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TIAA Expands into 401(k) Plan Market

Posted on January 20, 2022 by -

For the first time in its 100-year history, TIAA is offering its guaranteed lifetime income solutions to the corporate 401(k) retirement plan market through the “TIAA Secure Income Account.” Until now, TIAA has offered those services mainly through 403(b) plans at non-profits and academia.

“Now, private-sector companies can provide employees with TIAA’s unique, pension-like guaranteed income for life as part of their retirement plan,” according to a release from TIAA president and CEO Thasunda Brown Duckett. 

TIAA was founded as a teacher’s retirement fund in 1918, it was funded largely with grants from Pittsburgh steel magnate, financier, and philanthropist Andrew Carnegie.  

The TIAA Secure Income Account is a deferred fixed annuity that offers a predictable, steady stream of guaranteed income for life in retirement. Plan participants’ contributions are guaranteed to grow over time and are protected from losing value no matter what the market does. The account is fully cashable during employees’ working years and fully portable to another 401(k) plan or rollover RIA,  

Employees can choose—but are not required—to turn some or all of their savings into monthly income paychecks for life when they stop working. They also have the opportunity for more growth and higher amounts of income the earlier and longer they contribute because of the unique way TIAA shares profits with its individual clients. 

Lifetime income payments may also increase once people are in retirement, which can help offset the effects of inflation. In 2022, for example, many currently receiving income from TIAA fixed annuities are enjoying a 5% increase in their lifetime income payments—the largest bump in 40 years.

TIAA’s 2021 Lifetime Income Survey found that more than 70% of workers say they would choose to work for, or stay with, a company that offers access to guaranteed lifetime income in retirement compared to one that doesn’t.

The TIAA Secure Income Account is specifically designed to be a Qualified Default Investment Alternative, which means the account can serve as an allocation in a managed account or target-date fund and that participants can be defaulted into it when they enroll in a plan.

Plan sponsors can automatically direct plan participants to a product with principal protection, guaranteed growth, low volatility and lifetime income with potentially increasing payments. Employees who choose to annuitize will not pay any expenses or commissions. 

Lifetime income solutions turn simple savings accumulation vehicles into true retirement investing and payout plans,” said Colbert Narcisse, TIAA’s Chief Product and Business Development Officer, in the release.  

The TIAA Secure Income Account is available through the defined-contribution investment-only distribution channel overseen by Nuveen, TIAA’s asset manager. It is the first in a series of innovative lifetime income solutions TIAA plans for a variety of retirement savings vehicles, including employer-sponsored and individual IRAs. 

Nuveen, TIAA’s asset manager and a provider of “outcome-focused investment solutions,” will provide investment management expertise. For more information, please visit www.tiaa.org/secure-income

© 2020 RIJ Publishing LLC. All rights reserved.

American Life & Security FIA adds ‘macro regime’ index

Posted on January 20, 2022 by -

American Life & Security, a Nebraska-based, B++ rated fixed indexed annuity (FIA) issuer that got new life in 2018 after asset manager Vespoint LLC bought control of its owner, Midwest Holding, will offer the Goldman Sachs Xenith Index to owners of its FIA contracts, according to a release. 

Vespoint aims to capitalize on the “convergence” of the insurance and asset management businesses, according to a November 2021 investor presentation. “The insurance industry is archaic; Midwest is here to help,” their website said.

Midwest Holding describes itself as a technology-enabled, services-oriented annuity platform. Midwest designs and develops in-demand life and annuity products that are distributed through independent distribution channels, to a large and growing demographic of US retirees. Midwest Holding went public on NASDAQ in December 2020 and has a market capitalization of about $78 million. 

Midwest “originates, manages and transfers these annuities through reinsurance arrangements to asset managers and other third-party investors. Midwest also provides the operational and regulatory infrastructure and expertise to enable asset managers and third-party investors to form, capitalize and manage their own reinsurance capital vehicles,” the Midwest website says.

“We are a unique cross-disciplinary team of insurance, technology and investment professionals building innovative businesses at the intersection of insurance and technology,” according to a release. 

Midwest Holding has assembled the machinery to execute that strategy: a fixed annuity issuer, a reinsurer in a regulatory haven (Seneca Re in Vermont), 1505 Capital, a registered investment advisor, and a cloud-based policy administration system, m.pas, according to its website.

The group’s latest announcement involves its licensing agreement with Goldman Sachs for the Xenith index, which uses macro-regime asset allocation. According to Goldman Sachs’ paper on the index:

The Goldman Sachs Xenith Index is designed to provide exposure to a diversified portfolio that adjusts its exposure between five underlying assets… depending on whether a monthly Growth Signal is signaling a rising economic growth or a decreasing economic growth environment. In a rising growth environment, higher exposure will be allocated to equities and copper than in a decreasing growth environment and, in a decreasing growth environment, higher exposure will be allocated to fixed income and gold than in a rising growth environment. 

Regardless of the growth regime, the basket will always provide a constant exposure to the Commodity Curve Component… the Index is also subject to a volatility control mechanism that adjusts the exposure of the Index to the Underlying Assets in order to achieve a predefined volatility target of 5%, subject to a leverage cap of 125%.

“Instead of relying purely on the S&P 500 Index for exposure to US equities, the index employs an intraday overlay that can reduce equity exposure based on intra-day trading ‘signals.’ As a result, the strategy incorporates real-time market movements, in addition to other factors, in its rules-based methodology,” a Midwest Holding release said.

Depending on the prevailing market regime, the Goldman Sachs Xenith Index also provides commodity exposure by switching between copper and gold based on anticipated economic growth.

Midwest Holding recently announced the closing of a majority ownership sale of a consolidated reinsurance facility to a subsidiary of ORIX Corporation USA (ORIX USA). Under the terms of the agreement, a subsidiary of ORIX USA purchased approximately 70% of Seneca Incorporated Cell, LLC 2020-01 (SRC1), a Midwest consolidated reinsurance cell. 

Midwest established SRC1 in early 2020 as the first reinsurance cell of Seneca Re, a Vermont domiciled captive reinsurance company. SRC1 has reinsured premium from its sister insurance company and Midwest subsidiary, American Life & Security Corp. ORIX Advisers, LLC, another subsidiary of ORIX USA, will be the manager of the assets underlying SRC1’s reinsurance obligations going forward, replacing Midwest’s asset management arm, 1505 Capital LLC.

© 2022 RIJ Publishing LLC.

The coming wealth transfer: $84.4 trillion

Posted on January 20, 2022 by -

Multigenerational wealth transfer is one of the most significant factors affecting the high-net-worth (HNW) and ultra-high-net-worth (UHNW) segment—its impact in the coming decades is set to increase substantially. 

Shifting wealth into next-gen’s hands will reward firms that are able to sustainably establish advisory relationships with younger clients in the years to come, according to Cerulli’s latest report, “U.S. High-Net-Worth and Ultra-High-Net-Worth Markets 2021: Evolving Wealth Demographics.”

Cerulli projects that wealth transferred through 2045 will total $84.4 trillion—$72.6 trillion in assets will be transferred to heirs, while $11.9 trillion will be donated to charities. Greater than $53 trillion will be transferred from households in the Baby Boomer generation, representing 63% of all transfers.

Silent Generation households and older stand to transfer $15.8 trillion, which will primarily take place over the next decade. $35.8 trillion (42%) of the overall total volume of transfers is expected to come from high-net-worth and ultra-high-net-worth households, which together only make up 1.5% of all households.

As a result, firms that can remain on the cutting edge of complex planning and wealth structuring tactics will be invaluable to clients as taxation becomes a more pressing worry. According to the research, grantor trusts (77%) are far and away the most common way to increase the tax-efficiency of wealth transfer events among HNW practices, followed by spousal lifetime access trusts (54%) and strategic gifting (46%).

“As taxes become an increasingly pressing regulatory issue among legislators, wealth managers will need to keep a pulse on the latest developments at the state and federal levels,” said Chayce Horton, an analyst at Cerulli.

As transfers lead to changes in family dynamics as well as engagement preferences, financial services providers across the wealth spectrum must adapt their business models. “Winners of walletshare will need to be prepared for changes to their business model and to evolve with the needs of a younger demographic,” said Horton. According to the research, family meetings and regular communication (81%) is considered the most-effective wealth transfer planning strategy by HNW practices, followed by educational support (59%), and organized succession planning (31%).

To improve relationships across generations, Cerulli recommends making family events a regular part of the advisory process. “Extending interfamily relationships to involve the entire range of stakeholders rather than just the current controllers of that wealth will create a greater sense of responsibility and inclusion among heirs that will help in the likely case that more complex discussions about management of the family’s wealth occur in the future,” said Horton.

© 2022 RIJ Publishing LLC. 

A 5-Year Cushion against Market Risk

Posted on January 20, 2022 by -

Louis S. Harvey, the founder of Dalbar, a kind of J.D. Power for the financial services industry, analyzed stock market history and found that since 1940 US equities have always recovered, even in real terms, within five years of any crash. 

He uses that finding—which might surprise a few people—as the basis for a portfolio asset allocation strategy that he’s now sharing with the world. 

In a recent white paper, Harvey asks, Is an “Arbitrary Asset Allocation” more efficient than a “Prudent Asset Allocation.” By “arbitrary,’ he means setting a ratio of stocks and bonds according to an investor’s current risk tolerance and then rebalancing the portfolio back to the same ratio if the winds of volatility drive it off course. 

