August 2007

LPL Chairman & CEO, Mark Cassady, to be Subject of Leaders & Innovators Interview

Mark S. Cassady, Chairman & CEO of LPL Financial Services will be my interview subject as part of the Leaders & Innovators series. Cassady heads-up the nation’s largest independent brokerage firm in terms of revenues. LPL is represented by more than 7,000 advisors in 4,500 branch offices. The firm, which has its own clearing platform, has been a leader in many areas including the development of technology.

I’m eager to explore numerous issues with Cassady including his vision for LPL’s continued growth, and it’s strategies around Boomer retirement security.

©2007 David A. Macchia. All rights reserved.

Interview with Heather Dzielak; Head of Lincoln Financial’s RISV Group Cites Need to Reduce Product Complexity; Describes Planning Focus As Key to Compliant Sales

dzielak-oct-2005Heather Dzielak is Senior Vice President of the Retirement Income Security Ventures (RISV) group at Lincoln Financial. She is heading a unit whose stated mission is to position Lincoln as the nation’s “preeminent provider of retirement security.”

Dzielak is an executive who’s clearly on top of her game. In this wide-ranging interview, she addresses a host of issues including product complexity, distribution challenges, communications, non-traditional competitors and income-generation strategies. She also describes Lincoln Financial’s strengths in terms of balance sheet and distribution, and she provides insight into how new distribution models may evolve to meet the future needs of various market segments.

Macchia – First of all thank you for agreeing to let me interview you.

Heather Dzielak is Senior Vice President of the Retirement Income Security Ventures (RISV) group at Lincoln Financial. She is heading a unit whose stated mission is to position Lincoln as the nation’s “preeminent provider of retirement security.”

In this wide-ranging interview, Dzielak addresses a host of issues including product complexity, distribution challenges, communications, emerging competitors and income-generation strategies. She also describes Lincoln Financial’s strengths and provides insight into how new distribution strategies may evolve to meet the future needs of various market segments.

Dzielak – You’re very welcome.

Macchia – To begin, Heather, would you describe your title and role at Lincoln.

Dzielak – Absolutely. The official title that I carry right now is Senior Vice President of the Retirement Income Security Ventures Group. And it’s a new group that was formed in October of last year. The group was really the outgrowth of the more strategic work that Lincoln has undertaken over the last three years.

Former CEO Jon Boscia had a vision that the baby boomers moving into retirement are going to create some unique opportunities for the financial services industry– most particularly for insurance companies, given our ability to underwrite both mortality and morbidity risk. It’s a capability that we believe is going to be critical to helping secure retirement income for our boomer clients.

With that said, Jon asked a group of us over the last couple of years to really think about what all of this means to Lincoln Financial Group. What does it mean in a way that wraps the entire company around it? Our current strategic intent is to be the leader in retirement income security.

We did some strategic work about two years ago. And in 2007, we really began to focus more on execution – the top initiatives that we as a company need to undertake to position ourselves for the future. And out of that work came some execution items, but more importantly came the realization that this opportunity is big enough; that it warrants a group of folks who could think about it and begin to understand and watch this phenomenon on a 24/7 basis. That really was the formation of the Retirement Income Security Ventures (RISV) Group.

It was a commitment by the company, recognizing the magnitude of this opportunity and the need to have a group that sits horizontally across our company to help each of our businesses make sure we continue to position ourselves as a leader in this space. So, that’s the group that I head, and it’s going to be a very lean, agile group. If I were to describe it to someone in our industry such as yourself, it’s like an internal consulting group. We really partner with the businesses to make sure we’ve got the focus and discipline to drive the strategic intent.

Then secondarily, there will be a subset of our group that’s really going to be focusing on the future. What do we think the world will look like 2 to 3 to 5 years out? Much more in an R&D capacity. Really observing the behavior of the boomers and making sure we stay ahead of the trends that emerge as they move into their retirement years.

Macchia – Right. So what you’re describing is a group that sits cross-silo.

Dzielak – Yes.

Macchia – I imagine that given the strategic importance of what you’re attempting to do, having a view across silos was inherently important. Is that right?

Dzielak – Yes. It was very important. It’s important to have the cross-silos seat, but also to sit on the same management team as the business leaders so that this group partners with them. When you think about driving initiatives and accountability, leadership from the highest levels and throughout the business units agreed that it’s about partnership. All of the business leaders, including myself, report to Dennis Glass.

Macchia – When you articulated the stated mission to become the preeminent provider of retirement income solutions

Dzielak – Security

Macchia – Security… Sorry, Security.

Dzielak – Yes.

Macchia – I said to myself that’s a mighty big apple to pick.

Dzielak – Yes, it is.

Macchia – What is it about Lincoln particularly in terms of its inherent strengths or willingness to innovate – what are the qualities that you understand that you think make that possible?

Dzielak – I guess I think about a couple of things. First and foremost when you think of retirement and retirement security, I want to be clear that our mission here isn’t about just creating retirement income streams. It’s more about understanding clients’ risks in retirement and a recognition that the products that we bring to market today are uniquely positioned to help clients manage many of the risks that are of top concern to them.

I can articulate the five risks that we’re focused on. If you think about what’s unique about Lincoln, at the highest level it’s the products that we bring to market to address market risk, inflation risk, longevity risk, healthcare risk – in some capacities there are some opportunities for innovation there – and the last one we call “sources of income” risk– that’s the recognition that clients are no longer going to be able to fully retire on pensions or Social Security and that there are other forms of income that they are going to have to build into their plan.

So, I guess that one level is about our products. That is, as we tend to phrase it, our “franchise rights”. There are some innovations that Lincoln brought to market within our product categories, such as Money Guard®, which is a hybrid product to help deal with long term care risk. We have an innovation around income called i4Life®. Both of those products have been recognized in the market as innovative products that are attracting and meeting retirement income needs.

The second distinguishing feature of Lincoln that gives us the belief and comfort that we can be the leader is our distribution. We have an incredibly powerful wholesale distribution group – Lincoln Financial Distributors. And what’s unique about LFD is that they’re a distribution group with all of the product lines under common management.

When we think about retirement income security, it’s not just about an annuity play, it’s not just about a mutual fund play, it’s not just about a life insurance play– it’s about how we bring our product capabilities together to effectively meet consumers needs. We have the competitive advantage in our distribution because they all fall under common management. We’re not dealing with three or four silos of product-oriented wholesalers. They come together under common management, which gives us the unique platform to launch what we believe is important in a retirement income security plan. We also have an incredibly powerful retail distribution outlet which gives us an opportunity to actually pilot some ideas we’re already talking about in a very controlled, disciplined environment. So it’s the combination of the wholesale and the retail distribution that we believe positions us well.

