Tuesday, January 19, 2010

Bloomberg: Obama Administration Looks to Annuities to Improve on 401ks

What is old is new again...

 I've advocated that the 401k plan is going to be revealed as a massive disaster for the private sector American worker - of course many in the private sector never have been exposed to this paradigm shift and enjoy the old school pension plans.  But asking  said private workers to invest with a 30 year time frame, with a prudent savings discipline, and then having them make investment choices (with most Americans never taking a basic economics or finance class of a high school level) had all the makings of a disaster.  As we wrote a year ago in [Feb 7, 2009: WSJ - 5 Ways to Fix Up Your 401k Plan]

The move from pensions (which are unaffordable to companies in a global competition versus peers who do not need to fund them) to 401ks (which require diligence, stable job participation, 30+ year time horizons and financial acumen; all things severely lacking in the U.S.) will prove to be a long term disaster... but since it won't all explode in a 3-4 year time frame like the mortgage mess, this will be an issue that will come to the fore front over the long run. When many baby boomers realize they are going to be working "til they drop". (not to mention the cost is punitive to most small businesses, which employ the majority of Americans)

Savings is not part of our culture anymore. [Dec 29, 2008: What Happens if America Returns to a Historical Savings Rate?]   Delayed gratification is not part of our culture anymore.  And asking people to make investment decisions, when they have little to no exposure to the investment world, is a joke upon itself.  You see how many "do it yourself" home improvement projects work out, right?  Eventually a professional is called in to fix the mess the DIY person did.  Or better yet - are you asked to do surgery on your friends?  Or do you get a professional?  Yet somehow everyone is supposed to be an expert in "investing" with just a few hours a month of time spent (if that).  [please note - this is not to say many "professionals" in the investment world have done a good job taking care of their clients either!  It's all relative]

As with all things in Cramerica the push away from defined benefits was a great thing for corporations.  The risk was moved from the corporation to the worker, what is not to love? [Oct 20, 2009: WSJ - Slump Prods Firms to to Seek New Compact with Workers]  Even in the best of economies, and best of stock markets this would of ended up in horrors for reasons I listed above.  But throw in a bubble economy with a bubble stock market (with 2 crashes in a decade) - not to mention the fact that when needed the corporation can just walk away from matching [Jun 23, 2009: Companies Say Cuts are Here to Stay] (which is the only part of the 401k plan that in any way mirrored the definded benefit plan) and you have the steaming mess we have now. 

(please note - this discussion does not touch on the larger question of SHOULD corporations be involved in retirement and healthcare benefits; this is largely a US centric thought process)

Annuities seem like a reasonable middle ground, although the new age version needs to have far lower fees than the current private sector crop.  There needs to be a widespread retirement product that guarantees a steady stream of income - the 401k has proven to be a farce, and with the average "kitty" of something under $50K that should last the average American a good... 2-4 years.  Living on Ramen Noodles.

If these new proposals do catch mindshare, we can expect a massive win for (drumroll) the insurance companies .  I can almost see the lobbyists salivating from here.  That said, while not the perfect solution I am not sure what else could be offered in the imperfect world of retirement savings, that would save the most amount of Americans from themselves.  Effectively the annuity would be a self funded pension program... for those who can still save after a decade plus of inflation adjusted wage stagnation. [Apr 30, 2009: First Quarter Labor Costs Rise Least on Record]

  • The Obama administration is weighing how the government can encourage workers to turn their savings into guaranteed income streams following a collapse in retiree accounts when the stock market plunged.  
  • The U.S. Treasury and Labor Departments will ask for public comment as soon as next week on ways to promote the conversion of 401(k) savings and Individual Retirement Accounts into annuities or other steady payment streams, according to Assistant Labor Secretary Phyllis C. Borzi and Deputy Assistant Treasury Secretary Mark Iwry, who are spearheading the effort.
  • Annuities generally guarantee income until the retiree’s death, and often that of a surviving spouse as well. They are designed to protect against the risk that retirees outlive their savings, a danger made clear by market losses suffered by older Americans over the last year, David Certner, legislative counsel for AARP, said in an interview.
  • There’s a real desire on a lot of people’s parts to try to encourage something other than just rolling over a lump sum, to make sure this money will actually last a lifetime,” said Certner, legislative counsel for Washington-based AARP, the biggest U.S. advocacy group for retirees.
  • The average 401(k) fund balance dropped 31 percent to $47,500 at the end of March 2009 from $69,200 at the end of 2007, according to a Fidelity Investments review of 11 million accounts it manages.  The average balance of the Fidelity accounts recovered to $60,700 as of last Sept. 30 as the stock market rebounded.  (that extra $13K should get the average retiree through another 6 months of enjoying the 'good life')
For investing purposes - eventual winners may include:
  • Promoting annuities may benefit companies that provide them through employers, including ING Groep NV and Prudential Financial Inc., or sell them directly to individuals, such as American International Group Inc., the insurer that has received $182.3 billion in government aid.  
Oh the irony!
  • Retirement plans, including 401(k) accounts, held $3.6 trillion in assets at the end of the second quarter of 2009, while annuity investments of all kinds totaled about $2.3 trillion.
  • The top sellers of individual annuities in the U.S. include AIG, MetLife Inc., Hartford Financial Services Group Inc., Lincoln National Corp. and New York Life Insurance Co., according to figures from the American Council of Life Insurers for 2008. The top group-annuity sellers include ING, Prudential Financial, MetLife and Manulife Financial Corp.

Other options:
  • In addition to annuities, the inquiry will cover other approaches to guaranteeing income, including longevity insurance that would provide an income stream for retirees living beyond a certain age, she said.
  • “There’s been a fair amount of discussion in the literature taking the view that perhaps there ought to be more lifetime income,” Iwry, a senior adviser to Treasury Secretary Timothy Geithner, said in an interview.    “The question is how to encourage it, and whether the government can and should be helpful in that regard,” Iwry said.
Of course when it comes to the bottom line in Cramerica - it's all about the people lobbyists.  While the insurance lobbyists are giddy - the asset managers lobbyist are screaming about the dangers of such a move.  Much like buying drugs from Canada! They will kill you!  Don't make the switch away from the 401k model!
  • Asset managers are concerned the government may go too far in encouraging annuities, said Mike McNamee, a spokesman for the Investment Company Institute.
As stated above, today's version of annuities are fee rich, and not quite so wonderful - perhaps more competition is needed in the space to provide better products.... lobbyists for the industry however would object saying only the insurance companies specialized expertise would be helpful to the American people. 
  • John Brennan, the former chairman of Vanguard Group, the Valley Forge, Pennsylvania-based mutual-fund company, criticized annuities today as often expensive and offering little inflation protection. 
But there is always incremental improvements.. if only we had a will... and less lobbyists.
  • AARP’s Certner said policy makers could avoid many of those pitfalls by encouraging the use of group annuities, which are bought by employers rather than individuals and often carry lower fees, or using approaches that provide retirement income without commercial annuities.
Of course at the end of the story is some person living about 2 generations ago... ah, the simpler life when we could all live like public workers ;)
  • A better approach would be to give employers incentives to revive defined-benefit pensions, which have languished as employers have focused on cheaper and more flexible 401(k) plans, Ferguson said.
As they say... once you go 401k, you never go back!

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