fate of the rule has chilled the market for annuities, costing them untold billions of dollars in lost product sales.

The DOL set out to break the influence of manufacturer-paid commissions on advisors’ product recommendation to clients. That has been happening, and will probably continue to happen. It has had disruptive implications up and down the annuity supply chain, at least where third-party distributors are involved.

“We don’t control our compensation rates anymore,” lamented Bill Lowe, president of Sammons Retirement Solutions, which wholesales Midland National Life annuities. “We used to set the compensation levels. Today, [brokerage] firms say, ‘Here’s what you will pay.’ The paradigm has shifted. There’s been a complete flip in who sets the compensation rates.”

He’s referring to new policies at brokerages like Raymond James, which sells Midland National’s no-commission fixed indexed annuities (FIAs). For instance, Raymond James is setting one advisor comp for all brands of three-year indexed annuities, one for all five-year annuities and one for a seven-year annuities, as Raymond James’ senior vice president Scott Stolz told RIJ. Midland must retool its products accordingly.

The brokerage tail is wagging the life insurer dog, in effect. Raymond James is also reducing the compensation it will accept for selling structured variable annuities, which have lower guaranteed floors but higher caps than FIAs.

“We’re telling the structured product people that you have to take the money you save on commissions and put it back in the product,” Stolz said. (For FIAs at Raymond James, the differences in commissions are based on the number of years that the client can be expected to own the product, Stolz said.)

‘Tell Ken Fisher to Stuff It’

Variable annuities were a frequent topic of discussion. Once the fiery chariot of the annuity industry, it has been suffering not just declining sales but negative net flows. Life insurers, led in recent years by Jackson National Life, still sell about $100 billion worth of VA contracts each year. But the category’s future is unclear.

One wirehouse executive envisioned major product changes. “I see the unbundling of the insurance and the investments in the variable annuity. Putting those investments into an insurance wrapper creates complexity. You can unbundle it so that the client knows exactly what they’re spending on what,” said Ben Huneke, managing director and head of Investment Solutions at Morgan Stanley Wealth Management.

Bill Lowe of Sammons, which distributes indexed annuities, noted that VAs have become expensive relative to the limited upside they now offer. “Why are sales of the VA with the guaranteed lifetime withdrawal benefit declining? Because we’re asking for risk-transfer pricing in that product but were not transferring customer risk,” he said. That is, investments inside most VAs are now so risk-dampened, that they provide little or no more upside than indexed annuities despite their higher fees. “It’s all one indexed market now,” Jeremy Alexander of Beacon Research told RIJ.

One VA veteran struck an optimistic chord. “The DOL issue is a wonderful opportunity,” said Bob Saltzman, the retired CEO who in 1994 pioneered variable annuity sales at Jackson National Life.

“The fee structure of variable annuities will drop to the level of mutual funds, and you’ll have the opportunity to sell an investment with no tax event,” he said in his IRI Hall of Fame induction speech Monday night. “It will better than mutual funds. You’ll be in a position to tell Ken Fisher to stuff it very soon.”

Weatherford begins a long goodbye

Amid the commotion of the conference, IRI president and CEO Cathy Weatherford announced that she would retire at the end of 2018. On the brink of the financial crisis in September 2008, she took over a narrow-focus trade group called the National Association of Variable Annuities, welcomed all kinds of annuity manufacturers and distributors into the fold and turned it into a robust lobbying organization.   

Weatherford, a former Oklahoma insurance regulator, persevered in the face of low interest rates, departures of several firms from the VA business, and an unsympathetic Obama administration, whose DOL rule was aimed precisely at her organization’s members’ business models. In a short speech, she assured her members that there would be a smooth succession, but she didn’t indicate who her successor might be. 

© 2017 RIJ Publishing LLC. All rights reserved.

Trump Tax Plan Revealed

The nine-page tax reform framework that the Trump administration released Wednesday referred only briefly to the treatment of retirement savings. There was no sign that the current tax deferral regime would change, but the document left the door open to future adjustments.

Here’s what it said about retirement: “The framework retains tax benefits that encourage work, higher education and retirement security. The committees are encouraged to simplify these benefits to improve their efficiency and effectiveness. Tax reform will aim to maintain or raise retirement plan participation of workers and the resources available for retirement.”

The document, entitled, “Unified Framework for Fixing Our Broken Tax Code,” also contained these proposed federal tax law changes:

“Zero tax bracket”   

The framework doubled the standard deduction to: $24,000 for married taxpayers filing jointly, and $12,000 for single filers. To simplify the tax rules, the additional standard deduction and personal exemptions for the taxpayer and spouse are consolidated into this larger standard deduction. These changes create a larger “zero tax bracket” by eliminating taxes on the first $24,000 of income earned by a married couple and $12,000 earned by a single individual.

Individual tax rate structure    

Under current law, taxable income is subject to seven tax brackets. The framework aims to consolidate the current seven tax brackets into three brackets of 12%, 25% and 35%. Typical families in the existing 10% bracket are expected to be better off under the framework due to the larger standard deduction, larger child tax credit and additional tax relief that will be included during the committee process.

An additional top rate may apply to the highest-income taxpayers to ensure that the reformed tax code is at least as progressive as the existing tax code and does not shift the tax burden from high-income to lower- and middle-income taxpayers. The framework also envisions the use of a more accurate measure of inflation for purposes of indexing the tax brackets and other tax parameters.

Enhanced child tax credit and middle-class tax relief

The framework repeals the personal exemptions for dependents and significantly increases the Child Tax Credit. The first $1,000 of the credit will be refundable as under current law. In addition, the framework will increase the income levels at which the Child Tax Credit begins to phase out. The modified income limits will make the credit available to more middle-income families and eliminate the marriage penalty in the existing credit. The framework also provides a non-refundable credit of $500 for non-child dependents to help defray the cost of caring for other dependents.

Individual Alternative Minimum Tax (AMT)

The framework repeals the existing individual AMT, which requires taxpayers to do their taxes twice. The nonpartisan Joint Committee on Taxation (JCT) and the Internal Revenue Service (IRS) Taxpayer Advocate have both recommended repealing the AMT because it no longer serves its intended purpose and creates significant complexity.

Itemized deductions   

The framework eliminates most itemized deductions, but retains tax incentives for home mortgage interest and charitable contributions.    

Death and generation-skipping transfer taxes

The framework repeals the death tax and the generation-skipping transfer tax. 

Tax rate structure for small businesses

The framework limits the maximum tax rate applied to the business income of small and family-owned businesses conducted as sole proprietorships, partnerships and S corporations to 25%. The framework contemplates that the committees will adopt measures to prevent the re-characterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate. 