The next area that we view as a competitive advantage is our employer market business. If you think about the future of retirement income security and the future of retirement for many of our clients, they’re all likely going to be coming out of some employer sponsored plan. We have a very large employer based business – 403(b) and 401(k) – which we believe are going to lead to future growth. That business today is teaching us a lot about how clients want to think about their retirement. The bulk of that business actually sits right in the sweet spot – the baby boomers . So as much as our retail distribution gives us an opportunity to study how advisors are going to meet this need, this employer market business is giving us the window directly to consumers as they hit that tipping point and realize retirement is down the road. We’ve got an interesting opportunity to study them, and we believe that they are also giving us insights that will lead to industry leadership. It’s the bench strength that’s going to be the engine that will drive retirement income security.

Macchia – What else?

Dzielak – The last thing I’d say, and this is a little bit from the conversation we had two weeks ago, one of the areas where we have a lot of improvement to do…there is a belief here at Lincoln that the winners in this game aren’t going to be about just product. They aren’t going to be just about distribution. They are going to be thinking about creating that experience for the customer. And we’ve got a new model that emerged with the integration of Lincoln and Jefferson Pilot – we consolidated all of our customer service capabilities under common leadership – we call it a Shared Services organization.

But, there is a belief and an interest in that organization to really think about how we can service our customers in a very consistent way regardless of where they are in their life stage. Whether they came to us as a participant in an employer plan or came to us as an annuity contract owner through LFD, but service them in a way that’s consistent. Again, no matter where they entered Lincoln in their life stages, or no matter if they have a life insurance policy, an annuity policy or a defined contribution plan, Lincoln has created an environment where they understand why they own our products and they understand why those products are so critical for their retirement income security. I believe we’ve got the combination of products and distribution, but also somewhat of a structure that enables us to execute more effectively than we could have years ago.

Macchia – Right. Inherent in those advantages is the reality that Lincoln is a large multi-faceted company.

Dzielak – Yes.

Macchia – Do you think there’s an inherent competitive advantage going forward in boomer retirement on the basis of the size and breath of a company?

Dzielak – Yes, I do. I think size and scale is going to be critical. It’s much more difficult to move a bigger organization, but size and scale is so critical in the way we’re thinking about playing in this environment. If you hear what I’m saying about retirement income security, it’s about having the capital and the wherewithal to really honor those guarantees and points of security that we’re going to be promising to our consumers.

So, from a size and scale play I think distribution is going to be crucial. There are several ways to look at it – there’s breadth of distribution, but there’s also having the capital capacity to be the provider that customers truly believe can pay off on those guarantees. So size and scale do matter from a couple of perspectives.

Granted, it will challenge our nimbleness and our ability to execute. And that’s why, when I think about Lincoln, to have this unified strategic intent that drives every line of business is so critical because of our size. We need all of our 8,000 to 10,000 employees thinking the same way, so we’re not corralling stray cats. It’s really, David… it’s been kind of a refresher for a lot of folks that are on the ground here to have a single common strategy to drive to. I think it’s very unique for Lincoln, and it’s created a level of simplicity in how we think about our business which helps when you’re as big as we are.

Macchia – Heather, you mentioned advisors.

Dzielak – Yes.

Macchia – And I know that Lincoln has a large and highly skilled advisor distribution network.

Dzielak – Yes.

Macchia – That collides demographically into a consumer base of tens of millions of people who will be needing distribution guidance in the future. Moss Adams in a recently released LIMRA study indicated, among other things, that 70% of the industry rather, is made up of solo practitioners who don’t want to grow, and that in absolute terms there’s too few advisors for the amount of available prospects who will be needing assistance. I wonder what you think about when you hear me say that, and what you think the implications are for advisors and for other forms of distribution?

Dzielak – I completely agree with you. It’s one thing we think about a lot as we’re embarking on this work.

One thing that we believe in wholeheartedly at Lincoln is advice. I didn’t say advisor, I said advice. We’ve built a very profitable, successful business based on a face-to-face advisor relationships, which I believe will continue to be absolutely critical in the markets we operate in today. But, the reality, as you just stated … I mean there’s the whole other side of the population that either has chosen not to engage with an advisor, for whatever reasons – and we’re going to be studying that – but also the population that may never choose to engage with an advisor.

I don’t believe it’s completely about wealth and wherewithal. I think people like to do business the way they like to do business. And what we are recognizing and discussing right now is a notion we call ‘stages of advice,’ … especially with the size of our employer-based business, we need to think about bringing advice to these customers in a variety of ways. Whether that’s online, through a call center, the OnStar kind of capabilities, or whether that be face-to-face– which could be similar to our high-end fee-based channels.

Or, there’s another face-to-face model that’s much more economic and also appealing to consumers who aren’t interested in the traditional advice channel. So, we also want to create an environment as I referred a moment ago as stages of advice. You may enter at one place and go as far as you can on the phone or on the web, but you may want to be referred out. So, it’s not about building separate self-contained advice channels, but advice channels that can give clients market entry into Lincoln in ways that are comfortable for them— but provide flexibility as they understand how complex their needs may be or may not be. That type of thinking is very much in infancy, but I think, in general across the company, there’s a recognition that the way we’ve been so successful today will continue to help us be successful in the future— and we also need to think of alternative ways to expand our reach to keep customers that we believe would benefit from our products and services.

Macchia – In my judgment, that’s a very well conceived formulation and the future is probably going to hold all of those pieces working simultaneously.

I’d like to ask you about something else and that is: What constitutes a “solution” to generate income? I say this understanding that there’s a more holistic view in terms of the other issues that need to be addressed. But, there’s a couple schools of thought about retirement income generation solutions. One is that it’s by definition going to require new types of products that have not yet been introduced in the retail world, and there’s another school of thought that says we have everything we need right now. We have ETFs and mutual funds and variable annuities and insurance products, long term care, fixed and variable annuities, etc., etc., etc., and that putting these products in strategic combinations is really the answer. I wonder if you have a view of which of those may be correct?

Dzielak – As of right now, I do believe that the products that are offered in the market today are ahead of the consumers. We have the right tools today to begin to meet the needs of retirement – whether it be with annuities, ETFs, mutual funds. The issue I believe we have as an industry is that we haven’t positioned them, talked about them or sold them to meet the income needs. They’ve still been positioned as accumulation products – even if you get into the withdrawal benefits on the annuities.

Bottom line, I do think on the whole we have the products that can carry us for the next 12, 18, 24 months. I think new product categories will likely emerge, probably more in the area of turning non-liquid assets into liquid assets. If you think about how much equity these boomers have in their homes, how do we convert that to income? So there’s probably new categories that will emerge – are reverse mortgages are the right thing? But, David, honestly I think we have the products right now. What we don’t have is the process to help the advisors better position those product options to meet the consumers’ needs.

