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This Is How You Sell Annuities

Posted on April 20, 2017 by Kerry Pechter -

The advisor Curtis Cloke learned long ago that one way to sell annuities to wealthy near-retirees is to show them—“with science and math,” as he likes to say—that if they buy enough guaranteed income they can take much more risk with the rest of their cash and end up all the richer.

For two decades, Cloke perfected this formula over kitchen tables in farmhouses near Burlington, Iowa. Later he taught other advisors how to use his method through his “Thrive University.” Now he’s encoded his technique into a web-based software tool called “Retirement NextGen.”

Cloke is not the only retirement specialist to claim that, under certain conditions, a barbell portfolio of safe income annuities and risky equities can outperform a system of safe withdrawals from a conservative balanced portfolio in retirement—especially for long-lived people. But Cloke, blessed with preacher-like zeal and armed with computer-driven charts, has applied that principle with unusual success, earning wide recognition and demonstrating that, with proper framing, even the very rich will agree to annuitize as much as half their wealth.

Recently, RIJ sat in on an online demonstration of Retirement NextGen. You’ll see that the hypothetical couple bought four annuities; a fifth was suggested. These purchases were based on a real case. The couple bought a life annuity, an indexed annuity with a lifetime withdrawal benefit and a qualified longevity annuity contract—while more than doubling, somewhat counter-intuitively, the predicted size of their state.

“I purchased four very different annuities with the thought that this would prove the software was product agnostic and would appeal to more agents,” the trainer, Bruce Widbin, told RIJ. “I did not maximize wealth in this webinar but simply wanted to show what the software would be able to do.”

Tom and Sue, the millionaires next door

The sample case involved Tom, 61, and Sue, 59, both teachers, each with Social Security benefits, defined benefit pensions, defined contribution accounts, life insurance policies, a paid-off $200,000 home, and a modest lifestyle. In the absence of annuities, they were on track, given expected returns on their stocks and bonds, to leave an estate of about $1.9 million.

Tom could expect $2,470 a month from Social Security at full retirement age (FRA). He also expected a military pension of $2,400 a month (75% continuation). Tom also had $186,000 in a 403(b) account, a $33,000 traditional IRA, and a $17,500 Roth IRA.

Sue, who evidently saved much of her income, had $1.3 million in a 401(k) account, $92,000 in a traditional IRA, and $15,000 in a Roth IRA. She also expected $1,332 a month from Social Security at FRA and a school pension of about $2,800 (50% continuation) a month. Together, Tom and Sue also had more than $400,000 in after-tax mutual fund and bank accounts.

Tom and Sue were aiming for a monthly net income of about $7,000, or $84,000 a year. They wanted at least $60,000 in ready cash and hoped to leave at least $500,000 to their children. The Fact Finder function of the software also revealed these exceptional factors:

Both Tom and Sue wanted to retire several years before they qualified for Medicare
Tom was adamant about claiming Social Security benefits at age 62, despite the reduced payout
Sue wanted to wait until age 70 to claim Social Security benefits
The second to die would face a drop in Social Security and pension income
They were invested very cautiously, with an annual return of only 2.66%

Retirement NextGen is wired into the Cannex annuity database, so annuity quotes were close at hand. In this case, the advisor recommended that Tom and Sue purchase several annuity products with about $1.1 million of their roughly $2 million in investable wealth, for a total guaranteed income (counting Social Security and pensions) of about $9,000 a month:

$120,000 for a non-qualified period-certain annuity to pay for the couple’s health insurance until they qualified for Medicare and to provide bridge income while Sue deferred Social Security till age 70
$250,000 for a fixed indexed annuity with a GLWB that would begin payments after a 10-year deferral bonus period
$500,000 for a lifetime income annuity for Sue, starting immediately, with 2% cost-of-living adjustment and a death benefit
$125,000 for qualified longevity annuity contract with a death benefit (QLAC)
An optional $100,000 immediate annuity to pay life insurance premiums for the couple’s grandchildren.

The plan also included potential conversions of qualified assets to Roth IRAs and a Home Equity Conversion Mortgage line of credit. A HECM line of credit, untapped but steadily growing in capacity, could be used for emergency liquidity or as a hedge against a future decline in home prices.

The major selling point of this strategy for the client, according to Retirement NextGen’s calculations, was that Tom and Sue would never, even under the worst sequence of returns, need to sell depressed assets for monthly income. Coupled with their time horizon of 20 to 30 years, that freedom would allow them to ramp up their risk exposure.

The major selling point for a financial advisor with securities and insurance licenses, was an upfront commission of tens of thousands of dollars on the annuity purchases, plus one percent of the investable assets every year. Over the lifetime of the couple, the commissions and fees could amount to several hundred thousand dollars for the advisor.

Higher risk would produce higher expected returns and—the most persuasive aspect of the Retirement NextGen process—produce a final estate value that the software estimated at almost $4 million.

Contagious enthusiasm

After one of the Thrive University bootcamp sessions a few years ago in Burlington, Iowa, one of the attendees, a successful Mississippi Valley insurance agent, was asked if he could “do what Curtis does.” He replied that in theory he could but, in practice, he might need Cloke’s passion in order to communicate it effectively.

Indeed, Cloke (right), who in his youth was an Iowa gypsum miner and now teaches in The American College’s Retirement Income Certified Professional program, has a zeal that may not be reducible to an algorithm or a computer display. But he believes that his basic retirement income principle—to reduce longevity risk to near zero via insurance products in order to maximize investment risk with the remaining assets—can be applied to a greater or less degree by any properly-licensed financial advisor.

“We’re trying to educate clients that when more of their income is guaranteed, the less capital they will need to liquidate for income and the less sequence risk they will have,” Cloke told RIJ recently. “Your income isn’t tethered to market performance.”

Cloke’s method apparently works well when an advisor has to satisfy the psychic needs of two clients, one of whom dreams of potential wealth while the other fears destitution. “This works really well with married couples,” he said, “where the husband is a risk taker but the wife is worried that she’ll be left without any money. We satisfy both those ends.”

The high cost of unretired employees

Posted on April 20, 2017 by Editorial Staff -

Given today’s concerns about retirement security for Americans, it’s easy to forget that private pensions were not created solely to support workers in old age. Corporations created pensions to buy older workers out of their jobs at a specific age and replace them with healthier, less expensive younger workers.

With the shift to defined contribution plans, however, mandatory retirement ages are a relic. Today’s workers have to save for and schedule their own retirements. Many of those who have not saved enough are planning to remain at their jobs for a year or even several years longer expected.

The purposeful inertia of these older workers is going to cost corporations a lot, according to the study, “Why Employers Should Care About the Cost of Delayed Retirements.” The report was conducted by Prudential Financial. It is based on research and analysis by the University of Connecticut’s Goldenson Center for Actuarial Research.

The findings include:

Delayed retirement trend and the aging of the U.S. population are expected to result in a higher concentration of older people in the workforce. By 2020, 7% of the workforce will be over 65, up from 4% in 2010; 25% will be over 55, up from 18% in 2010.
Delayed retirements typically result in higher costs for employers, including increased compensation, DB and DC retirement plan costs, and group benefits costs. Annual healthcare costs for a 65-year-old or older worker are twice those of a worker between the ages of 45 and 54.
A one-year delay in just one person’s retirement would result in an incremental cost of over $50,000—the cost differential between the retiring employee and a new hire. For an employer with 3,000 employees and workforce costs of $200 million, a one-year delay in retirement age may cost $2 million to $3 million.

To help employees avoid delays in retirement, Prudential recommended that plan sponsors adopt these best practices:

Employer matches and default features. Design DC plans to encourage employees to save for retirement while optimizing employer contribution dollars. This includes adopting matching contribution formulas, automatic enrollment features, and automatic escalation features that encourage employees to start saving earlier in their careers and at higher rates.
Guaranteed lifetime income products. Make available guaranteed lifetime income products to help reduce the level of DC savings that employees need to generate their desired level of retirement income. Prudential’s research estimates that incorporating guaranteed lifetime income productsinto a DC plan reduces the level of assets required for a typical participant to retire at age 65 by 36%. Fifty-three percent of surveyed finance executives believe DC plan participants will make better behavioral decisions (e.g., not getting out of investments at the wrong time) if they are invested in an option that includes a guaranteed income feature.
Target-date funds. Provide Qualified Default Investment Alternatives, such as target-date funds. Fifty-three percent of surveyed finance executives say that participants are apt to make better investment decisions when presented with pre-packaged diversified investments like target-date funds.

The link between wealth, education and longevity

Posted on April 20, 2017 by Editorial Staff -

Two research papers released this month cite statistical evidence that wealthier, better-educated Americans can expect to live longer than poorer Americans and, as a result, can expect to collect significantly more benefits from social welfare programs like Medicare and Social Security.

The research is expected to inform the anticipated political debate over proposals to reform or refinance federal programs for the elderly. The retirement of the Babyboomer generation is expected to put unprecedented pressure on the solvency of those programs over the next few decades.

The authors of both studies point out that proposals to reduce the cost of Social Security by raising the full retirement age “are motivated by the rise in mean life expectancy.” They caution, however, that the average life expectancy “masks substantial differences in mortality changes across income groups.”