Tax rate structure for corporations

The framework reduces the corporate tax rate to 20%—which is below the 22.5% average of the industrialized world—and aims to eliminate the corporate AMT, as recommended by the non-partisan JCT. The committees also may consider methods to reduce the double taxation of corporate earnings. 

“Expensing” of capital investments   

The framework allows businesses to immediately write off (or “expense”) the cost of new investments in depreciable assets other than structures made after September 27, 2017, for at least five years. This policy represents an unprecedented level of expensing with respect to the duration and scope of eligible assets.

Interest expense

The deduction for net interest expense incurred by C corporations will be partially limited. The committees will consider the appropriate treatment of interest paid by non-corporate taxpayers.

Other business deductions and credits

The current-law domestic production (“section 199”) deduction will no longer be necessary. In addition, numerous other special exclusions and deductions will be repealed or restricted. The framework explicitly preserves business credits in research and development (R&D) and low-income housing, however.    

Territorial taxation of global American companies

The framework will replace the existing worldwide tax system with a 100% exemption for dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10% stake). The framework treats foreign earnings that have accumulated overseas under the old system as repatriated. Accumulated foreign earnings held in illiquid assets will be subject to a lower tax rate than foreign earnings held in cash or cash equivalents. Payment of the tax liability will be spread out over several years. 

Stopping corporations from shipping jobs and capital overseas

To prevent companies from shifting profits to tax havens, the framework includes rules to protect the U.S. tax base by taxing at a reduced rate and on a global basis the foreign profits of U.S. multinational corporations. The committees will incorporate rules to level the playing field between U.S.-headquartered parent companies and foreign-headquartered parent companies. 

   

Bob Reynolds’ & the Future of 401k

Many of us dream about improving the U.S. retirement system, but few of us are as well positioned to influence its direction as Robert Lloyd Reynolds, CEO of Great-West Financial. Reynolds has just published a new book, “From Here to Security: How Workplace Savings Can Keep America’s Promise.”

The book combines industry advocacy with public policy recommendations. Reynolds, 65, is the former Fidelity Investments vice-chair who, since 2014, has consolidated Great-West Retirement, Putnam Investments and J.P. Morgan Retirement Services into Empower, now a top-five 401(k) recordkeeper with an industry-leading eight million participants and about $400 billion in assets under management.

Reynolds, a florid, physically imposing West Virginian, is also one of the industry’s opinion leaders. As for opinions, he’s a passionate cheerleader for the $7 trillion 401(k) business—though his book concedes its flaws. As for leadership, it’s notable that three House Ways and Means Committee members, two Senate Finance Committee members and a former deputy Treasury Secretary endorsed the new book.

Before going farther, let me say that I welcome almost any book that, like this one, calls for introducing guaranteed income options into defined contribution plans. “Lifetime income solutions, in plans and beyond, strike me as the holy grail of the next generation of workplace savings in America,” Reynolds writes.

“Done right, this could enable DC plans to match, or even surpass, the reliable incomes that traditional pensions once provided.” (Empower sells Great-West Secure Foundation, a guaranteed lifetime withdrawal benefits, to Empower plan participants. Reynolds also told RIJ this week that he’s interested in indexed annuities as participant options.)

But that’s not the main reason this book is timely. Reynolds and other leaders of the retirement industry are currently concerned that, if and when Congress and the White House mucks around with the U.S. tax code this fall, legislators might try to generate new tax revenue (to pay for tax cuts) by trimming back the blessing of tax deferral on

Allianz, Aegon et al Inject New ‘Variable’ into Dutch DC Biz

The €10bn pension fund of Dutch telecom giant KPN disclosed this week that it would allow its plan participants to choose a new kind of distribution option for their defined contributions to the plan: Payouts that fluctuate with the performance of the underlying investments.

That’s a relatively new development in the Netherland’s retirement system. It was only a year ago that the Dutch parliament passed legislation enabling defined contribution (DC) pension fund participants to opt for variable benefits after retirement—also known as drawdown plans—instead of a fixed annuity.    

As IPE.com reported, most Dutch plans have not introduced a variable benefit option. Only a handful of retirees has opted for them. The fund for the postal workers (Pensioenfonds PostNL) and the fund for construction workers (BpfBouw), have said they won’t. Participants in such plans must turn to insurers like Aegon, Nationale Nederlanden, Delta Lloyd and Allianz if they want variable payout arrangements instead of fixed annuities at retirement.

The four providers have designed products that differ considerably, with Aegon offering the highest risk profile, investing 66% of the available pension capital in risky assets during retirement. For Aegon, the high equity allocation is deliberate. “Participants often have additional DB pension entitlements of at least as much as their DC capital,” said Frits Bart, director of policy.

“We consider these to be a risk-free investment. In addition, people have benefits from the state pension, which often represents an equivalent value and can also be seen as risk-free. In our opinion, people need the 66% risk assets in their investment mix as part of their variable payment plan in order to benefit from continued investing.”

The three other providers choose to emphasize the security aspect of their plans. At Delta Lloyd, the risky asset allocation is linked to a participant’s risk tolerance and can be 15%, 30% or 45%. The variation in benefits solely depends on the risk asset holdings. Participants purchase fixed annuities with the remainder of their pension assets.

Delta Lloyd says it will calibrate the risk profile once every five years, and subsequently adjust benefits if necessary. Participants can also indicate if they want their risk profile reviewed, but the provider will adjust the ratio between fixed and variable payments only once a year.

Nationale Nederlanden’s variable benefit product invests 35% in a multi-asset fund with an allocation of almost 20% to fixed income and other liquid assets.

Participants bear longevity risk in some plans but not others. The variable benefits of the Aegon and Allianz products will decrease if life expectancy continues to rise, but the Delta Lloyd and Nationale Nederlanden plans insure against this.

Allianz offers a combination of fixed (75%) and variable (25%) benefits, with a risk assets allocation of 7.7%. Allianz’s riskiest investment variant has purely variable payments and the maximum risky asset allocation is 31%. After 20 years of variable benefits, Allianz customers will no longer be exposed to investment risk.

“At that time, the assets available for variable payments would have shrunk so far that investing no longer adds value for them,” says Bram Overbeek, head of products and markets for life and income at Allianz Benelux. “That’s why we will set the benefits at a fixed level by then. We want the man in the street with DC benefits to relax after he has retired. We don’t want people running unacceptable risks and therefore we have aimed at shock-proof and gradual changes without too much risk.”

