Ahead: Dislocation, Turmoil, Angst… and Growth; The SEC Finally Speaks on Fixed Indexed Annuities

An open meeting took place on June 25 during which the SEC decided to propose a new rule (151A) that would require many fixed indexed annuities (those that count for virtually all of the sales made) to be registered as securities with the SEC. Chairman Christopher Cox made it quite clear that “senior investment fraud” motivated the SEC to act at this time.

Quoting past North American Securities Administrators Association (NASAA) President, Patty Struck, Chairman Cox referred to an indexed annuity marketing landscape “littered with slick schemes and broken dreams” that has been “devastating” to the victims and their families. You can read Chairman Cox’s full comments by clicking here.

What’s certain about the SEC’s action is that it comes in direct response to the failure of the indexed annuity industry to arrest incomplete, misleading and confusing sales practices that should have been shut down years ago.

What’s in store for the indexed annuity industry if- as I believe it will- the SEC’s proposed rule becomes law?

Continued turmoil in the fixed indexed annuity distribution channels, for one. As the center of gravity for distribution turns permanently toward broker-dealers, many independent marketing companies that wholesale these products may become marginalized.

Non-registered agents will be factored out of the distribution of fixed indexed annuities unless they opt to become registered representatives or Registered Investment Advisors. The RIA option is one fraught with peril for insurance agents, however. For more, click here.

Insurance carriers that manufacture fixed indexed annuities will fall into two camps. Some will see sales decline dramatically as their market share is taken away by others that adopt new business models, new technology and new (FINRA-reviewed) sales tools.

Consumers- especially millions of individuals entering the “Transition Management” phase of retirement- will be the big winners as improvements in indexed annuity contract designs in terms of greater transparency and improved pricing lead to the indexed annuity finally becoming a mainline product.

As I’ve always stated, wipe away the bad sales practices, overly complex contract designs, and too high fees and you are left with a value proposition- downside protection combined with upside growth potential- that is as important as any found in a financial product.

Two years ago Wealth2k introduced www.FIAToday, a compliant, technology-driven solution to the problem of poor fixed indexed annuity sales practices. Arguably, it was ahead of its time. The SEC’s action has just increased its value to all parties. Exponentially. FIAToday is available at no cost by clicking here.

Excerpts from my May 9 Keynote Address at the Structured Products Americas Conference: Creating a Smooth & Successful Introduction of Structured Products in the Boomer Retirement Market

At last week’s Structured Products Americas conference I spoke about the opportunities and challenges facing structured products providers (and distributors) as they set their focus on the U.S. Boomer retirement marketplace. The potential for structured products is simply enormous. As more advisors and their clients shift their attention to outcome-oriented investing strategies, the outlook for structured notes, ETNs and other structured investment products is bright.

That said, there are several issues that will test the industry before it reaches its full potential in the years ahead. Delivering education efficiently to huge numbers of people (both advisors and consumers) is one. Reigning in the tendency to engineer complexity into product designs is another.

When thinking about the potentially large share of retirement investing dollars that structured products may attract, I’m convinced that their success will not be fully realized unless the structured products industry finds ways to link its products to near perfect context for their selection. If it succeeds at this it will inspire confidence among investors and advisors that yields market share and profitability.

Structured Products Americas Conference
The Biltmore Hotel
Coral Gables Florida
May 9, 2008

Good Morning.

I’ve been looking forward to this meeting and the opportunity to describe what I believe is going to be required for a smooth and successful introduction of structured products into the Boomer retirement market.

I think about the issue of Boomer retirement, a lot. and I view it through two lenses.

In my commercial life, my company, Wealth2k, has been in the business of delivering comprehensive solutions for retirement income distribution since 2003. That’s the “ice age” of income distribution. We’ve seen a lot, and learned a lot, all of which is reflected in leading-edge programs such as The Income for Life Model.

In my non-profit life I’m a Director of the Retirement Income Industry Association where I have the privilege of working with a host of talented individuals- from industry and academia- who have come together across industries and business silos to engage in the retirement income conversation.

he role of the Retirement Income Industry Association is to be sort of a retirement income version of Switzerland, a neutral place where all silos can come together in an unbiased fashion. You can see this fact in the diversity of member companies RIIA has attracted. Names like Merrill Lynch, Bank of America, MetLife Financial, Goldman Sachs. Oppenheimer, Wachovia and UBS, to name a few.

I also learn a great deal about retirement through the interviews I conduct with academics and executive leaders in financial services. The interviews appear at my blog, and also as a monthly feature in Research Magazine.

So, I come to this meeting with some pre-conceived beliefs. Including that the Structured Products industry has the potential to define the future of retirement security in the United States. But how the industry gets itself out in front of tens of millions of Boomer customers is the key question. How it educates advisors, regulators and consumers, packages its products, creates vital context for structured products and communicates their value are big questions that I’m going to talk about.

Sometimes looking back over history can help us see things that we should or shouldn’t repeat.

History matters, of course. Recent history has shown that one type of structured product has been offered to retail customers in the U.S. since 1995. And if there ever was an index case to show how the structured products industry should not behave as it targets the consumer market, it’s showcased in the example of the 13-year history of the Equity-Indexed annuity.

Looking very much like a vanilla Structured Note, the first equity-indexed annuity was introduced in 1995 by Keyport Life Insurance Company. The annuity was called KeyIndex. The annuity had a five year contract term. It provided upside growth potential based upon a 95% participation in any potential growth of the S&P 500 over the term.

The annuity also offered downside protection based upon minimum guaranteed interest crediting equal to the original investment compounded at 3%. This meant that, at a minimum, the annuity owner would be guaranteed 121% of the original investment after five years.

What actually happened, of course, is that the people who purchased these annuities in 1995 did very well. They just about tripled their money. Pretty compelling.

If you looked at the structure of this first equity-indexed annuity, you could observe some things: First, it was easy to understand. Fairly transparent, uncomplicated, and uncluttered.

Second, it offered a pristine value proposition that was quite appealing to the consumers it was target to: upside growth potential combined with downside protection.

Third, if the growth in the S&P had not occurred, the annuity owner would not have been particularly disadvantaged. A 21% gain would have been quite acceptable.

Fourth, liquidity was generous. There was a deferred sales charge of 5% grading down to zero at the end of five years. The commission to the retail agent was 4%.

The target market for this annuity was the segment of investors age 60 and over. And so it represented a particularly suitable type of story to bring to people who were nearing or already in retirement.

By year 2000, when the first generation of KeyIndex annuities was coming up for renewal, much had occurred in the equity-indexed annuity industry. Other insurance companies that had seen the success that Keyport was enjoying and they began to develop their own equity-indexed annuity products.

It was at this point we began to see the usual knee-jerk reaction response by insurance companies to their perceived competitive threats: add complexity, bury higher loads and fees, reduce liquidity and play upon agents’ weaknesses in terms of prospecting and productivity by juicing-up compensation.

So by the year 2000, it was possible to exchange the Keyport annuity for another insurance company’s equity-indexed annuity that offered 125% of the upside performance of the S&P 500.

But, as you can imagine, there had to be another dimension to this second-generation equity-indexed annuity. A modifier, if you will. And there was. It was the introduction of daily averaging of index values in the calculation of the ultimate annuity accumulation value.

The effect of adding the averaging formula to the interest crediting calculation was to create an annuity with far less growth potential than the original Keyport annuity. But it also created an annuity which could be marketed and misrepresented as if, in fact, it was actually a superior product. After all, if 95% of something is good, 125% of something must be even better.
This is when we began to see widespread market conduct practices that featured agents explaining only the upside of equity-indexed annuities. Frankly, as time went on, most agents struggled to understand how these ever-more-complex annuity products credited interest.

As sales success followed the introduction of such products, the insurance companies engineered more novel “features” such as two-tiered interest crediting and “bonuses” on the invested premiums. So, before long, an equity-indexed annuity could be sold that provided a 10% bonus on the original investment, on top of the 3% minimum interest rate guarantee, and another 10% paid in commission to the insurance agent. That’s 23% out the door in the first year. How could the insurance company possibly make money on this deal when it was investing most of the premium in bonds paying 6%?

Gimmickry takes care of that issue. The penalty period for early surrender had been effectively made permanent, so the investor couldn’t really liquidate his or her account value. The base interest rate was only credited on 85% of the original investment, and the 10% “bonus” was more cute than credible.

In practice, the only way to get back one’s money without suffering a horrific financial penalty was to take systematic withdrawals over a minimum of five years, to which the insurance company imputed a withdrawal factor based upon a below market internal rate of return. This contract provision effectively reduced the withdrawal penalty level down from horrific to only severe.
A relevant question for us to ask is, “Was this particular annuity a success in terms of sales?” Did consumers really put their money into it?

If fact, this particular equity-indexed annuity was such a success that it became the most popular selling equity-indexed annuity in history of the business. About $20 Billion in total sales since its introduction.

The sales success of insurers offering equity indexed annuities with ever more complex and gimmickry features, low levels of liquidity, extraordinarily high expenses and double-digit commission rates caused something to happen that had never before been thought possible: that is, almost by definition, annuities became viewed as unsuitable for retirees. Having begun my career 31 years ago, and having been taught that the only people who were suitable for annuities were seniors, this was quite a remarkable achievement for the insurance industry.

By 2005, the equity-indexed annuity marketing environment had become so misleading, so predatory and so reckless that FINRA, an organization with no jurisdictional responsibility for oversight of the fixed annuity industry, stepped-in with its Notice to Members 05-50. That notice directed broker-dealers to assume suitability review for equity-indexed annuity sales, for product selection and even for the training of their registered representatives who would continue to market the products.
As you can imagine the consumer press began to notice what was occurring in terms of annuity marketing. So did a number of regulators.

Articles began to appear in newspapers and magazines that cautioned seniors to, “Avoid a Costly Mistake.”

The front page of the New York Times exposed an open secret in the annuity business: agents using specious professional designations to position them as specially trained to manage seniors’ financial needs.

The ultimate reflection of how crossed-up the annuity business has become occurred just a few weeks ago. Using the same format as it has employed to snare child sexual predators, Dateline NBC set up a hidden camera sting operation to catch insurance agents in the act of selling indexed annuities to seniors.

In recent years as the annuity marketing environment became more hostile, the response by equity-indexed annuity providers was to add more and more required disclosure forms at the point of sale. These companies’ legal departments may have advised this approach, but it has been entirely ineffective in mitigating the criticism, poor publicity, class-action litigation and regulatory sanctions that have plagued the industry.

The annuity business today is badly broken. In fact, it’s so broken that its level of success in what should be its greatest sales opportunity, ever- Boomer retirement- may be compromised. This is a fact that the structured products industry should pay close attention to. Not only for what it makes possible, but also for what it teaches.

What’s at Stake Over Retirement Income

All of us understand that there’s a lot at stake in terms the business opportunities around retirement income. When you think about the Boomers’ needs as they approach retirement, when you think about the strategies required for effective management of their post-retirement income distribution challenges, it’s easy to see that insurance companies possess inherent advantages over other industries. Such as, for example, the structured products industry.

It’s insurers who have the historical competency and vast experience in providing lifetime annuity guarantees, asset liability matching and longevitization. But what are these tangible advantages worth if the stench associated with the industry is so strong it repels its natural customers?

This is really a tragedy on a grand scale for the life insurance industry. And, because of guilt by association, the experience of the equity-indexed annuity business is problematic for the other annuity product silos as well, including variable annuities and immediate annuities. The typical consumer simply cannot differentiate between these different types of annuity contracts. They just hear the word “annuity” used in some negative context and they recoil.

Interestingly enough, there’s been one meaningful development that is making a positive impact on the equity-indexed annuity industry. That is an effort called FIA Today. It’s actually my brainchild, undertaken by my company, with the goal to transform the equity-indexed annuity sales process. It’s a web application.

FIA Today utilizes web-based technology, digital media and FINRA-reviewed educational presentations in order, for the first time, to place a neutral, unbiased education at the center of the equity-indexed annuity sales process.
With this web-based application insurance agents are able to explain equity-indexed annuities in a fair and balanced manner, and investors may gain a meaningful understanding of the risks and rewards of owning these products. Before FIA Today, investors only heard about the potential rewards.

There are two things that are very, very important about FIA Today. The first is that it relies upon a delivery format that is meaningful for today’s consumers. Specifically, the key educational tool, a FINRA-reviewed movie that is able to convey a compliant educational story, but do so in a way that doesn’t sacrifice sales appeal. The movie is delivered to the web browser, on-demand. It’s the consumer who is empowered to be able to learn without sales pressure.

The second important aspect is personalization in terms of compliant, advisor-personalized micro sites that function as personalized virtual advisors. These virtual advisors deliver the educational experience direct to the consumer’s web browser while maintaining the advisor’s identity and central role.

In my judgment, the deployment of a similar, technology-driven, advisor-centric educational application is urgently needed for the retail Structured Products marketplace. In fact, Wealth2k is going to provide it.

We have unambiguous indication from some of the largest distributors in the U.S. that they want it. They want it because they have a huge stake in seeing that both their advisors and retail investors are provided balanced, neutral and unbiased education on Structured Products. I believe that the providers of structured products have a similar stake in this effort.

Context and Relevance

Let’s focus on some of the issues that will be relevant to achieving large sales success in the Boomer retirement market.

Here’s a key word: Context

To achieve the greatest level of success, structured products must find the best Context for their selection by advisors and investors.

The logical context for structured products in the Boomer retirement market has two parts. The first is in playing a vital role in retirement Transition Management, and the second is playing a vital role in post-retirement income distribution

It’s in the opportunity around transition management that the equity-indexed annuity industry has blown its chance, paving the way for structured products to take away its market share.

In thinking about transition management, we likely all understand that in the 7-8 years preceding retirement, retirement assets may double. Investment losses during this critical period will cause a lifelong reduction in the amount of retirement income that can be generated.

Similarly, investment losses occurring in the years immediately following retirement will also cause a lowering of retirement income if not portfolio ruin.

If you make an investing mistake when you are still 20 years away from retirement, you have time on your side. The negative effects of the mistake can be mitigated. If you make a poor investing decision one year away from retirement you have a very big problem.

In part, this reality is driving lots of activity across the financial services industry. One reason is that we cannot know the ultimate levels of financial liability that the industry faces as a result of investing mistakes i.e. bad advice or products that crater during the distribution phase.

The Empirical Validation Framework (EVF)

What will the responses be to such mistakes from the courts, from Government regulators or from self regulatory organizations?
To mitigate this liability potential, on the one hand, and to develop a more meaningful approach for retirement investing, on the other, an effort is taking place at The Retirement Income Industry Association- or RIIA, as we call it. Work is underway to create the next-generation framework for retirement income investing.

Called the Empirical Validation Framework- or EVF- this initiative stems from the realization that the Markowitz, mean variance optimization paradigm is just too limited in scope to recognize the multiple risk factors retirees actually face.
We’d all agree that investment diversification has fueled the growth of financial services for the past several decades. However, it will take much more than MPT to power the industry over the next decades.