One of the papers, from the National Bureau of Economic Research, asserts that the longevity gap between rich and poor widened between 1930 and 1960. The life expectancy advantage of the 20% highest over the 20% lowest earners was just five years for men born in 1930. But it was almost 13 years for men born in 1960.

Because their lifespans of the wealthiest men born in 1960 are projected to be almost eight years longer, they can expect to receive an average of about $130,000 more in Medicare and Social Security benefits than the lowest-earning men over their lifetimes, the research showed.

The NBER paper, “How the Growing Gap in Life Expectancy May Affect Retirement Benefits and Reforms,” was written by well-known retirement researchers Alan Auerbach, William Gale, Peter R. Orszag, Justin Wolfer and nine other economists from the Brookings Institution, the University of Southern California, the University of California–Berkeley, the University of Chicago and other institutions.

A second paper, from the Center for Retirement Research at Boston College, focuses on the link between educational levels and expected lifespans among American men and women. It also focuses on life expectancy at age 65 rather than on life expectancies at birth.

“Between 1979 and 2011, period life expectancy at age 65 for men in the lowest to the highest educational quartiles increased by 4.1, 5.0, 5.4 and 5.9 years, respectively.” For women, the gains were at 1.3, 2.3, 2.5 and 3.7 years, respectively. “All SES groups are living longer, but the gains are greater for the most educated,” the paper said.

The study, like earlier studies by others, found that “white men in the bottom half of the education distribution aged 45-54 saw their mortality rates increase at a rate of 0.5% annually between 1999 and 2011, with a larger increase of 2.0% per year for women aged 45 to 54.”

The CRR paper, “Rising Inequality in Life Expectancy by Socioeconomic Status,” was written by Geoffrey T. Sanzenbacher and Natalia S. Orlova of the CRR, Candace C. Cosgrove of the U.S. Census Bureau and Anthony Webb of the Retirement Equity Lab at The New School’s Schwartz Center for Economic Policy Analysis.

Treasury solicits opinions about ultra-long bonds

Posted on April 20, 2017 by Editorial Staff -

The U.S. Treasury has asked for feedback from bond dealers about the feasibility and advisability of issuing government debt with terms of 40, 50 or even 100 years, the Financial Times reported this week.

The survey of primary dealers, institutions responsible for underwriting the US government’s debt, comes ahead of the Treasury’s next quarterly refunding announcement in early May.

The Trump administration and Treasury Secretary Steve Mnuchin is considering extending the term of government debt. Smaller countries, including Italy, Austria and Mexico, already have very long-dated bonds.

Mark Grant, chief strategist at Hilltop Securities, said the government would likely see demand from big insurance companies with long-dated liabilities. Some investors believe it would help the US Treasury to reduce borrowing costs for the taxpayer, the Financial Times report said.

The Treasury survey of dealers focused on the following areas:

“What factors should Treasury consider when structuring a security with a maturity greater than 30 years?
How, relative to the current 30-year bond offering, would Treasury expect to price ultra-long bonds.

This week, the 30-year Treasury yield fell to a new low for the year of 2.80%, down from 3.21% in mid-March. Very long-dated bonds sometimes trade more cheaply than shorter-dated bonds. A trader at one primary dealer said the lack of premium for investing long-term could dissuade some investors.

But the premium might not matter much. “Treasuries are a way station for many investors at times like this when they don’t want to be in other asset classes,” said William O’Donnell, a strategist at Citibank. “In many ways valuations don’t matter. Bonds are the anti-stock.”

The current 50-year swap rate in the US, which is closely linked to Treasuries, is about three basis points below the 30-year swap rate, suggesting that a 50-year bond could cost the government than the current 30-year bond, O’Donnell said, adding, “But much will depend on supply and demand, how much issuance they bring and how often it is auctioned.”

Americans like ‘fiduciary,’ but can’t explain it

Posted on April 20, 2017 by Editorial Staff -

Americans overwhelmingly favor the intent of the Department of Labor’s fiduciary rule, when requires financial advisors who provide advice to rollover IRA owners to act in their clients’ best interests, according to a survey by Financial Engines, a major provider of managed accounts to 401(k) plan participants.

The rule, created by the Obama administration and in effect since last June but not yet enforced, is under review by the Trump administration. Industry groups have been pressuring the administration and legislators to undo certain aspects of the rule, such as the right it gives aggrieved investors to file class action suits against financial services companies and the restraints that it applies to sellers of fixed indexed and variable annuities.

According to the survey, 93% of Americans think financial advisors who provide retirement advice should be legally required to put their clients’ best interest first. But more than half of respondents (53%) mistakenly believe that all financial advisors are already legally required to put the best interests of their clients first.

Compared to a similar survey last year, Americans have a slightly better understanding of the difference between a financial advisor who is a “fiduciary” and one who is not (21% understand the difference today, compared to 18% a year ago). However, many Americans still don’t know how to tell if an advisor is a fiduciary. Only 50% of investors who work with a financial advisor are certain that their advisor is a fiduciary, while 38% don’t know if their advisor is a fiduciary or not.

Complete results of the survey can be found at https://financialengines.com/workplace/resources.

Honorable Mention

Posted on April 20, 2017 by Editorial Staff -

Athene Holdings gets a ratings upgrade

A.M. Best upgraded the financial strength ratings of Athene Holding’s operating companies to “A“ (Excellent) from “A-“ (Excellent). The Long-Term Issuer Credit Ratings (Long-Term ICR) of Athene’s subsidiaries were also upgraded to “a” from “a-.” The outlook of these credit ratings was revised to “stable.”

The rating agency specifically cited Athene’s “strong risk-adjusted capitalization, a trend of strong profitability and recent sales growth through retail initiatives, including its position as a leader in the fixed-index annuity market” as well as “a strong management team with proven ability to grow capital both organically and through new capital generation and the company’s strong trend of earnings and capital growth” as reasons for the upgraded rating.

A.M. Best also noted that the “quality of the group’s capital is high, as the capital structure currently employs no financial leverage and the company recently completed its initial public offering in December of 2016.”

The Athene companies receiving financial strength ratings upgrade from A.M. Best include:

Athene Annuity & Life Assurance Company
Athene Annuity & Life Assurance Company of New York
Athene Annuity and Life Company
Athene Life Insurance Company of New York
Athene Life Re Ltd.

Concurrently, A.M. Best upgraded the Long-Term ICR to “bbb” from “bbb-” of Athene Holding Ltd. (AHL) (Bermuda). The outlook of this rating has been revised to stable from positive. AHL operates as the holding company for its U.S. and Bermuda operations.

Steve Harris to lead compliance at Lincoln Financial

Steve Harris has joined the Lincoln Financial Group as senior vice president and chief ethics and compliance officer, the Philadelphia-based financial services firm announced this week. Harris will lead Lincoln Financial’s enterprise compliance team and will report to Kirkland Hicks, executive vice president and general counsel.

Hicks joined Lincoln Financial in December 2015 and has been focused on enhancing the Legal Department since his arrival. Harris’ appointment follows the January 2017 hiring of Andrea Goodrich as senior vice president and corporate secretary.

Harris most recently served as vice president and corporate chief compliance officer for The Hartford Financial Services Group. Formerly, he was a partner at Wiggin and Dana LLP. Harris earned a J.D. from Hofstra University School of Law.

Fidelity & Guaranty Life terminates merger agreement

Fidelity & Guaranty Life has announced updates on its review of strategic alternatives. The company has terminated its merger agreement with Anbang Insurance Group.

“The Company’s Board of Directors is continuing to evaluate strategic alternatives to maximize shareholder value and has received interest from a number of parties,” FGL said in a release. As permitted under the February 9, 2017 amendment to the Merger Agreement, FGL has been exploring and negotiating strategic alternatives with other parties. The Company was not permitted to enter into a definitive agreement with a third party while the Merger Agreement was in effect, but as a result of the termination of the Merger Agreement, FGL has no remaining obligations under the Merger Agreement and may enter into an alternative transaction.

“We have determined that it is no longer in the best interests of FGL’s shareholders to continue to pursue the transaction with Anbang,” said Chris Littlefield, President and CEO of FGL.

“Our business remains strong, we continue to focus on delivering on our plan for the year and our distribution partners and employees continue to be committed to our success. FGL is an attractive platform and we are well positioned to realize value for our shareholders as our Board continues to evaluate strategic alternatives.”

Boeing’s 401(k) Joins the Hueler Annuity Platform

Posted on April 19, 2017 by Kerry Pechter -

Boeing, sponsor of the largest 401(k) plan in the U.S., has decided to offer its plan participants access to Income Solutions, the annuity platform that allows participants to obtain annuity quotes and buy income annuities online, Kelli Hueler, CEO of the Hueler Companies and creator of Income Solutions, told RIJ yesterday.

The Hueler Companies also announced this week that it has improved its platform to better serve large plan sponsors. “Our new site is the first step in a series of planned technology enhancements designed to improve the participant experience, increase delivery flexibility, and facilitate greater connectivity between 401(k) investment options and lifetime income alternatives,” Hueler told RIJ.