Macchia – I agree.

Dzielak –I believe in my heart that we have made our products much more complex than customers can swallow- and advisors for that matter. I think we’ve out innovated ourselves. We need to move back to the basics and really simplify the products that we have.

Macchia – I also agree with that. Let me ask you about another aspect of this, and that is something that I see developing out there in the retail world. You have advisors who are increasingly interested in income distribution; they clearly need training and insight. But you have some that are tending to coalesce around what I would describe as analogous to the religions we have in the real world.

You have the religion of VA GMWB, you have the religion of target date retirement funds, or the religion of target date funds that are linked to a lifetime annuity, or you have other people who say that lifetime annuitization is the answer, others who say the religion of systematic withdrawals, and others who believe in time-weighted , segmented strategies. I wonder if you see this phenomenon, and if so, what you think the end game here is in term of choosing a religion.

Dzielak – We see it everyday– we are a very product lead industry. You’ll see certain advisors, brokers who migrate to their religion of choice. We believe that will continue to exist. We need to make sure in a product lead channel that we have the right solutions.

There is an emerging belief- not only at Lincoln, but I think in the market – not in your traditional wire house broker channels – that planning is really what’s going to bring advisor capability to the top, and what planning is about to me is understanding first the needs of the client and then matching the right product solution to meet those needs. And that’s the approach we’re taking here at Lincoln. I think we’ll have the most success as we move into this new era with those advisors and those advisor firms who really value the notion of needs-based selling and planning and aren’t as transaction and product lead. I don’t think you’re going to get away from it. I mean, it is very rooted in a lot of the advisors that we work with today. They specialize in one product line or one product for that matter, and have been extremely successful with it. There are solutions that enable them to provide some level of retirement income to those clients, but the real magic and the real successors will be those who take a much more planning lead approach.

Macchia – And, related to that, what about compliance and potentially future financial liability risk? If, for example, an advisor recommends to a consumer with $700,000, in retirement assets that putting it in a VA and using the GMWB as the retirement “solution” is the answer. Does that perhaps denote a problem in the future?

Dzielak – Absolutely. It’s interesting because that’s why we believe so much in this planning process that we’re working so hard on. It’s going to have some substance as to why you recommended that portion of the portfolio being an annuity or that portion of the portfolio being in this basket of mutual funds. It’s definitely a fine line, and we’ve engaged our compliance area in the work that we’re doing on the planning process.

We believe with the proper planning approach that it is going to be a much more compliant sale. Today, I don’t know, to be candid with you, what the thought process is in a lot of our advisors heads on why they recommend a certain portion of the portfolio in annuity. There’s not a lot of rigor around matching the annuity sale up with the income need. The tools and capabilities we hope to bring to market will give a lot more credence to the product recommendations to justify why a portion of the client’s portfolio does belong in an annuity and why a portion may belong in this insurance policy and mutual fund.

But it is a very interesting area, and it’s going to be. I do think we’re going to have to challenge the norm on some of the compliance. There is some game-changing stuff here that this industry really needs to step up and challenge traditional norms- around the annuity sale in particular, but also enable advisors to provide more advice than they do today.

Macchia – Your comments remind me of something that Wealth2 has recently done, driven by one of our large independent broker-dealer clients which is to develop what may be the first risk assessment process covering retirement income.

Dzielak – Yes.

Macchia – It’s obvious that this is conventional wisdom in accumulation, but the exercise here is to try to determine – based upon 17 questions – a client’s volatility factor and guarantee factor. In other words, what is the tolerance for variable versus guaranteed income? How much of the overall income should be provided, say, by a GMWB benefit? And what target rate of return assumptions should be used to develop, over time, the variable income stream? Does this resonate with you as something that’s important?

Dzielak – Absolutely. Yes. As I hear you talk and think about the work we’re doing, it’s very similar. When we think about accumulation, a lot of what went into driving the accumulation success in individual markets is: Are you saving in the right products? Is your asset allocation appropriate? Are you getting yourself enough upside and protecting the downside?

As we move into retirement and think about what clients are going to face, it’s much more about product allocation than it is about asset allocation. Product allocation helps you more effectively address the risk side of this equation. But I think what Wealth2k is undertaking is very similar to the types of questions that will lead to the product solutions that we believe are critical to securing income in retirement for these clients. And it’s the questions that we’ve gone out and talked to advisors about; they are not questions that are being asked en masse today.

Macchia – Clearly.

Dzielak – They’re not driving the recommendations that advisors are providing the customers.

Macchia – I think that, while I’m happy to hear you say it, and I agree with you completely. I want to ask you about something else and this is a question that I ask in every interview because it goes to the core of my beliefs of what’s at stake in terms of boomer retirement.

I have many times stated and have sometimes found absolute perfect agreement in my assertion, and other times I have been challenged, sometimes vigorously challenged, over my belief that in this high stakes contest over boomer retirement assets, the ultimate winners will not be those companies that have the “best products,” but rather will be those companies that are best able, most effectively able, to communicate their value to large and fluid segments of a marketplace. I wonder what … I wonder if you buy into that?

Dzielak – I completely agree with you. I do not believe this game will be won by product leadership or product innovation solely. I think that will be table stakes. When I think about retirement income security–it’s probably articulated in this interview in a way that makes you and potentially the readers of this interview think that it’s about products that bring security. To me, I think the more important aspects of security are a relationship with a company and an advisor that make them comfortable that retirement is going to be okay.

So when I think of what we could do at Lincoln and what we’re thinking about at Lincoln is creating that experience— but extend it well beyond our product set and give the advisor and the ultimate consumer, or consumer directly, comfort that Lincoln understands their needs. They’ve developed products, their capability, how ever they think about us, that addresses those needs and gives them comfort that they don’t have to worry about their finances in retirement. The winners are going to be a very customer-experience lead company.

Macchia – I agree again. Is it true? Do you have a formal experienced officer; someone who’s been identified…

Dzielak – No, we don’t. But in the group we spoke of when we first started this interview, I do have an area of our team that is focused on the product/service experience. So we are incubating that notion here within the group that’s been formed. The work they’re doing bridges across how we’re creating the experience and the products we’re building, the services we’ll be providing– how we’re creating that experience at every customer touch point. I think it will grow and emerge to something like an experience officer, but it’s very new territory for us, so we haven’t justified that role yet.