Moving beyond asset allocation to the new paradigm of retirees’ financial risk management, we can see that we have to add the components of pooling, hedging and risk free asset determination while still incorporating investment diversification.
If you think of this as a triangle you see Pooling, Hedging and Diversified Risky Assets at the various points of the triangle. With an important additional dynamic- advice- right in the center.

This arrangement is important because it more accurately aligns with the actual risks that retirees face, and with the strategies needed to mitigate those risks. RIIA has created a risk matrix in order to map the various risks so that people are able to better understand their full spectrum and how their personal situations may be impacted.

Once the risks are understood, advisors can begin to think about applying risk management approaches to these numerous risk factors.

When we think about investment diversification we think about what we might refer to as a prudent man index case for asset allocation. Call it 60% / 30% / 10%.

But when we think about retirement investing in the context of the EVF, we may think about this differently.
Maybe something that looks more like 40% / 40% / 10% / 10%

Now we’re covering the areas of Diversification, Pooling, Hedging, and the inclusion of Risk Free Asset (advice).

For any given investor these percentages may vary in recognition of individual investor suitability. That’s where the advice component comes in.

Financial services companies may implement the suitability-adjusted EVF with the specific products they offer. The EVF is product neutral. It does not identify the specific products that should be used to implement the risk management mandate.

That said, one can easily see a natural context for the value proposition provided by structured products. For example, in a solution for income generation based upon a strategic combination of products, structured products, for instance, designed to simultaneously grow and protect, and others designed to generate income , offer relevance that’s obvious.

In retirement income distribution there are several methodologies employed to generate income. I call these the religions of retirement income. Let me give you just one example of how the structured products business can capitalize.

One retirement income religion which is rapidly increasing in popularity is time-segmented asset allocation. This approach creates perfect context for structured products, where they me used as funding vehicles designed to meet time-specific targeted rates of return and targeted income levels. That’s a slam dunk if there ever was one

As I said the development of the retirement income EVF is being led by the Retirement Income Industry Association. RIIA’s Founding Chairman, Francois Gadenne, has energized the organization’s Research Committee on this project, and he has enlisted the participation of many noted academics from many universities.

The academics are conducting research in multiple areas that relate to the EVF including:

The optimum risk management allocations based on utility theory
The optimum risk management allocations based on consumption smoothing & living standard risk/reward framework
The impact of Arrow/Debreu State Preference Theory on risk management allocations, and,
– The impact of the Theory of Lifecycle Saving and Investing on risk management allocations

Now the emergence of a new retirement income investing framework implies much, including the imperative to train financial advisors on its use and context.

In fact, the very definition of a financial advisor’s role is in the process of undergoing transformation. Let me read this from one of RIIA’s Education Committee’s decks:

“As investors move through their lifecycle, approach retirement and live in retirement, a financial advisor is increasingly pressed to acquire new knowledge and to master new tasks that depart from traditional investment accumulation and move towards retirement income management. Such new knowledge and tasks have become sufficiently numerous and complex to require the formalization of new professional job definitions.”

RIIA is well into its development of this new job description, as well as a Body of Knowledge and curriculum for the training of FAs on these issues. It will offer a program for a new professional designation, Retirement Management Analyst(TM)- RMA- that will equip advisors with the skills they need to properly guide their clients through the distribution investing stage.

I’m not here to be a recruiter for RIIA- but I can’t help myself. It’s out of my passion I have for what the organization is contributing to the future health of retirement income businesses. No company intent on maximizing its opportunities in Boomer retirement can afford to not be member, in my judgment.

* * *

Formulating Success with Boomers

Let’s shift to something else. Let me talk about something close to my heart, something that I believe is vitally important to structured products providers and distributors. It has to do with a formulation for success with the consumer market.

Here’s my assertion: The key to success in delivering structured products successfully to the Boomers is not going to be found in a product or a piece of software. Instead, it’s going to be found in an emotion. It’s the emotion of Confidence.
Why is the creation of confidence so important? And confidence in what, exactly?

Here’s what I mean. Over 31 years in financial services I’ve seen one consistent phenomenon repeat itself over and over again during the accumulation phase. That is, investors putting their money into products that, at best, they only had a hazy understanding of. What these investors did have is confidence- in their advisors.

As we now look toward the years ahead in the distribution phase, I see the role of confidence changing in a significant and potentially dangerous manner. Due to financial liability potential that is so significant for all parties, I believe that investors will require confidence not only in the advisors, but also in the products, solutions and investing strategies themselves.

So, if I’m right about this- and I’ve staked a big bet that I am- then we have much work to do in the area of communications. Communications is the key to creating confidence.

Here’s the communications-based formula for the creation of confidence:
Clarity + Comfort + Compelling = Confidence

Clarity isn’t a commodity. Rather it’s the result of artful communications and storytelling.

Comfort is a by-product of Clarity. It’s the sense that clients understand and accept your clearly conveyed value.

Compelling is another word for “Why?” Why should the client select a particular product or strategy out of the universe of many?

The sum of Clarity, Comfort and Compelling is confidence in the particular financial product or strategy you wish to sell.
I see companies commit lots of money to product development. And I see them investing heavily in software modeling tools. These are appropriate investments. It’s the investments I don’t see that troubles me.
What I don’t see is the investments in the sorts of communications tools that advisors really need in order to stimulate interest in and understanding of structured products. Advisors will need a balanced set of hard and soft tools if they are maximize success with non-traditional products.

And here I’ll observe that if a company has a communications department, it doesn’t mean that that company is generating the kinds of communications products that are really called for.

Look at this quote from FPA President, Nicholas Nicolette. He says something that we should all pay close attention to:

• “The resources financial planners value most- in light of the increased retirement income business- are the ones that enable and facilitate their communication and conversations with clients.”

He is describing a need that almost all financial advisors indicate is critical to them. But it’s a need that isn’t being met.
The industry is building a coin with only one side. I see this in many parts of the business. For example, the variable annuity industry is making a huge investment in technology for straight through processing. But what is the advantage to making it easier to purchase an annuity if there is no interest in purchasing an annuity.

The investment in STP needs to be matched with an investment in communications and education that give consumers the context for understanding- and creates the demand for- the benefits of variable annuities.
We must realize that a brochure is simply insufficient to accomplish that objective.

Remember Hillary Clinton’s book, “it takes a Village?” Well, to the Structured Products industry I say, “It takes a Movie!”

You will have to give people the education, the motivation, and the confidence they want in a format that they want to receive it.
Let’s recognize that the digital video revolution is real. More and more people now learn by watching rather than reading. Consumers want to be entertained at their web browsers. On-demand. Maybe at 1:15 in the morning. Whenever they want it.
Web video has already marginalized or transformed large industries like newspapers and broadcasting. It’s had a profound impact on politics. Who would have thought that we’d be watching YouTube Presidential debates?

The adoption of broadband on a wide scale has changed everything when it comes to explain the value of complex financial products. Broadband is the brightest development that has occurred for the industry. It’s opened up the potential for dynamic growth, but it won’t mean much if it isn’t utilized.

This technology can be leveraged to solve many of the challenges we face. It will absolutely solve the compliance and market conduct challenges. It can be harnessed to furnish vital context and create widespread demand for structured products among millions of digitally-centric Boomers.

It can explain the advantages of structured products in a manner that is unimpeachably compliant, timely and convenient.
It’s the key to mass advisor education, and mass investor education. It’s the key to up selling and cross selling.
It’s the key to making people understand that the word derivatives shouldn’t scare them to death.
It’s the key to solving the advisor’s prospecting woes. It’s the key to penetration of the independent broker-dealer marketplace.
***
All of this is a function of communications and what I call the Retirement Income “C-Words of Retirement ncome Success:”

Confidence

Clarity

Comfort

Compelling

Context

There one more C-word I want to mention. It’s the not so good C-Word: complexity.

The grave danger for the structured products industry is that complexity becomes such a burden that it turns out to be an impediment to effective communications. The mass market retail customer does not need the most complex, arcane, and exotic structured product that can be created.

The typical advisor does not need the most complex, arcane, and exotic structured product that can be created.
What both groups need are well-designed, easy-to-understand and timely structured products that can be conveyed compliantly and passionately, and with clear and compelling context.

If the industry meets this test it will achieve not only greatness in terms of sales success, it will have served American Boomer investors in an honorable manner throughout the most financial challenging period of their lives.

Before I conclude, one more item from history. Anyone recognize this guy?

Right. This is Bill Gates (photo from 1977). It’s Bill Gates long before he was fully formed (current Gates photo), long before his company’s products were packaged and destined to become part of the everyday lives of millions the world over.

This progression we see in Bill Gates life reminds me of the structured products industry. Not yet fully formed, not yet packaged for the masses, but having the potential for market dominance for a very long time.

Thank you for listening.

***
Copyright 2008 David Macchia. All rights reserved.

Interview with Allianz Life’s Tom Burns: Head of Distribution Calls for Annuity Companies to Work Together; Describes Unambiguous Commitment to Consumers’ Interests

It’s no secret that I’ve been critical of certain annuity sales practices, especially those associated with equity-indexed (fixed indexed) annuities. I’ve cited Allianz Life specifically as a company whose past product development and marketing strategies have not been good for the long-terms interests of the annuity industry. In stating publicly what many in the industry whispered privately I staked out a lonely position.

But the truth is, for years it has been impossible to think about the indexed annuity business in any context that does not involve Allianz Life. It would be hard to imagine another large industry where a single player for so long a period of time commanded such a large share of the market; about one in three indexed annuities sold have been issued by Allianz Life.

That Allianz has experienced significant challenges is no secret. It’s been the subject of class action lawsuits and sanctions by regulators. I’ve heard some of Allianz’s defenders infer that this unwelcome attention has been the result of its standing out as the industry’s largest provider. But that line of reasoning never rang true, in my judgment.

Yet it would be unfair to presume that Allianz Life’s traditionally aggressive, sales-driven culture couldn’t change. And that its perceived commitment to the best interests of consumers couldn’t improve. When I spoke with Tom Burns I came away from the conversation with exactly this belief. Corporate cultures can change. Such change, when it occurs, is generally driven by a changeover of top management. That’s what’s happened at Allianz Life.

I found Burns to be quite candid considering the scope and sensitivity of his responsibilities at Allianz. In fact, Burns struck me as coming from a background similar to my own; one rooted in the values-based mindset engendered in young life insurance agents. So, it would seem that Allianz Life has turned a corner.

I was most surprised with Burns’ calling for annuity providers to “work together” in the best interests of the annuity industry. This is certainly a change from the past. Judge for yourself as you read the interview.

 

tom-burns-allianzDAVID MACCHIA: Tom, to begin, my readers would be interested in knowing about your background. Will you tell me about your life before entering the life insurance business?

Tom Burns: I’ve been around awhile. My father was an agent with Prudential in a small community in southwestern Minnesota for 30 years. I really wanted to be a professional baseball player. I decided I’d play college ball and if I’m really good, the scouts would be there. Guess what, the scouts were not there. I played four years of college baseball, ended up with a degree, joined my father in the business and, unfortunately, he passed away three months later.
I found out real quick at age 21 how important life insurance and planning for a family really are, especially for my mom and the rest of the family. I ended up running an agency for 15 years here in the Twin Cities, the largest agency for Prudential Preferred. And then in a weak moment they talked me into the home office. I managed the whole country on the brokerage general agency side. And then I got a call from Securian Minnesota Life about five years ago, and I went over there and ran all their distribution for about four and a half years. And I was very fortunate with some help of a lot of great people to turn it around and they had three record years. And then I got a call from Allianz about 14 months ago – and you know the challenges that we’ve had here.

DAVID MACCHIA: When I think about you coming into Allianz now, considering the new leadership that’s taken charge, I make an analogy, based upon years of observation of Allianz, that it’s like sort of having a close relative who just goes a little sideways for a while, and then at some point, somebody is able to bring him back to center, and puts him on the road to growth and happiness again. Does that analogy ring true to you?

Tom Burns: In the time I’ve been here, I’ve found that this company had such rapid growth, and with such rapid growth you start looking inward. And, you know, I think you’re right that with rapid growth comes challenges. Any business that grows that fast will present issues to deal with. We have been able to streamline some things recently and are continuing to put additional measures in place.

DAVID MACCHIA: Let me ask you about what you obviously know, which is that a lot of damage has been done to the index annuity business.
And the result of that is that some segments of the annuity business – especially indexed annuities – plummeted in terms of public perception. Now, here you are with this huge responsibility in a company that’s been a market leader for a long time in this line of business. From your vantage point what measures can be taken to improve the public image of the index annuity industry?

Tom Burns: The whole industry needs to work together on this issue. One thing that we need to do is more effectively convey the value of annuities as a part of overall retirement planning. As a society we have yet to fully come to grips with the implications of people living longer but with much less of the income protection that we used to see from traditional pension plans and, at the same time, more people relying on social security income while fewer workers are available to support it.
At the same time, we need to continue to improve our processes to ensure that the products are marketed appropriately. Suitability review is a very important part of that. We launched our suitability program nationwide in 2005. Our program today is much improved since then, and we are committed to continuing to make it better. We’re working through industry associations on “suitability” standards. I want to make absolutely sure that our suitability is the best it can be.

DAVID MACCHIA: I want to come back to the question of the past, which I recognize is not your responsibility, but it is your legacy to some extent. You’ve inherited a mantle and I think that you’re simultaneously blessed, blessed to walk into such a robust sales organization with so many agents and such a heritage of sales leadership, but also cursed because you’re also saddled with some of the negatives, the baggage that is a hold over from the past. So in terms of the marketing and sales activities, I don’t have to tell you that Allianz has been criticized by regulators and it’s been the subject of civil litigation and regulation at the state level and actions that you’re aware of. I imagine that it would be more enjoyable for you to be able to look forward only and not have to look at the past. How do you balance the legacy issues with an eye toward the future?

Tom Burns: We can use the experiences of the past to inform what we do today and how we can make it better tomorrow. Let me go back to suitability as an example. When we first launched our suitability program nationwide, we allowed policyholders to opt out of providing financial and other information to us. This opt-out is allowed by state suitability regulations. But after working through the program, we grew increasingly uncomfortable with opt-outs because without that information we could not do our own assessment of suitability. So last year we eliminated the opt-out option. If a policyholder is not comfortable providing us with the information we need to assess suitability, we understand that, but if we cannot independently assess suitability, we will not issue the policy. We will continue to use the experience of the past as a guide to how we can improve in the future.

DAVID MACCHIA: Wealth2k for years has enjoyed a robust business making the preeminent multi-media presentations for a number of indexed annuity providers. I also owe it something else in the larger sense of the annuity business, namely that the annuity business gave me more financial reward, more education, more professional opportunity than I had any right to expect as a young man entering the business in 1977, a rookie agent selling tax sheltered annuities. So when you consider – I mean your words resonate with me – companies working together, prioritizing the consumer, not so much always worrying about distribution. Why then, given what you just said, would it be hard to get companies behind an effort that is so manifestly pro-consumer as placing unbiased consumer education in the very center of the process. Why would you imagine it would be difficult to do that?