Boeing’s DC plan, the Voluntary Investment Plan, has more than $47 billion in assets and more than 200,000 current and retired participants. Other large 401(k) sponsors using the Hueler platform include IBM (the second largest U.S. defined contribution plan) and General Motors (the seventh largest). Vanguard, the giant full service 401(k) provider, provides access to the Hueler platform for all of its plans’ participants and its mutual fund shareholders. Hueler is based in Eden Prairie, Minn., a suburb of Minneapolis.

Lots of players in the retirement industry have observed the incomplete nature of the defined contribution system, which helps people accumulate savings but doesn’t help them turn the savings into what they’ve been saving for: retirement income.

Certain plan providers, such as TIAA, and a few life insurers, like MetLife and Principal Financial Group, are active in the so-called in-plan annuity market, where participants buy future income with their salary deferrals at below-retail and gender-neutral prices. But most plan sponsors, fearful of legal entanglements, have avoided in-plan annuities.

Hueler’s platform offers a simpler, out-of-plan annuity option. “I first assumed back in 2000 that we’d be serving the in-plan distribution option, I had no idea that we would have to create a rollover capability,” said Hueler (at right). “But this is what the plans needed. Our connectivity is simple and straightforward. Its easy to implement anywhere with any plan. We don’t need a lot of infrastructure. We’re just a link on the benefits portal.”

Hueler’s web-based Income Solutions platform, established 10 years ago, sits outside 401(k) plans (and outside their recordkeeping platforms). Participants use the platform to roll over all or a portion of their 401(k) balances to an IRA. They can then apply the IRA assets to the purchase of an immediate or deferred income annuity. One of Hueler’s salaried, licensed agents executes the sale.

The platform was designed by Hueler to change the informational asymmetry of the typical retail annuity sales process. Hueler wanted potential annuity buyers to be able see a cross-section of bids, the way personal advisors can, rather than one annuity price in isolation. The annuity contracts are gender-specific, meaning that the payouts are higher for men than for women.

The annuity manufacturers that offer products on the platform submit competitive prices that Hueler says are often significantly lower than those offered in the retail channel. Some insurers, like New York Life and Northwestern Mutual, have declined to participate in the platform out of reluctance to create competition with their other distribution channels, such as captive agent forces.

The life insurance companies that offer bids for single premium immediate annuities, deferred income annuities and qualified longevity annuity contracts at Income Solutions include AIG, Integrity Companies, Lincoln, Mutual of Omaha and Symetra. (These are the firms that bid on business from Vanguard clients; the mix of life insurers may be different for different plan sponsors.)

Plan sponsors typically conduct months of due diligence before deciding to use the platform, Hueler said.. Many of the large plan sponsors are long-time customers of one of her companies, which sells data on stable value funds to plan sponsors. “We’ve had our Stable Value Analytics business for 30 years, and when we designed the Income Solutions program in 2000 we met with large plans across the country, many of whom used our stable value product,” Hueler told RIJ.

Many jumbo plan sponsors no longer offer defined benefit plans but have a tradition of doing so. Providing access to annuities through Income Solutions allows them to satisfy their sense of responsibility to long-tenured employees without undertaking the chores or assuming the liabilities of a formal defined benefit pension.

Besides using her own network of relationships, Hueler develops clients for the platform through partnerships with plan providers and certain fee-only plan sponsor advisors. Plan sponsors each pay the Hueler Companies a flat annual fee for access to the platform. Hueler earns an additional service fee when it fulfills a transaction between a participant and an annuity manufacturer.

Some of those access fees have recently gone to pay for technology upgrades at Income Solutions. The service has a new website and a new ability to create and push out projections of future monthly income, based on real-time pricing, to the desktops of thousands of plan participants. Repeatedly reminding participants that the real goal of saving is to produce income is considered essential to preparing them to make the decision to purchase an annuity at retirement.

“With the automated nudging that we’re creating, we’re hoping to move the needle in the participant space,” Hueler said. “If a plan sponsor wants to show participants exactly how their balances equate to income, we can process thousands of lives at a time. The information will be made available to them. The idea is to push more communication out to the participant on automated basis.”

“If you just put an annuity in front of people,” she added, “they won’t have much interest in it. But if you show them that it’s a way to create income for life, and if the messages touch them over and over instead of once in a blue moon or when they leave the plan, and if you offer an institutional value proposition that’s designed to be low cost, and then give them the ability to compare products and encourage them to take the next step, then I think we’ll see a shift in attitudes, and eventually even see people buying annuities inside their plans.”

iTDFs: ‘Self-Driving’ Retirement Cars

Posted on April 19, 2017 by Per U. K. Linnemann -

An awareness of the need to improve target date funds (TDFs), which according to Morningstar had a combined value of $880 billion in the U.S. at the end of 2016, has been steadily growing. As Nobel Prize winner Robert Merton has said, the use of an investor’s age as the sole determinant of a TDF’s glidepath doesn’t pass even a “minimal test of common sense.”

My startup company in Denmark has developed a new TDF design, which we call iTDFs. Our “smoothed income” approach gives each individual investor a dynamically self-adjusting glidepath with automatic re-balancing and re-allocation of assets.

Metaphorically speaking, we’ve added intelligent shock absorbers and an automatic transmission to existing TDFs. We’ve used these new features to convey clients seamlessly from the accumulation stage to the income stage. iTDFs, we believe, could be the retirement equivalent of self-driving cars.

A smoother ride

Smoothed income iTDFs can be delivered as a fully automated solution. They may also be developed for the Internet as a direct-to-consumer concept. The algorithm-based product design allows scalability, portability and low cost. It can work well for life and pension companies, banks, wealth managers, asset managers, financial advisors, “robo-advisors” or technology companies.

Where traditional TDFs never convert savings to income, iTDFs are designed to produce smooth income during retirement, either for a pre-defined period or, if combined with longevity insurance (e.g., a deferred income annuity or Qualified Longevity Annuity Contract) for as long as the account owner lives.

In our design, the level of retirement income is managed in a capital-efficient way using an innovative formula-based shock absorber that smoothes payouts by adjusting to fluctuations in portfolio value over time. The product doesn’t require additional assets as buffer capital, and the provider assumes no investment risk.

A choice between payment profiles can be offered. For instance, income could be weighted toward the early years of retirement, when retirees tend to be more active. It could be weighted toward the latter years to offset the effect of inflation. The shock absorbers could be adjusted to provide a “harder” ride, with some exposure to the ups and downs of the markets, or to provide “softer,” more level income.

Key benefits of iTDFs include:

Automated personalized investment management with built-in systematic withdrawals
The potential for investment growth in retirement
An optional lump-sum payout at the target date
Smooth payouts despite fluctuations in portfolio value
Seamless transition from wealth accumulation to retirement
Adaptability to “phased retirement”
A choice of investment risk levels
Contributions that can be fixed or variable, e.g., with annual adjustments

Automated personalized investment management can also be combined with longevity insurance. Smoothed income iTDFs can offer a liquidity period followed by a life contingent period with seamless transition between the two phases.

During the last-mentioned period you may still be invested in accordance with the dynamic investment strategy and receive an investment return as well as a return for being alive (mortality credits) that increase with age.

Moreover, iTDFs can be combined with an ongoing floor and ceiling approach on withdrawals, e.g., for fulfilling minimum and/or maximum required distributions.

A lot at stake

In sum, iTDFs present a comprehensive, holistic and customized approach to retirement. They offer the opportunity to co-ordinate investment, distribution, and longevity protection strategies. Relying on a robust algorithmic framework, they will fit easily into an increasingly digitalized and mass-customized world. Different versions of iTDFs can be tailored to local market conditions and purposes.

There is a great deal at stake. Americans held $25.3 trillion in household retirement assets at the end of 2016, according to the Investment Company Institute. Of that number, $7.0 trillion was in defined contribution plans and $7.9 trillion in individual retirement accounts (IRAs). As Ernst & Young’s Malcolm Kerr wrote last year, “There will be little margin for complacency in this space. Almost all players now recognize that managing money in retirement for, say, 25 years, generates significantly greater revenues than those generated during the accumulation stage.”

iTDFs’ smoothed income and lump sum solutions provide an opportunity for firms to obtain key competitive advantages and a differentiated position in the huge retirement income market place. More importantly, they represent an opportunity to improve the lives of millions of people throughout the world by giving guidance to their withdrawal decisions for a smoother retirement journey.

Many Happy Returns!

Posted on April 13, 2017 by Kerry Pechter -

Arriving about halfway between Mother’s Day and St. Patrick’s Day, Tax Day shares a bit of the spirit of both. It makes you want to cry, “Oh, Mama!” and then drown your sorrows in a pint of green beer.

But it’s not so bad. If taxes are your worst financial headache, you probably have a lot of money. If your property taxes reach well into five figures, then your public schools are probably top-notch and your roads pothole free.

Senior citizens in particular seem to resent taxes—probably because taxes are often their single biggest expense. Of the over-70½-year-olds who hate required minimum distributions—RMDs are just an annual tax bill for many of them—many don’t need the distributions for living expenses. If you like tax deferral, you should at least tolerate RMDs. They’re inseparable.