Macchia – I understand. I want to ask you about something else which relates to the communications question and the high stakes nature of this contest. But while insurers slowly and, in some cases, glacier-ly ready themselves to prepare for this opportunity, other types of organizations have set their sights on the same customer base. In terms of large asset management firms which for years have successfully developed, marketed and sold structured products in the institutional markets, there’s a great deal of focus currently on building products with guarantees and qualities that mimic, say, variable annuities or other insurance-related products, and selling those into the large consumer market right in the middle of the insurers’ ball field. And some of these companies are very large, very sophisticated and move quickly and have a high degree of marketing savvy. I wonder if you think about that. I wonder if you think about that in a year or two or three … that Lincoln or other insurers could be facing a whole new level of competition, and if so, what you think the implications of that might be?

Dzielak – Yes. We think about it every day. In this role that I have here at Lincoln, if you ask me who my peer group is, it extends well beyond – and it may not even include a lot of the top insurance companies that we face off with – it does include the asset management companies. It does include brokerage. It does include banking.

The world’s watching and very aware and concerned because they are the companies who have the customers today. If you look at asset management and defined contribution – a Fidelity, or an American Funds – they have huge client bases that, if they out execute us, they have a high likelihood of success. The one area that we still own is the guarantees. Yes, there are synthetic guarantees being built, as you know. Is that of equal value to customers? Is that level of guarantee going to be acceptable to the customers? It’s something that concerns us.

This is our game to lose and execution is going to be the key. We’ve got something special in the insurance industry. As you mentioned in your question, traditionally we’ve operated at glacial speed. The formation of this group here at Lincoln was based on a recognition and a challenge to pickup the pace, to out execute and to think less about operating at a traditional insurance company pace, but keeping up with asset management and brokerage firms.

The other thing I’d say to you, as much I get anxious about the activity going on out in the other competitors … is it all about one company owning this opportunity or is it about creating relationships with some of these forward thinking asset management companies? Is there a way to bring our franchise rights in combination with some of them so it comes together? We own this space. Who’s going to win this game? I don’t believe it’s the company that’s going to build all of the necessary capabilities, but companies that create those appropriate relationships with other folks in this industry who want to be leaders and bring our complementary skills together. So as I think about it, it’s not as much our strategic intent as it is that we want to be the retirement income security company; we may get there through joint ventures, through partnerships or building our own capabilities. That’s still to be determined.

Macchia – I actually see the potential of that in a similar fashion. I think there are important strategic opportunities, but I also think that a minority of insurers will be able to execute on those strategic opportunities.

Dzielak – Yes.

Macchia – But, for those that do…

Dzielak – it will be big.

Macchia – It could be really big and highly rewarding.

Dzielak– Before I forget, when I think about partnerships and joint ventures, the other thing that the insurance industry has been woefully behind on is technology. So, when you think about creating this experience for customers– is there a way for us to leap frog some of these other industries or competitors that we just talked about and think about joint ventures more on the technology and service side, too? It’s not just about the assets and asset management and insurance, but also looking towards technology as being an enabler. How do you create some distinct competitive advantage there, too?

Macchia – Well, in my commercial life I’ve certainly staked a large financial bet on the truth in what you just said.

Dzielak – Yes.

Macchia – We’ll see. Heather, we’ve covered a lot of ground. Is there any area that I have failed to address that we should talk about?

Dzielak – The only other comment I would make is that we’re just at the beginning. There are a lot of folks out there that don’t believe that the wave has hit yet, and question why everyone is focusing on retirement income. One of the things we talk a lot about here as a real challenge as we embark on the next one to three to five years is that we recognize that it’s an evolving era we’re entering.

A lot of the work that we’re doing today is creating capabilities that will allow us to watch and study consumer behavior, so that we’re ahead of the trends. One thing I worry about and that we’ve tried to be careful about here at Lincoln is to build capabilities and infrastructure that enable us to evolve. I can guarantee that what we understand today is going to be very different than how we understand it two years from now. We need to create environments in financial services that allow us to observe customers at a much more direct level. Most of what’s driven our business today is a lens through our advisor channel. The financial services industry needs to take some learnings from the consumer products industry and other industries – the credit card industry – that have become much more in-tune with buyer behavior. I think we’re going to learn a lot from our customers in the next decade and we better be setting ourselves up to be willing and able to learn and capture those learnings and transition them into products and solutions.

Macchia – On that very large thought, I like to transition into a couple personal questions, if I could.

Dzielak – Sure.

Macchia – The first one, Heather, is this. If I could somehow convey to you a magic wand and by waving this magic wand you could affect any two changes that you wish to make in the world of financial services, what would those changes be?

Dzielak – Oh, my goodness. That’s a big question.

Macchia – It’s my specialty.

Dzielak – If I could change anything, the one thing that I see holding companies back from progress is – how do I say it – silo or segment mentality. I believe that the way that companies – and I’m not just speaking to Lincoln, I’m speaking in general – the way that we’re structured, the way we’re “incented” drives the behavior today that’s not aligned with how customers interface and buy our products and have relationships with our companies. So, if there was a way to break down the silos and get more enterprise customer-facing thinking, I think progress would move at a much more rapid pace. Does that make sense?

Macchia – Well, to me it makes perfect sense. That’s why I helped to put RIIA together. That’s the reason. Let me ask you the next question. Which is: If you were not heading up the strategically important group at Lincoln, but instead you could have any position, any occupation in any other industry, anything in the world, what would you choose to do?

Dzielak – I’d actually be an entrepreneur. And I would be an entrepreneur that would be focused on proving financial advice to consumers. It’s interesting, I feel so passionate about the power of this opportunity, and I believe Lincoln’s the company that can be a leader. If Lincoln can’t or we can’t pull it off here because of the corporate culture or the size, there’s a tremendous amount of gratification I could get from personally figuring out ways to bring financial security to boomers.

I don’t know that I would engage in another corporate job. I think I’d like to be in an environment where I can actually affect execution on something I believe in. Whether that’s consulting or whether that’s building out my own advice capabilities. I don’t know what form it would take, but I would take the work I’m doing here and bring it into an environment where I can actually effect change and execution.

Macchia – Well, your passion for that is palpable. Last question. I’d like you to imagine your own retirement, but in its most conceivably perfect form. Where would you be and what would you be doing?

Dzielak – Where would I be and what would I be doing? My kids would be grown up and successful. I would still be very active. I don’t believe I would be– I know I wouldn’t be active in financial services. I’d be active in doing good for my community, doing good for the less fortunate and doing it in an environment where I never had to think about my finances. I want to get to a point in my life where I can really create a legacy for folks that are less fortunate. I worked with someone in the past who talked to me about income as freedom, and it rings so true to me. I want to get to a point where I feel very comfortable– and that’s not traveling around the world to me. It’s about knowing I can wake up in the morning and actually do good for people that haven’t been able to do good for themselves. For me, retirement is not about the glamour. It’s about the time in my life where I’ve taken care of my family, protected myself, and now have the financial wherewithal to make a difference in some else’s life.