Tom Burns: After 29 years, I want to be known as someone who made a difference. This is new for me to have the negative press. So what can I do personally and professionally to change that? First of all, it’s reputation. Secondly, it’s adding customer value. So, when I talk about a legacy, that is so, so important for me because I’ve been blessed, too. My father was a good agent, and the opportunities that this industry has afforded me and my family are unbelievable. And I’ve seen life insurance work in people’s lives.

DAVID MACCHIA: I can’t disagree with anything in your answer, but you didn’t address the question I asked. Can the industry progress from an ideal that says companies should get together and prioritize the consumer in a functional, demonstrable way? Can we go from the ideal to a reality that actually shows that?

Tom Burns: Well, I think we can. I really believe we can. I know that we wholeheartedly support unbiased consumer education. That’s what our new Partnership for Consumer Trust is all about – making sure consumers are fully informed about the products they are purchasing, which, by the way, we believe are incredibly useful to them. The industry knows that this is important and that we can’t let it slide.

DAVID MACCHIA: I agree with that because it will be at the industry’s peril. And one of the ways it imperils the business’s future success is something that I’m deeply involved in for a number of years – of boomer retirement security. One of the reasons that I have been so aggressive in my comments, and critical of poor sales practices and inferior contract designs, has to do with boomers approaching retirement and what their march toward retirement means in terms of a business potential for the annuity industry. What I’m getting at is, and I’m sure you know this, that it’s been academically demonstrated that as people approach retirement, in those years leading up to retirement, it becomes very important to put a principal guarantee under accumulated retirement assets while also maintaining upside growth potential.

Similarly in the first few years after retirement the same protection is called for. And the reason is if you have investment losses in those two periods, the result is, at the very least, you will have less retirement income than you otherwise would have had or, depending on when the loss occurs, you may run out of money entirely while you’re still alive.

Tom Burns: Yes.

DAVID MACCHIA: So, given that the value proposition I describe – downside protection combined with upside growth potential – is the value proposition of an indexed annuity which the industry has allowed to get so clouded and camouflaged through such a poor level of transparency, and so much misleading sales practices activity, that the pristine value proposition got lost. And so what I’ve been trying to do, in my own way, with limited resources, is liberate that value proposition. Because, as I’ve said often and publicly for two or three years now, the $28 billion dollar high water mark for indexed sales could easily be $100 billion.

Tom Burns: I Disagree that there has been a lot of misleading sales practices. Obviously there has been litigation alleging misleading sales practices. The problem here really ties back to the need for more and better public education about annuities. One of the challenges in selling annuities is that people don’t start out with a solid baseline of knowledge about annuities, compared to other financial products such as CD’s and mutual funds. So in some cases selling these products presents a challenge in getting people to understand the fundamental concept of an annuity.

DAVID MACCHIA: If I’m reading you right, it sounds like Allianz is committed to altering course and really changing that.

Tom Burns: I would say as a business there’s leadership here that absolutely wants the consumer first. And also we value distribution, but the consumer first.

DAVID MACCHIA: Now, let me ask you this: Do you worry about the onslaught of negative that continues around the annuity business – and specifically the indexed annuity business? And we’re aware that — I’ve read where Dateline NBC has, done a story on annuities using hidden cameras taping the annuity presentations. It sadly reminds me of the approach they take with the child predator programs that they’ve run. I mean you open up the cover of Parade Magazine and you read a headline like, “Don’t Make A Costly Mistake.” And a lot of this was driven by a liquid contracts and two-tier contracts and I’m mindful of the fact that you mention that the focus now is on single share contracts. My point is — my point is do you fear that the negative press and the deteriorating public perception can sink so low that the annuity business may not be able to turn the corner and start to go the other way?

Tom Burns: I don’t fear for the future of annuities because the need for them has never been greater, and will continue to increase. And we will continue to offer two-tier annuities because for people who are looking to the long term, and who want a product that offers periodic payments for the long term, they can be a very good alternative. We will turn the corner and go forward. I don’t know if you remember, but Metropolitan went through it and Prudential went through it in the old life insurance days. Painful, but I think you become a better company and a better industry as you get through it. You look at all the wonderful agents and registered reps who do such wonderful work, and you believe we can get through it.

DAVID MACCHIA: Other large financial industries are obviously very aware of the baby boomer retirement opportunity, and they’re aware of the financial need that I mentioned earlier in terms of the importance of providing principal protection combined with ongoing growth potential. And companies that are not insurance companies have clearly set their sights on the core annuity customer. Now, what does it mean for an annuity provider, such as Allianz, say, when companies perhaps with names like UBS, Merrill Lynch, Morgan Stanley, Deutsche Bank, and others are developing and offering products aimed at the same core customer, products which develop the same essential value proposition? Does that make this a special urgency for the annuity business to align itself more appropriately than it is right now?

Tom Burns: Yes and yes. Competition is challenging for us but in the long run good for the consumer. But keep in mind that annuities offer something that the others don’t: that option of a guaranteed income for life. So the value proposition being offered by some of these competitors may be similar, but it isn’t the same. Every Tuesday for 2 hours we get together – the chief actuary, the chief distribution officer, the president of North America, I mean the senior-senior most people of this company – and we look at today’s products and what the future products are going to be 12 to 24 months down the road and who is going to be selling them. The future is going to be really exciting to see, and I want to be part of that versus being complacent, being innovative versus being reactive. We’re developing some products right now that I can’t share with you, but it’s going to be really exciting.

DAVID MACCHIA: Let me ask you this: If we were to be speaking again three years from today, looking back over those three years, what would have had to have happened in order for you to feel great about the progress you made?
Tom Burns: We would be a company that consumers, agents and registered reps would really treasure doing business with. Secondly, our employees would continue to feel that there is great opportunity here for growth and development. And then lastly, we would be known as an innovator. When we walk into an industry meeting, not only are they excited to see us, but they say, “’Wow,’ Allianz is quite a company.”

DAVID MACCHIA: An admired company?

Tom Burns: Yes. Look at the great opportunity we have for all the people who are going to retire, but who don’t want to retire with less money, or less income than when they were working. We’re calling that stage “decumulation” because it’s different from all the working years when people were accumulating assets. So, what we’re thinking about is how do we position ourselves in our industry to be the company people choose to help them with their income needs for the rest of their lives.

Tom Burns is chief distribution officer for Allianz Life Insurance Company of North America. He is responsible for sales, distribution, and marketing.

©Copyright 2008 David A. Macchia. Al rights reserved.

New Interviews and Essays to be Published Here Beginning Monday; Leaders & Innovators Interview Series Expands in Research Magazine

When I came up with the idea for a blog based, in part, on interviews with executive leaders in financial services I couldn’t have known how popular the one-of-a-kind conversations would become. Nor could I have foreseen that Research Magazine, under the byline David Macchia Interviews, would publish one of my interviews each month in both its print and online editions. To my delight this has significantly expanded readership. Research kicked-off with my interview with LPL’s Mark Casady in its March issue. DWS Scudder’s Philipp Hensler appears in the April issue.

Some of you may have noticed that it’s been a while since I’ve published any new items here. But after taking a month-long sabbatical I’m charged-up with ideas. Look for more essays and interviews beginning Monday, March 31.

If you’ve enjoyed my writings on the annuity business you may find the next interview to be especially interesting. Somewhat to my surprise, Allianz Life’s Tom Burns agreed to speak with me. After stepping into the lion’s den, Burns revealed much during our conversation. Look for it on Monday.

Coming Soon: Fascinating Interviews with Bob Pozen, Zvi Bodie, Philipp Hensler, Peng Chen and Tom Burns

When I began the Leaders & Innovators interview series I didn’t expect it to so rapidly explode in popularity. But it did. And today I’m delighted to announce that it continues to attract some of the sharpest minds in financial services. Given the prestige of the participants and their enormous knowledge and insight, it’s really no surprise that the interviews have become so popular with people from all corners of financial services.

MFS Investment Management Chairman, Bob Pozen, Boston University Professor of Finance, Zvi Bodie, DWS Scudder Chairman and CEO, Philipp Hensler, Ibbotson Associates President & Chief Investment Officer, Peng Chen, and Allianz Life Chief Distribution Officer, Tom Burns, add to the stellar roster of individuals who have honored me with one-of-a-kind conversations.

As always, it’s a privilege to share this conversation with you. If you would like to receive an email notification when these interviews are published in the near future, please click here…

©Copyright David A. Macchia. All rights reserved.

Study: Boomer Retirement Websites a Bust; Widening Deficit Highlights Negative Implications for Retirement Income Businesses

Last week an Ignites article by Hannah Glover highlighted a study of Boomer-directed websites that found that most companies’ retirement websites fail to live up to their sponsors’ advertising pitches. The report entitled, “Online Support for the New Retirement,” conducted by Practical Perspectives and Gallant Distribution Consulting, found retirement firms’ websites are typically, “…too scant, too pushy or too hard to find.”

My regular readers will know that I agree heartily with this assessment. I’d go even further in describing many retirement income websites; downright off-putting. That’s why so much attention to this very issue has been made here. What financial services companies must realize- and quickly- is that the gap between consumers’ expectations versus what companies deliver via their websites is dangerously wide. That deficit, however- as wide as it is- is the opportunity.

Future success in retirement income and retirement websites are interlinked, in my judgment. The reason is that more than in the past, the websites are going to be relied upon to create the confidence in retirement products and strategies that is essential to success.

To explain the magnitude of the difference between investing for accumulation versus investing for retirement income distribution, I’ve often used the analogy of the beginning of retirement as being the economic equivalent of puling up stakes and “Moving to Tibet.” In other words, leave everything you know behind and enter a strange, new world. I think the “Tibet” analogy is relevant to describe the extent of the disparity between the websites of financial services companies and those of large companies in other industries. If you would like to see some examples of how non-financial companies create engaging website/microsite experiences designed to better convey their value- and help their intermediaries, just visit Mercedes-Benz.TV, Calloway Golf, the Boston Pops and Cadillac.Catch a Digital Wave (close the gap), click here.

©Copyright 2007 David A. Macchia. Al rights reserved.

Role Reversal! Annuity Market News Turns the Tables on Me

As someone who generally plays the role of interviewer, I’m appreciative of Senior Editor, Kerry Pechter, for the interview he conducted with me that appears in the December ’07 issue of Annuity Market News. Kerry asked my about a variety of issues that are important to me including the state of the variable and fixed annuity industries, retirement income, and the emergence of structured products in the U.S. retail market. I appreciate his capturing my views accurately.

If you would like to read the interview, please click here.

Interview with Tom MacLeay: Chairman of National Life Group Describes Boomers as “Sensitized” to Personal Financial Needs; Sees Bright Future for Life Insurers Despite Competitive Challenges

 

macleay2Thomas MacLeay is Chairman of the Board, President and Chief Executive Officer of the National Life Group and was elected to the Board in 1996. He served as president and chief operating officer of National Life from 1996 until his brief retirement in 2001, and returned to the company to fill the top executive positions, first on an interim and subsequently on a permanent basis. He joined National Life in 1976 and served in several investment management, corporate planning and financial roles before being appointed chief financial officer in 1991. Tom is also Chairman of the Board of Sentinel Group Funds, Inc. and currently serves on the Board of Directors of Chittenden Trust Company, the Life Office Management Association and the Central Vermont Economic Development Corporation, and is a Trustee and Chairman of the Finance Committee of the Air Force Aid Society.

Macchia – Let me begin with a big thank you for your taking time for this conversation. I’m very appreciative, Tom.

MacLeay – You’ve had some great interviews on the blog.

Macchia – Thanks. It’s been a wonderful learning experience. Is it okay to begin?

MacLeay – Sure.

Macchia –To begin, would you be kind enough to describe your title and the specifics of your role at National Life Group?

MacLeay – Okay, well, I’m Chairman of the Board, President and Chief Executive Officer, so basically I’m heading-up the holding company for our life insurance companies and our asset management group.

Macchia – I’d like to ask you a little bit about the long-term and then the recent history of National Life. I know National Life as a company that for many years has been considered to be one of the top tier, most prestigious life insurance companies, one with a very long and fruitful history. Could you just talk a little bit about the history of the company, its beginnings and what has occurred- over not just decades- but even centuries?

MacLeay – The company was founded in 1850, so it was one of the earliest life insurance companies in America and it was founded by a combination of a local doctor, by the name of Julius Dewey, who saw the need that families had when they lost a breadwinner. He teamed up with a group of prominent business people from New York and Boston who were looking to establish a life insurance company that was not focused locally or in a region, but had more a national scope.

That founding group including people like Henry Clay of Kentucky and Henry Cranston of Rhode Island. This was certainly a group of very prominent business people. Interestingly, this company was founded with the notion of providing for death benefits. Not just in the local area, but across the country. In fact our first death claim happened in San Diego harbor when one person was traveling by ship to the gold rush in California. So, the roots of the company are strongly here in rural Vermont, but we’ve always had this kind of national vision. In its early days the company established agency operations virtually across the country and this was at a time that travel was very, very difficult and communications were slow and difficult.

It’s really amazing to think about this today because I don’t know how long it took that claim to get filed or paid. Part of the story about that is that with that first death claim the company didn’t have a lot of capital at that point so the founders had to really scratch to make that claim and we’re very proud that they were able to do that. We’ve obviously reached or met all of our claim obligations since then.

So, it started with that idea and then it grew over the years, and was a mutual company. For many, many decades, a century probably, the primary product was participating whole life insurance. A very strong career agency operation really flourished in the 50s, 60s and 70s as the products became a little more sophisticated and the growth of the industry really took place during that period, particularly in the upper end of the industry. More estate planning and sophisticated use of insurance and in fact, financed insurance was a big thing for this company early on.

The company has also been known through the years as an innovator of products with lots of focus on the upper market and designing sophisticated products to meet the needs of that market. When the industry started to really transform from a whole life focus to the introduction of things like universal life and then variable life, National Life did not grow as fast in the 1980s and early 90s. In the mid 1990s National Life decided to diversify its products as well as its distribution. That’s when we started to not only sell through our career system, but also through an independent marketing organization. When these product innovations came out we did introduce universal life and variable and, in fact, our strategy today is to have a full complement of products. So we have fixed, variable and equity indexed versions of our universal life programs and we have variable life as well as traditional whole life, and really a mirror of that in the annuity market place.

The strategy is that we know that each of those products has behind it a particular attractiveness to different market segments with different needs, but also that consumer desires change over time. We take a very long -term view of our business and feel that our job is to meet the needs of those clients and to provide the kind of solutions that are best designed to meet those needs – and that changes over time. So, we can’t say that we’re a whole life company and that’s it. Over the last 10 years we have diversified significantly both our products and distribution.

In terms of the history of the company, part of that diversification was the acquisition of Life of the Southwest, which brought fixed annuity experience and the 403(b) market focus. LSW is also a product innovator and an early, early provider of indexed annuities, a consistent and long-term player in the marketplace. That’s been an important part of the organization for about 11 years now. We continue that product innovation push in those product lines where we think we can bring something to the market, most recently, indexed life, which we’ve had since 1998, I believe, but we came out with a new version last year and that’s gotten a very good reception.

Macchia – Let me ask you this: when you have a board meeting and you sit in the chair as Chairman of a company now in its 16th decade, does the history and the lineage convey to you a special responsibility of honoring the past, and maintaining the integrity and bright outlook for the company going forward?