The news that Paul Ryan and his minions will try to reform the tax code this summer serves as a reminder that the federal government has always been perplexed about who and what to tax.

It was Alexander Hamilton who decided—perhaps anticipating the current president—that the new Republic should fund its war debt with duties on imports. Taxing trade was suboptimal, however. The duties were as costly to American shoppers as they were to European manufacturers.

Early in our nation’s history , according to Albert Bolles’ The Financial History of the United States from 1789 to 1860, an unidentified observer suggested a tax on the wages of sin:

“There was a writer who proposed that the debt should be paid ‘without oppressing the citizens’ simply by taxing the vices prevailing at that time, the chief of which were perjury, drunkenness, blasphemy, slander and infidelity,” Bolles, a finance professor at the Wharton School, wrote in a footnote to his 1883 work.

“‘Would it not then be worthy of our consideration, and that of the different Legislatures, to inquire whether a moderate tax upon every particular vice would not be more conducive to our welfare than the cramping of our foreign and domestic trade? Such a tax must of necessity yield a vast revenue and prove a most infallible scheme for our prosperity.’

“The writer suggested a modest tax on perjury, which he took ‘to be the most important and particular staple vice.’ Drunkenness ‘I would only tax sixpence,’ ‘as it might prove prejudicial to trade, as the revenue, to discourage it.’ ‘Swearing would be most universal benefit toward augmenting these funds,’ though he thought that military men would object, and claim an exemption from it.

“‘Conjugal infidelity, as the world goes at present, would furnish the public with a large sum, even at a very moderate tax; for it is now made an essential part of the polite gentleman’s character, and he that has prevailed on the greatest number proportionately rises in reputation.’ Luxuries were also to be heavily taxed, but he did not favor the taxation of bachelors.”

Perhaps because he was a bachelor. Tax reform, according to the late Sen. Russell B. Long of Louisiana (son of Huey P. “Kingfish” Long, Jr.), simply means, “Don’t tax you. Don’t tax me. Tax that fellow behind the tree.”

Not long ago, around midnight in a hotel bar, a very senior executive from a large financial services firm mused in my presence that if poor Americans paid more in taxes they might feel less entitled and more like stakeholders in our nation. I’m not sure about that.

As a self-employed person who writes painful quarterly checks to Uncle Sam and pays both ends of his Social Security tax, I made my peace with the infernal revenue service long ago.

Tax equity is an impossible ideal. But as long as the government keeps recycling its tax revenues (and then some) into the broader economy—into every capillary of the country, from Key West to Bellingham—I’m confident that we’ll all thrive, more or less.

When the financial circulatory system becomes sluggish, when embolisms and thrombi form, then national infarction and ischemic attacks become a danger.

Spruced-up variable annuities from Principal Financial Group

Posted on April 13, 2017 by Editorial Staff -

Two new variable annuities from Principal Financial Group have been approved by the SEC—Lifetime Income Solutions II and Pivot—and are now available to the investing public through Principal’s proprietary distribution channel and through third-party distribution.

With Lifetime Income Solutions II, a refreshed version of a product that Principal had issued for the last ten years, Principal offers two fairly straightforward guaranteed minimum lifetime withdrawal benefits, one of which offers a deferral bonus. One of the two must be elected at purchase.

On this product, Principal practices risk control by reserving the right to reset the fees, the payout rates of the age-bands, and/or the size of the deferral bonus every month, depending on changing interest rates. The product also limits the contract owner’s investment options to a handful of Principal funds.

“We issue a monthly supplement in which we declare the fees, the withdrawal rates and the roll-up,” said Sara Wiener, assistant vice president of annuities at Principal. “The current rates are 5.25% for a single life contract at age 65, 5.35% at age 70 and 5.5% at age 75. There’s an annual simple five percent bonus for the first 15 years of the contract or until the first withdrawal.”

The product offers two lifetime withdrawal benefits, the Target Income Protector, which offers the 15-year roll-up, and the Flexible Income Protector, which doesn’t.

The second product, the Pivot Series, is a two-sleeve variable annuity that offers conversion to a fixed lifetime income stream. The first sleeve, designed for accumulation, offers investors a wide-range of fund options. The second sleeve, called Deferred Income, contains transfers from the accumulation sleeve to the insurer’s general account.

At a date fixed at issue (but which the owner has one opportunity to change), the owner begins receiving annuity payments for life. If owners wish, they can annuitize the entire contract, including both the investment sleeve and the value of the deferred income account.

“This mirrors what we offer on the 401k side, with our Principal Pension Builder,” Wiener told RIJ. “We are one of the few retirement providers that offers a deferred income annuity investment option inside a 401(k). This is the same concept: Individuals control their assets, and sweep contributions over into a deferred income annuity that triggers payment at age 65.”

Product details

Lifetime Income Solutions II offers two guaranteed minimum withdrawal benefit options, Target Income Protector and Flexible Income Protector. Only Target Income Protector offers a deferral bonus and its equity investment options are restricted to managed-volatility funds. The Flexible Income Protector offers four equity funds, a balanced fund and a growth fund as well as managed-volatility versions of each.

Because of its deferral bonus, Target costs a little more than Flexible. The rider fee is 125 basis points, versus 105 basis points for Flexible Income Protector. (Principal reserves the right to raise the annual rider fees to as much as 200 basis points). Both riders have mortality and expense risk fees of 125 basis points and investment fees that range between 50 and 65 basis points. There is a return-of-principal death benefit (currently 25 basis points) and a stepped-up value death benefit (currently 35 basis points).

If a contract owner invested $100,000 at age 50 and made no withdrawals for 15 years, the annual single-life payout at age 65 would be at least $175,000 multiplied by 5.25% (at current rates) or $9,187.50 for life. With all-in fees for the Target version of the product at about 300 basis points per year, there would presumably be little chance for step-ups in that payment without a bull market.

The Pivot product, which shares the two-sleeve, deferred income annuity approach with the Guardian ProFreedom and ProStategies variable annuities permits dollar-cost averaging from an accumulation portfolio with many investment options into the deferred annuity portfolio. Income at the annuity date would be calculated based on interest rates at the time of the transfer.

The Deferred Income rider is automatically attached to the contract at issue and has no separate mortality and expense risk fee or investment fee, since the money is in the general account and the fees are embedded in the fixed annuity payout. A one percent annual fee is levied on the value of the accumulation sleeve (85 basis points for the M&E, and a 15 basis point administration fee), the investments cost 50 basis points per year or higher.

There are two additional noteworthy features on this contract. The Liquidity Max feature, priced at 25 basis points per year, allows no surrender-fee withdrawals from the accumulation sleeve during the six-year surrender period (in addition to the 10% free withdrawals).

In another liquidity feature, people who need a lump sum of cash during retirement can use the “Advancement Feature.” It allows for up to six months of annuity payments at once—followed by a period of no payments for six months—during the income period. This lump sum option can be exercised up to four times during the life of the contract, with resumptions of monthly payments between them.

Fixed annuity option added to AXA’s DC recordkeeping platform

Posted on April 13, 2017 by Editorial Staff -

“In-plan” annuity options, which allow retirement plan participants a chance to contribute to a deferred income annuity, are still a rarity in much of the defined contribution world, but TIAA, MetLife and Principal Financial Group have been quietly offering them for some time. (Prudential and Great-West offer lifetime withdrawal options to their DC clients as part of their target date funds.)

Now AXA is getting into the act. A fixed annuity option will be included with the new AXA Retirement 360, which AXA Retirement Plan Services describes as “an open architecture defined contribution mutual fund program designed for 401(k), 403(b), 457(b) and 401(a) plans” that enhances AXA’s existing recordkeeping platform. Kevin Molloy, Head, AXA Retirement Plan Services.

Besides offering participants access to the “broad mutual fund marketplace,” the enhancement provides “a non-mutual fund option for retirement certainty with the “AXA Fixed Account” through a group fixed annuity from AXA Equitable Life Insurance Company. The option offers “principal protection, liquidity and a guaranteed minimum interest rate on savings.”

“The fixed account is generally intended to provide a guaranteed rate of accumulation, but participants have the option to annuitize to receive a lifetime income,” AXA told RIJ in an email this week.

“It has a minimum guaranteed interest rate of 1.00%, the current interest rate may be higher. Participant assets in the fixed account are liquid and can be transferred to other plan investment options,” AXA said. “If the plan elects to terminate the fixed account, the plan may take payments over a 5-year period or pay a Market Value Adjustment, if applicable.”

AXA Retirement 360 provides:

An intuitive website and dedicated team of retirement professionals. While a dedicated on-boarding specialist manages the plan’s setup and transition via an all-paperless process, plan sponsors and their advisors can track onboarding progress with complete transparency through real-time updates so they always know the status of plans in progress.
Fiduciary protection through Wilshire Associates, an independent professional investment advisory and consulting firm, in the selection and oversight of their plan’s investment lineup.
Education tools and resources, including a guided, jargon-free enrollment tool and live chat option.
Simple investment selection process, with options to select funds based on their retirement date or risk tolerance, as well as the option for the AXA Fixed Account, tailored for those concerned with principal protection or those who want a degree of retirement certainty.