Nationale Nederlanden customers will receive fixed benefits from age 85. Delta Lloyd says it will gradually reduce the investable part of the assets to zero over a nine-year period after age 85. Delta Lloyd is the only provider that will smooth both positive and negative income shocks over a standardized period of five years.

Jeroen Koopmans, managing director at the consultancy LCP Netherlands, said variable benefits could be attractive for many. “A comparison of quotes for fixed and variable benefits shows that the variable benefits will be considerably higher in the first year. The difference could be 20%, or even 35%,” he said.

“If you start at 35% plus, you could afford negative returns for some years. But it could also turn seriously wrong, with benefits ending up lower than fixed payments. If equity markets were to drop 25%, a participant with Aegon would lose more than 16% of their pension assets,” he said. Aegon said it discloses the risks of its product in its literature.

One hurdle for wider practice of the new variable option in the Netherlands is that existing DC funds are geared towards de-risking ahead of retirement, thus reducing the level of risky assets on the assumption that retirees will buy an annuity. This is set to change, however. Aegon, for example, says it will come up with a solution for that inconsistency later this year.

The insurer ASR says the lifecycle options in its DC plans will be adapted for continued investing from 2018, and is developing a product for this purpose.

Allianz has recorded the greatest interest for variable drawdown products, with a take-up rate of one in five. At €300,000 against €95,000, the average purchase price for variable benefits is much higher than for fixed annuities. Similarly, Aegon reported a purchase price of twice as much on average. However, its take-up for variable benefits is lower at just 10%. For Nationale Nederlanden the figure is 5-10%. Delta Lloyd declined to provide details.

Overbeek noted that the variable option could lose its attraction if interest rates and annuity payout rates rose in the future. “Taking risks must pay off. If interest rates rose to 7% or 8%, few would opt for continued investing,” he said.

The KPN plan said it decided to offer the variable option because 8,000 of its participants accrued pension rights under defined contribution arrangements when they worked for Getronics, an information and communications technology firm whose pension KPN acquired in 2007. 

© 2017 IPE.com.  

How to attract IRA asset transfers: LIMRA SRI

Yeah, we know about rollovers. But what about IRA asset transfers?

With some $8 trillion in IRAs, there’s plenty of interest among brokers in attracting IRA assets from other custodians. But how volatile is the IRA transfer market? What is IRA owner behavior with respect to transfers? What does it take to put their assets into play?

It turns out that IRA owners aren’t very fickle. New research from LIMRA Secure Retirement Institute suggests that only about 9% of IRA owners have moved their accounts from one broker or custodian to another in the past two years. And retirees, who have the biggest accounts, are least likely to change horses.

Indeed, the IRA custodial relationship gets stickier with age. Far fewer retirees than workers (18% vs. 82%) executed IRA transfers in the past two years. People ages 45 and older were significantly less likely than people ages 40 to 44 (29% vs. 11%) to move their IRAs recently. Gender-wise, men were much more likely than women to do so (63% vs. 37%).

Of those who moved their accounts, people with the largest IRAs—as common sense might suggest—were the most likely to seek lower fees when changing custodians. For IRA owners in general, however other factors mattered more, indicating that fees aren’t everything. “IRA companies that focus heavily on their low-cost offerings may be missing a substantial portion of the IRA-to-IRA transfer market,” an SRI release said.

By the same token, companies that do not (or cannot) compete on fees alone should highlight their brand and overall customer services, SRI advised. They should emphasize the prestige of their brand or mind their customer service manners more astutely.

Predictably, people who moved their IRAs to companies where they already did business cited “relationships” as their top reason for choosing their new custodians. People who moved their IRAs to firms where they had no prior relationship listed “recommendations” as the determining factor in their selection. 

Referrals evidently matter, especially with men. Sixteen percent of IRA owners said they changed to a firm recommended by a family member or friend. Nearly a third of men (32%) said a recommendation played a role in their decisions to move their assets compared with about one in four women (24%). 

In other findings by LIMRA SRI:

  • A company’s investment choices and services are more important to younger IRA owners than older IRA owners (12% vs. 7%). 
  • 10% of IRA owners ages 60 and older who switched firms said the new company offered to help them throughout the transfer process. 
  • Half of older IRA owners (ages 50-75) who transferred their retirement assets from one investment firm to another discussed the decision with an advisor. Of those, 60% said the advisor’s intervention was the most influential factor in the decision to move their money.
  • Nearly a third of IRA owners ages 40-49 said they discussed their decision with call center reps from one of the companies. Of those, 22% said the decision to move their money was most influenced by the call center rep from their former IRA firm.

“Companies should ensure that their representatives are well-versed on the features offered by their company and are able to share these with clients when they call,” the release said.

LIMRA members can read the full report by visiting: Money in Motion: Understanding the Dynamics of Rollovers, Roll-ins, and IRA Transfers (2017).

© 2017 RIJ Publishing LLC. All rights reserved.

MassMutual aims to compete harder for defined benefit business

To help beef up its share of the shrinking U.S. defined benefit (DB) pension market, MassMutual has introduced a new diagnostic tool to help DB plan advisors, consultants and sponsors assess DB plan health and, ideally, find ways to raise assets and reduce liabilities.

PensionSmart Analysis, as the new tool is called, is available to DB plan sponsors through financial advisors and consultants who serve the pension recordkeeping, investments and actuarial marketplaces, MassMutual said in a release this week.

“The tool… creates a ‘persona’ that details the plan’s current status, funding level or health, service structure, and a comparison to pension plans sponsored by other employers in the same industry.” It can also help advisors and consultants identify local plans that could use a checkup, the release said.  

Private and public DB pension plans in the U.S. had $8.6 trillion in assets and $4.2 trillion in unfunded liabilities as of March 31, 2017, according to the Investment Company Institute.  

According to the release, the PensionSmart Analysis tool can:

  • Diagnose plan health based on funding levels, administrative efficiencies and expense savings, communications to participants.
  • Examine, assess and recommend new funding, investment and de-risking strategies.
  • Evaluate different investment “glide path” options to help sponsors match funding with liabilities.   
  • Help advisors and consultants identify local DB plans that might benefit from a health analysis. The tool displays information on the sponsor, type of plan, size of the pension in assets and number of participants, funding level, status and service model.

© 2017 RIJ Publishing LLC. All rights reserved.

A few big IBD deals, lots of smaller RIA deals: Fidelity

So far in 2017, $136 billion in assets changed hands among independent broker-dealers (IBDs) as a result of five merger/acquisition deals, while $80 billion was spread across 82 deals between RIAs (Registered Investment Advisors) during the same time period, according to a new report from Fidelity Clearing & Custody Solutions, a unit of Fidelity Investments.