MacLeay – Absolutely. The leadership roles in an organization like this are more stewardship roles. In other words, we have an organization that has been here a good time before us and our forward looking approaches- you know, we plan for a very long future- so the current leaders are really here to both build on that history and strengthen the organization, and will turn it on to the next generation of leaders at some point in time. There is a special obligation to an organization that has the kind of history or market presence that National Life Group has. It’s more of an obligation to further strengthen the organization and move it forward. Of course, a great benefit of being a non-public company today is that you can take that longer view. We’re very cognizant of the need to be as profitable as we can be, but that’s only to strengthen the organization, not to satisfy a Wall Street analyst. So we don’t look at monthly profitability as being something that is the metric. Well, that’s probably not true, we do look at it as a key metric, but we’re not under pressure to perform in that short term.

Macchia –I’d like to come back to the corporate structure a little bit later, but one of the wonderful things that I’ve observed about the life insurance industry, in terms of some companies such as National Life, with such a long history, is that over a 150 plus years just about everything bad that can happen, happens. Whether it’s man-made disasters, wars, natural disasters, relative to anything that nature can conceive in a negative way, and to see the companies endure throughout all of these challenges is a very special thing and very noteworthy in our economy. I sometimes think that it’s underappreciated. Do you agree with that?

MacLeay – I do. I think it’s hard for people to, in today’s world, necessarily think of an organization as being an organism itself. In other words most people think of organizations in terms of ultimate transaction. Founders, for example, if you found a company, the typical track is that you found the company, you grow it, you must have an exit strategy. You end up selling it or maybe it becomes an independent public company, for example, but you’re thinking is really limited somewhat to your own personal needs. Whereas leadership in these kinds of companies are thinking about bringing the company to the next level of performance and making sure that we are delivering the value that we deliver to our customers and really building and maintaining the relationships that last way beyond any one particular person. I think that’s very hard for most people to understand about these businesses.

Macchia – For many years National Life was, as you indicated earlier, a mutual company. Then some years ago it made a decision to adopt the mutual holding company structure. I’m wondering if you feel that has given you the long-term view and staying power you need in the context of some who argue that size is all that matters and that smaller to midsize companies are going to be a challenged going forward, and you need $100 billion plus of assets to really be a strong player in the future. What’s your view on that?

MacLeay – Well, first off, bigger can help, but it’s not by definition better. We look at that and say we think that the key to success is being able to provide products and services that deliver real value. If you can do that then you have the ability to be a competitor and an independent company.

So the issue of size really comes down to the question of can the big companies leverage you or basically out-compete you, and the only way they could would be on price or reach. And so it creates a pressure for smaller companies because bigger companies can sometimes have more favorable price points, and it’s their time to grab market share. They can sometimes under-price products and gather market share.

We have been in a consolidating business, but I don’t think that means that there are going to be three big life insurance companies in the United States because our market is really driven by relationships that people build one-on-one. Our business is so very, very personal. So it comes down to being able to provide the products that have real value and building the relationships that can connect the customer with the company through an intermediary. That intermediary is where a lot of us compete for the relationships that we know kind of drive the business.

It’s kind of a long-winded answer, but we think that there is plenty of room in this country for companies who can be really good at a selected number of things and that being big gives you a little bit of credibility with the rating agencies and that kind of thing, but we’ve seen some pretty big, pretty bad companies over time. Not just in this industry, but in lots of industries. We think that we can grow and we need to grow.

Back to the mutual holding company, we think that the mutual holding company is a great structure because it makes you more flexible with respect to financing and the ability to grow through non-organic means, doing acquisitions and things like that.

But, it maintains at the core that it’s still a mutual organization, so what that means is that you basically reinvest the profits for the company in further growth and strengthening of the company rather than paying it out to some owner out there. We think that companies with a mutual structure are better for a long-term view than a public structure because in a public structure, frankly, money talks. At some price somebody can change your game. If you have an obligation to shareholders to do the right thing for shareholders, if you look out there today and see who the shareholders are and why they are shareholders, they are people who are making an investment and looking for a return. At any point in time there would be a price where that organization will be sold to some other organization to do with what they want if they have enough money to hit your price.

A mutual organization doesn’t have that consideration. We are building the company for the benefit of policyholders over a very long period of time. It’s not a matter of if somebody comes in with the highest price tomorrow morning saying that that’s necessarily the best thing for all of our policyholders.

Macchia – We’ve covered in great detail the past and the present. Now I want to ask you about the future. How do you personally see the outlook for life insurers over the next 5 to 10 years?

MacLeay – Well, let me say first off that a lot of companies that we think qualify as life insurance companies in the US, particularly the big ones, are doing an awful lot more than life insurance in the U.S. I think people get a little confused about what some of the bigger companies really are. There’s a lot of opportunity and a lot of activity for those companies who chose to be international or global. Those opportunities in terms of the growth are bigger overseas than they are here.

I think that the outlook for the U.S. market, in my view, is quite bright and it’s driven by this Baby Boom phenomenon. To which I have to say it’s kind of interesting how much press that is getting now because this has been the most predictable wave in our lifetimes, from the time we were born. At least I’m a Boomer. I’m kind of on the leading edge, I guess. This is not a surprise, but what’s different though is that the amount of press that the aging of the Baby Boomers is receiving, I think is a very, very good thing for the financial services business altogether, but for life insurance companies in particular.

I think it’s not just for the reason that they are approaching retirement. If you think about it the Baby Boomers are now 44 – 62 and those are the sort of sweet spot years for everything that life insurance companies provide. Protection, accumulation, distribution, wealth transfer; all of these things are very important to people who are 44 – 62. When I think of the opportunity right now I think these people are now in their peak earning years. They are now barraged with information that tells them that they have needs that they may have been ignoring. What this does is sensitizes them and conditions them to have a discussion with a trusted advisor and develop some relationships. That trusted advisor we think of as a person, normally, but I use that even more broadly.

What I feel is people now know that they have needs that they have either been ignoring or didn’t know they have, and that makes them a very, very good market for financial services companies and life insurance companies in particular. I see that as a huge plus and it’s not just about retirement distribution. It’s about understanding that you have these financial needs and there are ways to start your financial program to address those needs. Having said that, those needs are very personal, which means there’s not a one size fits all solution, which means you have to have the ability to do a comprehensive financial analysis, financial plan for individuals that have these needs.

I further think that it’s not just the Baby Boomers that are now sensitized to that because younger people read the same publications and watch the same programs on cable and hear the same things and are barraged with the same things over the web or however they get their information. I think there is just a heightened sensitivity to financial needs and that to me puts in place something that’s really positive for life insurance companies in particular. There are plenty of risks and challenges when you think about that, but just the conditioning, the fact that the Baby Boom market is there and the entire marketplace is much more conditioned to talk about their financial situation and their needs.

Macchia – I think that this is very important insight that you raise, and you hit upon a subject that’s very much a passion of mine right now, which is the notion of trying to help insurance companies realize their potential in this thirty- trillion dollar opportunity of Boomer retirement.

That said, I can recall since entering the life insurance business in 1977 that, back then, insurers controlled the pension business in the US. They then seeded that business away to the mutual fund complexes, which came to market with an arguably superior model for the consumer, greater transparency and those trillions of dollars were lost. Now we see the large asset management firms with trillion dollar asset bases.

The stakes for life insurance are very, very high in my judgment and what I try to focus on is quite vocally trying to publicize, in terms of essays in this blog, and also in other writing that I do in numerous journals, some of the inherent, almost disease state that exists in the insurance business. I feel as though if that disease isn’t cured the insurance industry is not going to seize upon the Boomer retirement opportunity in spite of the fact- as you correctly state- that its natural product set, competencies, and financial experience, would lead it to be the natural provider for this large group of customers. Do you ever think about that? Do you buy into what I am saying?

MacLeay – Yes, I do. I agree that, number one, we used to control more of the pension assets and we lost that battle to the asset management companies. I would say that many of us have asset management companies primarily for that reason. The product sets that are offered by asset management companies and the whole notion of a simpler, more transparent product has really taken hold, obviously, and grown that marketplace. I know you’re well aware of how that has happened.

Looking forward, the needs are similar, they haven’t changed, there’s just a better understanding of what those needs are. Some of those needs are well met by simple asset accumulation investment type product, but the ability to guarantee things and to pool risks is the domain of the life insurance business. The inner section of that core competency with the marketplace and communication of how these products and services fit people’s financial needs is kind of the area where I know that you’ve spent a lot of your time, and I agree, that’s where we have, in essence, fallen short. There are a lot of reasons for that, not the least of which I think, is how people get paid. I think that’s at the root of product pushes that are not necessarily in all cases well thought out and responsive to the customer’s needs or their situation. The industry has frankly struggled with how to be more transparent in what we’re doing.

I believe that the products as we move forward, the kind of disclosures and transparencies that will be in the market will look much more like securities disclosures and so on. Technically, that information will all be out there, but it’s kind of like looking at a prospectus and a statement of additional information for a mutual fund. You can find anything you want, but customers don’t go there. So, who is actually making that interpretation is the advisor or wherever that communication link is happening. I think that’s where we have probably one of the biggest challenges. That is: how do we get that communication link that’s clear and in the customer’s best interest? I don’t have an answer for that, except that we try to be very specific in the way that we train people and the way that we roll out our products to make sure that they can be clearly communicated and we can identify those areas where the products really fit the best. It’s a big challenge and I think that especially on the leading edge of the Baby Boom you’ve got more traditional methods of one-on-one consultation and brochures for a lack of a better term.

At the younger end, and the generations to follow, electronic communication is kind of the expected communication and paper is more to be thrown away then it is to be read or anything like that. I think part of the opportunity is to get that information, that set of information, whether it’s hard copy or electronic, get it to be able to be much more responsive to individual situations, and frankly viewed in a broader context than a single product sale. I think that the challenge for the industry is that a lot of the distribution and a lot of the sales efforts are for a particular product as opposed to creating solutions around a specific individual needs. I’m really talking about the upper-middle and upper markets. I think we’re talking a whole different challenge for the middle markets and down. There’s not enough money, there’s not enough incentive or reward for the kind of tailored response or tailored solution that I think you need in the upper markets. We do some in the middle markets; those are much more packaged. I think that those packaged solutions have to be clearly defined with the product features disclosed very carefully, and with as many tools, as many communications tools as you can, electronic as well as hard copy.

Macchia – Let me ask you this Tom, because the magnitude of the Boomer opportunity is obviously apparent to sectors of the financial services industry beyond insurers. There is a competitive threat that I foresee to life insurance companies which may emerge in the next year or two or three. It’s the migration of structured products in the institutional market to the consumer market.

There are large asset management firms that have been talking about this for some time. I heard a senior executive of a bank, a very large bank, say quite pointedly that he felt that insurance products were less likely to be used by his institution whereas a reliance on structured products in the future was where they saw their vision taking them. I asked Moshe Milevsky about this point specifically, recently. It was his projection that within the next couple of years there could be, perhaps, two dozen new players on the street offering products that directly compete with some of the individual annuities that life insurers offer. Is this something that you think about? If so, is it something that worries you? And if not, is it something that you think insurance executives should be worried about?

MacLeay – Yes, I think viewed broadly the capital markets are very creative and very responsive to opportunity. When you think about our products which are basically financial promises, they are financial instruments that are of a long-term nature. There are a ton of very smart people sitting around Wall Street everyday looking for opportunities in that arena, so I think that it is definitely a trend or a risk, I guess. The other side of that is that I think that the more kinds of alternatives that get developed and the more people become aware of their needs and the alternative ways of solving those needs that creates, if you will, a bigger pie. I’m not as concerned that the capital solutions are going to come overtake life insurance, but we have to be equally as creative and responsive in terms of the things that we can provide.

So, the short answer of your question is, yes, I see it, I think there’s something to it. What we have to be is looking for where is it that we can provide value. We can’t just play defense and say somebody has come up with a better solution for what we have a product for. We need to say where is it that we can provide better value, because frankly in any business at any time if you can’t provide better value, and that doesn’t mean necessarily just the dollar and cents part of the product, but the whole experience and the whole customer relationship and all. If you can’t, if you get people coming in and providing better solutions, then you better sharpen your game. I see it, but I’m not as concerned about it as a threat. I think it’s actually more of an opportunity to open a horizon that we haven’t opened up yet.

Macchia – When I hear you use terms like responsive and creative it reminds me of another issue which is very close to my heart. It’s the assertion that I make that, in the final analysis, the winners in Boomer retirement are not going to be those which necessarily have the “best” product, but rather are those organizations that are the best, the very best, at communicating their value to a large and fluid marketplace. I wonder if you buy into my belief on this.

MacLeay – Well, I would state it a little bit differently. I think that the winners are those who can connect the best to provide solutions that people need. I think we’re saying the same thing, but what you’ve done is focused on the communication link, and that is the connection. I don’t know that there is much of a difference to what we’re saying. I think of it more as, if people respond best to an individual sitting down with them and visiting with them each quarter and providing a set of recommendations, if that’s the way that people want to be served, that’s what we need to do in that segment. If there is another segment of people who says, I like to sit down at my computer, I’ll figure it out, then I like to be able to call somebody up and I like to be able to do this or that and then I like to be able to go someplace and figure out what all of my values are and all of that. So, to me, it’s not like there is necessarily one crystal clear answer, and in fact there probably isn’t because there are different sets of fluid markets.

People think of the Baby Boomers like it is some kind of consistent group. All they are is a certain age, but there are all kinds of different sub-segments in there. I think the difference of what I’m saying is that there has to be, for a lack of a better term, mass-customized ways of dealing with different segments within the market. Those companies that are successful are those who are going to be able to make those connections in those segments of the market that have great opportunity for the organization.

Macchia – I agree with your take on that, agree with you completely. When I see the fulfillment of what you just described, that vision, I see that it’s not possible to avoid the inclusion of technology to aid and abed intermediaries to better communicate with people. Do you agree with that?

MacLeay – I do agree with that, absolutely.

Macchia – Let me ask you about another issue that I’ve been very much focused on over the past year. Again, out of the desire to try to galvanize industry leaders into recognizing that there are some foundational problems within the industry that have to be addressed in order to set it on the right course to enjoy what should be its greatest business opportunity ever in terms of working with the Boomers.

I’m describing the individual annuity business and specifically the sub-segment of that which would be the indexed annuity business. When I look at the indexed annuity I look at the essential, inherent value proposition and I say here is a vehicle that places an underlying guarantee under a principal asset, and also simultaneously provides upside growth potential. Then I think about that value proposition in the context of some of the that Moshe Milevsky and others have done- that the Retirement Income Industry Association has explored- which is this notion of the transition management phase where say roughly ten years before retirement to ten years after retirement, that during that 20 year period it’s critical to place underlying guarantee under the retirement asset, yet maintain upside growth potential.

I say, oh my God, isn’t that a natural fit for the equity indexed annuity. Then we have the reality where we’ve seen the product morph since its introduction in 1995 from a 5 year contract which would be viewed as having obvious, strong consumer value to variations of that which have surrender charges as much as 25 years, loads as much as 35% or 40%, commissions as much as 20% or more. It’s one of the rare examples in modern financial services where a financial product is introduced and then dis-innovates consistently year after year. I wonder what you think about this. First, about the product’s inherent value proposition, and then what’s happened to the product over a decade plus?