Macchia – Pretty beautiful vision.

Dzielak – It will come true; I know it will. I think about it a lot and feel so lucky to have the life I’ve had, and I just can’t wait for the day when I can share it with someone who just hasn’t had that fortune.

Macchia – I wouldn’t bet against you. Let’s put it that way. Thanks so much.

Dzielak- I’ve enjoyed it.

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

What May Start-Ups and Retired Households Have in Common?

fg1Retirement Income Industry Association Founding Chairman, Francois Gadenne, has contributed numerous essays to this blog (soon to be called a “magazine” because that’s what it has turned into). Today Francois explores the similarities between the financial challenges of start-up companies and households. It’s an interesting way to look at financial dynamics which show remarkably consistent characteristics.

A key to understanding the 20th Century is to focus on the development of science. In particular, towards the end of the century, cumulative growth in science brought about a widely visible convergence of once diverging fields under a common narrative – evolution/systems dynamics – that allows for the explanatory merger of nature and culture and just about everything else.

For instance, think of Physics and Chemistry, Computer Science and Biology, Geology and Genetics, etc.

I remember the despair felt while studying in France in the 60s and 70s as it appeared that we were all condemned to make a life-limiting choice to become specialists who would be increasingly unable to communicate with one another. I also continually feel the surprise and joy since the 1980s with the increasing diffusion of generalizable findings from System Dynamics, to the New Darwinian Revolution and Complexity Theory etc.

Relevant concepts include the difference between stocks and flows, feedback loops vs. simple causality, time delays vs. immediate feedback, linear thinking vs. structural non-linearities, etc.

And, for the investment industry in particular, all of this matters before we even get to our own bounded rationality, biases, distortions, errors and defensive routines that we learn about in Behavioral Finance.

Here is a small example of such convergence in our industry: What may start-ups and retired households have in common?

Let’s start with the start-ups.

How do you kill a start-up company? There are probably more than 50 ways, but one has always amazed me because it often seems to surprise so many entrepreneurs. It is indeed counter-intuitive and it fits in one word: Growth.

The device that turns growth into a start-up killer is working capital. The enabler is success as evidenced by the growth of the business and its increasing demands for cash. As you grow, it is easy to let working capital requirements grow faster than your ability to raise cash from existing operations, lenders or investors. Pretty soon, you can run out of cash entirely.

This is an example what can happen with delayed feedback.

This puts the start-up at the mercy of the next round of funding and the tender mercies of funding sources, if they are available. Venture capitalists thrives on the situation while entrepreneurs get stomach ulcers. Funding the growth will leverage great wealth away from the latter and toward the former. This reality can be made more tolerable if the start-up is a home-run (rather than a single), grows far beyond initial expectations, given the injection of capital, and beats its competitors since start-up economics often leads to a winner-takes-all outcome. But what are the odds?

How does this relate to retired households?

This is the same class of problems that households face when managing their budget. How can you keep your expenses inside the time and dollar envelope of your cash in-flows as your family grows?

This problem is not limited to young households. Retired households can have the same experience. Health care shocks come to mind for instance. The problem in all cases is related to the lumpiness and delayed feedback of expenses vs. income. However, while there can be a redemptive upside for home-run start-ups, can there be one – ever – for retired households?

This would suggest that retirement income plans need to factor in such lumpiness and delayed feedbacks.

Let’s close with two questions:

- Are traditional retirement plans built for the best of all worlds? Do they assume a precision (instead of accuracy) that comes easily from automated computation but that does not fit well in the daily experience of the real world?
- When real-life shocks hit your clients, in what ways do your products and processes allow for correction and adaptation?

To be continued…

Francois Gadenne

Retirement Income Authority and Certified Financial Planner, Philip G Lubinski, Takes On Fixed Annuity Income Riders: “Quit Implying It’s Simple!”

On the topic of retirement income planning Phil Lubinski is one the most experienced and knowledgeable financial advisors practicing. His virtually exclusive concentration on income distribution over more than two decades places him among a tiny minority of advisors who have mastered the investment and income tax strategies required to properly place retirement assets into a distribution mode.

Lubinski, who is both a friend of mine and business associate, doesn’t believe in easy answers to income planning needs. Too often, he says, advisors take the easy way out by substituting products for good planning. In response to yesterday’s essay Lubinski sent me his views on income riders that are increasingly being applied to fixed indexed annuity contracts. I thought I’d share his commentary as he makes some great points.

Insurance companies would be well-advised to move cautiously and carefully in the positioning of these fixed annuity income riders to both agents and consumers, in my judgment. Already, some broker-dealers have become concerned about financial liability potential arising out of their registered representatives’ positioning of variable annuities with guaranteed income riders as “solutions” to retirement income needs. Among the concerns expressed are worries that these riders in many cases may not provide step-ups in retirement income over time. This worry is arguably more urgent when the same type of riders are placed on fixed indexed annuity contracts where the long-term growth potential is less than with variable annuities.

The tendency of some insurance companies to seek the easy way out with their agents by appealing to the agents’ desire for an “easy” solution to a complex income planning challenge may provide insurers with short term gratification. But that gratification may come to insurers at the expense of long-term financial pain should consumers determine that these riders are really not the “solution” they expected.

David Macchia

I appreciate the attempts by annuity providers to create single product solutions, but I feel they are trying to cater more to the needs of the “fixed only” licensed reps, than to the true retirement income needs of retirees.

Research has shown that systematically withdrawing from a growth asset class is “risky business” Yes, a fixed indexed annuity protects the client from negative returns, but it does not protect them from losses due to “over withdrawing” during periods of “low” returns over normal market cycles.

Additionally, when markets are strong, every indexed annuity I’ve seen deprives the investor of S&P 500 dividends (2-3% of the total return) and credits interest based on complicated mathematics that I haven’t found an advisor or even a wholesaler can adequately explain it to me. All I know is that when discussing the rate-of-return goals of an indexed annuity with actuaries, I’m told that, at best, an EIA will deliver 50-60% of the S&P 500.

Moreover, when I’ve looked at research that has tested annuities with income riders, there is a significant probability that the account balance can go to zero leaving the beneficiaries nothing. Also, who in their right mind would want to tie the success of their retirement income to one company, one asset class and one product?

Imagine if doctors wrote prescriptions in this manner (we certainly wouldn’t need to worry about longevity any more). Indexed annuity products may have a place in an overall, multiple product/multiple strategy retirement income model, but they certainly are not a solution in and of themselves- no matter what income riders they may offer.

