JULY Inside this Issue

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1 JULY 2013 Eric Nordman CIPR Director Kris DeFrain Director, Research & Actuarial Shanique (Nikki) Hall Manager, CIPR Dimitris Karapiperis Research Analyst III Anne Obersteadt Senior Researcher Inside this Issue Private Equity and Hedge Funds Seek to Move into the Insurance Arena 2 The NAIC Financial Analysis (E) Working Group recently noted the increased interest by private equity-backed en es and hedge funds in managing life and annuity investment assets. Another trend making headlines is the recent establishment of several hedge fund-backed, offshore reinsurers. This ar cle will examine these two growing trends and discuss some of the key regulatory concerns. Focusing on Flood Insurance and Implementa on of the Biggert-Waters Flood Insurance Reform Act of In July 2012, the U.S. Congress passed and President Barack Obama signed into law the Biggert-Waters Flood Insurance Reform Act of 2012, which reauthorized the Na onal Flood Insurance Program through Sept. 30, 2017, and made a number of reforms aimed at making the program more financially and structurally sound. This ar cle focuses on implementa on of the changes required by the legisla on over the coming year. Re rement: Will You Need a Golden Egg for Your Golden Years? 8 Sound planning for re rement is complicated, and lack of planning can prove disastrous. This ar cle will examine how the median re rement age has been steadily increasing and some of the factors behind this trend. The ar cle will also discuss in great detail some of the tradi- onal and emerging re rement products available to help plan for re rement. Insurance Consumers with Demen a: Regulatory Implica ons 16 Demen a is something we hear a lot about in the news and con nues to be a growing issue in many realms, including the insurance industry. This ar cle will bring a en on to some of the issues surrounding the sale of insurance and/or annuity products to seniors with demen a. The Rela onship of Insurance Ac vity and Economic Growth 18 The insurance industry is recognized as an important part of the financial services sector and an essen al component of economic growth. The aim of this ar cle is to explore the role the insurance industry plays in the overall economy and track the rela onship between the industry s performance and economic stability and growth. CIPR Symposium Explores Health Care Reform Issues 24 The CIPR recently hosted a symposium tled, Health Care Reform Tools for Oversight and Assistance in the New Marketplace. A primary objec ve of the symposium was to review and discuss many of the tools and resources available to assist with the Web-based insurance marketplaces. This ar cle provides an overview of the most per nent topics of the symposium. NAIC Central Office Center for Insurance Policy and Research 1100 Walnut Street, Suite 1500 Kansas City, MO Phone: Fax: h p://cipr.naic.org NAIC s SVO Regulatory Treatment Analysis Service 28 In addi on to monitoring the solvency of insurers as an important consumer protec on, state insurance regulators also monitor the general insurance and financial markets in which their insurers par cipate and are impacted. This ar cle will discuss how the NAIC Securi es Valua on Office (SVO) aids in both of these monitoring processes as well as an overview of their Regulatory Treatment Analysis Service. NAIC Research and Actuarial Department: Data at a Glance 29 July 2013 CIPR Newsle er

2 P E H F S M I A By Michele Lee Wong, NAIC Capital Markets Bureau Manager, and Ryan Couch, NAIC Reinsurance and Surplus Lines Manager I The NAIC Financial Analysis (E) Working Group (FAWG), which coordinates mul -state efforts in addressing solvency problems, including iden fying adverse industry trends, recently noted the increased interest by private equitybacked en es and hedge funds in managing life and annuity investment assets, either through the acquisi on of life insurers or the reinsurance of life and annuity risks. This growing trend, which has been the subject of recent news ar cles, was highlighted in a memorandum from FAWG to its parent Financial Condi on (E) Commi ee earlier this summer. The memorandum outlines related concerns and provides poten al considera ons on how to approach the issue from a regulatory perspec ve. The E Commi ee was suppor ve of FAWG s ini al recommenda ons and recently agreed to establish a new working group to look at the issue more closely. The working group will consider, inter alia, the development of procedures and best prac ces that regulators can use when considering ways to mi gate or monitor associated risks. Another trend making headlines is the recent establishment of several hedge fund-backed, offshore reinsurers. This ar cle will examine these two growing trends and discuss some of the key regulatory concerns. P E F A L I A B B In recent years, a non-tradi onal acquirer of life insurance and annuity businesses has emerged. Private equity-backed en es have entered into the U.S. life insurance market primarily via acquisi ons but also through reinsurance agreements. With the protracted low interest rate environment and increasing capital requirements pressuring earnings and profitability, some life insurers have opted to exit certain underperforming segments or blocks of businesses, in par cular fixed annui es. However, these assets have been a rac ng non-tradi onal, financial buyers such as private equity-backed companies who are seeking to reduce their reliance on leveraged takeovers and believe they can manage the assets more effec vely with more aggressive investment strategies rather than tradi onal, strategic buyers such as other insurance companies. Athene Holding, Ltd. (Athene), which is affiliated with Apollo Global Management LLC, will become the second largest issuer of fixed indexed annui es in the United States, a er closing the acquisi on of Aviva plc s U.S. annuity and life opera ons (Aviva USA) later this year. 1 In connec on with this acquisi on, Athene has agreed to sell, through a reinsurance arrangement, Aviva USA s life insurance business to Commonwealth Annuity and Life Insurance Co. a wholly owned subsidiary of Global Atlan c Financial Group (formerly the Goldman Sachs Reinsurance Group). Athene has been ac ve in making acquisi ons of companies and blocks of business in the fixed annuity market since According to a Moody s Investors Service (Moody s) report dated May 2013, Athene has completed six fixed annuity acquisi ons