The report, “Insights from Independent Broker Dealers,” the latest in the Fidelity Wealth Management M&A Series, reveals that fewer, but bigger M&A transactions are changing the IBD channel. A press release about the report didn’t name the firms involved.

Large IBD acquirers (firms with $10 billion+ in assets) drove the five IBD deals to-date and are helping to shape the IBD channel into a concentration of a small number of large firms. The top ten IBD firms now manage 65% of all broker-dealer assets and 48% of all broker-dealer advisors, the report said.

What’s driving M&A in the brokerage and RIA worlds? Costs are rising as broker-dealers invest in technology, advisor education and oversight to comply with regulations. Lower advisor productivity is straining bottom lines: Average assets per IBD advisor are $32.9 million, whereas advisors at independent RIAs manage $66.6 million.

Drawing upon  interviews with executives at Large IBD Acquirers, the report shows how M&A enables IBDs to:

1. Refine their growth strategies. The report found that two models are emerging in today’s IBD landscape – large firms with scale and focused firms with a distinct value proposition to serve a niche.

2. Balance size and culture. Post-acquisition, large IBD Acquirers are standardizing practices and procedures to improve efficiencies, while also maintaining advisor independence and choice. The report found that the large firms are focused on advisor engagement, management continuity and productivity improvements.

3. Strengthen value propositions. Large IBD Acquirers are creating additional value to appeal to firms looking to sell and to retain advisors post-acquisition through four key strategies:

  • Leverage technology as a strategic advantage: The race for technology has IBDs investing in their platforms to improve the advisor and client experience.
  • Reinforce advisor independence: A range of operating models supporting both fee- and commission-based business provides IBD advisors with the choices they need to stay in the channel.
  • Ease the transition: Taking lessons learned from the past, firms help retain advisors by creating a positive first impression with a smooth onboarding process.
  • Help acquired advisors grow their businesses: Investing to help advisors expand their books of business strengthens ties with the home office, while creating more consistency in productivity levels across the firm.

4. Mitigate operating and regulatory risk. Reducing risk is top-of-mind for Large IBD Acquirers as they evaluate acquisition targets and the advisors affiliated with them. The report found that many Large IBD Acquirers are experienced buyers with well-defined strategies and thorough vetting processes, and they will decline deals that pose potential risks to their culture, sales record and firm value.

For more information, read Insights from Independent Broker-Dealers, the latest report from the Fidelity Wealth Management M&A series.  

© 2017 RIJ Publishing LLC. All rights reserved. 

Honorable Mention

Advisors recommend closed-end funds for income: Nuveen

Overall closed-end fund (CEF) usage has increased significantly since 2013, according to a study focused on financial advisors and their use of CEFs released today by Nuveen, the investment management arm of TIAA. When looking for new sources of income, more than half (57%) of all advisors recommend CEFs as an investment option.

Nuveen’s study monitors trends in the CEF space, specifically tracking usage among the financial advisor community, which has increased since the inaugural study in 2013, and remained steady from 2016. Nearly two-thirds of advisors (62%) currently use CEFs in client portfolios – up from roughly half (51%) in 2013. Closed-end funds remain an attractive investment option as financial advisors are reportedly recommending the funds to clients seeking income and diversification opportunities for income portfolios.

Of those advisors who reported increasing CEF usage over the past year, the top two reasons include the attractive yield and return on investment as well as helping clients generate more income in their portfolios. Nine out of 10 advisors (91%) say clients ask about income producing investments – such as CEFs and other fund types. Increasing income remains the top reason for using CEFs in investment portfolios, according to 62% of the financial advisors surveyed who use CEFs.

Dubick & Associates conducted the latest version of the study of financial advisors’ closed-end fund usage on behalf of Nuveen using a sample drawn from the Discovery Database.

The study, also conducted in 2013 and 2016 by Dubick & Associates, included a weighted statistically valid sample of 326 financial advisors from wirehouses, regional broker/dealers, independent broker/dealers, registered investment advisors, bank and insurance companies. The 2017 study was fielded from April 27–May 11.

Ubiquity Retirement + Savings recognized for growth rate

For the 11th consecutive year, Ubiquity Retirement + Savings, a flat-fee 401(k) provider for small businesses and individuals founded in 1999, has been named in the Inc. 5000 list of the nation’s fastest-growing private companies.  

The 2017 Inc. 5000, unveiled online at Inc.com and with the top 500 companies featured in the September issue of Inc. (available on newsstands), is the most competitively successful group in the list’s history. The average company achieved a three-year average growth of 481%.

“Our placement on the Inc. 5000 for so many years represents our commitment to supporting small businesses and educating the market on the importance of personal savings,” said Chad Parks, CEO and founder of Ubiquity Retirement + Savings, in a release. “Since 1999, Ubiquity has strived to reach unserved markets, which makes up more than 40% of our nation’s workforce.” 

Conning publishes study of life-annuity leaders

A new Conning study, “Individual Life-Annuity Growth and Profit Leaders: Preparing to Change Tack” analyzes individual life-annuity insurer performance, identifies the most successful firms based on Conning’s multi-year leadership criteria, and identifies shared characteristics among the successful firms.

“Companies that met our criteria to be considered growth and profit leaders did so by successfully managing through operating and market complexity,” said Steve Webersen, Head of Insurance Research at Conning.

“Leading companies of all sizes consistently exhibited faster capital growth than their peers and had bond portfolios of longer maturity than the remaining companies. Overall, annuity products performed better in the period than life insurance, which explains the predominance of annuity specialists among the leading companies,” he added.

© 2017 RIJ Publishing LLC. All rights reserved.

The Normalization Delusion

There is a psychological bias to believe that exceptional events eventually give way to a return to “normal times.” Many economic commentators now focus on prospects for “exit” from nearly a decade of ultra-loose monetary policy, with central banks reducing their balance sheets to “normal” levels and gradually raising interest rates.

But we are far from a return to pre-crisis normality.

After years of falling global growth forecasts, 2017 has witnessed a significant uptick, and there is a good case for slight interest-rate increases. But the advanced economies still face too-low inflation and only moderate growth, and recovery will continue to rely on fiscal stimulus, underpinned if necessary by debt monetization.

Since 2007, per capita GDP in the eurozone, Japan, and the United States are up just 0.3%, 4.4%, and 5%, respectively. Part of the slowdown from pre-crisis norms of 1.5- 2% annual growth may reflect supply-side factors; productivity growth may face structural headwinds.