Retirees should be looking for advisors with legitimate credentials (CFP or ChFC), and multiple licenses (life and health, series 6, 7 & 65) who can demonstrate a comprehensive approach to retirement income planning. We’re dealing with an individual’s life savings here, folks. Quit implying it’s “simple”. It’s NOT

Philip G. Lubinski, CFP
Denver, CO

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

Which Industry Will Grab the Brass Ring of Consumer Confidence and Principal Protect Boomers’ Retirement Assets?

In spite of its warts, the indexed annuity industry and the products it provides may well play an important role in helping Boomer investors maximize their capacity to generate retirement income. People like me who advocate for an improved annuity industry hope that the indexed annuity industry will meet its varied challenges head-on and ultimately realize its full market potential.

Today I’d like to share some information about Wealth2k’s efforts to promote improvement in the indexed annuity industry in terms of sales practices, consumer education, product quality, suitability and agent productivity. As I see it these are the five main problem areas which cry out for improvement.

Armies of Virtual Agents In Response to 05-50

Largely in response to the publication of NASD NTM 05-50, about 18 months ago Wealth2k developed a vision for a new and better way for annuity agents to market, present and close indexed sales. We believed that by fostering improvement in key areas we could help lift the fortunes of those indexed product providers that wished to be perceived as being tangibly separated from the poor sales practices and inferior product designs that were driving significant business to some providers.

In part, Wealth2k’s new strategy was designed to help annuity agents increase their productivity, thereby making it possible for them to begin to transition to selling indexed annuity products that offered greater consumer value albeit with lower commissions on a percentage of premium basis. Increasing the productivity of annuity agents is an elusive goal that has not received the attention it deserves.

Annuity agents typically do not connect with enough prospects for the products they sell. So, among other things, the Wealth2k strategy would have utilized our Traject network’s capacity to dynamically create virtual agents for each human agent, technological alter egos designed to extend the human agents’ reach and brand.

The virtual agent’s job would be to support and strengthen the human agent’s capacity to prospect and educate on indexed annuities. The virtual agent meets with prospects at their web browsers and utilizes streaming video presentations to deliver high quality education on indexed annuity products. The engaging video presentations are fair and balanced and they serve to help prospects gain realistic expectations of an indexed annuity’s performance potential.

No human agent is capable of working 24 hours a day, not to mention working without salary and benefits. But that’s what the virtual agent offers as a non-stop “sales assistant” toiling away on behalf of its human boss.

Not bound by constraints of geography and time, the virtual agent meets with prospects at any place and at any time the prospect chooses. It’s the prospect who’s in control of every interaction with the virtual agent without ever being subjected to sales pressure.

After meeting with the virtual agents the prospect may click on a button to send a message to the human agent:” I just watched the movie at your website and this product seems to make a lot of sense. Let’s get together and talk about it for some of my retirement money. Are you free on Tuesday? 7:00?”

Growing the Pie

Growing the entirety of the indexed annuity pie was and is a major aspect of Wealth2k’s strategy. I’ve long stated and have written in published articles that the $27 Billion high-water mark for indexed sales has the potential to be four times that level in the not too distant future. $100 Billion in sales is an attainable goal because the underlying value proposition indexed annuities offer- principal protection combined with continuous interest growth potential- is one that is critically important to millions of Boomer customers as they enter the Transition Management phase of retirement.

Academic research has shown that investment losses occurring over the period beginning roughly eight years prior to retirement and continuing until ten years after retirement will cause a lifelong reduction in retirement income if not portfolio ruin. (to read an academic paper on this topic that I co-authored with three other members of the Retirement Income Industry Association click here).

To implement its strategy Wealth2k set about to create what amounted to an advanced “operating system” for the indexed annuity business. In terms of its distribution, the industry has been operating on what would we believed was analogous to the old DOS operating system for PCs in as much as the functions that couldn’t be delivered were serving to both limit growth and expand future financial liability- a bad combo, to say the least.

Our analysis revealed that the “old” operating system was deficient in these areas:

It had little or no capacity for real-time management by compliance officers

It didn’t put video at the forefront of its prospecting and educational efforts

It failed to leverage web-based technology to boost marketing effectiveness

It did little to help agents increase their overall sales volumes, and,

It wasn’t in harmony with broker-dealer culture or process.

For these reasons I led Wealth2k’s effort to develop the” windows” analogy application for indexed annuity distribution: modern, technologically-advanced, compliance-centric, consumer friendly, video enabled, even successfully reviewed by the NASD. This was a model for success if there ever was one!

The Peril of Being Too Early

Did it work? No. Why not? Simply put, it was just too far ahead of its time. By April of 2006 when we had finished the application that we called…

• The Massachusetts Securities regulator had not yet set his sights on annuity sales practices. He hadn’t yet sent a letter to every senior in Massachusetts advising them to exercise caution before purchasing an annuity.

• Regulators’ focus and criticisms over specious professional designations for annuity agents had not yet begun

• Hundreds of articles in the consumer press negative to annuities had not yet appeared

• The Parade Magazine expose on fixed annuities had not yet been published

• The devastating front page article (July 2007) in the New York Times had not yet appeared and been parroted by hundreds of other news outlets

• Certain class action lawsuits had not yet gained certification, and,

• Congressional hearings looking into indexed annuity sales practices had not yet been deemed necessary

On May 9 of 2006 Wealth2k brought together nine indexed providers for a meeting in Boston to explain our vision of how to transform, improve and set-up the indexed business for compliant, quality growth.

I opened that meeting by introducing our goals and during my remarks predicted virtually every sad event that’s taken place over the succeeding fourteen months. Honestly, I even predicted the New York Times’ front page article.

The value proposition that day to the carriers was straightforward:

Act quickly and decisively to separate yourselves from the questionable sales practices of certain indexed providers and upend your competition

.Take action to enhance your marketing and distribution by adding features that are far more “B-D friendly” in terms of compliance and process.

• Place high-quality, balanced consumer education front and center in the sales process

• Give your agents impressive, consumer-facing technology that allows them to reach more prospects with compliant, value-based messages

• Set yourselves up for robust growth at the expense of others who won’t be endowed with the same compliant tools, technology and strategies that you will be working with

The company representatives who came together that day were mightily impressed. But they could not as a group get together to act on the opportunity we presented.

Why? With the benefit of hindsight it’s quite understandable. When things are going well there’s little in the way of perceived urgency to make changes. The focus on short-term tactical needs and quarter-by-quarter sales goals is simply too powerful to undertake a structural repair job. Who needs to upgrade operating systems when the present one is still serving your needs?