since that me by either directly purchasing a life insurance company or reinsuring a block of business. Guggenheim Partners (Guggenheim), through its Delaware Life Holdings affiliate, has also been an ac ve player in this space. In December 2012, Guggenheim agreed to purchase Sun Life Financial s domes c U.S. annuity business and certain life insurance businesses. The annuity business includes both fixed and variable annui es marking the first me that Guggenheim has ventured away from fixed annui es and into the variable annuity market. Harbinger Capital Partners (Harbinger), a private investment firm specializing in event/distressed strategies, has also ventured into the fixed annuity space. Harbinger agreed to purchase the fixed annuity business of Fidelity & Guaranty Life in August 2010, but has not made any recent acquisi ons. Although private equity firms are well known for their investment exper se, they generally have a higher risk tolerance and invest more aggressively than a typical life insurer. For example, life insurers investment por olios are typically more weighted toward less risky and more stable investments (such as government securi es, investment grade corporate bonds and/or municipal bonds), while private equity-backed en es tend to invest more heavily in riskier and more vola le investments (such as high-yield bonds and structured securi es, which include residen al and commercial mortgage-backed securi es). In addi on, investors have varying investment horizons and investment strategies depending on their goals and objec- ves. For instance, life insurers typically engage in a buy and hold investment strategy focused on the yield or average rate of return earned if a security is purchased today and held to maturity. Because they tradi onally sell longtailed products in which claims on the policy are not expected to be filed for a long period of me, life insurers have a longer-term investment horizon. They focus on asset (Continued on page 3) 1 The New York Department of Financial Services recently expressed concern over this transac on. See: Spector, Mike and Scism, Leslie, New York Regulator Targets Insurer Deal, Wall Street Journal, July 15, July 2013 CIPR Newsle er

3 P E H F S M I A (C ) -liability management, as much as possible, closely matching their assets dura on to that of their longer-term liabili- es so that the cash flow streams of the investments are synchronized with when liabili es become due. Life insurers are generally less sensi ve to market value fluctua ons as long as their assets and liabili es are properly matched. Statutory accoun ng requirements in which life insurers generally report bond investments at amor zed cost, subject to valua on requirements for impairments are well aligned with insurers buy and hold investment strategy. A typical life insurers longer-term investment horizon also fits in nicely with the regulatory riskbased capital (RBC) framework and the model that is u lized to determine asset risk charges, as it assumes a 10- year me horizon (or holding period). Private equity-backed life insurance companies, on the other hand, are likely to invest on a total return basis the percentage gain (or loss) on a security based on the purchase price plus any interest, dividends or other income that may have been received or accrued in a similar fashion to their parent or affiliated sponsor. Total return investors ac vely trade in and out of securi es with a short-term view of maximizing capital apprecia on and income. Their focus is more so on risk-adjusted rela ve value where the a rac veness of an investment is measured in terms of risk, liquidity and return rela ve to another investment more so than asset liability management. This might possibly lead to an asset/ liability mismatch and might result in a ming issue whereby the insurer runs the risk of being forced to sell an investment at an inopportune me to meet an upcoming liability payment. In addi on, a private equity-backed insurer s focus on market value and shorter-term inves ng is inconsistent with the basis of amor zed cost in statutory accoun ng and the me horizon assump ons for bond investments in the RBC framework, respec vely. Private equity firms can have a number of different financial businesses under its umbrella, such as asset managers, broker-dealers or reinsurers, among others. There is, therefore, the poten al for intercompany transac ons with affiliates that could result in taking cash out of the insurance company. If the affiliated asset manager is hired to manage the assets of the insurance company, the insurer would have to pay a management fee for this service. The management fee should be reasonable and comparable to what others in the market are paying. Some mes, the asset manager might opt to hire a sub-manager to invest in a specific asset class that it does not have exper se in, crea ng the poten- al for addi onal management fees. It should also be noted that if the affiliated asset manager invests in funds or transac ons managed by the private equity sponsor, there might be addi onal fees charged. Furthermore, buy or sell transac ons with an affiliated broker-dealer might also generate more fees. All of these layers of poten al fees would result in cash being extracted out of the insurer and reduce the amount of cash available to meet future liabili es. Affiliated transac ons should be monitored closely, with regular repor ng of intercompany transac ons and/or targeted exams of investment por olios, or prohibited altogether if determined prudent to do so. Other intercompany transac ons that can result in taking cash out of the insurance company is the purchasing and selling of securi es with another account managed, maintained or trusteed by the asset manager. The concern is that a transac on will be executed at a price other than the current market price, resul ng in a poten al conflict of interest. Although this raises concerns, adequate safeguards such as requiring the documenta on of at least two broker quotes from unaffiliated broker-dealers for each transac on can be put in place to ensure that intercompany transac ons are executed at arm s-length. Although private-equity backed life insurers might follow different investment strategies than tradi onal life insurance companies, they can likewise effec vely manage their assets to meet future liabili es. However, there are some concerns related to their differing investment strategies which could poten ally lead to addi onal investment