These are not your grandfather’s (or Gary Brinson’s) withdrawal rates

Posted on April 13, 2017 by Editorial Staff -

For advisors, two worthwhile articles on the topic of sustainable annual withdrawal rates from total-return retirement portfolios appear in this April’s Journal of Financial Planning.

In one article, Jack DeLong Jr. and John H. Robinson, creators of Nest Egg Guru planning software, write that a “spend bonds first” or a “simple guardrail” strategy (spend down stocks and bonds proportionately, but never liquidate depressed stocks) produce much more median final wealth than either “spend stocks first” or the often-used “spend down stocks and bonds proportionately and maintain a constant asset allocation” strategy.

In the second article, Morningstar’s David Blanchett asserts that clients can spend 6% per year if 95% of their wealth is in guaranteed income, but only 2% if just 5% of their wealth is. He adds that targeting a 75% Monte Carlo portfolio success rate can be better than demanding a 95% success rate–especially for clients with ample guaranteed income.

Advisors who like teasing out the various variables inside the Rubik’s Cube of withdrawal rate strategies should find these articles rewarding.

Honorable Mention

Posted on April 13, 2017 by Editorial Staff -

eMoney launches ‘best interest’ compliance tool despite uncertainty

The fiduciary rule may be delayed, but eMoney Advisor, the Fidelity-owned maker of financial planning software, said it would launched its Advisor Assurance software on schedule on April 4, according to a release this week.

Advisor Assurance, a new function on the eMoney dashboard, is intended to provide advisors, broker-dealer compliance officers and administrative users comply with “documentation and archival of advisor-client interactions throughout the financial planning process” in order to demonstrate compliance with the now-endangered rule.

Ed O’Brien, CEO of Radnor, Pa.-based eMoney Advisor, said users of AdvisorAssurance can:

Monitor manual account changes.
Assist with oversight of consolidated reporting.
Offer real-time access to seven years’ worth of a firm’s event logs.
Access deleted records.
Allow managers to review and approve advisor presentations.
Track email exchanges (an enhancement planned for 2017).

A year ago, O’Brien moved to eMoney from his post as senior vice president for head platform technology at Fidelity Investments, which bought eMoney two years ago. A long-time IT specialist, he was granted a patent in 2011 for the technology design behind WealthCentral, a platform for registered investment advisors (RIAs). He also launched AdvisorTech, a technology platform for financial advisors in Japan, South Korea, and Germany.

Advisor Assurance is part of eMoney’s Fiduciary Framework, a response to the fiduciary rule’s promulgation last June. Nearly 10,000 of eMoney’s 45,000 clients have adopted or are implementing Advisor Assurance, including financial institutions, broker-dealers, insurance companies and RIAs.

In 2016, New York Life again dominates income annuity sales

New York Life Insurance Company set new company records in life insurance and annuity sales, life insurance in force, dividend payout and surplus for 2016, the giant Manhattan-based mutual insurer announced this week.

The performance of the company’s core life insurance business and annuities and asset management operations enabled New York Life to pay out a record amount in dividends to its whole life policy owners and benefits to its customers, while producing an all-time high surplus.

In 2016, the firm said it posted its 20th consecutive year of growing life insurance sales through its agents. Strong results from the company’s in-force block of life insurance and annuity products helped raise the surplus and asset valuation reserve to a record $23.3 billion, despite a record dividend payout and the low-interest rate environment. New York Life said it remains one of only two companies out of more than 900 in the life insurance industry to receive the highest financial strength ratings from all four major financial rating agencies, Standard & Poor’s, Moody’s, Fitch and A.M. Best.

Performance highlights as of December 31, 2016 included:

$1.95 billion in operating earnings for 2016, the second highest in company history.

$10.1 billion in dividend and benefits paid to policy owners.
$1.8 billion dividend payout, a 35% increase since 2012.
$1.3 billion in life insurance sales and $957 billion in in-force policies, both record highs.
$13 billion in annuity sales, a record high.
24% market share in fixed immediate annuities
33% of the deferred income annuity market.
$230 billion in cash and invested assets in the general account, and $538 billion in total assets under management.

About one in four Americans feels financially insecure: Northwestern Mutual

While Americans feel like the country is currently “on firmer financial footing” today, overall confidence has waned, according to new research by Northwestern Mutual. The company’s 2017 Planning & Progress Study found:

43% of U.S. adults 18 and over say the economy will be better this year than in 2016 (up from 31% who said the same last year).
72% of Americans feel financially secure.
48% of U.S. adults aged 25-65 say most Americans can still attain “the American Dream” (down from 58% who said the same in 2009).

The Planning & Progress Study is an annual research project commissioned by Northwestern Mutual. It explores Americans’ attitudes and behaviors toward money, financial decision-making, and the broader landscape issues impacting people’s long-term financial security.

Financial vulnerability: down but still high
The 2017 Planning & Progress Study suggests that while Americans still feel a high degree of financial vulnerability, there are some signs of improvement over last year:

67% of U.S. adults 18 and over believe that, over time, there will likely be more financial crises (down from 76% who said the same in 2016).
43% of U.S. adults say the economy will be better this year than in 2016, versus 31% who said the same last year.
72% feel financially secure.
38% expect their financial security to increase in the next year.
19% expect to feel less secure in the coming year.
28% of Americans feel a level of financial insecurity.
11% feel “not at all secure.”

Financial habits are slipping
Despite widespread expectations that financial crises are likely to occur again, people are slipping in terms of their long-term financial planning. The study found:

50% of U.S. adults 18 and over say they need a plan that anticipates up and down cycles (down from 57% who said the same last year).

41% say their long-term savings strategy has a mix of high-risk and low-risk investments, compared to 44% last year.

About the study
The 2017 Planning & Progress Study was conducted by Harris Poll on behalf of Northwestern Mutual and included 2,117 American adults aged 18 or older (2,117 interviews with U.S. adults age 18+ in the General Population and an oversample of 632 interviews with U.S. Millennials age 18-34) who participated in an online survey between February 14 and February 22, 2017.

Funded status of biggest pensions hovers at about 81%: Milliman

In 2016, the funded status of America’s 100 largest pension plans fell by $21.7 billion, according to Milliman’s 2017 Pension Funding Study. Although plan assets appreciated by $32.3 billion, the funds’ projected benefit obligation rose by $54.0 billion.

The Milliman 100 plans finished 2016 with a funded ratio of 81.2%, down only from 81.9% the year before. But the incremental drop in funded status “masked a year that experienced volatility across the board for pension plans,” according to the global consulting and actuarial firm.

“The last year was a tug-of-war for these pension plans,” said Zorast Wadia, consulting actuary and co-author of the Milliman Pension Funding Study, in a release.

While the funds’ overall 8.4% investment return in 2016 was far higher than the 0.8% return in 2015, the discount rate fell by 30 basis points. The funded ratio oscillated for most of the year before the post-election bump and ended the year close to where it began.

Study highlights include:

Analysis of asset gains. The 8.4% investment returns were well above the expectation of 7% set for 2016. Employers’ 2016 plan contributions were up 38% from the year prior. Higher plan contributions improve funded status and reduce PBGC premium expenses.

Impact of updated mortality assumptions. Future life expectancy declined for the second year in a row, resulting in significant reductions in projected obligations for several Milliman 100 companies.

Use of spot rates increases by 24%. Of the largest 100 plan sponsor companies, 46 will consider recording the fiscal year 2017 pension expense using an accounting method change linked to the spot interest rates derived from yield curves of high quality corporate bonds. The move to spot rates will result in pension expense savings.

Pension Risk Transfers continue. The estimated sum of pension risk transfers to insurance companies (“pension lift-outs”) and settlement payments increased from $11.6 billion in FY2015 to $13.6 billion in FY2016.

The Case for ‘Behavioral’ Portfolio Theory

Posted on April 12, 2017 by Meir Statman -

A segment of “60 minutes,” the television program, featured Leona and Harry Helmsley, owners of the Helmsley Palace Hotel and 200 other New York buildings. Leona described the expressive and emotional benefits they derive from their wealth as they stand on a hotel balcony overlooking New York’s Central Park. Harry points at buildings and says: “I’m taking inventory. I own this, I own this, and that one, and that one.”

Behavioral portfolio theory describes portfolios on behavioral-wants frontiers and prescribes them to investors whose wants extend beyond the utilitarian benefits of high expected returns and low risk, to expressive and emotional benefits such as those of demonstrating sincere social responsibility, high social-status, hope for riches, and protection from poverty.

People are not likely to distinguish an 80% probability of reaching a goal from a 90% probability, but they are likely to distinguish something they need from something they merely want, and something they wish they had from something they dream they will have.

The process of sequencing “goals to reach” and “circumstances to avoid” transforms advisers from experts at investment management or estate planning to competent and caring professionals, good at eliciting clients’ wants and associated goals and helping clients satisfy them.