By “Prudent Asset Allocation” Harvey means something different. His prudent approach involves two buckets. The first bucket should contain enough safe (“preservative” or “protection”) assets to cover cash needs (in excess of expected income) for the next five years. 

The second bucket, including the rest of the client’s investable money, goes into growth assets. Once a year, the preservative bucket gets replenished with gains, if needed, from the growth bucket. The rolling five-year buffer, like the shadow of an eclipse crossing the landscape, moves one year forward.  

“We said, let’s examine every possible combination in history to find the maximum recovery period for stocks—the longest it ever took for equities to recover their pre-crash value—and it came out to about 4.9 years,” Harvey told RIJ recently. “In the worst case scenario, if you have a diversified portfolio, you are more than likely to recover your losses in five years or less.”

The five-year buffer 

Born in Puerto Barrios, Guatemala in 1942, Harvey emigrated to the US with a degree in physics from the University of the West Indies. He started Marlborough, MA-based Dalbar in 1976. Dalbar surveys financial services providers, establishes benchmarks for quality, publishes syndicated research and gives out awards. Harvey based the “Prudent Asset Allocation” technique on his own experience as an investor.  

Here’s how it works:

  • Set up a bucket of safe assets equal to the difference between expected income (salary, Social Security, pension benefits, systematic withdrawals from a 401(k) plan) and spending needs over the next five years. 
  • Safe assets include principal-guaranteed products, guaranteed income investments, FDIC-covered savings, US Treasuries, money market mutual funds, other cash equivalent securities.
  • When market conditions are favorable (anytime but right after a decline, before a full recovery), growth assets (individual securities, are sold to replenish the protection bucket. 
  • If there is a buildup of Preservative assets from rising income or windfalls (or appreciation of the Preservative assets net of spending), the excess goes into the Growth class.
  • The process is applied during an annual reevaluation. The procedure is intended to continuously deplete the Preservative assets at a rate that is slower than the growth of the Growth class.
  • Revisit the strategy when there’s a major change in circumstance, such as an inheritance, retirement, job change, birth or divorce.

“The procedure is intended to continuously deplete the Preservative assets at a rate that is slower than the growth of the growth class,” Harvey writes. “When market conditions are favorable, Growth assets are used to replenish the Preservative class,” the white paper said. “Favorable conditions are considered to be any time except immediately following a decline, before a full recovery is achieved.”

Stocks have always rebounded

Louis S. Harvey

The Prudent method is grounded in Harvey’s finding that stocks have crashed less often and their prices have bounced back faster than a lot of loss-leery investors tend to assume or imagine. According to his back-testing exercises, the S&P 500 Index fell 10% or more in only eight calendar years since 1940 (see chart below) and took no more than five years to recover the loss.

Ipso facto, an investor should be able to maximize returns and keep anxiety far away—a sustainable armistice between greed and fear—by hoarding enough cash to avoid a forced sale of depressed assets for up to five years and stretching for growth with the rest. 

Before you run to your spreadsheets to prove that this two-bucket approach is an illusion (because a balanced fund performs the same as two one-asset funds), or purely behavioral (i.e., prevents panic-selling) or impossible to prove (because no two plans will ever perform identically), or rife with market-timing issues, remember that Harvey isn’t claiming that the Prudent method optimizes a portfolio. He’s saying that it outperforms the popular Arbitrary method and relieves stress.   

Back-testing the Prudent allocation method vs the Arbitrary allocation method over the score of years from 2001 to 2020, Harvey found that his strategy beat an arbitrary portfolio of 60% stocks (S&P 500 Index) and 40% bonds (10-Year Treasuries) and found: 

  • In 13 (65%) of the 20 years, total return for a one-year time horizon was superior for the Prudent Asset Allocation
  • In 12 (60%) of the 20 years, total return for a ten-year time horizon was superior for PAA
  • For the years 2010 to 2020, PAA outperformed AAA in one-year returns (23.78% to 15.58%) 
  • For the years PAA outperformed AAA in ten year returns (98.62% to 60.94%) 
  • Where the Arbitrary method outperformed, the Prudent method allowed the investor to wait (up to five years) for a market recovery instead of selling in a down market

“The arbitrary method is not focused on what’s changing in the market place, or in the investor’s personal circumstances,” Harvey said. Instead, “We suggest that you have an annual schedule unless there’s an extraordinary event—such as the market going berserk. If it’s significant, go back and revisit your asset allocation.”

Good for decumulation or accumulation

Harvey’s approach is intended to work for people of all ages, in either the “accumulation stage” before retirement or the decumulation stage” after retirement. “People at older ages, who no longer have an earned income, can substitute their Social Security income for earned income and perform exactly the same calculation. It is most applicable in the decumulation stage, but also in the appreciation stage,” he said. 

“When you look at society, you can see that so many people are in both stages. You can’t reasonably draw a line between the two. So many people are working and receiving retirement income at the same time. The same principle applies, regardless of how old you are, even if the numbers change.” [I assume that Harvey would recommend dealing separately with tax-favored accounts and not incorporating them into the Prudent method until after retirement.]
“If you have millions of dollars, you might need to hold only two or three percent of your net worth to cover the next five years. The method is also totally fluid; it’s just a function of your net cash needs,” he added. In other words, the more total savings you have, relative to your need for excess cash each year, the easier it is to run this strategy, and vice-versa.

The Prudent method accommodates almost any selection of growth assets. “It doesn’t have to be stocks,” Harvey said. “If you feel comfortable with alternative assets or options, go ahead and use them. You can make that determination yourself. The amount of risk you take will depend on your personal preference or gut and skill. Using risk ‘appetite’ to determine asset allocation, without segmentation, without consideration of income needs, is a cruel waste.”

Harvey acknowledges, without apology to the bucketing-skeptics, that the Prudent method is a kind of bucketing or time-segmentation. “It’s 100% supportive of time segmentation. One of our goals was to make it real simple. Using expressions like ‘bucketing’ or ‘time-segmentation’ can make it sound complicated. But any advisor and many individuals can implement it without rocket science.”

In calling for a rolling five-year window of safety, however, the Prudent method differs from retirement bucketing strategies that consist of, for example, four five-year buckets from age 65 to 85. In that strategy, each bucket’s assets grow for five, 10, or 15 years before they’re sold and the proceeds swept into the active spending bucket. The Prudent strategy calls for a rolling five-year buffer of safe assets. 

“The bottom line of Prudent asset allocation is to have the confidence of knowing that over the next five years, you don’t have to worry about market conditions,” Harvey told RIJ. “It changes the character of your approach to risk, and it generally means that you can put more money into growth assets.”

© 2022 RIJ Publishing LLC. All rights reserved.

LGIM America launches ‘Retirement Income Fund’ and four other funds for DC plans

Posted on January 14, 2022 by -

LGIM America (Legal & General Investment Management America), a registered investment adviser (RIA) specializing in designing and managing investment solutions across active fixed income, index, multi-asset and liability driven investment in the US market, today announced the launch of five new mutual funds. 

The funds are designed for distribution through the defined contribution plan market in the US. LGIM America’s flagship fund, Legal & General Retirement Income 2040 Fund, focuses on “retirement income and investment solutions that help retirees make the right spending decisions throughout their retirement journey,” the company said in a release today.

Details of the five funds, which are offered only to institutional investors, include:

The Legal & General Retirement Income 2040 Fund is composed of the four funds listed below. Its goal is to provide current income during the early and middle-years of retirement while ensuring capital is not exhausted prior to the fund’s terminal date.

The Legal & General Global Developed Equity Index Fund seeks to provide investment results that, before fees and expenses, track the performance of the MSCI World Index.

The Legal & General Cash Flow Matched Bond Fund seeks current income through the management of investment grade credit with a final maturity between zero and five years. The Fund does not have a specific target for its average duration. The Fund’s portfolio is laddered by investing in fixed income securities with different final maturities so that some securities age out of the zero- to five-year maturity range during each year.

The Legal & General Long Duration US Credit Fund aims to maximize total return through capital appreciation and current income. It primarily invests in investment-grade fixed income securities with an average portfolio duration that is within 10% of the Fund’s benchmark, the Bloomberg Long Duration US Credit Index.

The Legal & General US Credit Fund looks to maximize total return through capital appreciation and current income. It primarily invests in investment-grade fixed income securities with an average portfolio duration that is within 10% of the Fund’s benchmark, the Bloomberg Capital US Credit Index.

“These Funds are part of a larger retirement income solution initiative and complete our retirement income strategy, which is designed to bring investors through the early- to middle-years of retirement. Within the first several months of 2022, we anticipate completing a long-life strategy, which is the longevity piece of our solution and designed to support individuals into their later years of retirement,” the release said. 

© 2022 RIJ Publishing LLC. All rights reserved.

Breaking News

Posted on January 14, 2022 by -

DPL and Security Benefit add ‘total return’ index option to FIA

DPL Financial Partners, the insurance purchasing platform for Registered Investment Advisors, has partnered with Avantis Investors and Security Benefit Life on the design of a new, no-commission, fixed indexed annuity contract availability only to DPL customers. 

The contract, Security Benefit Life’s ClearLine fixed indexed, will feature the Avantis Barclays Volatility Control Index, created by Eduardo Repetto and Pat Keating of Avantis Investors.

A total return index, its performance of the Avantis Barclays Volatility Control Index includes the dividend yield of the underlying companies.