risks, as well as a ming issue, with mee ng their fixed guaranteed liabili es and the poten al for intercompany transac ons which could lead to cash being extracted out of the insurance company. These concerns can be mi gated somewhat with be er transparency and adequate safeguards, such as regular monitoring and repor ng. The recent trend of non-tradi onal acquirers of life insurance assets is expected to persist if tradi onal insurers con nue to opt for exi ng certain fixed annuity businesses given the protracted low interest-rate environment. H F -B R Over the past several years, hedge funds have primarily sought investment into the reinsurance market through alterna ve, or non-tradi onal, risk-transfer structures (e.g., catastrophe bonds or other insurance-linked securi es, collateralized reinsurance vehicles, sidecars, etc.), or by taking equity posi ons in holding companies that have reinsurance opera ons within the group. Over the past several months, substan al amounts of capital have been flowing into the non-tradi onal risk transfer space from hedge funds and (Continued on page 4) July 2013 CIPR Newsle er 3

4 P E H F S M I A (C ) other ins tu onal investors (e.g., pension funds, private equity, sovereign wealth funds, etc.). The primary a rac on to this market appears to be diversifica on from inves ng in a rela vely uncorrelated asset class that is currently providing a favorable yield when compared to other investment op ons. In addi on to the third-party capital surging into the nontradi onal risk transfer market, several hedge fund managers have recently demonstrated an increased interest in the tradi onal reinsurance market. Specifically, four start-up reinsurers backed by hedge funds were established in Bermuda during These include: Third Point Re ($780 million) established in January 2012 by John Berger, former chief execu ve of Harbour Point. AQR Re ($260 million) established in January 2012 by AQR Capital Management. PaCRe ($500 million) established in April 2012 by execu ves of Paulson & Co. SACRe ($500 million) established in July 2012 by SAC Capital Advisors. Each case essen ally consisted of capital being sent to Bermuda to establish the reinsurance en ty, and then sent back to the United States in order for the hedge fund to manage the respec ve reinsurer's investment por olio. Tradi onal reinsurers generally maintain rela vely conserva ve investment por olios due to the underwri ng risks inherent in their insurance/reinsurance business. In contrast to the tradi onal model, it is understood that these hedge-fund backed reinsurers intend to take on more risk within their investment por olio, while assuming less risk from an underwri ng perspec ve. In other words, they are seeking to deploy less of their available capital to underwri ng risks as compared to other tradi onal reinsurers (and, in many cases, assume reinsurance business with more predictable underwri ng results), while being exposed to the poten al for less-predictable, more vola le results from their invested assets. Naturally, there are ques- ons as to whether the hedge-fund approach to inves ng aligns with the tradi onal reinsurance model. According to a Bloomberg ar cle published in February 2013, the first prominent hedge fund to establish a Bermuda-based tradi onal reinsurer was Moore Capital Management LP in 1999 with the forma on of Max Re Capital Ltd. The ar cle notes that, while it was ini ally intended for Max Re to invest heavily in the hedge fund, the reinsurer never invested more than 40% of its assets in hedge funds, and currently invests less than 5% in such funds. A few years later, in 2006, Greenlight Capital Inc. established Greenlight Capital Re Ltd. (Greenlight Re) in the Cayman Islands. Greenlight Re, which became a publicly traded company in 2007, has successfully employed the hedge fund-backed reinsurer strategy since that me. However, a recent ar cle published by the website Artemis.bm highlights some of the poten al risk for increased vola lity in a hedge fund-backed reinsurer's investment por olio. According to the ar cle, Greenlight Re incurred investment losses of $52.2 million, or 4.4% of the value of its investment por olio, in the fourth quarter of From the hedge funds perspec ve, inves ng directly in a tradi onal reinsurer provides diversifica on within its overall investment strategy through exposure to a largely uncorrelated risk via reinsurance underwri ng. This strategy also provides the hedge fund with a steady inflow of investable cash from the reinsurance premiums collected by the reinsurer, along with fee revenue and a stable pool of assets under management through the investment management arrangement. U lizing a Bermuda based en ty reportedly provides certain tax advantages, as well. The Bloomberg ar cle referenced in the previous paragraph ques oned the legi macy of three of these arrangements, sugges ng that the primary purpose of the transac ons was to exploit a tax loophole, resul ng in reduced and delayed payment of U.S. income taxes by the hedge funds. Industry representa ves, regulators and government representa ves from Bermuda strongly rebu ed that argument, in part by no ng that these reinsurers are subject to the same regula on, oversight and repor ng as other Class 4 Bermuda-domiciled reinsurers, and that Bermuda has worked with the United States for many years in the area of tax coopera on. A.M. Best highlighted the developments related to hedge fund-backed reinsurers in a special report from December The report indicates that A.M. Best has now added hedge fund-backed reinsurers as a fourth category it tracks within the Bermuda market. The report also discusses how these reinsurers plan to take a different approach to the reinsurance market by seeking to balance opportuni es between the underwri ng and investment sides of the business depending on the respec ve market condi ons. A.M. Best suggests that this model is not likely the new reinsurance model for the future, but notes it may have its niche for some me. (Continued on page 5) 4 July 2013 CIPR Newsle er