MacLeay – Well, I think the inherent value proposition, from my point of view, is that the opportunity is active. I still view it as a fixed annuity. The opportunity is greater return than a fixed interest annuity and the mechanics are, well, we know what they are, equity participation and underlying guarantee, but I think of it more as a higher potential fixed return.

I think in some ways some of the issues around the product and some of the concerns that the FCC and the NASD have with it are that these returns are dependent upon stock market movement. We’re careful when we talk about them to think more in terms about them than to think more in terms of the potential for a greater fixed return because it’s a guaranteed product. It has an interest return and not a change in underlying principal value. That may be too technical, but it’s another way of looking at it and we have been in the business since 1996, so we’ve seen all this.

Our products have evolved to remain competitive and I think that what it is, is those changes that you mentioned are a change of the reflection of the power of distribution, the power of people who can get out and make the relationships they do in order to sell the products and that’s what’s driven it. It’s not like companies are saying, gosh, we should pay 20% commission on this. It’s been that tremendous battle in the market place for those folks who are successful at reaching people that have a need for product like this and the leverage that they have coming back, and that’s driven a lot of that. We were an early provider and we were in the top 10 companies for the first few years and then we dropped out of the top 10 for a long time and we’re not back. The reason is simple. It’s because we’re not going to play those games of pushing product features and commissions and all that beyond the point of reasonableness. I think it’s a great example, but it’s not the only example. Many products in our business, when they are innovative and when they are first introduced, have very strong features and then those features and structures get competed away in the market as the folks who are in the distribution end demand more of a bigger piece of the pie, they get a bigger piece of the pie.

Macchia – The power of distribution to alter an insurance company’s behavior, even when it’s working against its own self interest, I think, has been proven beyond doubt, certainly with this example. It leads me to think about the future and where the real opportunity is. That is, if I try to think back over my own career, which has been somewhat unique, Tom, in the sense that I spent many years in the distribution business as an agent, as an agent trainer, as an agent manager, recruiter, IMO principal for two large IMOs, simultaneously for the last 20 plus years as a marketing consultant. I see that the root problem is that over the past 25 or 30 years agent productivity has consistently fallen off. When I started in the insurance business I was told that the smallest acceptable productivity that I could have was one sale per week. There were many people in the agency where I was recruited that sold 2 and even sometimes 3 policies per week.

These days there are agents who make a respectable living on 3 sales per year. The lack of productivity has caused agents to continually and more aggressively seek out products that pay higher and higher individual commissions, which has forced the companies to design products that have been less and less consumer oriented, which to a large extent has put us in the bad position where the industry finds itself.

So, I believe that where a splendid opportunity exists for insurers is to do some imaginative and creative things that help agents increase the volumes that they are able to sell, so that they don’t have to make as much individually on each sale, but still can earn a very respectable living and stay in the business over the long term. That can’t happen in my judgment unless there’s a wholesale change in the way that agents communicate and prospect with clients with a heavy reliance with creative and compliant technology to help them. I’m wondering if you buy into this vision.

MacLeay – Well, I’ll tell you, David, one of the very consistent things that I see, which is probably not obvious until you see it enough times, is the motivation often in agents and field reps is more around points then it is about dollars. It continues to amaze me that your point is if you could increase the volumes obviously you don’t need to pay as high of points of commission or whatever it is, but the world out there is still very points driven so you talk to people about a contract that has huge consumer appeal and low commissions in terms of percentages per point. How many examples have there been out there of these things that just don’t go anywhere because people in the field forces seem to be so hung up on, you can give me a contract that has 8 points for an annuity, that’s got to be better than 4. Well, no it doesn’t. Four could be a heck of a lot better if the product was really much more consumer friendly and was supported in a way that was selling in huge volumes. Some people get that, but most people don’t. It’s very, very frustrating.

Macchia – I would think that part of the reason that we have this reaction is that it’s not enough; I think it’s manifestly proven that it’s not enough to put a superior product in the producers’ hands. You have to put an infrastructure and a context around that product that enables him or her to market and sell it successfully in higher volumes. I think that’s what’s been the missing element up to this point. Which reminds me of another thing that I think is going to happen and I’d like to know if you agree with me. The industry right now is beset with a number of challenges in terms of potential financial liability.

Because of the sales of some of these products that are really anti-consumer, you’re well aware of the fact that some class action suits have been certified against large annuity providers. The implications of these financial liabilities run into the hundreds of millions of dollars, perhaps even billions of dollars, and could make a market change in the way things happen. I think what this proves is that for an insurance company to be a quote, unquote manufacturer and put products out into the hands of its agents and then rely upon those agents to self-create the way that they sell those products. Realistically there is no way to provide oversight and the insurance company cannot know what expectations the client is receiving out of that process and can’t really know what he agent in saying.

Over a channel of 1,000 or 2,000 or 10,000 agents you literally could have 10,000 different explanations of a product. What’s going to have to happen in the future for the company to protect itself and its agent is that products are going to have to be introduced simultaneously and linked to a context that is compliant from the very beginning, that consumers can understand in a fair and balanced manor, and from that can get realistic product performance expectations. This comes again out of the creative utilization of technology and media, which is largely not being done right now. I see this as a solution of a myriad of problems, especially this one of cleaning up the problem where agents are explaining products with such great variability that the insurance company is unable to have a consistency of message. I’m wondering if you buy into my vision of this and if so, why?

MacLeay – I think you raise an excellent point. I think that the solution to it is very complicated. I agree with philosophically with what you’re saying. I think it’s going to be a long and difficult road. I still think that the primary thing that people need is that advisor, you know, that person that they are talking to, has to be delivering a message that has their interest at heart and is responsive to their needs. This happens a lot and I think that by and large our industry has been very good at that and then you have this other situation which is really the product push type sale where you say, my job is to sell anybody who breathes this product this afternoon. Well, none of the products today are that generic.

I guess term insurance might be. But, these products are only really suitable in certain situations and they are very good at doing certain things. How do we get people to communicate those to make sure that they are offered to the right people for the right reasons? I do agree with you that that is a huge communication challenge that is going to become more and more driven by the life companies and the product providers because they are the ones that have the deep pockets that have to pay up at the end of the day in these class actions or whatever happens. I think that generally I agree with you. I think it’s a huge challenge. We have, in our history, when you have a career agency system you are able to deal with that a bit better, and it’s the reason by the way that we deal with marketing organizations rather than just general, broad brokerage, one-off situations. Because we know it’s important that people understand what the products are, where they are useful and where they are appropriate and where they are not. You are absolutely right. We are going to need much better communication capability and the technology has got to be part of this and we, of course, as everybody is, we’re doing a lot of that with everything, product rollouts, all the rest of that, tools that we have, compliance cleared tools to use with customers to describe products and where they are appropriate.

Macchia – My wife is going to be pleased with your answer given all of our money that I’ve invested in this belief.

MacLeay – I think it’s true. Some things are obvious, but not easy. It’s pretty obvious, but it’s very, very difficult to implement and to use consistently. What it comes down to is that you have to have good, honest people trying to do good things for the folks that they are working with. I’m not discouraging anybody here, but that’s really what it comes down to and any time that you’re totally driven by your pocketbook or whether you make the next sale or not that’s what leads to the problem, that’s what leads to pushing products where they don’t belong.

Macchia – Tom, this has been very enlightening and enjoyable. I think I’d like to ask you a couple of personal questions, if you don’t mind. The first one is, if I could somehow convey to you a magic want, and by waving this magic want you could make any two changes in the financial services industry that you wish. What would they be?

MacLeay – Oh…the magic wand question, huh? Okay. Well, I guess the first one would be to have people more receptive to planning their financial needs. Particularly in respect to life insurance. Life insurance is a fabulous product, it’s way under-penetrated in our market and it’s too hard to sell and it shouldn’t be. It’s something that people need and if we could wave the magic wand and have people wake up in the morning and say, I do need that, I do want to talk to someone about that, and I do want to act on it. I think that would be very positive, and not just in terms of being self serving as a life insurance company, but it would help a lot in a societal sense as well. So that’s magic want number one. And magic wand number two, I guess is if we could connect better. You’ll like this answer David. People need advice, they need to trust someone.

I’m talking broadly. I’m not talking just about National Life or life insurance agents. But if we could wave a wand and people could figure out that they can make this connection, I think that would be a huge plus for the industry overall because I do think that life insurance on the one hand, but even more broadly in financial services, there are many more solutions or way more things that we can do to help people if they were open to it.

Macchia – That’s a wonderful answer. Let me ask you the next personal question which is, if you were not the Chairman, President and CEO of National Life Group and you could be anything else in any other field, what would you choose to be?

MacLeay – Well, if I could be anything else in any other field…I don’t know if you’re used to that long of a pause on this one…

Macchia – Take your time. There’s no wrong answer.

MacLeay – I know, but there are so many possibilities. It’s tough; I would say if I could do anything it would be something that had a significant value to people somehow. I don’t see myself as a social worker, you know? Let me keep mulling this one over.

Macchia – Alright. Here’s the next one. I want you to imagine your own retirement in its most conceivable ideal and perfect form. Where will you be and what will you be doing?

MacLeay – I will be here. I’ve grown up in Vermont. I will be doing a lot of traveling. We’re part of a community, we like being part of a community, we’ll continue being part of a community and I think one of the dangers of retirement is going off somewhere and being behind a gated community and then trying to figure out what you’re doing there. We might have another location at some point, but I would be based out of home, as home is important and relationships are important and we’ll be very active with our family as well. We would be using travel as a way to get involved in things. Some of that travel may be many, many months getting involved in something. I don’t see sitting around playing golf forever as an idea.

Macchia – Good answers. I’ve got to tell you. This has been a magnificent interview. Very enlightening for me, and I can’t thank you enough. I’d love to catch up with you for a lunch or dinner the next time you’re in Boston.

MacLeay – We’ll do that. I get down there once in awhile.

Macchia – Thanks, again, Tom.

©Copyright 2007 Daviod A. Macchia. Al rights reserved.

Interview with Mark Casady: Chairman & CEO of LPL Financial Services Talks About the Challenges and Opportunities that Come with Being Number One; Highlights Technology, Culture and Continuing Efforts to Improve Economics and Business Processes for Financial Advisors

Over the course of two lengthy conversations with <strongMark Casady I came to understand more than a few things about the man who leads the nation’s largest independent broker-dealer. Many business leaders have a genuine passion for their work. Casady’s passion is palpable, and it is, in part, reflected in his efforts to maintain the tradition of innovation, technology-leadership and meritocracy introduced by LPL’s founder, Todd Robinson.

“Balanced” and “humble” are two additional adjectives I would say appropriately describe Casady. I came away from our conversations feeling that he is a man who, in a quiet, confident manner, clearly recognizes his strengths and talents, but is equally aware of his limits.

I also came away with the impressions that no one in LPL’s management structure takes success for granted, that there is a continuing process of re-invention in place, and that the best interests of the firm’s customers is always priority one.

m-casady_cropMacchia: Mark, I appreciate you sharing your time with me. Although you are a very well known figure in financial services, I’d like to start by asking you to explain your title, role and responsibilities at LPL?

Casady: Absolutely. I’m the Chairman and CEO of LPL and have been since the end of ’05, when I assumed the chairman’s title. I was CEO, I believe a year before that, and came in as COO about five and a half years ago. So that’s the title and a little bit of the timeline. And responsibilities are sort of typical for a chairman and CEO; setting the strategy for the firm, and determining a whole range of what I would think of as operating principles and goals for the company, even in conjunction with the Board of Directors and the shareholders. And then execution against the plan that we set forth.

Macchia: In terms of questions I don’t quite know where to begin, I’ve been so much looking forward to this conversation. But I’ve got some down-and-dirty sort of issues that I want to ask you about, and let me just sort of peel them off if I can. Number one is this: with the frequency of compliance sweeps and the severity of the fines that we’ve seen levied, and how each has been increasing, has this caused LPL to change or adapt its business model in any way?

Casady: Our founder, Todd Robinson, was always very innovative. And so he built a culture here that we very, very much try to make sure is alive and well and growing. And part of that culture is about flexibility and trying new things. So he just built a very open place for dialogue, a very open place for trying new things.

The other thing that he did was really build a meritocracy, and really kept, for his 20-year tenure here, what I would describe as a real significant pruning shear. Meaning he looked at the tree and said, “I feel a little deadwood going up there; I’m going to trim that.” Or, “I don’t see a branch quite as strong as I’d like it be, I’m going to reinforce it or change it in some way.” And those are legacies that allow us, I think, to be quite flexible and innovative when it comes to changes in the industry or changes in our business, and thoughtful about how to approach them. This really comes from that core culture.

Macchia: This culture that you talk about emanated originally from the leadership of Todd, a mantle that you’ve inherited, obviously. You’re acknowledged to be an exceptional leader and CEO.

Casady: And who said that? My mother? You talked to my mom?

Macchia: Yes, I have. But what I want to know is, what you define as the component parts of a great leader.

Casady: That’s a good question. I think that the first part is to not confuse brains with a bull market, to be blunt. And that everything in life has a rhythm to it. Whether it’s sports or whether it’s a business situation or whether it’s a relationship, there’s a rhythm to these things. There’s a rhythm to business. And I think success in part is about understanding that rhythm, that’s a natural part of the business, and understanding the way to know when you’re in the right vein of that rhythm and when you’re not.

It doesn’t mean that you should just be set to the forces of the wind. You can definitely change a rhythm to a business; you can change a rhythm to a cycle. But there are certain cycles you can’t change. We here at LPL cannot affect the American economy much. Inasmuch as I expect we could, we really can’t. We can’t make the stock market go up and we can’t make it go down much. It is important for a leader is to understand when they’re in the right rhythm with the forces that are beyond their control.

Macchia: And that implies, as you said, a recognition of one’s limits.

Casady: Yes, exactly. I think the second thing that’s really important in a great leader is humility. And I will say that I try every day to make sure that as a leader I guide with humility. There was a time when I thought that with enough muscle and brain power or just sheer nerve and raw will you could change anything. But as I mentioned earlier as you mature as leader it really is about being aware of the rhythm of the business and the opportunities that presents.

The CEOs that you and I might have grown up knowing, the Jack Welches and others — were known as very dynamic leaders who were very strong willed and really commanded, even in the military sense. I think today we manage companies in very different ways. I think we have to ask people to serve and we have to think about ourselves as leading a fairly massive effort towards specific goals and you’ve got to help people see the goal, envision it and want to be part of it.

Macchia: I think that’s a great insight. Notwithstanding the importance of humility and the coordination of a massive effort, that massive effort at LPL has led to it being the number one firm. And it occurs to me there must be many advantages with being number one. But I’m wondering, what are some of the disadvantages?