But part of the problem is deficient nominal demand. Despite central banks’ massive stimulus efforts, nominal GDP from 2007-16 grew 2.8% per year in the US, 1.5% in the eurozone, and just 0.2% in Japan, making it impossible to achieve moderate growth plus annual inflation in line with 2% targets. US inflation has now undershot the Federal Reserve’s target for five years, and has trended down over the last five months.

Faced with this abnormality, some economists search for one-off factors, such as “free” minutes for US cellphones, that are temporarily depressing US inflation measures. But mobile-phone pricing in the US cannot explain why Japan’s core inflation is stuck around zero. Common long-term factors must explain this global phenomenon.

Labor-market developments are key, with wage growth remaining stubbornly low even as unemployment falls to “normal” pre-crisis levels. Japan is the most extreme case: with a shrinking labor force, minimal immigration, and a 2.8% unemployment rate, all standard models predict accelerating wage growth.

But however much Prime Minister Shinzo Abe urges employers to give Japanese workers a raise, growth in compensation remains sluggish: in June, total wages grew just 0.4%. In the US, too, each new batch of monthly data indicates strong employment growth and surprisingly low wage growth.

Three factors may explain this trend. For 30 years, labor markets have become more flexible, with trade union power dramatically weakened. At the same time, globalization has exposed workers in the tradable sector to global wage competition. But, most important, information technology delivers ever-expanding opportunities to automate all economic activities. In a fully flexible market labor with, as it were, a reserve army of robots, the potential for pervasive automation can depress real wage growth even with full employment.

Nominal demand, meanwhile, is still being held back by an overhang of unresolved debt. Between 1950 and 2007, advanced economies’ private debt grew from 50% to 170% of GDP. Since 2008, debt has shifted from private to public sectors, with large fiscal deficits both an inevitable consequence of post-crisis recession and essential to maintain adequate demand.

In addition, the global economy has been kept going by China’s enormous leverage increase, with the debt-to-GDP ratio up from around 140% in 2008 to 250% today. Worldwide, total public and private debt has reached a record high, up from 180% of global GDP in 2007 to 220% in March 2017. As a result, interest rates cannot return to pre-crisis levels without risking a new recession.

Facing this debt overhang, loose monetary policy alone was bound to be ineffective and, beyond some point, potentially harmful and counterproductive. Neither investment nor consumption responds strongly to ever-lower interest rates when debt burdens are high. Very low interest rates, meanwhile, generate asset-price increases, which benefit the already wealthy and reduce the income of less wealthy bank depositors, who in some circumstances might cut consumption more than deeply indebted borrowers increase it.

In this context, as Princeton University economist Christopher Sims argued in 2016, loose monetary policy cannot work through normal transmission channels, and is effective if, and only if, it facilitates fiscal expansion by keeping government borrowing costs low.

Nominal GDP in the US has grown faster than in the eurozone since 2007 because the US ran deficits averaging 7.2% of GDP versus the eurozone’s 3.5%. Global growth today is crucially underpinned by China’s 3.7%-of-GDP fiscal deficit, up from 0.9% in 2014. Japan’s continued growth is assured only by large fiscal deficits stretching well into the 2020s; the Bank of Japan, which now holds government bonds equivalent to about 75% of GDP, will hold some of them forever, permanently monetizing accumulated fiscal debts.

The partial recovery this year thus reflects neither a return to pre-crisis normality nor the success of monetary policy alone. But, even if inflation rates remain below target, there is still a good case for some interest-rate increases. Because ever-looser monetary policy alone is decreasingly effective beyond some point, it can be partly reversed with little danger to nominal demand; and slightly higher interest rates would temper, even if only mildly, the in-egalitarian impact of the current policy mix.

But the rate increases will and should be very small. I doubt that the US federal funds rate will exceed 2.5% in 2020, while Japanese and eurozone rates will rise only marginally, probably remaining well below 1%. Inflation is more likely to undershoot than to exceed 2% targets. Moderate growth at best will be insufficient to offset the impact of the lost decade of 2007-17.

The psychological bias to expect a return to “normality” will remain strong. But the drivers of post-crisis economic performance are so deep that no return to normality is likely any time soon.

Adair Turner, a former chairman of the United Kingdom’s Financial Services Authority and former member of the UK’s Financial Policy Committee, is chairman of the Institute for New Economic Thinking. His latest book is Between Debt and the Devil.

© 2017 Project-Syndicate.

On the Case: Income from a ‘Certified’ Used Annuity

Bryan Anderson and Nathaniel Pulsifer are two expert fly-fishermen in northwestern Montana who also sell annuities to investors all over the country via the web. Anderson leads AnnuityStraightTalk, their indexed annuity (FIA) business. Pulsifer heads up DCF Exchange, their secondary market annuity (SMA) business.

An SMA and an FIA are central to the retirement income plan they’ve submitted for Andrew, 64, and Laura, 63, the real-life near-retirement empty-nesters who have $1.25 million in a balanced portfolio, most of it tax-deferred, about $1 million in home equity. RIJ asked its readers to submit income solutions for them, and this is the fifth plan that we’ve published. (For more about Andrew and Laura, click here.)

SMAs, if you’re new to them, are the “used” contracts referenced in our headline. These are income streams or lump sum payouts that were originally awarded to individuals as monetary awards in wrongful injury suits. The recipients of these annuities have the option of keeping them or selling them to investors for lump sums.

Asset securitization firms like J.G. Wentworth are able, with court approval, to buy billions of dollars of such “structured settlements” at steep discounts. Smaller factoring firms, like DCF Exchange, also buy the income streams. They restructure and resell them to individuals for up to 25% less than the price of a comparable retail annuity.Nathaniel Pulsifer

Indexed annuities also figure in the income plan that Anderson and Pulsifer (right) created, but in a counterintuitive way. Instead of recommending that the couple buy an FIA and use a lifetime income benefit rider, they suggest purchasing an accumulation-only FIA and using the 10% annual no-penalty withdrawal option as a source of emergency income.  

Quick takeaway

Anderson and Pulsifer noticed that most of Andrew and Laura’s $1.24 million in savings is in SEP IRAs. The couple can therefore expect to take required minimum distributions of at least $40,000 a year starting at age 70½. They advise the couple to spend about half of their qualified savings on two contracts: A fixed period-certain SMA to provide income roughly equal to their RMD for the first 15 years of retirement and an FIA for growth or contingent income.

The annuities, pension and Social Security will provide the couple with income that’s immune to market volatility. Since the couple won’t need to sell other assets for income, they can afford to invest most of the rest of their savings in equities. The anticipated growth from equities, plus home equity and long-term care insurance, can finance their lifestyle and medical expenses later in life. In the meantime, equity upside can help protect them from inflation risk.