5 P E H F S M I A (C ) A.M. Best has rated at least three of the four reinsurers men oned above as A-, based, in part, on the fact these reinsurers deploy less of their available capital to the underwri ng side of the business than other tradi onal reinsurers in an effort to offset the increased risk taken on within their investment por olios. According to a recent ar cle in Global Reinsurance, this model is being reconstructed to fulfill the needs of the investment community. SACRe chief execu ve Simon Burton is quoted in the ar cle as saying, The investment community is clearly sending us a message that they are dissa sfied with the packaging of reinsurers. From the U.S. regulatory perspec ve, state insurance regulators remain focused on the ability of an insurance company to pay claims. While these en es are not directly supervised by state insurance regulators, it is likely that these reinsurers will assume business from U.S. ceding insurers. With respect to reinsurance, state insurance regulators are primarily concerned with the solvency of U.S.-domiciled ceding insurers, the poten al impact that reinsurance agreements have on their financial condi on, and ul mately, the poten al impact to insurance consumers. With any reinsurer assuming business from a U.S. ceding insurer, the primary regulatory concern is with the quality of reinsurance protec on provided; i.e., that the reinsurer is willing and able to meet its obliga ons to U.S. ceding insurers when called upon to do so. Reinsurance is essen ally a contractual promise that a reinsurer will indemnify a ceding insurer for losses the ceding insurer incurs with respect to its underlying policies. In many cases, the reinsurer is not called upon to fulfill that promise un l many years a er the contractual obliga on is created. Without having any specific informa on regarding the investment por olios of offshore reinsurers, a logical concern with any reinsurer is that it has the assets available to sufficiently meet its obliga ons when those assets are needed. While no NAIC commi ee or working group has specifically discussed this development or taken any posi on with respect to these par cular hedge fund-backed reinsurers, generally speaking, the poten al for increased vola lity within a reinsurer's investment por olio is a reasonable cause for concern as to the reinsurer s poten al ability to meet its reinsurance obliga ons when they come due. U.S. state insurance laws regulate the credit for reinsurance a U.S. ceding insurer is allowed to reflect in its financial statements based on characteris cs of the reinsurer and the reinsurance contract itself. The U.S. regulatory framework includes substan al repor ng and disclosure requirements designed to monitor specific details with respect to U.S. ceding insurers counterparty exposures, and is designed to ensure that reinsurance agreements are transparently and accurately reflected in the statutory financial statements. It is cri cal for ceding insurers to effec vely manage their exposure to reinsurance counterparty risk, and it is equally important for insurance regulators to evaluate whether ceding insurers are doing so in an acceptable manner. The U.S. system does include certain mechanisms that have been developed in an effort to minimize this risk (e.g., collateral requirements applicable to reinsurance ceded to unauthorized reinsurers, and a new cer fica on process for reinsurers domiciled in qualified jurisdic ons in accordance with the recent revisions to the NAIC credit for reinsurance models). 2 The NAIC and state insurance regulators will con- nue to monitor these developments in the reinsurance market in an effort to address any concerns. 2 Credit for Reinsurance Model Law (#785) and Credit for Reinsurance Model Regula on (#786). July 2013 CIPR Newsle er 5

6 F F I I B -W F I R A 2012 By Sara Robben, NAIC Sta s cal Advisor and Brooke Stringer, NAIC Financial Policy and Legisla ve Advisor While state insurance departments regulate most types of insurance, the Na onal Flood Insurance Program (NFIP) is a federal program administered by the Federal Emergency Management Agency (FEMA). In July 2012, the U.S. Congress passed and President Barack Obama signed into law the Biggert-Waters Flood Insurance Reform Act of 2012 (BW-12), which reauthorized the NFIP through Sept. 30, 2017, and made a number of reforms aimed at making the program more financially and structurally sound. 1 Over the past year, a few of the provisions of BW-12 have been implemented, while others are being phased in over me. The purpose of the legisla on is to change the way the NFIP operates and to raise rates to reflect true flood risk, as well as make the program more financially stable. BW-12 also involves changes regarding how Flood Insurance Rate Map (FIRM) updates impact policyholders. These changes will affect some but not all policyholders over me. This ar cle focuses on implementa on of the changes required by the legisla on over the coming year. BW-12 K P R S C The first change resul ng from BW-12 was the crea on of an addi onal exemp on to the 30-day wai ng period for insurance coverage for private proper es affected by flooding from federal lands. This provision took effect shortly a er BW-12 was signed into law in July Sec- on of BW-12 addresses property owners affected by flooding on federal land caused, or exacerbated by, post-wildfire condi ons. Under these circumstances, an excep on to the 30-day wai ng period is implemented for a policy purchased not later than 60 days a er the fire containment date. 2 In light of the many wildfires in the United States in recent years, this change may prove to be important. Following this change, FEMA next began working on insurance premium adjustments designed to strengthen the financial solvency of the NFIP, as required by Sec on of BW-12. Beginning Jan. 1, 2013, a 25% increase in premium rates per year was put into place, and the increase is to con nue un l premiums reflect full-risk rates. This increase in premium rates affects homeowners with subsidized insurance rates on non-primary residences. The increase also affects structures built prior to the first FIRM (pre-firm proper es), which receive subsidized rates. These are proper es that have not been substan ally damaged or improved. The phase out of subsidies affec ng non-primary residences was also mandated by a previous NFIP extension bill that became law in May Sec on of BW-12 also addresses a phase-out of subsidies and discounts on flood insurance premiums for owners of business proper es with subsidized premiums; owners of severe repe ve loss proper es with subsidized premiums; and owners of any property that has incurred flood-related damage in which the cumula ve amounts of claim payments exceeded the fair market value of such property. These proper es will begin seeing a 25% increase in premium rates each year un l premiums reflect full risk rates. This subsidy phase-out is set to begin Oct. 1, Although BW-12 requires the elimina on of subsidies and discounts on flood insurance premiums, it also addresses policies that have lapsed or were not purchased prior to the enactment of the law. Beginning Oct. 1, 2013, full-risk rates will apply to owners of proper es that meet these criteria. 