(Many indexed annuities now offer bets on price return indices that don’t include dividends. Since options on those indices tend to be cheaper than options on total return indices, issuers can set afford to higher caps on their performance. Whether a higher cap on a price-return index will beat a lower cap on the total-return version of the same index, it’s impossible to predict.) 

In a release, Avantis Chief Investment Officer Eduardo Repetto said, “FIAs can complement an existing allocation of equity and fixed income. FIAs offer risk mitigation, like fixed income, while diversifying the driver of returns away from bond yields. I think this structure can help advisors improve their clients’ portfolios, in particular during these times of extremely low bond yields.”

Security Benefit’s ClearLine Annuity, designed by DPL with Security Benefit, also offers a lifetime income rider with a 2% annual increase on income.  

Americans expect market volatility in 2022: Allianz Life

The average American worries a lot: about COVID mutations, potential blitzkrieg in eastern Ukraine, and the rising prices of gas and groceries. That’s in addition to the baseline “It’s-always-something” problems that they wake up to each morning.    

In the financial realm, more than 75% of Americans believe the markets will be “very volatile” in 2022, according to the 2021 Q4 Quarterly Market Perceptions Study from Allianz Life. Two out of three American fear that a COVID-driven recession ad almost three-fourths fear worry about an imminent loss of purchasing power. 

Another 64% of those surveyed say their income isn’t rising as fast as their expenses. The same percentage worry about tax increases. In Allianz Life’s other findings:

  • 57% say risks from market volatility will have a major impact on their plans to retire in the next few years
  • 61% say they are worried their current financial strategy won’t provide the lifestyle they’d like to have in retirement.
  • One-third say that putting some money into a financial product that provides a guaranteed stream of income in retirement is the most important step in having a secure retirement
  • 39% of Gen Xers expressed the most interest in a product that offers guaranteed income, compared with 33% of Millennials and 30% of boomers 
  • 66% of Americans believe it’s important to own a financial product that protects their retirement savings from market loss

Allianz Life conducted an online survey, the 2021 Q4 Allianz Life Quarterly Market Perceptions Study, in December 2021 with a nationally representative sample of 1,004 respondents age 18+.

Lincoln redesigns participant-facing website

Lincoln Financial Group has elevated a new retirement plan participant website, featuring “intuitive navigation” and “innovative tools to help participants plan for and achieve income in retirement,” according to a Lincoln release this week.

The new mobile-adaptive design provides “a simple and secure digital experience” including “a clear picture of where they are on their paths to retirement” and making it easy to “increase contributions.”

“Through our newly redesigned site, participants can access personally relevant information and streamlined plan transactions — all designed to drive positive outcomes,” said Sharon Scanlon, senior vice president of Customer Experience, Producer Solutions and Retirement Plan Services Operations at Lincoln Financial Group. 

“Through research, user analytics and usability testing, this new digital experience is designed to help meet the evolving needs, wants and expectations of plan participants, and help them save for and work toward the retirement they envision.”

The pandemic has inspired almost 80% of US workers to reevaluate their finances, career and retirement, according to Lincoln Financial Group’s 2021 Retirement Power study. Lincoln’s new participant site features include:

“My Target” tool: This personalized digital calculator helps participants estimate their retirement income and determine if they are on track for retirement.

Investments: New, easy-to-understand investment graphs help participants understand where their money is allocated and how their account has grown over time.

My Next Steps: This feature shows participants how to improve retirement readiness.  

Mobile-Enabled Navigation: Participants can now manage their account anytime, anywhere with a mobile adaptive design, while ongoing investments in cybersecurity help keep plan and participant information secure.

The new platform also features a content hub with videos, articles and tools to educate participants, as well as single sign-on access to Lincoln WellnessPATH, an online financial wellness solution. 

(c) 2022 RIJ Publishing LLC. All rights reserved.

MassMutual flies into the ‘Bermuda Triangle’

Posted on January 14, 2022 by -

MassMutual is now active in what RIJ calls the “Bermuda Triangle” business. There’s no reason why a strategy that’s been productive for publicly traded life insurers can’t work for a big mutual company. And, since buying Great American, MassMutual sells fixed indexed annuities—a key input of the triangle play.

This week, the 160-year-old giant mutual insurer helped launch Martello Re Limited, a licensed Class E Bermuda-based life and annuity reinsurance company. A consortium of MassMutual, Centerbridge Partners, Brown Brothers Harriman, and Hudson Structured Capital Management Ltd. capitalized Martello Re with equity of $1.65 billion. 

Centerbridge, an alternative asset manager, and Barings—MassMutual’s own $300 billion investment arm—will act as asset managers for Martello Re, “providing access to extensive public and private asset origination and underwriting capabilities across all asset classes.”

Roger Crandall, chairman, president and CEO of Massachusetts Mutual Life Insurance Co.

MassMutual, based in Springfield, MA, and its subsidiaries will initially reinsure approximately $14 billion of general account liabilities with Martello Re and also enter into a flow arrangement to reinsure new business. Both transactions are expected to close in February 2022 and have received regulatory approval.

By reinsuring those liabilities in Bermuda, MassMutual will likely see a big drop in its required surplus, which means it will suddenly have perhaps hundreds of millions of dollars freed-up for new uses. Many publicly traded life insurers are spending their “released capital” on share buybacks. It’s not clear what a mutual insurer, which has policyholders rather than shareholders, might do with such a windfall. 

Martello Re “will initially focus on providing MassMutual and its subsidiaries with reinsurance capacity on current product offerings, after which it will offer its services selectively to other top insurers in the life and annuity space,” according to a release.

All three corners of the Bermuda Triangle strategy are here: A life insurer that gathers lots of fixed-rate and fixed indexed annuity premiums each year; a well-capitalized reinsurer in a jurisdiction with a GAAP accounting regime; and an alternative asset manager that originates customized private credit instruments. 

In the first half of 2021, MassMutual sold $1.7 billion worth of fixed-rate annuities, $618 million worth of fixed indexed annuities (FIAs) and $553 million of payout annuities (immediate income annuities, deferred income annuities, and structured settlements) in the US, according to LIMRA. In May 2021, MassMutual paid $3.5 billion for Great American, a well-established FIA builder. In the first half of 2021, MassMutual and Great American combined for $1.85 billion in sales of FIAs—enough to rank fifth in FIA sales overall.

In the strategy, the life insurer sells annuities, then reinsures the liabilities (releasing priceless surplus capital as a result) and sends the money to the alternative asset manager for deployment. The asset manager lends that money to credit-starved businesses (currently underserved by banks), using its financial engineering skills to turn those loans into sophisticated assets with a variety of risk/return profiles. 

Some of those assets—collateralized loan obligations, senior tranches of mortgage backed securities—are held by the original life/annuity company. But the asset managers are also feeding an enormous global demand from endowments, family offices, corporations and other insurance companies who can no longer get the yield they need by buying plain-vanilla corporate bonds in the public markets. 

What’s confusing is that life insurers appear in different roles at different times in this drama—sometimes as the targets of acquisition, as clients of alt-asset managers, often as purchasers of exotic risk-managed products, and sometimes as part of a holding company that brings the whole business under one roof—thus enjoying all sorts of synergies, efficiencies and, sometimes, conflicts of interest. 

Martello Re will be led by CEO Dennis Ho, a 22-year industry veteran and life actuary who most recently founded Saturday Insurance, an online insurtech platform. Prior to founding Saturday, Ho held a range of other leadership roles including CEO for Longitude Re, Managing Director at BlackRock Solutions, and Head of US Life Insurance Solutions at Deutsche Bank.

Martello Re will be overseen by a Board of Directors made up of investors and Martello Re’s CEO. The initial members of the Martello Re Board of Directors will include Chairwoman Ellen Conlin from MassMutual and Michael Baumstein of Barings, Matthew Kabaker and Eric Hoffman from Centerbridge, Jeff Meskin and Taylor Bodman from Brown Brothers Harriman, and Mr. Ho.

Following MassMutual’s announcement, AM Best commented, “The credit ratings of Massachusetts Mutual Life Insurance Company and its life/health subsidiaries, remain unchanged following the Jan. 12, 2022, announcement that it has launched a licensed Class E Bermuda-based life/annuity reinsurance company, Martello Re Limited (Martello Re).”

© 2022 RIJ Publishing LLC. All rights reserved.

‘Smart,’ from UK, Enters the US PEP Market

Posted on January 14, 2022 by -

During a Zoom conference last fall on the future of defined contribution (DC) plans, I used the “Chat” function to chat up another attendee. Sidebar conversations during webinars are wrong, apparently—like passing notes in class. I might have lost my seat at the conference because of it. 

But I wanted to make contact with that other attendee, Catherine Reilly. She’s the director of Retirement Solutions at Smart, the recently established US branch of a substantial defined contribution retirement plan recordkeeper in Britain called Smart Pension. 

In the UK, Smart runs a $2.7 billion, 80,000-employer “master trust.” That’s the British version of Pooled Employer Plans (PEP), the multiple-employer plan design enabled by the SECURE Act of 2019. In the US since October 2020, Smart’s “recordkeeping solutions and retirement income solutions are purpose-built for PEPs,” according to its website.

With US headquarters in Nashville, Smart is moving fast. With capital from JP Morgan, Barclays, Natixis, Chrysalis, and Legal & General Group plc, Smart has just bought Stadion Money Management, a managed account provider, and is partnering with Finhabits, a provider of bilingual (Spanish/English), smartphone-mediated financial services.