Now, of course, it’s a very different world. The indexed annuity industry has two black eyes, a few broken bones and an uncertain diagnosis. The accumulated toll of so many unfortunate events over the past fourteen months serve to validate Wealth2k’s strategy, in my judgment. It’s past time for the industry to embrace a new model that can be perceived by objective observers as serving consumers’ interests.

My sense is that the entire indexed business is really up for grabs in a way that’s never before happened. Or maybe what’s up for grabs is not so much the indexed annuity industry as it is its value proposition. Already, other industries are targeting the very same economic benefits offered by indexed annuities. Have no doubt that competition from non-traditional sources will pose big challenges for all indexed annuity providers.

Will it be the structured products providers that grab the brass ring of consumer confidence? Or will it be one or more enlightened and committed insurance companies?

That’s a key question in determining which industry will serve millions of Boomer customers by addressing a fundamental financial need.

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

Interview with Bob Kerzner: LIMRA International President & CEO Describes Benefits of a LIMRA/LOMA Merger; Cites Career Advantage of Field Experience

rkBob Kerzner is a passionate advocate for the life insurance industry. Since 2004 he has been the President & CEO of LIMRA International, a world-wide organization dedicated to providing its nine-hundred member companies research, value-added marketing and distribution expertise. As Kerzner describes it, over its ninety-year heritage LIMRA has become the repository for all of the life insurance industry’s knowledge and research. Kerzner offers us some valuable insights in this wide-ranging interview including comments on the insurance industry’s future role in Boomer retirement.

Macchia – To begin, Bob, and before we jump into the LIMRA discussion, I think people would be interested in knowing about Bob Kerzner, the executive. Would you be kind enough to talk about how you came into the financial services industry, how that began, and the steps that led you to your current position as President and CEO of LIMRA?

Kerzner – Sure. Actually when I graduated from college, David, I said that I would do anything except sell life insurance. It was the only thing that I had absolutely indicated I wouldn’t do.

And yet an opportunity came my way that I absolutely found fascinating. It was, in fact, an opportunity to sell life insurance in a different way, working through independent agents and working with their best, wealthy clients. Once I got into it, I found out that I loved it—that it was an intense business and one that would allow me to be creative in helping people find solutions to complex problems using a unique financial tool. I worked for one company for 30 years–working my way up from the lowest field sales position to field management and ultimately running the entire life insurance division with both top-line and bottom-line responsibility. I really had a wonderful career.

After I retired, I decided that it was time for a change, to do something different. Being CEO of LIMRA allowed me to use my 30 years worth of knowledge in a very different way and allowed me to do something bigger for an industry that I’ve grown attached to.

Macchia- Your answer reminds me of something, perhaps because it’s reflective of my own background. But I’ve always believed that people who entered the business through the door of sales, people who have had real experience at the retail level, who understood the dynamics of prospecting and presenting to retail clients and all that that implies, that such people obtain what amounts to a life-long advantage in terms of how they are able to apply their knowledge and skills of the business no matter where their careers may take them. I wonder if you buy into that?

Kerzner- Unequivocally. My experience in the field–having the experience of actually sitting across a table from a potential customer and trying to convince them that our product could solve a problem –gave me a unique perspective when I was running the division many years later. I don’t think that there’s any other way that you get that kind of perspective.

And frankly, one of the saddest things today is that very, very few of the most senior people – the CEO roles in our industry – are coming from the field. We’re certainly seeing less and less. And I do think that you get a very different point of view, as you say, that stays with you forever.

Macchia- A relevant analogy can be found, again, in terms of my own experience in which I describe my having had a leg in each of two separate and distinct ponds. Meaning, the different experiences of the world of agents and distribution, the salt water pond, and another set of experiences having to do with he business challenges of product manufacturers- the fresh water pond.

I observe that it’s rare that these two ponds meet and the water becomes brackish. And because they do not meet well, it’s seldom that there is genuine understanding of each other’s challenges and frustrations and it’s rare that meaningful communication exists between the two populations. Do you agree with how I see it?

Kerzner- Well, from my viewpoint I see it slightly different. We’re creating a product in our business that’s very technical. It must be passed through 50 different states, often the SEC, and the NASD, which will care about how you sell it. During the development process, it’s easy to get wrapped up in the complexities and lose sight of the consumer’s needs.

I think that having the experience of facing customers eyeball-to-eyeball, face-to-face gives you a perspective to step away for a moment from all of the technical parts and say, “OK, how is this going to play out at the kitchen table.”

Macchia- Let me ask you about LIMRA. LIMRA is an organization with a long history. It has a high profile, and it’s well thought of. For readers who may not be familiar with the organization’s mission and activities, would you describe them?

Kerzner- The first thing, to your point, is to explain that LIMRA is ninety years old. If you think about how few companies make it ninety years, I think that will tell you that there’s something about what we’ve done that is significant.

First and foremost, LIMRA is about research. For ninety years we’ve been the repository for of all the industry’s knowledge and research. Generally speaking, when somebody reads a report about insurance or suggests that somebody’s number one in the industry, they’re usually referring to LIMRA’s benchmarking of the industry.

We also do a lot of the forward-thinking research about where the business is going. We’ve certainly been conducting more consumer research to try to understand how people see our industry, and think about our products; and what motivates people to buy or not to buy our products.

A leading strength has also been in the distribution area. We’ve trained many managers throughout the industry. Most of the industry’s senior people were products years ago of LIMRA training.

We’ve expanded abroad. We’re now in 64 countries worldwide with more than 800 member companies. We’re now training in emerging markets in Eastern Europe, as well as throughout Asia, on ways to modernize distribution and increase productivity to help companies be more successful.

Macchia- That’s certainly a broad array of activities LIMRA is involved in. But I want to ask about the organizational structure. LIMA is chartered as a non-profit organization, I believe?

Kerzner- Yes. We are owned by our members. They fund all of the research, but I should mention that we also have businesses that are not part of our 501 C(6). We have a wholly-owned subsidiary that provides an array of services to the industry. For example, for 65 years we have done the testing for companies to determine who is most likely to become successful as a producer. Today, we do similar testing for a number of fortune 100 companies, including leading stock brokerage firms. We’ve become significant in the compliance business. We help provide shared solutions to the industry designed to address real problems companies are facing.

Beyond the research, we conduct an array of other activities, such as consulting, with a strong practice in compensation planning. And, David, I think I’d be remiss if I didn’t mention one more thing that is really at the core of LIMRA, and that is networking. We run a broad spectrum of conferences and committee meetings throughout the year where people who share the same roles and responsibilities can talk about and share best practices, share ideas and really get to know one another. That’s a really important aspect of LIMRA. It’s where the industry meets.