5 BW-12 further requires the phase-out of subsidies and discounts on all flood insurance premiums. Sec on of BW-12 phases out grandfathered rates and moves to riskbased rates for most proper es when a community adopts a new FIRM. If a community adopts a new, updated FIRM, grandfathered rates will be phased out. 6 These premium increases will be implemented in late To find out how a certain state will be affected, the NFIP has provided a Web page 7 that shows the number of subsidized flood insurance policies by state and by county. Zooming out and then clicking on a state will provide a pop-up of the state breakdown of policyholders, and zooming in un l the county outlines appear will provide the breakdown for specific coun es. Preliminary flood maps can be found at h p://hazards.fema.gov/femaportal/prelimdownload. In addi on to the premium changes, another provision in BW-12 designed to increase the fiscal soundness of the NFIP requires FEMA to build up a reserve fund to help cover losses in higher-than-average years. Most policyholders will see a new charge on their premiums to cover the reserve fund assessment. Ini ally, there will be a 5% assessment to all (Continued on page 7) 1 For addi onal informa on on BW-12 please see: Biggert-Waters Flood Insurance Reform Act of 2012, CIPR Newsle er, October cipr_newsle er_archive/vol5_biggert-waters_flood_reform_act_2012.pdf 2 P.L , Sec P.L , Sec P.L , Sec Ibid 6 P.L , Sec h p://bit.ly.15fukbq 6 July 2013 CIPR Newsle er

7 B -W F I R A 2012 (C ) policies except preferred risk policies (PRPs). The reserve fund will increase over me and will also be assessed on PRPs at a future date. R C A BW-12 I As BW-12 implementa on moves forward, cons tuent concerns over flood insurance premium increases have prompted some in Congress to pursue legisla ve efforts to delay implementa on of some of these reforms. Lawmakers from the Gulf Coast and the East Coast areas affected by Superstorm Sandy have been par cularly ac ve on this issue. As of June 2013, a total of seven pieces of legisla on have been introduced in the U.S. House of Representa ves and the U.S. Senate to delay the phasing in of higher flood insurance rates as required by BW-12. While none of these specific bills have advanced in either chamber, during considera on of the House fiscal year 2014 Department of Homeland Security Appropria ons bill (H.R. 2217), an amendment by U.S. Rep. Bill Cassidy (R-LA) was adopted by a vote of to delay, for one year, implementa on of Sec on of BW-12. The Senate Appropria ons Commi ee has approved its Homeland Security Appropria ons bill and included the same language as the House. The Senate bill now awaits floor ac on by the full Senate. An annual appropria ons bill only covers one year, so this does not mean that FEMA would be permanently prohibited from implemen ng this provision. In addi on, the Senate Banking Commi ee is expected to hold a hearing this summer with FEMA s Director Craig Fugate to discuss the impact of implementa on of BW-12 s reforms. Save the Date CIPR SUMMIT: EXPLORING INSURERS LIABILITIES Tuesday, August 27, :00 AM - 2:30 PM During the NAIC Summer National Meeting in Indianapolis, IN Please visit the CIPR Events Page for the latest information: July 2013 CIPR Newsle er 7

8 R : W Y N G E Y G Y? By Cheryl Coffman, NAIC Sr. Data Management Specialist I When you hear the word re rement, it is easy to conjure up images of healthy, happy young at heart seniors relaxing on a sunny beach watching their grandchildren build sandcastles or play games of chase with the undula ng surf; and of those same seniors tootling back and forth across the con nent in their Class A motorhome replete with their cuddly miniature Yorkshire terrier. For some, this scenario is a pillar of the American Dream and, for those lucky enough to have made it through the Great Recession of 2007 rela- vely unscathed, these prospects are s ll within the realm of possibility. Sound planning for re rement is complicated, and lack of planning can prove disastrous. When it comes to re rement planning, the fact that so many Americans are not adequately prepared has been widely documented. This ar cle will examine how the median re rement age has been steadily increasing and some of the factors behind this trend. The ar cle will also discuss in great detail some of the tradi onal and emerging re rement products available to help plan for re rement. P R Planning for re rement takes on different a ributes, depending on where a person falls within the age-group meline. Those in the depression baby ( ), war baby ( ) and some in the early baby boomer period ( ) are in the stage where their goal is to manage withdrawal strategies from their por olio through the re- rement years. The transi on boomers ( ), who are currently on the cusp of re rement, are watching company pensions disappear, feeling the impact of the financial crisis on their re rement funds, and seeing home equity plumme ng in value. Their main focus is to have guarantees in their re rement por olio rather than risk losing money in another market downturn. The memory of the recent Great Recession, along with be er health in the golden years, and the desire to remain ac ve and produc ve has spawned a new era for the transi- on boomers: that of the phased re rement or so re- rement. Many companies have started to offer phased re rement programs that allow employees to par ally re- re and draw on half of their earned re rement benefits, but con nue to work part- me and earn pay. Stanley Consultants Inc. and the U.S. Office of Personnel Management are among those recognizing the benefit of retaining the vast experience of their more senior employees. Con nuing F 1: U.S. A E I W A R When you reach re rement age, do you think you will [con nue working, and work full me, con nue working, and work part- me, (or) stop working altogether]? (Asked of those who will con nue working or stop working) And would you do that [because you want to (or) because you will have to]? Apr 7-11, 2011 Apr 4-14, 2013 % % Will work, by choice Will work, by necessity Will work, unspecified why 1 1 Will stop working, by choice Will stop working, by necessity 3 3 No opinion 