Casady: That’s a good question. One disadvantage is that you can believe that you’re number one, for some reason, beyond the day to day work you do. We’ve been number one for, I think, 12 years now. When I arrived five years ago, what I said to the management team was, “Hey, you’ve been number one for seven years. Pat yourself on the back and forget about it.” Because if you let yourself fall into the belief that that somehow gives you a privilege in the marketplace, you somehow fall into the belief that you don’t have to work as hard because you’re number one, you are sadly mistaken.

And so the downside is that it tends to foster a lack of humility and it tends to foster a comfort that really masks the reality of it, which is being number one attracts a lot of attention and it attracts, therefore, a lot of imitators. And it demands a need to really be very constant and innovating and staying ahead of those people who are very close behind you. So you have to, I think, really be proud of the fact that you’re number one, but you’ve got to realize that it also makes you an easier target.

Macchia: After setting a record price multiple in your recent private equity buyout, do you feel that more firms are strategic takeover targets for LPL?

Casady: Well, I don’t think it really has to do with our price. I think our price is quite appropriate by any measure. I’ve done probably 22 or 23 transactions corporately, taking companies public. I’ve bought and sold them. I didn’t set out to do that 26 years ago in my career, I sort of happened into it. And so I’ve gotten some deal experience.
I think what really happened was that people realized that it was a moment in time. 2005 was a moment in time, we’re past the bubble, we’re in a different phase, and there must be something about LPL that’s different.

So conversations that we’ve been having for years with organizations about acquiring their B/Ds or how they were thinking about their business, I think really changed after that. Because they said there’s something different at LPL because TBG, one of the world’s largest private equity firms, and Hellman and Friedman, another one of the world’s largest private equity firms, paid this level of money which was quite different than what we all expected the company to be worth, and therefore they must be something different there.
And then when we explained to them, well, we’ve spent $525 million in technology in the last eight years, they go, “Oh, we’ve spent ten.” And so you can see that they start to get to the fundamentals, but then make them realize that unless they’re willing to make an investment in their technology and in their service and in their capabilities for their advisors, they’re fighting a losing battle.

Macchia: The idea of this duality of corporate personality seems to provide an enormous financial advantage in the sense that if you can acquire a firm at 1X GDC and make them worth 2X GDC, that’s a pretty good business strategy. You don’t disagree, I presume.

Casady: Actually, I do disagree. If your business strategy is to buy a business at 1X because your company gets a 2X multiple from the market, that’s not a good strategy at all because that’s just a rollup strategy. You’ve got no value by that. What you have to do is you have to be able to say, I can take a property that’s for sale at one time, I can do something to it that changes its characteristics to look like the rest of my business that’s worth 2X. It’s a completely different way of saying it. And I’m rather sensitive about it because I see a lot of companies that have rollup strategies. I’ve seen a lot of announcements in our business about people who are doing rollup purchases of RIA practices or rollup purchases of securities license professionals, and I think those strategies are ultimately doomed to strategic failure because they don’t change the value equation. They merely rely on inaccurate pricing from one level of the market to another.

Now, that’s not a strategy, that’s an arbitrage. And so when you look at the specific broker-dealers, we purchase them using this metaphor of 1X, whatever. And they will be worth 2X, whatever, they’re not worth that today because they need a significant investment in their technology and a significant investment in their capabilities for them to get to that point. And we think it’ll probably take us a good three years, maybe two years, to get them to the point in which we say, hey, we’ve done the blood, sweat, and tears work to get them to have an environment in which their advisors can grow their businesses and be even more successful.

Macchia: Mark, what was it about LPL that created the realization that technology was going to be so important in the future?

Casady: I think we had a seminal vision by our founder and by his president, Dave Butterfield. Todd and Dave put every nickel back in this company up until they sold it in 2005. So they never took, what I’ve discovered, any kind of significant money out of the business until they did the transaction. And that’s why we’ve invested literally hundreds of millions of dollars in technology. And the logic that Todd and Dave used was that it would make the profits just that much more efficient, so that he would sometimes joke about it by saying, “Well, I’m just too cheap. I don’t want to hire 100 people to have to do the work that, with technology, we could do with 10 people.” And if you have 100 people, as good as they are, they’re going to have an error rate, whereas a straight-through process for processing a trade is going to be 100% accurate if it was entered accurately in the first place.

Macchia: Your answer implies the question: Can a small broker-dealer reasonably compete and survive well today?

Casady: Well, I think in business, it doesn’t matter whether it’s broker-dealers or whether it’s steel– steel is probably a bad example– in most businesses, there comes a time in the maturity cycle for that sector in which something happens, and that is that the big get bigger and the small stay very focused in the world, and the middle-sized companies are the ones that get squeezed. And that’s the phase we’re in for broker-dealers today.

We were in that phase that money managers where in probably ten years ago, and that industry really consolidated. People say that the money management industry didn’t consolidate; I argue no, no, it consolidated. It created some mammoth giant players. The difference is it has a very vibrant small firm sector because it’s an easy business to get in to. And I’d argue broker-dealers are probably somewhat the same in that if you follow that logic that any industry is going to have the very large and then the very small, then the small broker-dealers can certainly do fine. And that might be defined as a broker-dealer with like five people in it, or a broker/dealer with 100 advisors in it, because there’s something about that relationship set or their physical location that makes it a unique offering for them, and that’s their distinction.

They won’t be able to distinguish themselves on technology or capabilities, because that will be too expensive. And so for people who say, “Hey, I want that relationship type of feel in that kind of setting,” or, “I’m with my buddies who I used to be an employee with somewhere, and that’s what’s most important to me,” then I’m sure that model will be fine. And particularly with technology and service companies, scale matters a lot. Therefore, scale allows you to do something we call the virtual circle.
The virtual circle is the way we explained it to the private equity firms in ’05. For instance, if we create a technology like iDoc, which basically images all paper in your office as an advisor, then you kind of eliminate the paper. In every office, do you know what the most expensive space user is for them? It’s the paper file cabinets. And this is nerdy stuff, but this is the stuff we saw. Seriously, if you look at their footprint of their businesses, literally, the footprint of their physical space, and you look at their P&Ls, and if you look at dead space, which paper files are about as dead as they can go, it’s actually the biggest use of space in their office. It’s usually bigger than their conference rooms, it almost always equals to the size of an office that could be used for another investment professional or for a planner or whatever they want from there.

So we just simply set out to create a system that would allow them to eliminate that paper, make their life a lot easier because they can look at it online, and then you basically eliminate the need for the use of that space, which they can either take to their bottom line because they shrunk their space footprint, which is a real savings. Or B, they can put someone in that space who actually is productive and they can turn it into revenue. And that’s a simple example of making the investment through technology. The other thing that we do in the virtual circles is we say that by lowering prices, if you’re a believer in supply side economics, your volume goes up. And so the other explicit part of our virtual cycle is to give back to advisors lower prices. That allows them to be more competitive with their clients and with their prospective clients, and lo and behold, their business grows. And when their business grows, because we’ve made it more efficient through something like iDoc or through the lowering of prices, guess what happens to us? Our business grows, because we’re just reflecting of their success, and that new business grows and turns into profits, and therefore, that’s helping shareholders get paid . And then it all starts over again.

As employees, the fun we get to have is thinking about how we’re going to make that virtual circle happen. And really we’re excited by things like iDoc, and we’re excited by thinking about how pricing works and we’re excited by the growth of advisors and their success. So everybody gets a seat at the table there, whether you’re an employee, or a shareholder, or a client.

Macchia: What certainly is not mechanized or technological is something that I get from you in large volumes right now, and that’s passion. How does passion get communicated through an organization?

Casady: I think first of all, you have to start with yourself. I think the first part is you have to ask yourself whether you have a passion about your clients and the business you’re in. And if you have that passion, then you’ve got to want to find a bunch of other passionate people that you can share it with. And that’s what struck me about LPL. I knew LPL as a client from my previous frim, and when you talked to people at LPL, they were very passionate about what they did, they were very passionate about their clients.

In fact, if you come here and you’re not passionate about those things, you tend to stand out, and you’re not very successful. We’re really very zealous leaders, and guard this passionate view of what we’re doing.

Macchia: That’s really interesting to me. Let me shift gears, however. With all the talk we hear about explosive growth in RIAs, do you think there are challenges, going forward, of keeping a traditional BD relevant? And I’m not implying that LPL is a traditional BD. Rather, in general.

Casady: The question we ask ourselves is what do we think is going to happen in the world that will make us irrelevant? If you were starting the business today, David, and you were in our space, what would your business look like? Would it look like us, or would it look like something completely different? And we go through that exercise once a year and when we do our budget process, to ask ourselves where are we losing relevancy? Where are we gaining relevancy?
And out of that, we almost always come to some really interesting thoughts, and it’s out of that that led us to think about how we price advisory business. So I’ll give you a real tangible example of your point.

LPL has created the fourth largest mutual fund wrap in the country, and we’re the ninth largest advisory platform in the country, remembering we don’t do any fee-based brokerage. So if you took the fee-based brokerage out of the system, we’d probably be a little further up. But long-story short we’re successful. But if we looked at pricing, an advisor who’s here who would look like a registered investment advisor but isn’t, they’re part of our corporate RIA, they were paying us a premium at high levels that might be as much as $200,000 a year more than they would pay a custodian for the same work. Because we’ve said to ourselves, “Well, that’s not going to last,” right? Because those people are going to maximize their profits by finding ways to do this cheaper.
So we announced in August at our national conference that starting January 1st of ’08, we’re completely changing our pricing for our advisory platform in two ways.

One is we’re reducing our ticket charges for mutual funds so that basically 60% of all mutual fund trades will be free and about 20% will be at $4.50, and then the last 20% will be at $26.50. And it’s an enormous group of funds, something like 7,000 different funds that you can trade there. And then secondly, we’re going to give you an advisory fee rebate, so we charge an administrative fee for an advisory count so that now if you’re that same advisor who was paying us $200,000 more, they’re only going to pay us about $15,000 more than they would a custodian. So we’ve really leveled pricing at that end. And why would they even pay $15,000 more? Well, because we do everything for them. We provide all their client statements, and we provide E&O coverage. We do all the privacy mailings, so they basically outsource their operational activity to us for a very slight cost over and above a custodian.

If they were at the custodian, they would have to do all that work themselves, and it would be much more expensive for them to go to a custodian model. So I think what happened is, our view was that basically there’s a space in the market where these distinctions between a brokerage firm and a custodian firm are really only a result of a historical accident and not a result of economics.

Macchia: These changes that you mentioned are not the kinds that elicit protest from advisors.

Casady: Last year when he did it, the production bonus changed. It went up to 98%. It got 17 rounds of applause. This year it only got 12, so they’re pretty happy.

Macchia: I want to shift to one of two of my favorite topics. The first one is baby boomer retirement. I have been focused in two ways on this since early ’04. First, in my commercial life where Wealth2k develops solutions for advisors to use as compliant frameworks to attract and engage investors in opportunities like retirement income. But also in another part of my life where I’m a co-founder of a non-profit think tank called the Retirement Income Industry Association, which has been very significant in contributing to the industry in bringing together retirement businesses across silos and across industries to have the retirement income conversation in the view of a unified framework if you will. I wonder what you think about when you look at this 30-odd trillion dollar transference, the greatest movement of money we’ll ever see in our lifetimes. How do you see LPL’s role playing into that opportunity?

Casady: And the transference is that money going from retirement–

Macchia: Yeah, from accumulated retirement assets into distributed income.

Casady: It’s interesting, and of course, it’s been going on for a while. I mean, my mother did it 15 years ago when she retired. So I look at it and say what is really happening is a change in volume, not a change in type. And so it’s been happening since time began that people go from accumulation to distribution, and the question is, how do you do that at scale, and what makes you unique in the world?

So I think the first way we think about it is what products will get created by manufacturers that we think are interesting for our advisors to understand or represent sort of a different way of looking at this issue. And we think that there’s a lot of innovation occurring, particularly among the insurance companies around issues that are going to be relevant to people who are going through that change. And the second thing we look at is what should change about the way we think and the kind of service we provide in terms of information to our clients’ advisors that they can use for their clients, the end consumer? So what our statements look like, what kind of information is on statements, and so forth.

And what it’s led us to is to believe in what we describe as a wide spectrum approach, meaning that what you’re seeing is, again, sort of the pig of the pipeline go through, in which there’s still going to be a lot of people accumulating after this generation retires, but the reality is that pig of the pipeline gets a lot of attention, and therefore you have to have a competitive response to it. We actually think it’s probably a little early in the cycle and we’re trying to understand a little bit more of what others are doing. And then we will come along with some innovations that start to recognize, perhaps, a different way of communicating to end clients.and identifying the best products that are being created by manufacturers.So we’re still on the exploration phase of how we think that changes the dialogue and the work.

Macchia: Let me ask you this. If you were to accept the fact that most advisors over the past two or three decades have squarely been in the accumulation mindset, and if you further accept that the tax strategies and techniques of placing accumulative assets into a distribution mode require different strategies, and then what’s implied by that is that it requires a level of education for advisors that may not be supplied in the correct amounts right now. Is that something that you think about?

Casady: It’s interesting. Because I don’t see it quite that same way, David. What I see is– I spend a lot of time on our clients. And so I’ve been in the business a long time, and I can tell you that back in the mid-eighties, we worried about how to deal with families that were going through enormous wealth creation or were in the distribution phases, or were in the income generation phases because the work part of their life, or the wealth creation part of their life really had ended. But those obviously are very wealthy families, so it was clearly very upper-end.

But when I talk to advisors here, whether their practice is focused towards the wealthy or whether their practice is focused more towards the middle income American, the issues are the same. And the very best advisors here have dealt with this issue for a long time., And as I said, I think what’s changing is that, there is a bigger market opportunity to help them, because more of their book will be converting to the income payout phase, and therefore they can’t do at scale what they could have done at scale before. Instead of 5% of their book in that phase, it’s going to be 50% or 40%. But that’s what we see is an opportunity for us to help our advisors manage the complexity of having to create information on a larger scale. It’s what led us to put in the system called Wealth Vision, which is our partnership with eMoney. It is a very powerful tool because it is modular and it sets up the issues through financial planning methodology. It helps the clients think about the kind of income they will need in retirement.
So I always come back to people who are very good at this business already doing a reasonable amount of it, they just don’t have to do it at scale yet. And so it’s not a complex problem.

I agree with you that the challenge we face in any part of our business– and we think training is one of the four pillars under which we’re successful, so we say technology, service, investment research, and training are the four pillars that build LPL. And so in our training programs we focus on on providing programs that help advisors with retirement and legacy issues. We also need to help the manufacturers offer more of those educational opportunities and the things they’re doing as they bring advisors into their shops and so forth as a way to help the broader group maybe see some of that and understand how to manage it.

Macchia: You know, Mark, you mentioned pillars, before- which make perfect sense to me. I would argue that there’s another potential pillar to think about, which is communications and communications technology. Whereas so much effort has been applied so successfully in terms of the technology that makes the advisor’s life easier in all the ways that you’ve described, the same technology and demographics implies that we have to do more in terms of the technology that we forward project in the way we communicate with people, improving the experiences we deliver to the web browser, recognizing that people are delivering and learning in different ways, that we’re transitioning as a society less and less readers and more and more watchers. Is this something you think about, the idea of improving the forward projection of communications?