For RIJ, Smart is interesting because it aims to reduce the often clunky process of accessing 401(k) savings in retirement to a few thumb strokes on a smartphone or key strokes on a laptop, while also helping retirees bucket their savings into short-term, medium-term and long-term money. 

Historically, US recordkeepers have performed this critical function reluctantly, inefficiently or not at all. But without it, they’re just giving retired participants a reason to roll their money over to an (expensive) brokerage IRA. “The retirement income feature keeps people in the plan,” Smart’s US CEO Jodan Ledford told RIJ in an interview. “This optimizes their ability to preserve their base.”

The ‘grout in the mosaic’

Jodan Ledford, CEO of Smart USA

Ledford is responsible for growing Smart in the US. He already has a track record here. In his last job, he grew Legal & General’s US asset management business seven-fold, to $210 billion. Despite his British-sounding name, he’s an American. He tends to describe Smart’s services in metaphors.

“I like to use the term, mosaic,” he said in the interview. “In a pooled employer plan, for instance, the investment manager, the recordkeeper, and the plan administrator would be the pieces of the mosaic, and we could be the ‘grout.’ Or we could be the pooled plan provider that selects the other pieces. 

“We will likely partner with recordkeepers to offer PEPs. Or we could be the 3(16) TPA (the third-party administrator, with fiduciary responsibilities). What we don’t provide is the 3(38) role (the asset manager with fiduciary responsibility for managing the investments in the plan).

“Say, for instance, that we approach a large registered investment advisor (RIA) or broker-dealer with financial advisers who serve small business plans. We say, ‘You can be the 3(38) fiduciary and select the funds.’  The RIA tells its advisers, ‘Here’s a new pooled employer plan. We have a system that lets you sign up the small business clients in less than hour.’ It lets the RIA or the broker-dealer do more business with small plans,” Ledford said. 

“We could also partner with a recordkeeper, or with a large pension risk transfer company,” he added. “They could say to their corporate client, ‘If you liked our annuity for your defined benefit plan, why not use this retirement income system for your defined contribution plan?’”

Smart sees existing asset managers and recordkeepers held back by older technology systems that hinder them from providing what people now take for granted: fast, easy onboarding of new clients; personalized solutions; and scheduling of customized money transfers from any plan account to any bank. 

The SECURE Act made it legally easier to aggregate many small plans into a single large plan (a PEP) that a large asset manager or recordkeeper could, in theory, administer for much lower expenses than individual small firms currently pay.  But those large service providers don’t necessarily have the integration tools (e.g., the Application Programming Interface or API software) necessary to fill in the communication gaps between lots of unrelated clients and partners—like participants’ banks. Smart (and its competitors) aim to furnish some of those tools. 

No annuity feature—yet

These tools will allow Smart to help retirees take systematic withdrawals from their 401(k) plans. Reilly, the Smart executive in charge of Retirement Solutions, told RIJ that Smart’s “decumulation platform” will give retirees “the flexible access of an IRA” while their money stays in the 401(k) plan.

Catherine Reilly, director of Retirement Solutions, Smart USA

“It’s a guided journey into retirement,” said Reilly, whose varied career has included stints as a McKinsey consultant in Helsinki, overseeing State Street Global Advisors’ $70 billion target date fund suite, and senior fellow at the Defined Contribution Institutional Investment Association. “You can set up a paycheck or move money around. It might be most closely related to a managed account.” [Under US labor law, managed accounts, along with target date funds, are Qualified Default Investment Alternatives into which the payroll deferrals of new, auto-enrolled participants can be automatically deposited.] 

Smart uses a time-segmentation or bucketing approach, dividing income distribution into four periods:

  • A flexible spending account providing systematic withdrawals between age 65 and age 80
  • A rainy day fund for emergencies at any age
  • A “later-in-life” reserve fund for spending after age 80
  • A legacy fund, if needed, to provide bequests to children, charities, etc.

The current product doesn’t incorporate the option to purchase an annuity, but it may eventually allow for the purchase of a deferred income annuity (DIA) for guaranteed income in old age. Legal & General sells immediate annuities in the UK, but according to Reilly, won’t be marketing annuities through Smart. Instead, the Smart platform calculates a “sustainable income” for every year of retirement up to age 80. 

“Monthly payments can be set up, and you can always change them or make flexible withdrawals,” Reilly said. The system suggests an asset allocation, but the payments, once set, won’t automatically adjust or rebalance in response to market volatility.  

“In the US, the recordkeeping industry has struggled to issue paychecks. Sometimes the recordkeeper is the problem. Sometimes plans just weren’t designed for retirement income payments,” Ledford told RIJ.  

Replicating UK success

How does Smart get paid? “If we provide recordkeeping services, it can be basis points, flat dollar, or mix of both. Flat dollar is popular now,” Ledford said. “In the PEP-only model, we’d charge basis points. Either way, we’re trying to provide the service at a cost point that’s not a barrier to entry. In the small market today, according to the benchmarking we see, a small plan pays about 260 basis points (2.6%) a year in fees. We want the cost to be under 100 bps (1.0%) all-in.”

In the US, Smart hopes to repeat its successes serving retirement plans in the UK, Ireland, and Dubai. In the UK, it’s a major provider of a defined contribution “master trust”—the UK equivalent of a pooled employer plan in the US—serving more than 80,000 employers in Britain and 900,000 participants whose plans have £2 billion ($2.74 billion) under management.

Smart’s recent acquisition of Stadion adds a ready-made chunk of US business. Stadion provides personalized managed account services to some 4,000 retirement plans with $2.3 billion in the US. Stadion serves as the fiduciary that chooses the funds and designs the glide paths for the managed accounts. 

Smart’s partnership with Finhabits will give it access to the Latinx community in the US, where there are an estimated 4.65 million Hispanic-owned small businesses, many of them lacking retirement savings plans.

What obstacles might Smart face in the US? So far, it seems to bill itself as a retirement jack-of-all-trades, refusing “no job, big or small.” That’s a key that could unlock a lot of doors. One potential speed bump: Prospective clients in the US might wonder if they have to hire at least some of Smart’s partners—like JP Morgan, Stadion and Legal & General—in a bundled solution. But Reilly said, “By buying Smart you’re not committing to any of our partners.” 

Another possible hitch: Smart could be misgauging the way retired Americans tend to use their 401(k) money. In fact, many of them tend not to start taking money out of their retirement plans until the government forces them to at age 72. Distributions are taxable, and so not to be taken lightly. Investment advisers often tell clients to spend tax-deferred money last.

In the managed account market, it will certainly face competition from providers like Morningstar and Edelman Financial Engines. But the managed account market is big. According to Cerulli Associates, “The top nine DC managed account providers comprised more than $400 billon in DC assets and the vast majority of DC recordkeepers now partner with at least one managed account provider.” Smart may end-run that traffic by specializing in helping big asset managers and recordkeepers address the burgeoning PEP market—the kind of market Smart appears to have mastered in the UK.   

© 2022 RIJ Publishing LLC. All rights reserved.

Why Asset Managers Keep Buying Annuity Issuers

Posted on January 13, 2022 by -

An article in yesterday’s Wall Street Journal helps explain why so many alternative (alt-) asset managers have been acquiring or establishing life insurers, reinsurers, and/or blocks of fixed annuities.

WSJ explains that big institutions, desperate for higher yield than they can get from bonds in the public markets, are bringing boatloads of cash to asset managers and asking for the custom private credit instruments–insurance-linked securities, leveraged loans, mortgage-backed securities, collateralized loan obligations–that those asset managers create.

These instruments often involve bespoke loans to below investment-grade borrowers; the asset managers use securitization and long maturities to immunize credit risk with an ‘illiquidity premium’ and ‘tranches’ of varied risk.

“Funds that make such loans now control about $1.2 trillion, nearly twice the capital they had five years ago,” the WSJ said. “‘We think this market dwarfs the alternatives market,’ Apollo CEO Marc Rowan said in the story, which added, “The figure could be as great as $40 trillion, he said. Apollo manages about $340 billion of credit investments, much of them private.”

One source of money that asset managers use to write these high-return loans are the proceeds of the sales of fixed annuities by life insurers to risk-averse American retirees and near-retirees. Apollo, through its parent, Athene Holding, was one of the first, if not the first, to see annuity assets (which many life insurers have been eager to unload due to stress from low interest rates on bonds) as raw material for risky loans.

We now have major asset managers like Apollo, Blackstone, and KKR owning or affiliated with large issuers of fixed annuities, including Athene, F&G, and Global Atlantic, respectively. They enhance margins by reinsuring the annuity liabilities in jurisdiction with easier capital requirements, like the Bahamas, Arizona or Vermont. They claim to be doing a good deed by infusing more capital into the annuity business; perhaps in the short run they are.

I have written about this phenomenon from the annuity end, calling it the ‘Bermuda Triangle strategy.’ The WSJ article explains it from the institutional investor end. When I talk to practitioners of this strategy, they claim to be solving the low-yield problem for clients in good faith. What is concerning are not so much the practices of pioneers of this business.

More concerning are the ‘me-too’ players–smaller johnny-come-lately asset managers who want some of those billions flowing from desperate institutional investors. They are hastily buying tiny life insurers, setting up offshore reinsurers, and reducing the transparency of their assets. I’m not the only one concerned; so is Moody’s. The NAIC is paying some attention to this, but not enough.