1 1 Source: Gallup. to work in part- me posi ons as an employee or as an independent consultant becomes a win-win for both the company and the employee. The company slows costs of training and produc vity losses ed to turnover and the employee remains engaged and produc ve. This concept of phased re rement was introduced in the 1970s in Sweden and is a growing prac ce in the United States. The companies receive value in a reduced payroll without the accompanying loss of an employee s exper se and experience. A recent Gallup survey found that many adults plan to con nue to work by choice or necessity when they re re (Figure 1). For seniors s ll trying to rebuild their re rement income, a phased re rement offers the ability to benefit from more me away from work while enjoying the security of a regular income. A recent survey by the Insured Re rement Ins tute (IRI) reported that the number of individuals age 65 and older s ll in the labor force was 17.9% in 2011, a sharp rise from 10.7% in Moreover, 34.9% of baby boomers surveyed in the study say they plan to con nue working past 65. A significant por on of this group (30.8%) as well as those in the Genera on X ( ) group (26.7%) are unsure of when they will re re. Among workers age 50 and older, 38% expressed an interest in the phased re rement program, with 78% of those interested sta ng that such a plan would (Continued on page 9) 8 July 2013 CIPR Newsle er

9 R : W Y N G E Y G Y? (C ) encourage them to work past their expected re rement age. More than six-in-10 boomers (64.4%) and seven-in-10 Gen Xers (70%) are an cipa ng that some form of work a er re rement will be a source of re rement income. 1 Wells Fargo observed in a recent re rement survey that those in the younger genera ons, Gen Xers and early Millennials ( ) say paying off large student loans (which exceeded the $1 trillion mark as of the end of ) and other debts is their top concern. They are faced with the op on of either paying down crushing debt loads in the immediate future or saving for something that is much further down the road. This fact has long-term consequences for a genera on who, if the current trend con nues, are going to be solely, or at least primarily, responsible for what their re rement looks like. Millions F 2: U.S. P A G L The longevity variable adds another element of complexity to re rement planning. A well-known company is currently airing a television commercial focused on a huge wall do ed with hundreds of blue s ckers placed by people asked to show the age of the oldest person they ve known. The purpose of the ad is to emphasize the need to have a financial plan in place for all of the years a er re rement not just the immediate few. The sheer number of boomers entering into their golden years has garnered considerable a en on to the myriad issues surrounding re rement. According to the U.S. Census Bureau, in 1950, the 25.5 million members in the 55 and older age groups comprised about 17% of the U.S. popula on. By 2011, there were 79.5 million in this same cluster and the percentage increased to 25.5%. The Census Bureau projects this same age grouping to reach 87.4 million (or 26.8%) by 2015 and 97.8 million (or 28.7%) by 2020 (Figure 2). The fact is, it is a gamble to determine how long a person will live and every expert has their own opinion regarding that bet. Every situa on is different. According to the U.S. Social Security Administra on (SSA), a man reaching age 65 today can expect to live, on average, un l age 84, and a woman turning age 65 today can expect to live, on average, un l age 86. The SSA expects about one out of every four 65-year-olds today to live past age 90, and one out of 10 will live past age Source: U.S. Census Bureau T I A R One of the cri cal decisions most people face regarding re rement is determining at what age to re re. Some have no choice because of company policies or illness or disability. But the vast majority will have to look at their op ons and make an informed decision. One of the greatest risks in op ng for an early date is that some or all of their re rement benefits will be exhausted before the end of their life me, when they will be in the greatest need generally because of health issues and the inability to re-enter the workforce. A recent Gallup Economy and Personal Finance survey showed that the average U.S. re rement age is now 61, up from 57 two decades ago (see Figure 3 on the following page). The survey also reported that 66 is the average planned age for those in the non-re red fac on. A MetLife Mature Market Ins tute report (May 2013) stated that, of the 1,003 surveyed that were born in 1946, about 52% are fully re red, 21% are employed full- me, 14% work part- me and 4% are self-employed. Of this group, the majority are planning to re re fully by the age of 71. P R When the SSA first started paying monthly benefits in 1940, it was never the inten on for those payments to comprise an individual s en re re rement fund. It is important to remember that Social Security allowances replace only about 40% of the pre-re rement income for an average worker, (Continued on page 10) 1 Insured Re rement Ins tute, Work and Re rement, Current Workers Expecta- ons vs. Re rees Real Experience, September Retrieved at: h ps:// avectra.myirionline.org/eweb/images/work%20and%20re rement.pdf. 2 According to the Consumer Financial Protec on Bureau rement-age.aspx. July 2013 CIPR Newsle er 9

10 R : W Y N G E Y G Y? (C ) F 3: A W A D R? Among Adults who are Re red Source: Gallup. while financial experts recommend at least 70% 80% for a comfortable re rement. This significant gap emphasizes the importance of having addi onal pensions, savings and investments; and, because the average baby boomer may spend 25 to 30 years in re rement, financial planners see this as more of an ongoing educa onal process than a point -in- me event. Solu ons should adapt as needs evolve through various phases of re rement. So, where do these addi onal funds come from? This is where each individual must set a goal and carefully assess their op ons to reach that objec ve. According to a recent Deloi e survey (2013), more than 58% of the general popula on currently does not have a formal re rement savings and income plan. This percentage increased to 70% among those who are not expec ng to leave the workplace for 15 years or more. Part of the issue is that many are simply not familiar with the variety of re rement product op ons available to them and have not made adjustments