Casady: Yes, I agree. To be honest with you, I’m not sure how to visualize that, because that, to me, sounds like a technique.

Macchia: I guess what I’m saying is that demographics would imply that there aren’t enough advisors to personally interact in the manner that they currently do with all of the prospects who may need guidance in the distribution phase. Will there be web-based strategies that allow advisors to reach people in novel ways?

Casady: Yeah. I have a good friend that uses the word, “modality,” which I always think is a funny word. Because I looked it up once. It’s the definition of different ways people take data, which I never knew until I started to use it. And so if we think about the innovation of the cell phone, what’s A versus B, the land line, that was just a change in modality. And so I fully agree with you that the way that we interact with an advisor today is quite different than how we interacted with them five years ago. And today we use a variety of technologies that are web-based, CD-based, or a whole range of ways to educate and inform that are quite different techniques than we used before. Those haven’t made their way to the end client as much, but they certainly will, I completely agree with that.

Macchia: I’d like to shift to a couple of personal questions, if you don’t mind. The first one is this. If I could somehow convey to you a magic wand, and by waving this magic wand you could effect any two changes at all that you’d wish to make in the world of financial services, what would they be?

Casady: I think the first thing I would do hope for the country to deal with the broader Social Security issues. Let’s call it a retirement security problem. Because you really have three groups of people in the world, or in the U.S. You’ve got folks who, generally speaking, make more than $200,000 a year who are going to be fine no matter what. Then you’ve got people who make $40,000 a year to $200,000 a year that aren’t going to be so fine. But there are corporate processes like 401(k) plans, and there’s tax incentives and things that could be dealt with, and there’s folks who make less than $40,000 a year– just to use rough math here– that are in real trouble if Social Security is insolvent.

The second one, that’s an interesting one. I would be tempted to probably wave it towards some rationalization of the regulatory world, meaning that– the U.S. market is a very odd market. I spent a lot of time overseas for Scudder Investments, and a little bit of time for Northern Trust, and what I was struck by the sameness of regulation in those countries. So there’s one regulator in the U.K. for financial activities towards retail consumers and towards institutions, and here we have at least three, if not four or five that are involved in that kind of work. So if there were another wand to wave, I think I’d probably wave it towards some form of uniformity approach towards regulatory matters. Because it would clear up a lot of gray areas in the way things are done. And it would, I think, create a better regulatory environment in the sense that it would be more effective. Because our problem in this industry is that people who do bad things are, luckily, fairly rare, but quite difficult to find. And therefore the costs get created to try to find them, but really tax the rest of the 99.9% of the systems that are all fine. And I probably would wave it towards that, because I think that would help consumers and I think it would help the industry with consistency of approach. So those are some things that come to mind.

Macchia: I suspect there’s many who would sign on to both of those. Let me ask you the next question. If you were not the chairman and CEO of LPL, but instead could have any other occupation in any other type of industry, what would you choose to be?

Casady: Excuse this one. Far and away, and if I weren’t here I’d be in the same job somewhere else in the same industry, because I love what I do. If it were more esoteric, meaning that I was just ready to have a different phase in my life, which I’m not, I love music, and I’d do something related to the music industry. I’ve always thought I’d like to have a record label and I’d like to do concert promotions, and I’d like to have a chain of clubs, kind of like the House of Blues. Those are all the sort of fantasy worlds that were there. I’m certainly not ready for that, but just for the normal course of saying if you couldn’t do this, what would you do completely different, that would be the completely different thing I would do.

Macchia: That’s interesting. One of my never-to-be-realized fantasies is to be a great trumpet player.

Casady: Is that right? You have no musical ability?

Macchia: Not enough, certainly. But lastly, on this score. If you were to imagine your own retirement in its most conceivably perfect form, where would you be and what would you be doing?

Casady: That’s a good question. I don’t know what that is. Work would have to be involved in some way, David, because I’ve learned a long time ago that for me, doing something– maybe not as intense as what I do now– but doing something beyond board work is going to be a big part of my life for a long, long time. And so what I try to do is– Bob Pozen is a good example of it–here’s a guy who’s working as the chairman of MFS,-that implies less of an operating role than the CEO. He’s obviously on some boards and he is a big contributor to the industry. He’s done some work in the state government here in Massachusetts. And I look at people like that and think, well, is that a model? And I think, well, I’m not sure I’d really like the government part of it, because that’s not part of who I am. But I sure admire the fact that he’s found interesting ways to be stimulated well beyond the years that one might normally want to do it.

Frank Zarb’s another one I know who’s part of Hellman and Friedman, and Todd is very close to Frank. I don’t know how well you know him, but he took over as chairman of AIG when Hank Greenberg had to step down. And he’s another person who is in government. He was in the Ford administration, and then he went into industry when they ran the NASD when it used to have the NASDAQ market as part of it, and split out NASDAQ and became the head of the NASDAQ, and then retired from that role and then went into Hellman and Friedman as kind of an executive in residence.

I just think those people have interesting lives because they’ve stayed actively involved. And so I’ve always envisioned that my retirement life would be certainly having more time to go to Chatham and more time to go to California and more time to do the things I like to do. I love to travel and go to music festivals and other things. I’d like to have more hours in the week to do that, no doubt about that. But I’d always have to have something to do two or three days a week that’s business related or nonprofit related, because I love that stimulation.

Macchia: Sounds like a pretty nice vision.

Casady: Not quite formed yet.

Macchia: Do your musical tastes include the Friday night band concerts in Chatham?

Casady: They used to. I don’t do those as much anymore because I’ve got four kids and we’re in that complex kid stage.

Macchia: Well, with eight year old twins, I’m still squarely in the blanket-on-the-grass stage.

Casady: You can take them anywhere. Julia and I just got back from Austin City Limits music festival, and it was just great fun. And you get three days to feel like you don’t have a care in the world and just listen to great music and hear a lot of bands that you’ve never heard of before, and a lot of bands that you love. It’s great stuff.

Macchia: Good for you both- and thanks for sharing your time. It was wonderful.
Casady: I enjoyed it, David. Thank you.

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Interview with Philip G. Lubinski, CFP. Leading Retirement Income Expert is First to be Featured in New Interview Series: America’s Elite Financial Advisors

philToday marks the introduction of my new interview series called America’s Elite Financial Advisors. I’m excited about these new series for many reasons but none more so than the opportunity to provide a platform to individuals who possess insights and knowledge that is too often insufficiently appreciated.

The subject of the inaugural interview is a man who counts me among the members of his fan club. Phil Lubinski is both a friend and business partner who has journeyed down the retirement income highway with me since 2003. Actually, I hitched a ride. Phil has been successfully navigating that roadway since 1984. It’s an obvious understatement to say that this was well before most had discovered the business opportunity in retirement income distribution.

It was Phil’s early work in crafting a time-weighted, laddered asset allocation strategy designed to generate sustainable, inflation-adjusted retirement income that led to the development of Wealth2k’s The Income for Life Model™ (IFLM).

Phil has brilliantly led the advisor education efforts around IFLM. He has completed training of more than 4,000 FAs using his one-of-a-kind approach to income distribution education. Focusing on the practical investment and income tax techniques that advisors are required to master in order to properly place retirement assets into a distribution mode, Phil’s IFLM Training Institute is hailed by advisors for the practical guidance and planning techniques they are taught. That advisors so easily relate to Phil is a key element in his ability to establish credibility with professionals who recognize that they are learning from one of their own.

A devoted Colorado Rockies fan (and season ticket-holder), I’m unable to easy Phil’s pain in seeing his favorite baseball team lose the World Series to the much superior Boston Red Sox. But I can make it possible for more people to get to know the man I refer to as the “Pope of Distribution.”

MACCHIA: Firstly, Phil, my sincere thanks to you for agreeing to have this interview with me. As you know, this is the first in a new series of interviews I’m calling America’s Elite Financial Advisors. I believe it’s important to gather the perspectives of those advisors who have managed to reach the highest levels of success. So, I’m happy you are the first to be interviewed. Thank you for that.

Phil Lubinski: It can only get better from here.

MACCHIA: I’m an optimist! Let me begin by asking you what you believe are the qualities of an elite advisor?

Phil Lubinski: Wow. You know I hope it’s not defined by the amount of commissions they generate on a yearly basis because, while that’s a measure of success, I really think the elite advisor is the one that has a relationship with a their clients that is far more than just transactional; elite advisors have a problem-solving relationship including advice and solutions in areas that have absolutely nothing to do with a product sale. A significant indicator of an elite advisor is the retention rate of their clients.

One measure of client retention was the National Quality Award. It was given to advisors who had an 85% or higher persistency rate, which correlates directly to client retention. Of all the top “production” awards I’ve received, my proudest accomplishment was receiving the National Quality Award for 20 consecutive years. The fact that I could retain more than 85 percent of my clients in good markets and bad spoke to the true nature of the relationship.

MACCHIA: You bring something up that resonates with me, Phil, because of my own background- having also entered financial services through the insurance door. And what you’re describing that doesn’t exist anymore is partly, if not totally, due to the fact that, along the way, insurance companies became product manufacturers with few exceptions. And the kind of development of not only the talent of salespeople but also, in a sense, the values of salespeople were lost. I wonder if you see that as being true?

Phil Lubinski: I see it as true and not necessarily in a malicious way. Like you, my roots also began in the insurance industry. My biggest decision 30 years ago was trying to select the best agency to join. In Denver, there were three very prominent insurance agencies that I interviewed; Northwestern Mutual, New England Life and State Mutual. Although all three companies had extremely competitive products, I chose State Mutual because its General Agent, Bernie Rosen, had a legendary training program. Not only was it a comprehensive 3 year program, but, more important, it instilled the “values” you referenced in your question. It was a true “needs” based approach that always placed the clients’ needs ahead of your own.

What I witnessed beginning in the late 80’s and through the 90’s was the explosion of the variable products combined with the greatest bull run in the history of the U.S. stock market. Planning and problem solving came to a screeching halt. Recommendations were no longer “need” based, but rather, “greed” based. Cost and performance became the mantra, insurance companies de-mutualized, stockholders needs seemed more important than the policyholder’s needs.

As the financial services industry focused more and more on profitability, budgets were cut, and one of the first things to go was advisor training. Unfortunately, the training was turned over to the product wholesalers. What I’m seeing now as we roll out the Income for Life Model™ nationally is advisors hungry for training. Advisors desperately wanting to learn how to sell the process, not the product. It has been an eye opener for me.

MACCHIA: Your answer raised many excellent points, some of which I want to come back to later- specifically in terms of retirement income. I want to stay on the issue of wholesalers for a minute because wholesalers are individuals that I know contact you and your associates quite often. And they are in the vanguard of distributing ever changing, ever more complex and ever more diverse products to advisors. How do you and your colleagues view wholesalers today? Do you like the process? Do you think it works? Do you think it’s broken? What is your general take on the whole notion of product wholesaling?

Phil Lubinski: I don’t know if our OSJ is a typical office or not. We have 11 advisors with more than 15 professional credentials and an average tenure of 17 yrs. We allow very few wholesalers to make presentations. The days of T-shirts and golf balls are over. We’re tired of hearing about yield and riders. Virtually every quarter there’s the new and improved rider, the “simple” single product solutions, the “my” fund beat “their” fund mentality. Even more alarming is that the products and features are changing so quickly that the wholesalers aren’t being trained adequately and several times have given us inaccurate information. We specialize in retirement income planning. We know there is no single product solution. We want wholesalers to show us how to strategically combine several products to meet our client’s needs. We’re not interested in hearing them “slam” their competitors. So, in answer to your questions, we don’t like the wholesaling process and through no fault of theirs…it is broke. Consequently, they bring little value to our table.

MACCHIA: Well, let me ask you this. In terms of products, in terms of the stories that you’re hearing about products and product innovation, do you view it that true innovation is occurring? Or do you view it that incremental changes are being made? Or do you find that it’s something different?

Phil Lubinski: It seems like many of the innovations are the same thing with a little different wrapper. There’s this kind of herd instinct out there though and I hate to keep picking on the annuity industry. The mix of business in our office is pretty equally spread between insurance, mutual funds, and advisory fee products. But on the annuity side that certainly has been where the changes have been the greatest. But what happens is every few months there’s “Here’s our new and improved rider. The one you sold your client six months ago (that was the newest and best thing then) isn’t as good as this one now.” And when there’s any play to that rider then there’s ten other wholesalers coming in saying, “We got one too, but here’s why ours is a little bit better than theirs.” It’s what happened with disability income insurance back in the early ‘80s.
The companies got so competitive trying to make their definition of disability unique that they almost put themselves out of the business. And now the annuity income riders have become so complicated that the wholesalers presenting them don’t understand them. What is more frustrating to us is that when a “new and better” contract comes out, the existing policyholders are not given the opportunity to exchange their contracts. It’s becoming more like the computer industry….”why buy one today, there will be a better one tomorrow”.

Are they innovative? I guess so, since prior to the income riders, your only choice was to take a systematic withdrawal and run the risk of over withdrawing and running out of money, or annuitizing the contract and giving up access to all your principal. They’ve played no role with our existing retired clients who have the traditional retirement with pensions and Social Security. They already have their base of guarantees and don’t need to be buying any more guaranteed income stream. But certainly those boomers moving into retirement without the guaranteed income streams their parents had definitely need a percentage of their income guaranteed for life. But certainly not 100%. In other words, the guaranteed income riders are potentially part of an overall solution, just not the only solution.

It’s kind of interesting that in 1952 a guy named Harry Markowitz suggested that diversification was a proper strategy for wealth accumulation. It was almost heresy to suggest such a thing but 40 yrs. later he was awarded a Nobel Prize. Today, diversification is a household term. Why wouldn’t the same diversification strategy work on the distribution side of wealth? Why would a retiree NOT diversify their income sources? Why not have a combination of income sources that offer guarantees, market opportunities and insurance against premature death, disability and longevity. Wrap all of these features and benefits up into a single product and now you have innovation. Until that happens, retirees need to diversify their income sources with a strategic mix of products. I just hope it doesn’t take 40 yrs. for this message to become widely accepted.

MACCHIA: Right. Well let’s talk about that. Let me begin with a compliment.

Phil Lubinski: I like that.

Macchia: One of the things that I often times- and publicly-say about you, Phil, and I know you’ve heard this before- but I’ll repeat my belief here that, after knowing you for a number of years now, and after working with you to develop solutions for retirement income, in my judgment no individual in the financial services industry has a greater practical, real-world understanding of the challenges associated with converting accumulated assets into distributed income than you.
Phil Lubinski: Thank you. You’re on a roll, keep going.
MACCHIA: Well, I’d like you to comment on a few things. One key thing that I have learned about retirement income planning is a phenomenon that I see repeating itself in the retail space over and over again. It’s financial advisors coalescing around philosophies or as I describe them “religions” of retirement income. There’s the religion of systematic withdrawals. There’s the religion of lifetime annuitization. There’s the religion of lifetime annuitization linked to, say, target date retirement funds. There’s the religion of laddered strategies- time weighted strategies. There is the religion of variable annuities and GMWB riders. I wonder if you see it this way? And what you think the ultimate conclusion of all this is going to be?
Phil Lubinski: Yeah, the religion analogy is a good one in that most religions will have a core belief and then they all have a different view on how to practice that core belief. Consequently, I don’t necessarily think that there’s a right religion and a wrong religion.