The portfolio pyramid

A central feature in behavioral portfolio theory rests on the observation that investors view their portfolios as sets of distinct mental account layers in a portfolio pyramid. Each mental account corresponds to a particular want, associated goal, and their utilitarian, expressive and emotional benefits.

An optimal behavioral-wants portfolio is one that balances wants while avoiding cognitive and emotional errors. Consider a 50-year-old investor with a $1-million portfolio, described by Harry Markowitz, Meir Statman and two of their colleagues. She divides her portfolio into three mental accounts of wants and associated goals, specified as target wealth at target dates. She places:

$800,000 in a mental account dedicated to retirement spending, with a $1,917,247 target wealth goal, implying a 6% annualized return during the 15 years till the target date.
$150,000 in a mental account dedicated to education expenses, with an $188,957 target wealth goal, implying a 8% annualized return during the 3 years till the target date.
$50,000 in a mental account dedicated to bequest money, with an $850,003 target wealth goal, implying a 12% annualized return during the 25 years till the target date.

Each mental account is optimized by the mean-variance procedure, where risk is measured by the standard deviation of returns.

Our investor faces three investments: a bond mutual fund with a 2% expected annual return and a 5% standard deviation of returns; a conservative stock mutual fund with an 8% expected annual return and a 20% standard deviation of returns; and an aggressive stock mutual fund with a 15% expected annual return and a 40% standard deviation of returns. The correlations between the bond fund and each of the two stock funds are zero. The correlation between the returns of the two stock funds is 0.25.

The investor calculates optimal mean-variance portfolios for each of the three mental accounts and the portfolio as a whole, displayed in Table 8-3. The annualized standard deviation of the returns of the retirement mental account is the lowest at 10.45%, followed by the 15.23% of the education mental account and the 25.28% of the bequest mental account.

The 6.60% expected return of the portfolio as a whole is a weighted average of the returns of the portfolios of the three mental accounts, but the 11.85% standard deviation of the portfolio as a whole is lower than the weighted average of the standard deviations of the three mental accounts. All the mental accounts and the portfolio as a whole are on the behavioral-wants frontier.

The proportion allocated to the bond fund is highest in the retirement mental account, lower in the education mental account, and lowest in the bequest mental account. Arranging the portfolio as a set of the three mental accounts does not imply that we need three “real” bond accounts, one for the bond fund in the retirement mental account, another for the bond fund in the education mental account, and a third for the bond fund in the bequest mental account.

Instead, we have one real bond account and three “virtual” bond accounts listing the allocation in the bond fund of each mental account. Investors can observe portfolios in two formats, an actual account format for the portfolio as a whole and a virtual account format for each of the mental accounts.

The presentation of the portfolio as a whole, with the sum of the three mental accounts has an advantage over a sole presentation of the portfolio as a whole. The mental accounts presentation speaks the language of normal investors. Investors want to reach their goals, not only have portfolios on the mean-variance frontier.

Wants-based mental accounts let investors articulate each want and associated goal, the target wealth at the target date, and the attitude toward risk, measured by standard deviation, in the mental account of each want and associated goal.

The Fed Reveals its Game Plan

Posted on April 12, 2017 by Stephen Slifer -

In the minutes of the most recent meeting of its Federal Open Market Committee the Fed indicated that it would most likely raise the funds rate another two times between now and the end of the year. That would boost the funds rate to 1.25%, which still leaves it far below the so-called “neutral” level of 3.0%. The Fed then plans to take a break from raising short-term interest rates and turn its attention to the reserves issue.

By year-end it will begin to eliminate excess reserves in the banking system. As part of its easing initiative in the wake of the recession the Fed embarked on an unprecedented bond-buying program. It purchased U.S. Treasury bonds and mortgage-backed securities from banks and put the proceeds from those transactions into a bank’s checking account at the Fed, which is known as a “reserves” account. In the process the Fed’s balance sheet exploded as did the volume of surplus reserves in the banking system.

Before the Fed embarked on its bond buying program excess reserves were $2.0 billion. They have since climbed a thousand-fold to more than $2.0 trillion. Thus far those funds have been sitting idle in commercial bank accounts at the Fed. Banks have been unwilling or perhaps unable to lend those funds to consumers and businesses.

As long as those funds remain at the Fed the economy receives no stimulus. But if banks suddenly become more willing and/or able to lend, those reserves could fuel a spending spree the likes of which we have never experienced. Hence, the Fed eventually needs to eliminate those excess reserves.

But when should the Fed begin? And how should it proceed? The Fed recently provided guidance.

One option would be for the Fed to sell securities to banks in the same way that it bought those securities earlier. But to do that the Fed would need to enter the market via its open market operations and announce to the world what it is doing. It is a very visible action and sends an implicit message that it is aggressively trying to slow the pace of economic activity.

That is not the Fed’s intention. Rather, it wants to eliminate those reserves in a more subtle manner.

A second option for the Fed would be to hold U.S. Treasury bonds and mortgage-backed securities to maturity, and then not replace them. Like an outright sale this option would, over time, eliminate the surplus reserves in the banking system without sending a message to the world that it was aggressively tightening its monetary policy stance.

But because the average duration of the Fed’s portfolio is about six years, if it chooses this option it would take years for all surplus reserves to be eliminated.

If the Fed were to raise the funds rate and simultaneously allow long-term securities to mature it would, effectively, be doing two forms of tightening at the same time – raising both short-term and long-term interest rates — which could jeopardize the expansion. Thus, the Fed has indicated its intention to raise the funds rate twice more this year, but then stop raising rates for a while as it allows some of its bond holdings to mature. It will probably choose that second option for most of next year.

The bottom line is that the Fed has begun the process of reversing its wildly accommodative monetary policy stance by returning interest rates to a more normal level and gradually shrinking its balance sheet to eliminate the volume of surplus reserves in the banking system.

The days of ultra-easy monetary policy have come to an end. But the Fed is well aware that it cannot move too aggressively without endangering the pace of economic activity. As long as the inflation rate climbs slowly it can afford to proceed at a leisurely pace — raising short-term interest rates for a while, then allowing some of its bond holdings to mature. Given a snail’s pace of removing excessive monetary policy accommodation, it is hard to envision Fed policy threatening the economy any time soon.

Look for the economy to grow at a steady pace for years to come and ultimately produce a record-breaking period of expansion.

Time for Retirement ‘SeLFIES’?

Posted on April 6, 2017 by Robert C. Merton and Arun Muralidhar -

California, Connecticut and other U.S. states are preparing to introduce pension programs for workers who lack workplace savings plans. Although these programs can improve access to pensions, they perpetuate the troubling trend of transferring responsibility for retirement security from governments and employers to individuals.

This shift in responsibility requires bold new thinking about how portfolios are managed and which instruments are available to investors who are saving for retirement. Our proposed SeLFIES (Standard of Living indexed, Forward-starting, Income-only Securities) would introduce a simple, low-cost, low-risk, and liquid retirement income option to participants who are largely financially unsophisticated. It would make individuals more self-reliant and, by doing so, be advantageous to government.

The challenge

We believe that members of defined contribution (DC) plans should focus on maximizing their funded status or retirement income (not their wealth, as in traditional investment approaches) [1]. This is more difficult to do in DC plans than in defined benefit (DB) plans. Unlike multi-generational defined benefit (DB) plans, DC plans must achieve their objectives in a single lifetime, and it is hard to pool risks because these plans are so flexible. For instance:

Participation in these plans is likely to be voluntary.
Participants have clearly stated (e.g., in the case of California) that they would require liquidity.
Retirement ambitions, risk tolerance and life expectancy vary across age, gender and wealth levels.
Employment patterns change over time (i.e., the gig economy doesn’t tether an individual to one company) and these plans need to be portable across state lines.

Given these circumstances, a new financial instrument is needed to enable financial security for retirees in the current environment.

The innovative SeLFIES design

DC investors seek to ensure a guaranteed, real income, ideally from retirement to death. They want to lead a lifestyle comparable to their pre-retirement lifestyle. But investing in existing risky assets (stocks, bonds, or REITs) doesn’t provide a simple cash flow hedge against desired retirement income. For example, viewed through the retirement income lens, a portfolio of traditional, ‘safe’ government securities, unless heavily financially engineered, would be risky because of the potential cash flow and maturity mismatch between traditional bonds and the desired income streams.

We think governments should issue a new ‘safe’ bond instrument, which we call SeLFIES. These would ensure retirement security and the government is a natural issuer [2]. A default-free bond offers certainty for DC retirement portfolios:

A commitment to pay over a particular time horizon (how/when one is paid).
A specific cash flow (what is paid). DC investors require a guaranteed cash flow that protects their real purchasing power in retirement. Two simple innovations could create the ‘perfect’ instrument.

The first innovation addresses ‘how/when one is paid.’ SeLFIES create forward-starting, income-only bonds. Forward-starting means that these bonds do not start paying immediately, but rather at some future date. Coupons-only payments would start at retirement and last for a period equal to the average life expectancy at retirement (e.g., U.S. bonds would pay for 20 years) [3].