that truly reflect the increased cost of living or the decrease in their investment returns. Tradi onally, the rule of thumb was the 60/40 rule as re rement neared 60% stocks and 40% bonds with a move to 80% bonds a er re rement. This was sufficient for older genera ons who lived 10 years or less in re rement. Now though, with the increasing number of years spent in re rement, that conserva ve approach does not keep up with the increasing rate of infla on compared to historically low interest rates. Another issue that tends to fly under the radar is that of orphaned re rement plans. A person will typically work at seven different companies during their career and have a rela vely small 401(k) or other employer-sponsored account they leave behind. Rather than rolling each account into a single Individual Re rement Arrangement (IRA) that they monitor, those individual funds o en languish untouched since the last automa c-deposit contribu on and are generally off kilter with current investment mes. T R P Re rement plans come in all shapes and sizes, and new and innova ve products con nue to emerge as demographics change and workforce needs evolve. All products have their own strengths and weaknesses, and none offer the proverbial silver bullet; none of them stand alone to completely address all re rement risks. Especially considering that everyone s situa on is different, there is not a one-size-fits-all solu on but, rather, a compendium of asset-alloca on and risk-management strategies. Defined Benefit Plans Defined benefit (DB) plans, commonly referred to as tradi- onal pensions, are generally funded in total by the employer with guaranteed automa c payout amounts determined by an actuarial formula based upon an employee s salary, tenure of service and vested interest. Benefits are distributed through a life me annuity, with equal periodic payments for the rest of the employee s life. (Continued on page 11) 10 July 2013 CIPR Newsle er

11 R : W Y N G E Y G Y? (C ) T R P Employment-based benefit programs have existed in the United States since colonial mes and represent a partnership among businesses, individuals and the government. An employer-sponsored qualified re rement plan is one that meets requirements established by the Internal Revenue Service (IRS) and the U. S. Congress. There are currently 15 classifica ons of plans that fall under these auspices: 1. Individual Re rement Arrangements (IRAs) 2. Roth IRAs (k) Plans (b) Plans 5. SIMPLE IRA Plans (Savings Incen ve Match Plans for Employees) 6. SEP Plans (Simplified Employee Pension) 7. SARSEP Plans (Salary Reduc on Simplified Employee Pension) 8. Payroll Deduc on IRAs 9. Profit-Sharing Plans 10. Defined Benefit Plans 11. Money Purchase Plans 12. Employee Stock Ownership Plans (ESOPs) 13. Governmental Plans Plans A Nonqualified Deferred Compensa on Plans In 1875, the American Express Company was the first to provide this remunera on and, by 1987, more than 232,000 private DB plans covered nearly 40 million workers. Even though the Pension Benefit Guaranty Corpora on (PBGC) reports that the number of private DB plans has decreased to around 26,000, there are s ll more than 40 million covered workers. 5 As investment op ons change and the complexity and cost of maintaining these plans rise, a decline in the number of plans is expected to con nue. In a DB plan, the employer bears the investment risk. If the plan assets are not adequate to pay benefits, the company is responsible for making up the shor all. If a company is liquidated in bankruptcy, the PBGC guarantees certain benefits. These benefits offer an annuity that can provide a life me payment stream ensuring re rees do not outlive their re rement benefit. Consequently, DB plans can be an integral component of a fixed, guaranteed and secure re- rement plan. Although the number of DB plans con nues to decrease, the $2.6 trillion in assets 6 are a significant share of this na on s long-term capital, and the more than $169 billion paid out (2010) in benefits provides important re rement income to workers. 7 Defined Contribu on Plans The most significant growth in the type of re rement plans has been in the defined contribu on category (Figure 4). A defined contribu on plan provides a means for both employees and employers to contribute a steady stream of revenue into the employee s re rement account. The employee s benefits during re rement depend on the contribu- ons made to and the investment performance of the assets in the account, rather than on the employee s years of service or earnings history. According to the U.S. Department of Labor, the number of par cipants in defined contribu on plans increased from 11.5 million in 1975 to more than 88.3 million in 2010 (Figure 5 on the following page) and plan assets have grown from $74 billion in 1975 to more than $3.8 trillion in 2010 (Figure 6 on the following page). Defined contribu on plans differ from DB plans mainly in employee involvement. The employee is not only primarily responsible for contribu ng monetary funds to the plan, but also for determining the types of investments toward which the funds are allocated. This allows each individual to make choices based on their personal risk aversion (e.g., high risk but poten al of high gain; low risk with lower returns but less chance of loss). Most funds have certain immediate tax (Continued on page 12) F 4: N P P T P Source: U.S. Department of Labor, Employee Benefits Security Administra on rement/ret_12_q July 2013 CIPR Newsle er 11

12 R : W Y N G E Y G Y? (C ) F 5: N P P P T P F 6: P P A T P Millions Millions Source: U.S. Department of Labor, Employee Benefits Security Administra on. Source: U.S. Department of Labor, Employee Benefits Security Administra on. advantages and some have the added benefit of employer matching contribu ons. One codicil is that the funds in these plans may not be withdrawn by the investor prior to reaching a certain age without incurring a substan al penalty. These IRA plans have defined contribu on limits set by the IRS, known as the Sec on 415 limit. The total 2013 deferral amount, including employee contribu on plus employer contribu on, is limited to $51,000 or 100% of compensa on, whichever is less. The employee-only limit is $17,500 with a $5,500 catch-up for those over 50 years of age. These amounts generally increase each year and are indexed to compensate for infla on. Defined contribu on plans are also riskier for the employees. The employee bears the full risk of underperforming