Less of this might be happening, IMHO, if much of the annuity industry had not already morphed into a quasi-investment industry. But that’s a longer story.

Research Roundup

Posted on January 6, 2022 by -

The field of retirement finance can sometimes seem hyper-specialized and remote from everyday life. But almost every major popular issue in the US contains at least an element or theme related to retirement policy. 

Today’s edition of Research Roundup is evidence of that. Overlaps between retirement and “machine learning,” human decision-making, monetary policy, and immigration are central to the five academic papers we feature this month. 

Here are questions and issues that these papers answer or address:

  • How machine learning could lead to smarter target date funds 
  • One way the rich get richer: they buy stocks. But why?
  • Putting the ‘Fed put’ in perspective
  • French lessons: How plan participants in France make investment decisions
  • Immigrants can help Americans grow old at home
How machine learning could lead to smarter target date funds

Machine learning (ML, aka artificial intelligence) involves chips and software that imitate human decision-making, only faster and at greater scale. The possible applications of ML in financial services are endless—but still largely unrealized. 

A research team at two big universities has been exploring the use of ML technology to help investors build better portfolios, both during their careers and during retirement. ML could lead to mass-customization of portfolios, they believe, and to smarter target date funds (TDFs).

Jonathan Parker

The team, including Jonathan A. Parker and Aaron Goodman of MIT,  along with Victor Duarte and Julia Fonseca of the University of Illinois at Urbana-Champaign, published its findings in a new paper, “Simple Allocation Rules and Optimal Portfolio Choice over the Lifecycle” (NBER Working Paper w29559).

The paper concludes that current TDF design leaves investors under-weighted in equities during retirement. A typical TDF in today’s market might call for an equity allocation of 50% or less at age 65 and after (and some people believe TDFs should hold zero equities at retirement). The authors’ ML analysis recommends 60% equities would provide more disposable spending in retirement. “The average optimal share in equity declines linearly to about 60% at retirement, after which it is roughly constant,” they write. 

“We think TDFs do well in the first half of life, but are too conservative in the second half of life,” Parker told RIJ recently. According to the paper, “While TDFs may lead households to avoid worse mistakes, because they impose the same portfolio on everyone of the same age, there is scope for substantial improvement—2% to 3% of consumption—from more individualized financial advice or from more customized TDFs.”   

The heart of the paper, however, is its exploration of ML’s applicability to fund design, financial advice, and robo-advisor platforms. The authors see ML enabling a mass-customization process where ML-driven software might annually tweak the asset allocations of smart TDFs in response to changes in client-specific variables, such as “non-traded labor income risk, home ownership and mortgages, health and mortality risks, pension income, family dynamics, liquidity needs, and taxes.”

“We’re building a ‘Game of Life,’ and asking an algorithm to play it,” Parker said. “It would be simple to encode this into a robo-advisor, with the goal of maximizing the average return and minimizing the variants.” Instead of a software “recipe” for successful investing, the investor gets a “trained apprentice” who thinks like a human advisor (more or less).

“You could develop a TDF that doesn’t condition on age, but instead on the state of the market,” Parker told RIJ. “This methodology, could be embedded in advisors’ desktops or online for people to play with.”  

Parker stressed that the equity allocation of a retirement portfolio would be higher than for non-retirement accounts, because of differences in investment horizons. An appropriate equity allocation for young adults saving in taxable accounts for down payments on homes might be as low as 30%, but as high as 90% in a tax-deferred retirement savings account.

One way the rich get richer: they buy stocks. But why?

Reviewing data from some 70,000 401(k) plans for the 2009 to 2019 decade, a team of researchers at Harvard recently tried to find correlations between the average equity allocations in plans and the demographics of the plans. 

Mark L. Egan and Alexander MacKay of Harvard Business School and Hanbin Yang from Harvard University published their findings in a December 2021 paper, “What Drives Variation in Investor Portfolios? Evidence from Retirement Plans” (NBER Working Paper 29604).

The team found that average equity allocations were higher in plans with relatively more wealthy and college-educated participants, and lower in plans with relatively more older and minority participants.

These differences were associated with different levels of risk aversion and different beliefs about the financial market. “Wealthier and more educated investors tend to have more optimistic expectations about the market,” the paper said. “Older investors, retirees, and minorities tend to have more pessimistic expectations about market returns.” Variation in beliefs and risk aversion explain 52% of the variation in equity exposure, the investigators concluded.

The differences in these attitudes varied by industry. “Investors who work in riskier sectors, as measured by the equity beta of their sector, tend to have more optimistic beliefs,” the paper said. 

“Investors from the most optimistic sector, Real Estate, expect the market return to be 40% higher than investors from the least optimistic sector, Accommodation and Food Services.” Investor beliefs also appeared to depend on past market returns, and on the recent financial performance by their employers. They became “more optimistic about the stock market following strong financial performance from their employer.”

Optimism and low risk-aversion didn’t always go together. “Investors in the Information Sector have the highest equity allocations but are only in the 60th percentile in terms of investor expectations of market returns,” the paper said. The authors found no significant correlation between a plan’s demographics and the number of equity funds the plan offers.

Perhaps reflecting the so-called wisdom of crowds, the investment returns expected by the plan participants proved highly accurate. “The average expected return over our sample is 11.50%,” the authors noted. “The compound annual growth rate (CAGR) of the S&P 500 over the period 2009-2019 was 11.22%.” 

Putting the ‘Fed put’ in perspective

Do low interest rates help or hurt the economy? 

As the Federal Reserve contemplates a modest tightening in 2022—by tapering its bond purchases and raising interest rates perhaps three times—observers wonder if such inflation-fighting moves might trigger a stock market correction or a credit crisis. It has happened before.

In a new NBER paper, four European economists review past financial crises and ask: Should a central bank deviate from its objective of price stability to promote financial stability? The short answer is: Yes and no. 

“The effect of monetary policy on financial stability is ambivalent,” write Frederic Boissay of the Bank of International Settlements, Fabrice Collard, of the Toulouse School of Economics, Jordi Gali, of Spain’s Centre de Recerca en Economia Internacional, and Cristina Manea of the Deutsche Bundesbank.

“On the one hand, loose monetary policy can help stave off financial crises. In response to the Covid–19 shock, for example, central banks swiftly lowered interest rates and acted as a backstop to the financial sector. These moves likely prevented a financial collapse that would otherwise have exacerbated the damage to the economy,” they write.

“[But] discretionary monetary policy actions, such as keeping policy rates too low for too long and then unexpectedly and abruptly raising them toward the end of an investment boom, can lead to a financial crisis.
“The financial sector is paradoxically more fragile when the central bank commits itself to backstopping the economy.” Why? Because such backstopping “eliminates the negative wealth effects associated with financial crises, raises the capital stock, which makes the credit market more vulnerable, and slows down the downward adjustment of capital that would be necessary to eliminate the existing imbalances,” the paper said.

“On the other hand, empirical evidence shows that, by keeping their policy rates too low for too long, central banks may entice the financial sector to search for yield and feed macro-financial imbalances.”

French lessons: How plan participants in France make investment decisions

A new study from researchers in the US and Brussels yields the behavioral-finance insight that participants are more likely to opt out of a plan when confronted with decisions they don’t like.

That was one of the findings in “Choice Overload? Participation and Asset Allocation in French Employer-Sponsored Savings Plans.” NBER Working Paper 29601), by James Poterba (MIT economist and president of the National Bureau of Economic Research) and two Belgian economists.

“French employers have wide discretion in structuring employee saving plans. All plans must offer medium-term investments, which cannot be accessed for five years. Employers may also offer long-term investments that cannot be accessed until retirement,” the paper said. 

“When plans include a long-term option, participation is lower than when the plan offers only more liquid medium-term investments. The presence of a long-term saving option also reduces the take-up of the plan’s default investment allocation, which must include a long-term component,” it continued. 

“One interpretation of the findings, consistent with the theory of choice overload, is that some employees are unwilling to forego the liquidity of the medium-term option but find it costly to make an active election when they opt out of the default, and therefore choose not to participate in the plan at all.”

The authors noted that, because French workers still get most of their retirement income from the national pay-as-you-go pension (similar to Social Security but more generous), they rely relatively less on their defined contribution plan savings (though most participate). “French firms have more discretion in setting match rates than their US counterparts,” the paper said, “in part because the stakes are lower and most retirement income is provided through a public pay-as-you-go pension system.”  

Immigrants can help Americans grow old at home  

In areas where more low-education immigrants have entered the US workforce, the chance that US-born elderly will be able to live in their own homes goes up, according to new research from Kristin F. Butcher of Wellesley College, Tara Watson of Williams College, and Kelsey Moran of MIT. 

In the NBER working paper 29520, “Immigrant Labor and the Institutionalization of the US-Born Elderly,” the three academics report that immigration provides “an abundance of less‐educated labor that can substitute for the elderly individual’s (or their family’s) labor…, potentially shifting the choice of technology for elderly care‐giving away from institutions. Immigration affects the availability and cost of home services, including those provided by home health aides, gardeners and housekeepers, and other less-educated workers, reducing the cost of aging in the community.”

More specifically, “a 10 percentage point increase in the less-educated foreign-born labor force share in a local area reduces institutionalization among the elderly by 1.5 and 3.8 percentage points for those aged 65+ and 80+, a 26-29% effect relative to the mean,” they write.