Investors who are saving for retirement don’t need coupon payments while still employed (the payments would have to be re-invested and create interest rate risk) or a stub principal payment at the end. They need a smooth stream of real cash flows. That’s why SeLFIES are forward-starting and coupon-only. They pay people when and how they need it, blending accumulation and decumulation by incorporating the retiree’s desired annuity-like cash flow profile in the payout phase.

The second innovation addresses ‘what is paid’ by indexing the bonds to per capita consumption. With longevity increasing, cumulative increases in the standard of living can leave a retiree feeling ‘left behind,’ just as inflation causes nominal fixed income retirees to experience a decline in standard of living. Instead of a Treasury inflation-protected securities (TIPS)-like adjustment, focused solely on inflation, SeLFIES would cover both the risk of inflation and the risk of standard of living improvements. (Right, Robert Merton).

SeLFIES foster self-reliance

SeLFIES would pay the holder annually for 20 years, starting at a fixed future date with a fixed amount (say $5), indexed to aggregate per capita consumption [4]. Today’s 55-year-olds would buy the 2027 bond, which would start paying SeLFIES coupons upon retirement at 65 in 2027, and keep paying for 20 years, through 2047.

SeLFIES greatly simplify retirement investing by allowing participants to be self-reliant in managing their portfolios. These innovations allow anyone to plan his or her retirement—without requiring a forecast of expected returns, optimizers/retirement calculators, or even intermediaries.

For example, if investors want to guarantee $50,000 annually to maintain their standard of living risk-free for 20 years in retirement, they could buy 10,000 SeLFIES ($50,000 divided by the $5 real coupon) over their working lives. The complex decisions of how much to save, how to invest, and how to draw down are simply folded into a calculation of how many SeLFIES to buy.

In addition to being simple, liquid, easily traded, and with low credit risk, SeLFIES can be bequeathed to heirs, unlike high-cost, inflexible and illiquid annuities. The inheritability of SeLFIES overcomes investor fears that premature death will “leave money on the table.” Buying SeLFIES would be similar to creating an individual DB plan, with a guaranteed pay-out determined by the number purchased. Further, investments in these bonds would be portable across states.

SeLFIES could become the safe asset in target-date strategies, in lieu of inflation-linked or GDP-linked bonds. They could also be used as safe, liability-hedging assets in dynamically managed target-income strategies—allowing investors to target a higher retirement standard of living or higher income by investing in risky assets early in their life cycles, then investing in SeLFIES dynamically to lock in their gains. (Left, Arun Muralidhar).

Further, simple account statements would illustrate the level of real, locked-in retirement standard of living, based on the number of bonds purchased. In today’s DC plans, statements that focus on wealth accumulation give investors no sense of their retirement standard of living or how they can achieve their retirement objectives.

The design of SelFIES would provide plan sponsors with a low-cost, low-risk default option for participants, and a safe harbor from legal risk. Furthermore, the insurance industry could use SeLFIES to improve their ability to hedge liabilities and to offer new low-cost annuities.

Longevity risk protection

As governments struggle to finance infrastructure, bonds with steady payments and forward-starting (deferred) payment dates offer an effective mechanism to finance such needs. Cash flows from SeLFIES offer governments an effective way to collect monies today for upfront capital expenditures for infrastructure projects, and pay these back in the future, once the projects generate revenues.

There are other benefits. Many U.S. DC corporate and endowment pension plan sponsors are being sued for allegedly costly or risky investment and pay-down options. There is a danger that, in response, many sponsors may choose not to offer any plans (DB or DC) to avoid legal risk. This would force more employees to make their own arrangements, and the resulting uncertainty would raise the cost to governments of ensuring retirement security among the aged.

SeLFIES can’t do everything. They can hedge interest rate, inflation, and standard of living growth risks, but they will not solve issues like insufficient savings, insufficient income growth (which locks in a low standard of living in retirement), or the cost of hedging longevity risk. For longevity risk protection, individual plan participants could purchase long-deferred annuities that pay out beyond age 85. The deferred annuity approach, combined with SeLFIES, would hedge individual longevity risk while preserving financial flexibility and control, and can be incorporated into a well-designed target income product.

Dr. Robert C. Merton, recipient of the 1997 Alfred Nobel Memorial Prize in Economic Sciences, is the School of Management Distinguished Professor of Finance at the MIT Sloan School of Management. He is also resident scientist at Dimensional Fund Advisors, a Texas-based global asset management firm.

Dr. Arun Muralidhar, author of “50 States of Grey and Rethinking Pension Reform” (with the late Franco Modigliani), is adjunct professor of finance at George Washington University, academic scholar advisor at the Center for Retirement Initiatives at Georgetown University, and founder of MCube Investment Technologies and AlphaEngine Global Investment Solutions.

Footnotes

R.C. Merton (2014). The Crisis in Retirement Planning, Harvard Business Review, July–August 2014.
Governments frequently serve the function of completing financial markets. Two examples related to meeting retirement funding needs are Japan’s issuing of a 40-year ultra-long bond in 2007 to provide a hedging instrument for pension funds and insurance companies, and UST issuing TIPS in 1997 to allow hedging of inflation risk.
See A. Muralidhar (2016). An Inventive Retirement Solution. Investment & Pensions Europe, June 2016.
A variation of this idea was first addressed in Robert C Merton (1984). On Consumption Indexed Public Plans. Financial Aspects of the US Pension Systems. Eds. Z. Bodie and J. Shoven, National Bureau of Economic Research, Cambridge, MA.

DOL Hints at Regulatory ‘Relief’ for Indexed Annuities

Posted on April 6, 2017 by Kerry Pechter -

When the Obama Department of Labor’s fiduciary rule, with little warning, decided last year that agents who sold indexed annuities couldn’t take commissions from insurers without signing the legally-binding “Best Interest” pledge to their clients, the $60 billion a year indexed industry went into fibrillation.

But the Trump DOL’s April 3 letter on the rule not only delayed its effect until at least the end of 2017, but also hinted that the DOL will reverse itself and allow complex indexed annuities and variable annuities to be sold on commission under so-called Prohibited Transaction Exemption 84-24, or PTE 84-24, which is the same light oversight applied to plain-vanilla fixed deferred annuities and single-premium immediate annuities.

“While it is not yet clear if the shift in allowing all annuity products to be covered by PTE 84-24 is more than a transitional tactic that will revert to the original plan next year,” wrote industry consultant Steven Saltzman in a client letter this week, “it could be a signal in terms of where a revision to the rule could be heading. At minimum, firms should consider outcomes related to the prospect of eventual use of PTE 84-24 for all annuities.”

Saltzman pointed page 55 of this week’s DOL letter:

“From June 9, 2017, until January 1, 2018, insurance agents, insurance brokers, pension consultants and insurance companies will be able to continue to rely on PTE 84-24, as previously written, for the recommendation and sale of fixed indexed, variable, and other annuity contracts to plans and IRAs,” it said.

“Some parties have expressed a preference to continue to rely on PTE 84-24, as amended in 2006, which has historically been available to the insurance industry for all types of annuity products,” the letter continued. “The Department notes that it is considering, but has not yet finalized, additional exemptive relief that is relevant to the insurance industry in determining its approach to complying with the Fiduciary Rule.”

If such “additional relief” is forthcoming, it could resolve the index annuity industry’s recent troubles. After peaking at more than $15 billion in the second quarter of 2016, sales faded somewhat in the second half of the year on fears that the fiduciary rule would discourage sales on commission. Rich commissions for insurance agents—along with a persuasive “downside-protection-with-upside-potential” marketing story—have driven the indexed annuity sales since its inception more than 15 years ago.

Lobbying almost certainly helped. There has been strenuous pleading by the National Association of Fixed Annuities and other insurance trade groups over the past year on behalf of indexed annuities, with “fly-ins” to Capitol Hill to visit legislators. Ironically, the same career DOL lawyer who wrote the Obama-era fiduciary rule, Tim Hauser, penned the latest letter.

“We are members of NAFA,” said Michael Tripses, CEO of CreativeOne, an insurance marketing organization whose agents sell indexed annuities. “Yes, we are tirelessly advocating and supporting legal costs. [We] will be lobbying the Hill in June. Of course others are lobbying as well, the American Council of Life Insurers, the Insured Retirement Institute, the National Association of Insurance Commissioners, et cetera, but NAFA is the one with the most focus on fixed annuities.”

More than 50 life insurance companies issue indexed annuities. Perennially, the largest seller has been Allianz Life, with a market share of 14.3% at the end of 2016. Its Allianz 222 product was the top selling indexed annuity for the tenth consecutive quarter in the fourth quarter of last year. The next four largest sellers included Athene USA, American Equity Companies, Great American Insurance Group, and AIG.

At least three insurers—Allianz Life, Great American, Lincoln Financial—created no-commission indexed annuity products in the past year. These contracts were designed to be sold by advisors who have stopped selling product on commission in order to avoid signing the fiduciary rule’s Best Interest Contract Exemption, and have switched to earning fee income based on a percentage of the value of the assets they manage.

The Best Interest Contract (BIC) Exemption is perhaps the most resented element of the Obama DOL’s fiduciary rule. In transactions where clients were using tax-deferred IRA money to buy an annuity or a mutual fund, the agent, broker or advisor couldn’t accept a commission from the product’s manufacturer without signing this contract.