But more important, advisors have to develop a religion of retirement income they believe in and practice it. They need to stop trying to practice all of them simultaneously. When training advisors I jokingly say that you can’t go to the Synagogue on Saturday and Mass on Sunday. It’s not because one is right and the other wrong, it’s just that you can’t follow both. Once an advisor decides which religion of distribution they are going to practice, then confidence and passion follow. I’ve never met an “elite” advisor who wasn’t passionate about their work and confident with their recommendations.
As you said there are several “religions”…..systematic withdrawals, annuitization, segmentation, laddered securities, dividend/interest sweeping, etc. They all work, just some more efficiently than others. I’m obviously bias to the Income for Life Model™ because I began developing it over 20 yrs. ago and have used it to help hundreds of my clients retire. All I know for sure is that “churches of distribution” are going to be popping up on every corner and advisors better do their homework and understand the pros and cons of each. Additionally, we as advisors, better not lose sight of an extremely important obligation we have to our clients which is “knowing them well” and in some situations protecting them from themselves. The best intellectual solution may turn out to be the worst emotional solution.

Some retirees need to have surrender penalty fences built around their financial house. Others may need more guarantees. Income riders may give certain retirees the courage to take market risk with the rest of their retirement money. Which religion is best for boomers transitioning into retirement? I guess we won’t know until the last boomer dies. All I know is that I’ve never had a client who followed my religion miss a monthly check or go broke. Let me give you a couple of “real life” examples of human behavior dictating decisions and products more than intellectual analysis.
A couple of years ago I had a client who was retiring and given the option to take her pension as a life income or a lump sum that could be rolled over into an IRA. Based on the amount of the lump sum vs. the life income with 100% survivor benefit, it was mathematically clear that she would be better off taking the lump sum. The next day, she called to tell me that she had decided to take the life income with the survivor benefit instead. When I asked why she had changed her mind, her response was “I couldn’t share this with you last night when my husband and I met with you, but my husband is a habitual gambler. If I took the lump sum and then died before him, he would take the balance of the account and be broke in a short period of time. If I leave him an income stream instead, I can’t stop him from gambling it away, but at least the next month he’ll have another check”. Intellectually and mathematically her decision made no sense, but emotionally, it was the right decision. I just had another case where a client of mine received an inheritance and wanted to invest it. I recommended an annuity.

One of my associates asked why I would recommend an annuity to a single person who is only 50 yrs. old. I responded by explaining to my associate that in the 20 yrs. I’ve been working with this client the only wealth he has is in his 401k. He is constantly in debt (even though he has always said he was going to pay it off), he refinances his home every time there’s equity in it. The only monies he leaves alone are the accounts that he can’t get without big penalties. As advisors we think that our most important responsibility is to protect our clients from taxes and inflation. Sometimes, our greatest responsibility truly is to protect them from themselves! I kid my clients about my T.I.U. protection plan, telling them that part of my job as their advisor is to protect “your” money from Taxes, Inflation and “U”. Because I find that sometimes individuals do more damage to their wealth than taxes and inflation combined. Only by having a planning and problem solving relationship and knowing our clients “well” can we make the proper recommendations. Elite advisors have such a relationship.

MACCHIA: Well I think you raise some key insights, Phil, and it leads me to ask you why, beginning in 1984, you focused on the development of a time weighted asset allocation model that has become the foundation of today’s The Income for Life Model™ program?. And I gather it’s because of the experiences of working with real people at ground level. Because you saw the dimensions of that emotional problem firsthand. And I assume saw that that particular strategy helped minimize the negative effects associated with emotionally-based investment decisions. I don’t mean to put words in your mouth, but, is that how you saw it?

Phil Lubinski: The Income for Life Model™ evolved totally from day to day, one-on-one work with my clients. It literally stems from being in the “trenches” and dealing with the unpredictability of human behavior and changing events in a retiree’s life. It is, to some extent, an academic/intellectual model because you have to mathematically validate it and prove that the assumptions made are reasonable. But, currently, it is the only strategy in the market place that can easily adapt to retirees changing needs.

It’s nice to lay out a long-term financial plan with spreadsheets projecting income and expenses for the next 25 or 30 years. But, here’s reality: in the 30 years that I’ve been in this business I’ve never had a retiree spend what they said they were going to… I’ve never seen rates of return be exactly what we projected…and, certainly, unexpected expenses are common place. Spreadsheets are nice, but, at best, they are an indication of the future, not a precise predictor.
What’s evident to me is if you’re going to design a retirement income distribution strategy it better have tremendous flexibility and a regular process for review and re-evaluation. This goes right back to the relationship with your client. Each year we formally review the model and the client’s goals and objectives. We’re not chasing the highest yields, not focusing on new sales, but we are constantly “fine tuning” the plan. Adapting it to changing circumstances, not changing markets. Single product solutions will never provide this type of flexibility. As far as I can tell, the Income for Life Model™ is the only strategy in the market place that has this type of flexibility and a 20+ yr. actual track record…not a hypothetical one.

MACCHIA: Next, I’d like to ask you about other advisors. You are very fortunate to have possess a wealth of experience in income distribution planning through your years of implementing with your clients, and that’s an experience framework that 95 percent of advisors do not share. Now I know that part of your time is devoted to training other advisors on income distribution planning. What are the things you’re telling them when you talk about the income distribution opportunity? And what do you see or observe among these other advisors in terms of how you think they are relatively prepared or unprepared for this business opportunity?

Phil Lubinski: I believe they are more unprepared than prepared. This was documented in a study a few years ago by Cerulli and Associates concluding that neither the industry nor its advisors were prepared. The challenge is how to train and arm an advisor with a solution that has moving parts and has the kind of flexibility that I personally feel is necessary. For some advisors the learning curve becomes so overwhelming that they revert back to doing things the same way they always have or seek out a simple, set it and forget it, single product solution. That’s very bothersome to me. I’ve actually been told by some advisors who have attended my training classes that wholesalers were not only sitting in the audience, but have approached them within a day or two telling them that the solution really doesn’t need to be that complicated. And, furthermore, assure them that their product will accomplish everything a multiple product solution, like the Income For Life Model™ can… with a single application.
Damnit! This is someone’s life savings we’re dealing with. It’s not simple

MACCHIA: Right, right. Tell me about the training that you do. What form does it take? How long does it last? What is the reaction among the advisors you train? What do you see that advisors are able to achieve after the training that they weren’t able to achieve before?

Phil Lubinski: I think the biggest advantage of the training is it’s one of their peers training them. I’m still in the trenches with them and I’m talking to them at their level. It’s not coming from the academic on high. It’s not coming from that person that’s never met with a single client but thinks they know what that clients needs. So the reaction is very favorable. I relate well with them because I am one of them. And the ah-ha that has that come out of the training is– I really see it now. I get it.

You know, ten years ago there was a sense that things never needed to change when you transitioned from accumulation to distribution. It was a seamless transition. You just kept doing it the way you were doing it on the accumulation side…in reverse. So if I successfully dollar cost averaged into the market, why wouldn’t I dollar cost average out. Then, the horror stories started coming out during bad markets of people going broke.

The result of advisors attending my classes is they understand that the strategies used to distribute wealth are inherently different than those used to accumulate wealth. They believe that multiple products must be strategically combined. They understand the importance of annual reviews. They appreciate the depth of the relationship I have with my clients. I know the class made an impact when an advisor says to me “I’ve been doing retirement income planning for my clients, I just didn’t realize I’ve been doing it wrong.”

MACCHIA: I want to turn the conversation toward products for a minute, and begin with a discussion of annuity products. Having come from the insurance business you’re very, very familiar with all types of annuity products and I’m sure you recognize that the annuity industry is navigating through what is probably the most hostile marketing environment it’s ever faced. Certainly in my 30 years I’ve never seen anything the equal of it. I wonder how you view annuities today? Are you using annuities in your practice? And how do you perceive that your clients may be view annuities?

Phil Lubinski: Unfortunately, because of the publicity around the abusive sales of annuities, the vast majority of clients have a bias against them when they come in. An important part of the process with the client is to educate them that annuities aren’t inherently bad as long as they are positioned properly. I always try to give them “real life” examples they can relate to. A good one is comparing annuities, or any other financial product, to prescriptions that a doctor might recommend. I tell my clients that most prescriptions aren’t “bad”, but there are certainly some that are “bad” for you. If, after understanding your goals, objectives, tax status and risk tolerance, I believe an annuity is appropriate…I’ll recommend it. If not, I won’t…pure and simple.

We have an extremely proud generation of boomers moving into retirement. For some, their biggest fear is outliving their income and becoming dependent on their children or the government. Obviously, annuities are the only financial instrument that can eliminate this concern. Once again, I don’t see them as the only solution, but certainly use them as part of the overall solution. It’s funny (not really funny). I’ve listened to a couple of radio shows. One tells the listeners that annuities are good and mutual funds are bad. The other show says mutual funds are the only answer and annuities are evil. I’ve been told that the guy doing the mutual fund show is not insurance licensed and the one doing the annuity program is not securities licensed. Yet, the poor listener believes they are hearing objective advice. How often do you hear a news story about the merits of an annuity? How often do you hear about the spouse whose husband or wife died after the 2000-2002 market crash, but was paid the pre-crash values? How often do you read about the 92 yr. old still receiving monthly income from an immediate annuity he bought 25 yrs. ago? All the time I hear people say “insurance is a bad investment”. My standard answer is “you’re right, and investments are bad insurance”. Why don’t we decide together what is good or bad for YOU, not what someone writing an article thinks.

MACCHIA: Right. Well said.

Phil Lubinski: Just more words than it should have been.

MACCHIA: No, no. Not at all. Let me ask you about the role of RIAs which have changed and expanded over recent years. When you look at the world of RIAs from your vantage point how do you see it?

Phil Lubinski: I see a lot of confusion from advisors trying to understand the RIA business. Not knowing whether to register their own or operate under their broker dealer’s umbrella. Not receiving a lot of guidance as to the responsibilities and liabilities of being one. Every advisor would love to have 40 or 50 million under management and receive advisory fees year in and year out. Certainly having those fees is a financial comfort to the advisor and creates “equity” in their practice that can be sold to a transition partner. In theory, it brings more objectivity into the advisor/client relationship and certainly a more structured review process with your clients. Financially, it is very difficult for the “commission only” advisor to transition into a fee structure. The beauty of the Income for Life Model™ is it is best funded with a mix of fixed commissionable products and investment portfolios that can easily be placed in advisory accounts.

If an advisor is going to focus on retirement income planning there needs to be a commitment to regular reviews with your clients. If all the advisor recommends are first year commission products, then how can they possibly fulfill their ongoing commitment with no continuing revenue? Additionally, why would a junior advisor want to purchase a practice that requires ongoing servicing with no compensation? It’s interesting, when I first started in this business at 28 yrs. old, new clients would wonder if I would survive. Now, at 58 yrs. old, my clients wonder if I will still be reviewing their retirement income plan for the next 25 yrs. And, if I am, what went wrong with my own retirement plan? Three years ago I began a 10 yr. business plan to introduce my clients to my transition partner who plans to work another 20 yrs. We have a business agreement for her to purchase my practice based on the value of the reoccurring income.

Having a portion of their income model in investment advisory accounts easily establishes the purchase price. More important, it gives my clients peace of mind knowing I have a practice continuation plan. Also, they have this 10 yrs. to get comfortable with my partner. Being able to operate under an RIA is beneficial to my clients, my transition partner and me.

MACCHIA: Let me ask you about another RIA-related development of recent vintage. That is, the notion of insurance agents who are being solicited into RIA status. The effort seems to be aimed at annuity agents who may be unhappy with broker-dealer incursion into the equity-indexed annuity business, and, or, generally-heightened supervision by broker-dealers. But the “pitch” that’s put forth is that they become RIAs, essentially cutting their practice down the middle, becoming RIAs for investment activities and maintaining the traditional insurance license and relationships on the insurance and annuity side. Do you think that’s a practical model? A model that has the requisite integrity to be viable over the long run?

Phil Lubinski: Any business model that is focused primarily on commissions and the avoidance of supervision is fatally flawed.
MACCHIA: Let me ask it another way. Agents by definition are fiduciaries for the insurance company they represent. They are agents for the company. RIAs are fiduciaries to their clients. Do you think it’s possible to be both with the same client?

Phil Lubinski:
That’s an interesting question having been in the “captive” world and having my own RIA at the same time. Fortunately, the company I was affiliated with had a “full” product shelf and the amount of proprietary sales that were required to maintain benefits etc. was a small percentage of my total production. Certainly, their proprietary products were competitive or I would not have been with them. Bottom line, by always doing what was in my clients best interest first and running a very busy appointment schedule, I was able to fulfill my responsibilities to the company and my clients. Now that I am affiliated with an independent broker dealer, I don’t find my recommendations changing. I have, however, known advisors who have affiliated with companies whose local agencies place a great deal of pressure on them to only sell proprietary products. I believe they have a difficult time walking that line.

MACCHIA
: Well, thank you for that answer. I think that makes sense. I want to ask you a couple of personal questions if I could.

Phil Lubinski: Okay.

MACCHIA
: How about this: I somehow convey to you a magic wand, and you can wave it and immediately institute any changes at all in the business of being a financial advisor. These changes could be related to products, regulation, marketing. It could be something I’m not thinking of. What change or changes would you make?

Phil Lubinski: Wow! This is probably one of those answers that three days from now you wish you could change. I would like to see a focus at the industry level on process rather than product. I’m hearing some lip service to that effect at national meetings but I’m not really seeing it being implemented in the field. Every advisor would love to see different regulatory oversight because it’s gone to an extreme. It’s certainly not limited to our industry. We’re seeing doctors leaving their practices because they can’t practice medicine anymore. We’re seeing teachers abandoning teaching because they can’t teach anymore. At times you feel you’re practicing law more than financial planning.

Specific changes I’d make are…
1. Better training
2. Less complicated products
3. Re-define the wholesaler relationship and their compensation
4. A planning/problem solving focus

MACCHIA: Good answer. One more personal question. As someone who has helped hundreds and hundreds of people enjoy more secure retirements, when you imagine your own retirement, in its most conceivably perfect form, where will you be and what will you be doing?

Phil Lubinski: We’ve have a genetic flaw in my family. My 90 yr. old father just retired this year. The thought of not being involved in this industry in some capacity is unimaginable. This has been the most emotionally and financially rewarding career I could have ever asked for. The ideal retirement for me will be knowing my clients are in good hands, being able to continue developing the Income for Life Model™ and helping advisors establish meaningful and impactful relationships with their clients. This intertwined with time to kick back, marvel at the continued success of our children, spoil grandchildren and someday see the Rockies kick the Red Sox’s butts in a World Series would be perfect.

MACCHIA
: Sounds pretty good- except the Red Sox part. Phil, I want to thank you for this conversation.

Phil Lubinski: Thank you. It was fun.

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