“The estimates imply that a typical U.S-born individual over age 65 in the year 2000 was 0.5 percentage points (10%) less likely to be living in an institution than would have been the case if immigration had remained at 1980 levels.” But benefits for the elderly come at the expense of lower pay for certain workers.

“Commuting zones with high predicted levels of immigration have lower wages among the less‐educated workforce and increased employment of health and nursing aides. We see similar impacts for other less‐educated occupations that may support home‐based care, such as housekeepers and gardeners,” the paper said.

“Home health aides are especially likely to see positive employment effects, and nursing home aides also experience effects depending on the specific measure. Licensed practical nurses have wage reductions but do not have employment increases, suggesting a reduction in labor demand. Registered nurses command higher wages and have, if anything, lower employment levels when immigration is higher.”

© 2022 RIJ Publishing LLC. All rights reserved.

 

Are Concerns over Growing Federal Government Debt Misplaced?

Posted on January 4, 2022 by -

If the global financial crisis (GFC) of the mid-to-late 2000s and the COVID crisis of the past couple of years have taught us anything, it is that Uncle Sam cannot run out of money. During the GFC, the Federal Reserve lent and spent over $29 trillion to bail out the world’s financial system, and then trillions more in various rounds of “unconventional” monetary policy known as quantitative easing. 

During the COVID crisis, the Treasury has (so far) cut checks totaling approximately $5 trillion, often dubbed stimulus. Since the Fed is the Treasury’s bank, all of these payments ran through it—with the Fed clearing the checks by crediting private bank reserves. (To see the original version of this article, go to levyinstitute.org.)

As former Chairman Ben Bernanke explained to Congress, the Fed uses computers and keystrokes that are limited only by Congress’s willingness to budget for Treasury spending, and the Fed’s willingness to buy assets or lend against them—perhaps to infinity and beyond. Let’s put both affordability and solvency concerns to rest: the question is never whether Uncle Sam can spend more, but should he spend more.

If the Treasury spends more than received in tax payments over the course of a year, we call that a deficit. Under current operating procedures adopted by the Fed and Treasury, new issues of Treasury debt over the course of the year will be more-or-less equal to the deficit. 

Every year that the Treasury runs a deficit it adds to the outstanding debt; surpluses reduce the amount outstanding. Since the founding of the nation, the Treasury has ended most years with a deficit, so the outstanding stock has grown during just about 200 years (declining in the remainder). Indeed, it has grown faster than national output, so the debt-to-GDP ratio has grown at about 1.8% per year since the birth of the nation.

If something trends for over two centuries with barely a break, one might begin to consider it normal. And yet, strangely enough, the never-achieved balanced budget is considered to be normal, the exceedingly rare surplus is celebrated as a noteworthy achievement, and the all-too-common deficit is scorned as abnormal, unsustainable, and downright immoral.

First the good news. The government’s “deficit” is our “surplus”: since spending must equal income at the aggregate level, if the government spends more than its income (tax revenue), then by identity all of us in the nongovernment sector (households, businesses, and foreigners) must be spending less than our income. Furthermore, all the government debt that is outstanding must be held by the nongovernment sector—again, that is us. The government’s debt is our asset. 

Since federal debt outstanding is growing both in nominal terms and as a percent of GDP, our wealth is increasing absolutely and relatively to national income. Thanks Uncle Sam!

But the dismal scientists (economists) warn that all this good news comes with a cost. Deficits cause inflation! Debt raises interest rates and crowds out private investment! Economic growth stagnates because government spending is inherently less efficient than private spending! All of this will cause foreigners to run out of the dollar, causing depreciation of the exchange rate!

With two centuries of experience, the evidence for all this is mixed at best. Deficits and growing debt ratios are the historical norm. Inflation comes and goes. President Obama’s big deficits during the GFC didn’t spark inflation—indeed, inflation ran below the Fed’s target year after year, even as the debt ratio climbed steadily from the late 1990s to 2019. 

The initial COVID response—that would ultimately add trillions more to deficits and debt—did not spark inflation, either. (Yes, we’ve seen inflation increasing sharply this year—but as I noted, the evidence is mixed and many economists, including those at the Fed, believe these price hikes come mostly from supply-side problems.)

Interest rates have fallen and remained spectacularly low over the past two decades. Anyone looking only at those 20 years could rationally conclude that interest rates appear to be inversely correlated to deficits and debt. 

While I do believe there is a theoretically plausible case to be made in support of that conclusion, the point I am making is that the evidence is mixed. And if you were to plot the growth rate of GDP against the deficit-to-GDP ratio for the postwar period, you would find a seemingly random scatterplot of points. Again, the evidence is mixed at best.

Finally, the dollar has remained strong—maybe too strong for some tastes—over the past 30 years in spite of the US propensity to run budget deficits, and even trade deficits for that matter. Both of these are anomalies from the conventional perspective.

So, while there are strongly held beliefs about the negative impacts of deficits and debt on inflation, interest rates, growth, and exchange rates, they do not hold up to the light of experience. When faced with the data, the usual defense is: Just wait, the day of reckoning will come! Two centuries, and counting.

Levy Institute Senior Scholar L. Randall Wray is a professor of economics at Bard College.

© 2022 The Levy Institute. Reprinted by permission.

The ‘Catch-22’ of Social Security

Posted on January 4, 2022 by -

In another attempt to undermine faith in Social Security (‘Should You Count on Social Security?’), economist Andrew Biggs mixes up the value of social insurance and defined contribution retirement savings accounts.

What do I mean by that? In the 1970 dark comedy about WWII, ‘Catch-22,’ Jon Voigt as quartermaster of a B-25 bomber base near Italy reveals that he sold the flight crews’ parachutes to capitalize a company he’d created. He stuffed the empty parachute sacks with certificates of company stock.

Social Security is like the parachutes, and 401(k)s are like the stock. They serve different purposes. Insurance by definition pays off during insurable events; Social Security pays off in the event that you live past a certain age or are disabled. All US workers pay taxes for it, they get credit for it on a database, and the gov’t guarantees that they will get what they earned–in case of the insured event.

Jon Voigt (left) and Martin Balsam in the film ‘Catch-22’.

The cost of Social Security is low (relative to private annuities) because almost all American workers contribute, not everyone experiences the insurable event, and the government runs the program at cost. Armed with Social Security, Americans can afford to worry less about a market crash during the five-year “red zones” before and after they retire. They can also worry less about longevity risk, market risk, and inflation risk.

Importantly, workers can afford to risk more money on stocks because they know those other financial risks (which stocks don’t cover) will be covered by Social Security. Without Social Security, most people would need to invest more of their 401(k) contributions in bonds. I contest Biggs’ characterization of Social Security contributions as taxes (i.e., an expense), 401(k) contributions as savings (investments), and Social Security money as a transfer from strapped workers to pampered retirees. I believe this plays a shell game with the facts.

Payroll contributions to Social Security are savings, in effect, and the workers and retirees that Biggs pits against each other are the same people at different times of their lives. Biggs concedes that there won’t be a big fiscal crisis when the Social Security trust fund is empty, but still manages to compare the program unfavorably to DC plans (without mentioning the massive annual federal tax expenditure to incentivize retirement savings or market crashes or the cost of bailouts).

Sure, you might be able to invest for yourself ‘better than the government can.’ But you can’t insure yourself against market, sequence, interest rate, inflation and longevity risk more efficiently than Social Security can. And, by the way, Social Security’s critics often denigrate its “unfunded” nature; in fact, Boomer contributions to Social Security exceeded the program’s cost for decades. The Boomer burden has been pre-funded. (In 2034, when the Boomers’ decades of excess contributions may finally be exhausted, about half of them will already be dead.)

Biggs would have you believe that there’s a zero-sum game between workers and retirees, between taxes and investment, and between the public sector and the private sector. This supposed zero-sum game is not reality. In 2021, about a trillion dollars was deducted from paychecks for SS tax and a trillion ended up in the bank accounts of Social Security beneficiaries. The banking system saw no big change in reserves or lending capacity as a result. Consumption rose. The elderly lived independently. Don’t let the pundits confuse you. Don’t trade your retirement parachute for paper. We need Social Security and employer-sponsored retirement savings plans.

(c) 2022 RIJ Publishing LLC. All rights reserved.

Fortitude Re, Midwest Holdings pursue ‘triangle’ strategies

Posted on January 4, 2022 by -

Fortitude Re, a major practitioner of what RIJ has called the “Bermuda Triangle” strategy, is growing. 

A $45 billion company built largely through acquisitions from AIG and backed by the Carlyle Group, which manages assets worth $276 billion worldwide, Fortitude Re has formed a Bermuda multi-line reinsurer and acquired a US life insurer, according to a release this week. 

By Bermuda Triangle strategy, we mean the trend, which began after the global financial crisis and has accelerated, of asset managers entering the fixed annuity business, where their affiliated life insurers issue contracts, they redeploy a large portion of the assets into marketable private credit or asset-backed securities, and their affiliated reinsurers release surplus capital for the life insurers through regulatory arbitrage.

In a related move, Fortitude Reinsurance Company Ltd., Bermuda’s largest multi-line reinsurer, said it has obtained approval to operate as a Reciprocal Jurisdiction Reinsurer, the first such approval to be granted by the Texas Department of Insurance. Fortitude Re can now “transact through multiple entities and structures to help its clients achieve their objectives,” the release said.