Some broker-dealers have been willing to sign the BIC, while others have not. The contract was designed to make the commission, and the advisor’s conflict of interest between the client and the manufacturer, fully transparent. Most importantly, the contract enabled dissatisfied clients to participate in class action lawsuits against the advisor and his wholesaler or broker-dealer. In the absence of the contract, clients could only take their grievances to arbitration panels.

The April 3 letter and the delay of the fiduciary rule until the end of the year also makes moot, Tripses told RIJ, an earlier proposal by the DOL, published in the Federal Register last January 19, that would have allowed only the largest insurance marketing organizations (IMOs) to be paid as wholesalers of indexed annuities that were sold by agents receiving third-party commissions.

The DOL thought that only the largest IMOs could take on the legal liability and agent oversight responsibilities of the BIC Exemption. According to the January 19 proposal, the DOL would “require the insurance intermediary to have had annual fixed annuity contract sales averaging at least $1.5 billion in premiums over each of the three prior fiscal years to qualify as a Financial Institution.

“This proposed threshold is intended to identify insurance intermediaries that have the financial stability and operational capacity to implement the anti-conflict policies and procedures required by the exemption.”

A Bold, Direct-Sold, Multi-Premium DIA from Nationwide

Posted on April 6, 2017 by Editorial Staff -

Anticipating the Uberization of annuity sales, Nationwide is piloting a potentially all-digital, direct-sold, multi-premium income annuity called “Guaranteed Retirement Income from Nationwide.” It would provide “monthly income for life after age 65 in exchange for small, consistent contributions over time,” the company said in a release this week.

The new product, currently available only in a pilot program in Arizona and accessible only through a portal on Nationwide’s website and not available from advisors, is designed for middle-class investors over age 35 with household incomes between $50,000 and $200,000, Nationwide senior vice president of life and annuities Eric Henderson told RIJ in an interview today.

Marketing for the program will be largely passive, as Nationwide expects that self-directed people looking for retirement income will come across links to the portal during their online searches. If the program is successful in Arizona, the company plans a national launch.

According to Nationwide:

Consumers can sign up for the product and manage their accounts online. There are no fees to sign up or for on-going administration.
Contributions can be as small as $10 per month or $120 a year.
The product is a fixed annuity, paying an income that isn’t affected by market volatility.
Participants can contribute between $120 and $12,000 a year for 15 years or until they are 65, whichever is the longer period of time.
Customers may contribute monthly, quarterly or annually and can increase or decrease their contributions at any time.
Nationwide requires purchasers to make at least one payment per year for at least 15 years or it will return the premium to client without interest. Paying interest on surrenders would encourage clients to look at the annuity as an investment account, not an income source, Henderson said.
If the purchaser dies, any unpaid premium is returned to his or her heirs without interest.
Purchasers permanently lock in the interest rate that’s used at the time of their first payment. For the sake of simplicity, benefits are not recalculated when interest rates change.
An online calculator will show people, for instance, how much monthly income they can expect in retirement in return for predictable monthly contributions.
People with existing accounts can use a calculator after logging in to simulate changes to contributions and potential outcomes.

The product’s strategy and design are predicated on Nationwide’s market research, which has shown that more than half of middle-class Americans don’t work with a financial advisor, that most retirement savings options are too complex, and that only 58% of workers in the U.S. have access to an employer-sponsored retirement plan.

Nationwide has also concluded that enough people are now adequately comfortable with an all-digital solution, even for traditionally “sold, not bought” income annuities. The program is designed to be done entirely online, in do-it-yourself fashion, without even the licensed representatives that one might encounter while buying an annuity through Hueler’s Income Solutions, Immediateannuities.com, Annuityfyi.com, or Fidelity’s annuity platform. It’s Nationwide’s acknowledgement of the digital future, according to Henderson.

“Our research found that most consumers are comfortable managing their finances online, and fewer middle-income consumers are using financial advisors to help with retirement planning,” he said in a release.

“We also know that these consumers prefer to conduct upfront product research online. Guaranteed Retirement Income from Nationwide provides consumers with an online retirement income savings option that doesn’t require a large initial investment.”

As of March 2017, Guaranteed Retirement Income is available exclusively to residents of Arizona between the ages of 35 and 70. The state’s middle-market demographics reflect the country’s and the company’s “solid brand presence and awareness in the state” made it natural choice for the pilot, Henderson said.

Retirement Clearinghouse gathers allies for its ‘auto-portability’ solution

Posted on April 6, 2017 by Editorial Staff -

First there was auto-enrollment, then auto-escalation. The latest proposal on the table, one that’s waiting for the government to approve it as a qualified plan default for automatically enrolled qualified plan participants, is “auto-portability.”

Auto portability is described by its creator, Retirement Clearinghouse (RCH), as the “routine, standardized and automated movement of a retirement plan participant’s 401(k) savings account from their former employer’s plan to an active account in their current employer’s plan.”

Auto-portability is “designed to work within the existing platforms and data flows of the country’s qualified 401(k) plan system,” according to a release that followed a presentation on the subject in Washington, D.C. last week. The system was conceived by RCH, which is owned by Charlotte, NC, billionaire entrepreneur Robert L. Johnson.

The main purpose of auto-portability is to prevent “leakage”—that is, the tendency of job changers with small 401(k) balances to spend their modest savings before they have a chance to amount to much. If auto-portability were fully implemented and if future leakage were limited to “hardship” withdrawals, current and future retirement savers would save $2 trillion more, in today’s dollars, by age 65, according to data presented by the Employee Benefit Research Institute.

Jack VanDerhei, Research Director at EBRI, presented these findings at “Retirement Plan Portability & Public Policy: Unlocking the Potential in Portability,” a forum hosted by the Financial Services Roundtable on March 30, 2017 in Washington, D.C.

Other speakers at the meeting were RCH president and CEO Spencer Williams, former Sen. Kent Conrad (D-ND), representing the Bipartisan Policy Institute, and Steve Saxon, principal and chairman of Groom Law Group, who is RCH’s legal advisor.

In June 2016, the Bipartisan Policy Center’s commission recommended the establishment of a nationwide retirement account clearinghouse, operated by the private sector, to make sure that retirement savings account balances follow workers from job to job.

Retirement Clearinghouse, LLC is a provider of portability and consolidation services for defined contribution plans, receiving transfers of small-balance 401(k) accounts that former participants have left behind and providing them with rollover IRA custody services until the owners claim them.

Retirement Clearinghouse’s portability solutions include a domestic call center providing specialized assistance designed to enable end-to-end portability and account consolidation; uncashed check services; and the capability to search for lost and missing participants.

Established as RolloverSystems in 2001, Retirement Clearinghouse serves some 20,100 retirement plans with more than 1.1 million plan participants and more than $16 billion in retirement savings.

Retirement trade groups gird to protect ‘tax deferral’

Posted on April 6, 2017 by Editorial Staff -

An armada of retirement industry groups announced its intention this week to defend the nation’s $100 billion-a-year tax expenditure for incentivizing long-term savings from Republican tax reformers who might be tempted to cannibalize it to make room for cuts to income tax rates, the capital gains tax or the estate tax.

“Tax reform is a worthy goal,” said a release this week from the Save Our Savings Coalition. “On the other hand, misguided proposals could unintentionally undermine the incentive for employers to offer retirement plans or for working people to save,” said Jim McCrery, former Ranking Member of the Ways and Means Committee.

The membership list of the SOS Coalition encompasses a $25.3 trillion industry. That’s the value of U.S. retirement assets invested in the equity and fixed income markets at the end of 2016, the release said. The Coalition believes that, without the incentive of tax deferral, Americans would not save nearly as much as they do.

“We need to make sure people continue to have access to retirement plans,” the release said, “because everyone deserves the opportunity to retire with dignity and financial independence.”

Not all members of the coalition necessarily share the same views on all access-related issues. Some members recently applauded the legislative defeat of a regulatory exemption that would have made it easier for cities to require companies that don’t currently offer retirement plans to either sponsor a plan or default employees into state-sponsored IRA-based savings plans at work.

Under our voluntary 401(k) system, workers have no access to the largesse of tax deferral unless their employer chooses to set up a plan. Large companies almost universally offer retirement plans, but many small companies do not. Some studies show that only about half of workers have access to a retirement plan at work at any given time.

The Coalition includes:

American Benefits Council
American Retirement Association
Committee on Investment of Employee Benefit Assets
Defined Contribution Institutional Investment Association
Employee Benefit Research Institute
Financial Services Roundtable
Investment Company Institute
New Economics for Women
Northern Trust
Plan Sponsor Council of America
Principal
SPARK Institute
TIAA
Women’s Institute for a Secure Retirement

Athene Holdings gets a ratings upgrade

Steve Harris to lead compliance at Lincoln Financial

Fidelity & Guaranty Life terminates merger agreement

eMoney launches ‘best interest’ compliance tool despite uncertainty

In 2016, New York Life again dominates income annuity sales

About one in four Americans feels financially insecure: Northwestern Mutual

Funded status of biggest pensions hovers at about 81%: Milliman

Data Connection

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