assets and extended longevity. Employees do have the op- on, however, of reducing the longevity risk by using those resources to purchase annui es at re rement as opposed to lump-sum withdrawals. Examples of defined contribu on plans include IRAs, 401(k) plans, 403(b) plans and 457 plans. Roth IRA The Roth IRA was introduced in 1996 as the newest addi on to IRAs available to individuals. It differs from other IRAs in tax treatments in that contribu ons are made from a er-tax earnings and, therefore, withdrawals are not subject to tax as ordinary income. Contribu ons to tradi onal IRAs are taxdeduc ble, but not those made to a Roth IRA. Required minimum distribu ons are not required at age 70½ but are required in tradi onal IRAs. When a Roth IRA is funded by rolling over a tradi onal IRA, yearly contribu- on limits do not apply to that ini al roll-over. This is commonly referred to as a backdoor Roth IRA. SEP IRA The Simplified Employee Pension IRA (SEP IRA) is a re rement plan vehicle for self-employed individuals and their employees. The plan is less complex and, therefore, easier to manage than other IRAs. The employee must establish his/her individual tradi onal IRA to which the employer will deposit SEP contribu- ons. One of the added benefits for employers is that contribu ons are discre onary, meaning they can skip contribu ons during those years when business is down. Contribu ons for employees cannot exceed the lesser of 25% of an employee s compensa on or the maximum limit set for that year ($50,000 in ). Withdrawals are taxed as ordinary income the same as with a tradi onal IRA. The age 70½ withdrawal requirement s ll applies. SIMPLE IRA A Savings Incen ve Match Plan for Employees (SIMPLE) IRA and the SEP IRA are similar in that both are less complicated to set up and manage and, therefore, easier for self-employed individuals. The 8 ons/p560/ch02.html (Continued on page 13) 12 July 2013 CIPR Newsle er

13 R : W Y N G E Y G Y? (C ) employer must have 100 or fewer employees who earned at least $5,000 during the preceding year. With this plan, an employer is required to make yearly contribu ons. Tradi onal IRA The tradi onal IRA is the most common type of IRA and, generally, the roll-over fund of choice when workers re re or change employers. When income falls below certain limits, contribu ons are tax-deduc ble, but are then viewed as pre-tax contribu ons and, therefore, subject to tax as ordinary income upon withdrawal. The minimum withdrawal at age 70½ is s ll applicable. 403(b) The 403(b) plan is for ministers, certain public school employees and employees of tax-exempt organiza ons established under Sec on 501(c)(3) of the Internal Revenue Code. This plan is established and maintained by the eligible employee. Accounts under this umbrella can be one of three types: (1) an annuity contract provided through an insurance company (also known as tax-sheltered annui es, or TSAs); (2) a custodial account provided through a re rement account custodian (investments are limited to regulated investment companies, such as mutual funds); and (3) a re- rement income account, for which investment op ons are either annui es or mutual funds. With this plan, the employee receives tax advantages through pre-tax contribu ons and tax-deferred earnings on contribu ons. Contribu ons made to a Roth 403(b) account enjoy the same tax-free withdrawal distribu ons as with a regular Roth IRA. 401(k) The 401(k) is the most common type of defined contribu on plan. Each employee decides how much to contribute and the employer deposits that amount into the individual s account on their behalf. The company serves as the plan sponsor but does not have anything to do with actually inves ng the money; rather, the employer contracts with another company to administer the plan and investments. The plan administrator could be a mutual fund company such as Fidelity, Vanguard or T. Rowe Price; a brokerage firm such as Schwab or Merrill Lynch; an insurance company such as Pruden al or MetLife; or a financial investment management firm such as Principal Financial. Each individual employee is then responsible for deciding how to invest their funds by choosing among the op ons offered through the plan administrator. Employee contribu ons are made with pre-tax dollars and are some mes matched up to a certain percentage by the employer. E M The re rement income market con nues to evolve as demographics change and more investors work with the technology available to research investments and manage their por olios. Investment plans are transforming, and hybrid forms combining the advantages of defined benefit plans with those of 401(k) plans are being developed to meet ever-changing needs. The two most common types of hybrid plans are cash-balance plans and pension equity plans. The formula for these plans consists of compensa on credit and interest credit. Compensa on credits end a er an individual terminates employment, but interest credits con nue un l a par cipant withdraws their benefit. Cash balance plans are in the pipeline as a fast-growing alterna ve to tradi onal defined benefit plans. There were 1,227 ac ve cash balance plans in By 2007, the number of ac ve plans expanded by 259% to 4,797. Although small compared to other types of plans, of significance is that, by 2010, there were more than 10.5 million par cipants in such plans and $777 billion in assets, compared to 41 million par cipants in DB plans, with $2.5 trillion in assets during the same period. IBM, AT&T, Boeing and Ford Motor Company are the largest holders of these plans, which combine the high contribu on limits of the DB pension with the flexibility and transferability of the 401(k). Companies are conver ng their DB plans in order to cap their pension liabili es. Some of the states are trying to follow suit, but state cons tu onality is causing some issues. Unlike 401(k) plans, which fluctuate with market returns, cash balance plans have a guaranteed return. The plan sponsor contributes money into an account based on a percentage of the employee s salary and a set interest credi ng rate represen ng a guaranteed rate of growth for each employee s balance. The rate is usually ed to the yield on the 10-year U.S. Treasury bond, but might be ed to a corporate bond index. The plan s trustees make all of the investment decisions. Payout op ons from the cash-balance plan include a singlelife annuity, a joint-and-survivor annuity or a lump-sum (Continued on page 14) July 2013 CIPR Newsle er 13