Today’s announcement follows other recently announced transactions that added to Fortitude Re’s franchise, including the acquisition of two U.S.-domiciled third party administrators from American International Group, Inc. and the pending acquisition of Prudential Annuities Life Assurance Corporation and its in-force legacy variable annuity block from Prudential Financial, Inc.

Effective January 1, 2022, Fortitude International Reinsurance Ltd. (FIRL) commenced operations as a Class 4 and Class E reinsurer, licensed by the Bermuda Monetary Authority. FIRL will complement Fortitude Re’s other operating entities and focus on reinsurance solutions for insurers domiciled outside the US

In addition, on January 3, 2022, Fortitude Re completed its acquisition of Rx Life Insurance Company (to be renamed Fortitude US Reinsurance Company) (Fortitude Re US) from Heritage Life Insurance Company. Fortitude Re US, which will serve as a US reinsurance platform for Fortitude Re, is an Arizona domiciled life and annuity insurer widely licensed in the US. This acquisition will enable Fortitude Re to offer clients a US-domiciled reinsurance option.

With the aim of extending its reciprocal jurisdiction reinsurer status beyond Texas, FRL expects to seek similar status in other selected US jurisdictions in the near future, the release said.

FRL’s Reciprocal Jurisdiction Reinsurer status allows US ceding companies to take full statutory credit for reinsurance ceded to FRL without any regulatory prescribed collateral requirements, effectively treating FRL for these purposes as a US domiciled reinsurer. FRL is among the first reinsurers to obtain such status in the US.

“The transactions and regulatory approval represent an important step in the evolution and expansion of the capabilities Fortitude Re is able to offer to clients to solve their most complex challenges. With the establishment of FIRL, we expect to grow our international reinsurance business in Asia and the U.K. and European markets,” said James Bracken, Fortitude Re CEO, in the release.

Midwest Holding’s new indexed annuity uses an ESG benchmark

Midwest Holding Inc., a company designed to blend the issuance of fixed indexed annuities with reinsurance and asset management capabilities, announced this week that its life insurer, American Life & Security Corp, has launched the industry’s first fixed annuities based on the S&P 500 ESG Index. ESG stands for Environmental, Social, and Governance.

The S&P 500 ESG Index consists of a subset S&P 500 companies, designed for investors seeking socially responsible investments aligned with a mainstream index, a Midwest Holding release said.
Midwest Holding Inc. describes itself as a “technology-enabled life and annuity company,” according to its website. It uses its “technology platform and reinsurance-supported capabilities to develop and distribute insurance products through third-party independent marketing organizations (IMOs).” The four coordinated businesses of Midwest Holdings are:

  • m.pas. Midwest’s cloud-based Policy Administration Solution. As a licensed TPA, it provides straight-through innovation and custom end-to-end policy administration infrastructure for fast product launches. 
  • 1505 Capital.  An SEC-registered investment advisor. We are building unparalleled risk-management technology designed to implement innovative asset liability management solutions for ourselves and our clients.
  • American Life & Security Corp. A Nebraska-based insurer founded in 1960 and reimagined in 2018, American Life leverages m.pas and 1505 Capital to provide life and annuity products. American Life & Security Corp. sells, underwrites, and markets annuities in 20 states and the District of Columbia.   
  • Seneca Re.  A Vermont sponsored captive reinsurance company which, with its 1505 Capital, brings capital markets-oriented capacity to the US insurance market.

The company was founded in 2003 and booked $12 million in revenue for the 12 months ended September 30, 2020. It listed on the Nasdaq under the symbol MDWT in December 2020. Piper Sandler was the sole bookrunner on the deal.  

Its stock price peaked on November 10, 2021 at more than $41, but the price fell sharply starting then and has traded below $20 since then. In November, the company’s founder and co-chief executive, Michael Salem, left the company.  

© 2022 RIJ Publishing LLC. All rights reserved.

 

Breaking News

Posted on January 4, 2022 by -

I-bonds now offer 7.12% return

Individuals can now get the equivalent of a 7.12% annual return by investing in Series I savings bonds, which they can purchased direct from the US Treasury from now through April 2022. 

It’s the second highest yield ever offered by the inflation-sensitive I-bonds, which are distinct from Treasury Inflation-Protected Securities, Bloomberg.com reported this week. 

“The US Treasury is committed to unlimited supply until it decides to change the policy. After 23 years, the total amount of I-bonds outstanding is still a tiny fraction of the national debt, so perhaps the US Treasury will continue supplying them under today’s terms without limit,” said Zvi Bodie, retired Boston University pension expert. 

In September, Bodie, David Enna, Mel Lindauer, and Michael Ashton published an “I-Bond Manifesto” in support of I-bonds, which were introduced by the US Treasury in 1998. It describes how I-bonds work and how investors can buy them.

Rising inflation is responsible for the high rate. The interest rate on the Series I bond is set twice a year based on recent changes to the consumer price index for all urban consumers. November’s pricing is based on the change from the previous March to September. 

The rapid surge in inflation means investors can now get double the six-months-ago offer of 3.54%. With interest rates still at crisis-era levels, I-bonds are one of the few places individuals looking for inflation protection can go without getting into higher risk investments. 

The maximum investment is $15,000 per calendar year, they can’t be traded, and purchases are limited to US citizens, residents and employees. The interest rate is guaranteed for the first six months and after that will rise or fall depending on inflation. You have to keep your investment for at least a year. If you exit before five years, you’ll lose three months of interest. 

A great year for life insurer stocks: WSJ

“The flood of private-equity money into the industry has also enabled insurers to shift some of their risks onto others, and these moves were broadly rewarded in share prices.”

So said a news article in the January 5 edition of the Wall Street Journal. 

The impact of COVID notwithstanding, life insurance company stocks in the US enjoyed a strong year in 2021, the Journal reported. The sector kept up with financials overall and rose about a third. According to Autonomous Research analyst Erik Bass, their variable-income portfolios—in asset classes such as equities and alternatives—delivered a roughly 10% to 20% bump in earnings over what was anticipated.

Life-and-health insurance stocks in the S&P 500 did quite well in December, rising over 6% or about twice the gain of the broader financial sector. Overall, they gained 32% last year. So now, the forward price-to-earnings ratio for S&P 500 life & health insurers is about nine times—about where the sector averaged in the five years preceding 2020. The sector’s multiple reached 11 times in 2017, when interest rates were rising.

AllianzIM issues new iteration of its buffered outcome ETF

Allianz Investment Management LLC (AllianzIM), a unit of Allianz Life Insurance Company of North America, today launched a new buffered outcome ETF with a six-month outcome period: the AllianzIM US Large Cap 6 Month Buffer10 Jan/Jul ETF (NYSE: SIXJ).

The initial cap on January 1 was 5.30% (4.93% after fees); investors who purchase today face different effective caps depending on the performance of the fund.

Using FLEX Options, AllianzIM’s new ETF seeks to match the returns of the S&P 500 Price Return Index up to a stated cap, while providing downside risk mitigation through a Buffer against the first 10% of S&P 500 Price Return Index losses for SIXJ over a six-month outcome period.

The initial 6-month outcome period starts January 1, 2022, and ends June 30, 2022, with subsequent 6-month outcome periods from July 1 through December 31 or January 1 to June 30.

“Amid record-low interest rates and volatile equity markets, SIXJ offers investors another option to help mitigate risk in their portfolios.” said Johan Grahn, Vice President and Head of ETFs at AllianzIM, in a release.

With an expense ratio of 0.74%, SIXJ is one of the lowest-cost buffered outcome ETFs on the market. With two outcome periods per year, SIXJ resets the cap and the buffer every six months and the ETF may serve as an alternative to short-term, low-yielding investment options and provide tactical applications within an investment portfolio.

AllianzIM debuted its six-month outcome period Buffered Outcome ETFs in October 2021 with the launch of the AllianzIM US Large Cap 6 Month Buffer10 Apr/Oct ETF (NYSE: SIXO). SIXJ and SIXO are the latest evolution in AllianzIM’s suite of buffered outcome ETFs. Between the two ETFs, investors can now benefit from defined outcome periods with an opportunity to invest in such a way that caps and buffers reset every three months.

Additionally, the AllianzIM US Large Cap Buffer10 Jan ETF (NYSE: AZAJ) and the AllianzIM US Large Cap Buffer20 Jan ETF (NYSE: AZBJ) today begin a new one-year outcome period with new upside caps.

Funding levels of large pensions rose with markets in 2021: Mercer

The estimated aggregate funding level of pension plans sponsored by S&P 1500 companies increased to 97%  as of December 31, 2021, from 84% as of December 31, 2020, according to a release from Mercer, a consulting business owned by Marsh McLennan. 

“Over the course of 2021, increases in interest rates used to calculate corporate pension plan liabilities and increases in equity and fixed income markets supported the increase in funded status. The estimated aggregate deficit of $64 billion as of December 31, 2021 is far smaller than the $407 billion deficit at the end of 2020,” the release said.

The estimated aggregate value of pension plan assets of the S&P 1500 companies as of December 31, 2020 was $2.19T. Estimated aggregate liabilities were $2.6T. At the end of 2021, the estimated aggregate assets were $2.33T compared with the liabilities of $2.39T.  

The S&P 500 index increased 26.89% during 2021 and the MSCI EAFE index increased 8.78%. Typical discount rates for pension plans as measured by the Mercer Yield Curve increased to 2.76% from 2.32% during 2021.