AnnuityStraightTalk assumptions

  • Andrew will work to age 70 (year-end 2022) to maximize his Social Security benefits.
  • Laura’s will switch to part-time work, starting immediately. The couple will save less but will not need to dip into savings before Andrew fully retires.    
  • The couple’s income (Andrew full-time, Laura half-time or less) during the next five years will exceed expenses by $100,000 per year, but the surplus will largely be consumed by graduate school tuition for their daughters.
  • The couple has a target pre-tax income of $140,000 starting in five years (in 2023), with $98,000 from a combination of Social Security ($81,000), Laura’s pension ($7,000) and net income from real estate ($10,000).
  • Their projected income gap is $42,000 per year, starting in 2023.
  • The couple will continue to make mortgage payments on their primary home ($1.23 million value; $248,000 owed, and November 2031 payoff date) and rental property ($435,000 value; $325,000 owed and October 2046 payoff date).

Advice point

Laura and Andrew need to be wary of sequence of returns risk. With about $1 million in tax-deferred accounts, including traditional and SEP IRAs, they will begin taking substantial required minimum distributions at age 70½. They also have a high equity allocation. “This can be a significant issue in volatile market years, with Uncle Sam forcing you to sell securities in down markets to satisfy RMDs,” Pulsifer and Anderson said. Their recommended solution provides guaranteed income to cover these RMDs and neutralize sequence of returns risk.

Advice point

With bond yields so low, the couple also faces interest rate risk. If they decided to rely on bonds or bond funds for income in retirement, they’d be exposed to the risk that rates might rise and reduce the value of their principal. If rates don’t rise, the low returns would stunt their portfolio growth. Anderson and Pulsifer’s solution, using the index annuity as an alternative allocation to their bond holdings, reduces this interest rate risk, and provides a safe protected growth vehicle.

Advice point

The two advisors considered and ultimately rejected single premium immediate annuities (SPIA), variable annuities (VA) and FIAs with living benefits, as well as the 4% withdrawal rule, as income solutions for Andrew and Laura. They chose a period-certain SMA instead of a retail SPIA because of its higher internal rate of return (IRR) and because the couple can buffer longevity risk with other assets. As for the guaranteed lifetime withdrawal benefits associated with VAs and FIAs, they found that an SMA cost less and offered higher monthly payouts. The SMA income was also more predictable than income from the VA. Regarding the 4% withdrawal rule (with annual inflation adjustments), they thought it carried little or no protection from sequence risk, market risk or longevity risk.

Advice point

Anderson and Pulsifer’s plan assumes a reallocation at age 85, rather than at the higher ages that other advisors have begun to use. “The surplus in their equity portfolio and in their two homes will be the couple’s longevity protection,” they told RIJ. “In our planning practice, very few people who have assets like Laura and Andrew need to annuitize or buy lifetime income. Longevity risk simply isn’t a concern for them. Their assets and other sources of income will be more than adequate.”

AnnuityStraightTalk/DCF Solutions recommendations

The optimal solution will allocate 40% of their combined qualified funds into two different annuity products. For guaranteed income, we use a period-certain guaranteed payment stream provided by a secondary market annuity from the DCF Exchange.

  • For income during the first 15 years of full retirement, we pay about $368,000 (almost all of it from the bond holdings in Andrew and Laura’s SEP IRAs) for a deferred period-certain secondary market annuity from the DCF Exchange. Starting in 2023, this contract would pay $3,500 a month for 180 months for a total payout of $630,000 and an effective yield of 4.5%. (A comparable annuity from immediateannuities.com pays under $2,878 a month, as of September 12, 2017.)
  • For additional income or growth, without the interest rate risk inherent in bonds or bond funds, we use $150,000 to purchase a fixed indexed annuity with a seven to eight surrender period and no income riders or added fees. “We see the index annuity as an ‘enhanced bond’ allocation. Principal is guaranteed and additional income can be drawn if and when needed through the free withdrawal provision of the contract. Left alone, this asset could may grow to about $350,000 at a 4% average yield until they reach age 85,’ Anderson said.
  • AnnuityStraightTalk use FIA providers such as Great American, Integrity Life, or Midland National. The surrender period will expire only two or three years after Laura and Andrew retire, giving them options for rebalancing their portfolio along the way.
  • We allocate Andrew and Laura’s remaining $746,000 in savings to equities, thus maximizing their chance for growth over the next 20 years, until they reach age 85. This will give them an overall allocation of about 60% equities and 40% “safe money.” 

Bottom line

Bryan AndersonAdding $42,000 in guaranteed income from an SMA to Laura and Andrew’s other safe sources of income (Social Security, pension and rent on their second home) will provide enough income to meet their income and RMD needs. This will maximize their peace of mind even as they devote the rest of their portfolio, almost $750,000 to equities or other growth-oriented investments.

“Rather than pay too much and lock themselves into a rigid paycheck for life, or let the markets rule their fate, Andrew and Laura should allocate a portion of their assets to two smart, safe-money assets that will protect their principal and create multiple sources of guaranteed income insulated from volatility. This relieves pressure on other investments, provides security, and allows for growth that will reduce their longevity risk and secure their inheritance goals,” Pulsifer and Anderson (at left) said.

SMAs, it should be said, are in relatively short supply and require careful due diligence before purchase. The supply of secondary market annuities is only $800 million to $1 billion per year, according to Pulsifer. Large asset securitization firms buy an estimated 80% of that amount, leaving the rest for smaller factoring firms. Because the market is so small, investors need to be careful, and to work only with reputable agents who can document each link in an SMA’s chain of ownership.

© 2017 RIJ Publishing LLC. All rights reserved.

Tax-Free QLACs? It Makes Sense

With tax reform soon to dominate our disquiet national discourse, I propose a modest change in the tax code with respect to qualified longevity annuity contracts, or QLACs. Income tax on withdrawals from QLACs should be eliminated. If so, QLACs would be the new Kardashians, in terms of media attention. 

Most Americans don’t know a QLAC from an Aflac. But retirement income mavens know that QLACs are deferred income annuities, purchased with up to 25% of a person’s qualified savings (or $125,000, if less) to generate income starting after age 70½ but not later than age 85.

QLACs haven’t had time to build much familiarity. The Treasury Department, in an effort led by deputy secretary Mark Iwry, introduced them in the second half of 2014. QLACs act as insurance against outliving your savings. Until you take income from a QLAC, you can exclude its value from your required minimum distribution (RMD) calculations.