Matt McDaniel, a partner in Mercer’s Wealth Business said in a statement: 

“Funded status rose three percent in December and was up 13% year over year. Over the course of 2021, we saw equity markets surge forward, frequently reaching fresh all-time highs, while rates rose propelling funded status to levels not seen since 2008.

“Nearly 40% of plan sponsors in the S&P 1500 are now over 100% funded.  With many of those plans frozen, it begs the question of how many will look to actively de-risk or even fully terminate their plans. We have seen a marked increase of sponsors asking ‘how close’ to full termination they are, so we believe termination activity may be on the rise. 

“For those plans still running deficits, the funding relief passed earlier this year is expected to reduce required contributions for several years so some may be leaning on investment performance to drive improvements in funded status. But this could be a risky strategy with equity markets at all-time highs, even as the Fed continues to taper and potentially increase rates this year.”

Vanguard reduces fees on bond ETFs and other funds

Vanguard has lowered expense ratios for 17 fund shares, including nine fixed income ETFs. Vanguard’s US bond ETF lineup has attracted $75.7 billion in cash flows through October 31, helped to drive economies of scale and lower expense ratios. (See tables below.) 

As of October 31, 2021, Vanguard managed $8.4 trillion in global assets. The firm, headquartered in Valley Forge, Pennsylvania, offers 418 funds to its more than 30 million investors worldwide.

Vanguard operates under a unique, investor-owned structure in which US fund shareholders own the Vanguard funds, which in turn own Vanguard. This structure enables the firm to return value to shareholders through lower costs and reinvesting to improve capabilities, technology, and client experience. 

AM Best upgrades Guggenheim Life and Annuity

Guggenheim Life and Annuity’s financial strength rating (FSR) has been upgraded by ratings firm AM Best to A- (Excellent). Guggenheim (GLAC) is no longer “under review with developing implications,” AM Best said in a release. 

Guggenheim’s FSR was upgraded from B++ (Good). Its Long-Term Issuer Credit Rating was upgraded to “a-” (Excellent) from “bbb+” (Good). The outlook assigned to these Credit Ratings (ratings) is stable.

“The ratings reflect GLAC’s balance sheet strength, which AM Best assesses as strong, as well as its strong operating performance, neutral business profile and appropriate enterprise risk management,” the release said.

The removal of the ratings from under review and subsequent upgrades are due to GLAC being acquired by Group 1001 Insurance Holdings LLC, the parent company of the lead rating unit, Group 1001 Life & Annuity Group (formerly known as Delaware Life Insurance Group), for which GLAC will now become a group member in accordance with AM Best methodology. The acquisition closed Nov. 12, 2021.

The grouping of GLAC with Group 1001 Life & Annuity Group is due to the consistent executive management, shared services, its material contribution to the group’s premiums and earnings along with the significant level of financial support already shown to GLAC through a $400 million capital contribution post closure.

Venerable appoints new chief actuary, Parul Bhatia

Parul Bhatia has been promoted to Senior Vice President and Chief Actuary at Venerable, a manager of legacy variable annuity business acquired from other entities. Venerable was created by an investor group led by affiliates of Apollo Global Management, LLC, Crestview Partners, Reverence Capital Partners, and Athene Holdings, Ltd.

Previously Head of Valuation at Venerable, Bhatia led valuation of statutory, tax, and US GAAP reserves and capital metrics primarily for variable annuities and payout annuities. In her new position, she will also lead the organization’s valuation, inforce management and strategy, and capital management and modeling teams.

Prior to Venerable, Bhatia was a consultant at Willis Towers Watson. She holds a Bachelor of Science in Commerce from the University of Delhi, is a member of the American Academy of Actuaries, and a fellow of the Institute and Faculty of Actuaries, UK, and the Institute of Actuaries of India.
Venerable is privately held, with operations in West Chester, PA, and Des Moines, Iowa.

SmartAsset launches TV ad campaign

SmartAsset, the consumer financial education and lead-generation site for advisors, has launched a national TV campaign this week produced by TV agency Marketing Architects. 

SmartAsset describes itself as an online destination for consumer-focused financial information and advice that powers SmartAdvisor, a national marketplace connecting consumers to financial advisors. It reaches ~75 million people each month (as of Sept. 2021).

Founded in 2012, SmartAsset offers free data-driven content, personalized calculators and educational tools to an estimated 75 million visitors per month. Additionally, SmartAsset operates SmartAdvisor, the leading independent client acquisition platform for financial advisors in America.

Marketing Architects worked with SmartAsset to pretest a variety of creative strategies. They landed on two spots, “Where Frank Used to Sit” and “Learning from Mistakes.” The commercials highlight how SmartAsset can help viewers prepare for retirement. 

Ranked on the Inc. 5000 and Deloitte Technology Fast 500 lists of fastest growing companies in 2021, SmartAsset recently closed a $110 million Series D round, valuing the company at over $1 billion. SmartAsset was also named to Y Combinator’s list of Top 100 Companies of all time and Forbes’ list of America’s Best Startup Employers in 2020.  

© 2022 RIJ Publishing. All rights reserved.

‘Retirement Bonds’ could increase income, lower risk: EDHEC

Posted on December 16, 2021 by -

One comment in particular caught my ear during an online presentation last week by Lionel Martellini and Shahyar Safaee, the director and research director, respectively, of the EDHEC Risk Institute in France. 

EDHEC, a business school and financial research institute, is probably the most important hotbed of decumulation studies that that you haven’t heard of. 

Shahyar Safaee

In his presentation, Safaee clicked to a slide showing a graph with the familiar rainbow of the “efficient frontier” of investing, with which we are all familiar. But on this particular slide the graph showed a double-arc rainbow: one arc composed of orange dots and the other of blue dots. (See below.)

The chart showed that at any given equity allocation, hypothetical retirees could get more income (on average, over a finite, 20-year window) with less risk if they put the balance of their assets into the “Retirement Bond” (more on that in a moment) that Safaee and Martellini were proposing—as opposed to investing in a standard fixed-income product assumed to be benchmarked by/represented by the US aggregate bond index. 

“If you’re at 30% equity allocation in retirement, that would bear the same level of retirement income risk as a 39% equity allocation, leaving an extra 9% of equity allocation available,” Safaee said in a live Zoom meeting from his office in Nice, on the French Riviera. 

“Using the Retirement Bond as the fixed income allows for more equity allocation for the same level of retirement income risk… and leads to a lower probability of a negative final cash balance,” the slides showed.

Note: This chart shows that using EDHEC’s Retirement Bonds for income during the first 20 years of retirement allow a higher equity allocation and higher final cash balance than using the bonds in the US aggregate bond index.

 

During my years in annuity marketing at Vanguard, we often promoted the idea that the addition of an income annuity to a retirement portfolio enabled retirees to take more risk with the remainder of their assets. This EDHEC research gives academic support to that idea. Martellini and Safaee’s slides also show the importance of knowing the yield of the zero-risk asset (the value of the y-axis at zero on the x-axis) in interpreting an efficient-frontier (EF) chart. When the risk-free yield increases (in this case Retirement Bonds are assumed to return more than the US aggregate bond index), the EF arc shifts upward. Zvi Bodie first pointed out to me the importance of the risk-free yield; it shows that the risk of portfolio failure associated with a given equity allocation is lower when the yield of the bond allocation is higher.  

Lionel Martellini

So what exactly is this Retirement Bond that would make up the rest of a retiree’s portfolio for the first 20 years of retirement? Martellini said it would resemble the SeLFIES bonds that Robert Merton and Arun Muralidhar have proposed.

SeLFIES, as RIJ reported earlier this year, are risk-free, consumption-indexed government bonds for sale to individuals or plan participants before retirement. SeLFIES resemble ladders of zero-coupon TIPS. Each one might pay out $5 a year for 20 years, starting at retirement. The price of each bond would depend on the number of years until retirement and on interest rates at the time of purchase. To eliminate longevity risk, SeLFIES could be combined with a deferred income annuity with payments starting, for instance, at age 85. 

EDHEC’s Retirement Bonds would correct a shortcoming of diversified bond funds as the “safe asset” in a retirement income strategy. The average duration of the fixed income component in target date funds, Martellini said, is too short for long-term investors; they would earn higher yields by investing in bonds with longer maturities. To make the bonds risk-free, they’d have to be issued by a government.  

He defined EDHEC’s Retirement Bond as a “fixed income security paying constant (or cost-of-living-adjusted) cash-flows for the first 20 years of retirement; it is the true risk-free asset for the first two decades of retirement.” It could be created by building a ladder of risk-free bonds whose durations span the maturities of the Retirement Bond cash flows.

Asked if a 20-year period-certain annuity could replicate the income from his Retirement Bonds, albeit without the liquidity that Retirement Bonds would allow, Martellini said, “A period certain annuity has pretty much the same payoff as a retirement bond, without the flexibility offered by market traded instruments.” 

He suggested that asset managers are missing an opportunity to meet retirees’ needs for safe income during the first two decades of retirement. 

“It actually seems highly inefficient for the investment industry to stay away from addressing the needs of their clients once they reach retirement,” he said. “Insurance companies are critically useful to provide longevity risk protection via late life deferred annuities, but simpler and cheaper asset management solutions should be made available for the first 20 years in retirement.”

© 2021 RIJ Publishing.