For example, a person with $500,000 in a rollover IRA at age 65 could buy a QLAC with as much as $125,000. At age 70½, he or she would calculate their RMD on the basis of $375,000 instead of $500,000. The QLAC exclusion reduces the RMD and the income tax bill by 25%. When QLAC withdrawals begin, they’re taxable as ordinary income.

QLACs are available if you know where to look. Vanguard investors can buy them at IncomeSolutions.com. Fidelity investors can buy them on Fidelity’s annuity platform. You can buy them through immediateannuities.com. New York Life and Northwestern Mutual Life agents sell them.

So far, sales are low. But nothing would jump-start the deferred income annuity (DIA) market or make longevity risk a top-of-mind concern better than eliminating future income tax on QLACs. Perhaps only those payouts that begin at age 80 or later would be tax-free. That would encourage the intended use of DIAs: to provide income during the years when you are least likely to be alive (and when longevity insurance is cheapest).

Uncle Sam won’t miss the tax revenue. The IRS, I’ve been told, doesn’t even bother to count taxes paid on RMDs separately from other income taxes. 

Deficit hawks are thinking: Whoa. Republicans and Democrats can’t afford to play the Two-Santa game any longer, with Republicans handing out new tax cuts to wealthy voters and Democrats handing out new spending programs to struggling voters.

Perhaps we can find the money. Maybe 401(k) participants could check a box that says they’ll take only 75% of the tax break on their contributions. They would pay for their untaxed QLAC withdrawals in advance. New research shows that, even in our instant-gratification culture, many people still like paying it forward.   

Or perhaps we could assume that QLACs would pay for themselves by reducing the likelihood that people over age 80 will run out of money and need public assistance. (Alternately, QLACs might meet the conditions of a “Medicaid-friendly” annuity and be excludable from available assets. It may depend on which spouse wants to qualify for Medicaid. I’ll check into that.)

Some might say that such a tax benefit would wasted on the many older Americans who aren’t likely to pay much tax on their QLAC income anyway. In that case, it wouldn’t cost much. But it would still raise awareness of QLACs.

Other countries have combined tax benefits with longevity risk protection. In Britain, before the annuitization mandates were repealed, the government sweetened annuity purchases by letting retirees spend 25% of their tax-deferred savings tax-free. Singapore, I believe, has experimented with a two-period retirement system, involving a period of systematic withdrawals followed by a period of annuitized income.

Longevity risk pooling—either with life insurance products or low-cost tontines (as Moshe Milevsky recommends)—is the most efficient societal response to the problem of financing unknown life expectancies. A tax break for QLACs would rivet the public’s attention on longevity risk. Now’s the time to ask for it.  

© 2017 RIJ Publishing LLC. All rights reserved.         

Tontines in the Townships of South Africa

For RIJ readers with an academic or commercial interest in tontine annuities, a South African company by the name of NOBUNTU —loosely translated from Zulu into female spirit of the community—has just launched a novel savings scheme for low income South Africans.

You can think of this as a micro-pension plan for domestic and other workers who have little in the way of savings for retirement. Right now their only source of retirement income is ad hoc support from their prior employer (a gift when they retire) plus a meager sustenance-level pension (Social Grant) from the government; hoping that president Zuma keeps his pension promises.

The way the new scheme works is that every month individuals or employers will contribute a handful of ZARs (South African Rand) to a savings fund, using a text message or WhatsApp. The technology is quite clever, if I may say so myself.

Half the invested or contributed funds are allocated for paying out funeral costs—which is a really big deal in South African culture—and the other half is allocated to what we would call a long-term pension plan. With that part of the pot, if-and-when a participant dies, the money in the pension half of their account is redistributed to survivors in their community in the spirit of solidarity, hence the name of the company Nobuntu. Upon death, the family or beneficiaries only receive the funeral pot. The other half of the pot is forfeited to the group. The participant’s pension investment return, then, is a blended mix of capital, interest and perfectly transparent mortality credits. In essence, this is a modern day (21st century) tontine scheme.

milevsky in sowetoNow, before you say to yourself: “tontines in the South African townships?” and laugh hysterically, please note the following. The company is targeting women in the 50 to 80 age range, many of whom are forced to support two or even three generations of family members in their household. They aren’t selling this on the streets. Note that the unemployment rate in these areas is a staggering 40%. So, this isn’t intended as a lottery, gamble or some perverse pyramid scheme. It is designed to squeeze the highest amount of return from the lowest amount of capital, while respecting their (cultural) need for funeral funds, etc. In other words, every ZAR is made to count using the tontine element.

Now to my part in all of this. When the promoters (Tyron, Ross and Reka) contacted me a few months ago and informed me about their plans, I was intrigued enough to swing by Johannesburg on my way from (lecturing in) Sydney to London. In fact, I spent 72 hours in and around Soweto, which was my first time in South Africa. (I’ll get to the safaris next time around.) 

It was an opportunity to observe the modern-day incarnations of the entrepreneurial Lorenzo de Tonti, pitching their novel scheme to potential participants and their employers. While many of the presentations took place in neighborhoods I would never dare to enter alone—and in the Zulu language which I don’t speak—I did pick up some great pointers on how to position annuities and longevity insurance almost anywhere in the word. It was a crash course in (African) behavioral finance and insurance. In fact, almost everyone spoke some rudimentary English and I was able to conduct real research in a place quite different from Monte Carlo.

If you are wondering, nobody in the audience asked about Internal Rates of Return (IRRs), yields to maturity or actuarial tables on which the dividends would be paid. But the audience did ask some really sharp questions about long-term security, fairness, trust and even—what we quants might call—credit default risk.

On a personal note, I developed a newfound and heart-wrenching appreciation for the personal financial challenges one faces with three generations to support and only one breadwinner in the household. Or, think about the technical challenge of pricing and valuing longevity-contingent claims when a large swath of the population has AIDS. It’s one thing to read about these things in academic papers or in books (such as Portfolios of the Poor, Princeton U.P. 2009, or the U.S. focused The Financial Diaries, Princeton U.P. 2017.) It’s quite another matter to be there in person.

Ok, so during the first meeting I was amused by the novelty of it all and readily admit my biggest concern was getting good pictures on my iPhone—much to the chagrin of my hosts. But by the second tontine enrollment meeting I started paying attention to the finer details, the audience dynamics and listening to (translations of) many of the audience’s questions. Trust me, this was no client appreciation event at Maggiano’s. Audience members were promised a can of coke and a half-donut, buy only if they stayed until the very end.soweto meeting

Eventually though, as the day progressed the big picture finally did sink in. It shook me. Even if these kind folks do sign-up (and start saving for their retirement) and eventually receive some tontine dividends, how will they ever manage? I was told by one of the ministers that every second person in the audience had a relative in their household who had died of AIDS.

So, Nobuntu isn’t selling souped-up variable annuities to American baby-boomers or planning on using Blockchain, Bitcoin or Etherium to help shelter your nest egg from income taxes and prying eyes. Etherium, you ask? Well, write a book about the history of tontines in the 17th century and I promise you too will be inundated with similar pitches. This plan is very different.

One of the reasons Nobuntu is such a fascinating experiment—and this young company is able to “move fast and break things”—is that they operate in a (very) loose regulatory environment, known as the Stockvel regime in South Africa. Traditionally Stockvels—well known to South Africans—have consisted of small community-based savings schemes in which friends and acquaintances help each other by pooling financial resources. Many have been plagued by fraud and other shenanigans.

This post isn’t the place or time to get into the regulations pertaining to Stockvels or how the company can innovate without bumping into multiple legal barriers. But the bottom line is that Nobuntu can get away with things that would land them in a heap of regulatory manure anywhere else in the developed world. I can only imagine what a regulator like FINRA or the SEC—let alone the state insurance commissioner—would have to say about such a scheme and the way in which it was presented.

To be clear, I don’t think there was any mis-selling taking place. The warm, kind and very welcoming people—I was invited into many of their homes, although the kosher thing got awkward—understood the risks involved. They live with constant risk. Yes, many of them might be classified as having a very low level of financial literacy, but I think they really do get what’s at stake, albeit in a non-numerical way.

So, I’m now back in North America for the fall teaching semester but I’ll be watching (what I call) the Sowe-ton-tines experiment quite closely over the next 6-18 months. The company’s success in the narrower world (i.e. “regulatory sandbox”) could be leveraged beyond the townships into a broader swath of South Africa. More importantly it could serve as a template in other developing parts of the world that lack suitable pensions or annuities. It’s a form of micro-insurance or micro-pensions with a very unique twist, the tontine element.

The founding partners of Nobuntu will soon be releasing a technical document (a.k.a. “White Paper”), to be posted on their website (http://www.nobuntu.co.za/). In it they have promised to explain exactly how they plan to manage the myriads of technical — actuarial, financial and even legal — issues that will undoubtedly arise in such a unique scheme. How will the funds be managed and invested? How will the tontine dividends be calculated? How will individuals of different ages be pooled? How will all of this be explained to participants in a way they can understand?

As you may suspect, I might even lend a hand with some of the mathematical and statistical problems, which are quite interesting in their own right. Perhaps good for a PhD thesis or even two. Stay tuned.

#TontinesForGood

Trend toward centralized investment advice will continue: Cerulli

To reduce dispersion of client returns and mitigate legal risks, more wirehouses and brokerages have begun encouraging their advisors to outsource portfolio construction and become relationship-builders, according to new research from Cerulli Associates, the global consulting firm.

“Going forward, if you want to be an advisor, you have to place your value-add on goal-based planning, and other higher-order planning activities. If your value prop is creating asset allocation models, then you have to rethink it,” Tom O’Shea, associate director at Cerulli, told RIJ in an interview.

The trend comes mainly from the Obama Labor Department’s fiduciary rule, which will have a big effect on brokerages regardless of how much the Trump administration weakens it, O’Shea said: “The people we talk to use a lot of metaphors like, ‘The horse is out of the barn’ and ‘the toothpaste is out of the tube.” 

Wirehouses and brokers have seen the dispersion of returns created by independent-minded “reps-as-portfolio-managers” using discretionary managed accounts, and see legal or regulatory liability there. That risk exposure would largely vanish if a single, centralized investment team laid down investment guidelines.  

More to the point, individual advisors too often deliver lower investment returns than the centralized team. “Many advisors pride themselves on their portfolio management skills,” said Cerulli, in a release. “But Cerulli finds that home-office portfolios outperform open portfolios managed by advisors.”

“As regulatory risk increases, firms look more closely at fees and pricing schedules, product choice, and advisor discretion. Home offices will require even the most sophisticated advisors to document each action to protect themselves from future inquiries,” the release said.

“Increasing due diligence may be cumbersome and expensive to many advisors. As a result, advisors will gravitate toward offloading this responsibility to their home office or a third-party strategist,” the release added.

“While advisors prefer managed account products such as rep-as-portfolio-manager (RPM) or rep-as-advisor, centrally researched, packaged offerings may be the future. Advisors enjoy the flexibility that RPM allows them, but more sponsors and advisors have started to realize that advisor discretion may not be optimal.”   

Whether advisors would still be able to claim their own “book of business,” in terms of assets under personal management, or evolve into soft-skilled planners, or make as much money, O’Shea couldn’t say. But he agreed that advisors may not be compensated as much for delivering packaged products as for managing risky assets where they can attribute upside performance to their own skills.

Regarding a product like no-commission indexed annuities, first introduced in 2016, O’Shea doubted that advisors could justify charging a full one percent management fee on the assets devoted to those products, which are guaranteed and relatively static. He likened them to bond-ladders, on whose underlying value firms might charge only “25 to 30 basis points.”

Of the managed account providers that Cerulli recently surveyed, 79% said they expected managed account fees to decline, with an expected reduction of about 10%, O’Shea told RIJ. “You’ll see advisory fees coming down. The industry understands that.”

The rise of computer-driven advice is also driving the trend. Digital advice appeared two decades ago with Financial Engines’s algorithms and Monte Carlo simulations for individual retirement plan participants. The arrival of Envestnet and other turnkey asset management programs (TAMPs), which now manage about $250 billion, added momentum. In the last three years, with cheap computing and API plug-ins, robo-advisors have piled in.

“Digital advice is part of this trend, in the sense that it’s a long term trend traceable to the beginning of online trading,” O’Shea told RIJ. “Stockbrokering went away as a value ad. Digital advisors have already shown that creating asset allocation and rebalancing and security selection is analogous to what happened to stock trading in the 1990s. Its not a value add for the advisor. Financial Engines invented this in 1999, so its been going on for a long time.”

Outsourcing of portfolio construction favors unified managed accounts (UMAs), which have grown 23.3% during the past year. Most advisors expect to increase UMA assets by 2018. At present, more than half (55%) of UMA assets are housed at wirehouses and 14.9% at direct firms, Cerulli said.

The third quarter 2017 issue of The Cerulli Edge – U.S. Managed Accounts Edition discusses in-sourcing versus outsourcing, and how age, designations, and channels are contributing factors, and how regulatory changes prompt review of packaged versus open or hybrid portfolios.

© 2017 RIJ Publishing LLC. All rights reserved.