Macchia- Sort of a vortex for the insurance industry.

Kerzner- I like your word better than mine.

Macchia- Let me ask you about another issue which may become very important in LIMRA’s future, and that is the idea of a merger between LIMRA and LOMA. I presume that the decision to combine LIMRA and LOMA comes out of an analysis that defines synergies and benefits arising out of such a combination. Will you talk a bit about LOMA’s work and then describe the benefits you see resulting from such a merger?

Kerzner- This is really an idea whose time has come. It’s been looked at in the past and for a variety of reasons, the timing was not right. LOMA is clearly in the education business. While we have educated the field, LOMA has been the major educator of the Home Office staff. Their FLMI designation within the back offices of companies is really the designation, the gold standard. It is the training, the broad knowledge that industry professionals want. Both, because of the depth and breadth of that training and because it actually helps them do what they do better.

LOMA runs conferences just as we do, but often there’s more of a technology or efficiency focus. So while we do many of the same things, we do them in different parts of the organization. Coming together helps us take care of the totality of these education needs.

A combination is also greatly complementary. They have built a great e-learning platform. We have not done that. Why should the industry pay for two e-learning systems? The benefits of merger are that the industry could have, for the same capital outlay, a much broader capability to serve the entire life insurance company. So, those are just a few of the highlights.

Macchia- Bob, I’d like to shift to some challenges and opportunities facing life insurers. As you know I am a creature of the insurance business having begun in 1977 as an agent at the lowest rung. I very much value the 30 years I’ve been associated with this industry. I’ve had opportunities and financial rewards beyond anything I could have hoped for including an excellent education. So as someone who has gained a lot from the industry I’m an advocate for its best interests in the future, especially in terms of the Boomer retirement opportunity.

I often times think, however, that life insurers are not likely to reach their fullest business potential unless and until some of the most intractable challenges and problems that hold back its growth are first identified, and then dealt with and eliminated so that the industry can set itself up for robust growth.

I wonder if, at a high level, this is something that you think about? And if it is, perhaps we can explore some subsets of this?

Kerzner- It’s something that we think about a lot. In fact, what I can tell you is that in large measure our annual meeting, which is our most senior and largest conference of the year, is really aimed at these very topics. This year’s theme is about execution.

In my opening remarks, I will take a clip of a comment made last year by the president of a major mutual fund company who charged that the life insurance industry is going to blow the opportunity because they have not been very good at execution. Ironically, that mutual fund company is owned by a life insurance company. So, I thought it was a particularly interesting statement. We took it seriously enough that we built this year’s program around the concept of execution. What does our industry have to do to capture their fair share of that opportunity that everybody knows is the biggest in history?

A couple of the things that are important to look at: First, many companies are too siloed to look at the total needs of the customer–we don’t spend enough time as some other parts of the financial services industry to really understand what the customer wants, how they think. Although, we certainly think that LIMRA can play a role in that piece.

Second, there’s a lot of discussion about whether we take too much of a product focus. The industry often takes a manufacturing view. Is that the best approach? Third is an issue that LIMRA talks about—it’s part of who we are, our fabric— and that’s distribution. The number of producers continues to decline in terms of career agents. The number of new agents continues to decline. So, will there be enough distribution to meet these needs? And, if not, which we believe is a certainty, what will the new avenues be to get our products in front of people more often?

So, these are some of the key issues that will be focused on at our annual meeting. I might mention that our special guest will be Alan Greenspan, who will certainly tell us about some of the macro-financial issues that we need to be thinking about.

Macchia- What’s you’ve articulated here is in my day-to-day wheelhouse. Let me begin this by telling you that one of the reasons that this blog was started was to try to galvanize the attention of industry leaders to some of the very challenges you’ve just mentioned. One of the issues that I’ve written about extensively is reflected in my own experience where 30 years ago I entered the business at the end of the rate book era and then saw that the introduction of the PC began to change things rather dramatically.

It became easier for agents to assess the relative benefits of different companies’ products, whereas previously they may have been focused exclusively on a single company’s products. And this led to a major shift in the way producers work which has led to today’s reality that most agents are independent agents.

As this change took root the insurance companies tended to revert to a stance where the concentration was increasingly on manufacturing products rather than developing producers. The intensive training and education that was once routinely provided was in many cases eliminated, and agents transitioned from career agents to what might be termed “free agents.” And I would argue that this is one of the most significant reasons that the industry is plagued by a poor public image and poor sales practices. I wonder if you buy into that historical chain of events and its leading to some of today’s problems?

Kerzner- Yeah…. ah… unfortunately, I think that there’s a missing piece in what you’ve suggested. We have created a model that actually talks about the natural events that occur as a market emerges. What I can tell you, David, is that virtually all countries begin with a very strong career agent system and over time, alternate distribution begins to enter. Part of the issue is that somewhere along the line, products begin to become much more sophisticated, producers may well not be trained adequately, sales practices become aggressive and issues emerge around mis-selling. Now I should be clear that this even occurs in alternate distribution.

So, it’s not just agents. Those practices tend to invite tighter and tighter regulation. There tends to be a scandal resulting in poor public image and then, ironically, it tends to become more difficult to recruit more people because now the job is harder. Anyone today, who has to go through the myriad of 30-page proposals, 200-page prospectuses and all of the rest, can certainly see what happens as products become more complex like they do in a mature market. But you can’t just lay that at the company doorstep. In fact, unfortunately, the actions of producers, whether they are career agents or people working for financial institutions, help to create this problem.

Macchia- You know, I think that’s fair. But don’t you also think there’s something more? As career agents have increasingly become independent, they have also become more increasingly underproductive than they were in the past. For instance, when I was a young agent I was expected to achieve at least one sale of life insurance per week. And some of the veteran agents completed two or even three sales each week. This is phenomenally more productive than today’s agents achieve.

As low productivity has taken root among the agent ranks there’s a natural tendency to seek out products which pay higher levels of commissions on each individual sale. And so you have the emergence of a viscous cycle where companies are more reliant on independent agents to a greater extent than ever before, and they attempt to placate the agents’ desire for higher and higher compensation, which leads to less and less consumer value in the products and to an ever-increasing negative public image. This creates a vicious cycle which is difficult to interrupt. Do you see that?

Kerzner- Well, yes, but once again let me cite some LIMRA data. In fact, over the past 30 years, the number of policies per year sold–hence the number of families we touch–has consistently declined every year, proving your point that agents have become less productive. However, producers at the same time are selling a total amount of life insurance premium that continues to escalate.

So what I would suggest the data says that, number one, agents have gone upscale and have continuously moved more up-market, selling fewer but larger face-amount policies. Second, as you are well aware, agents are selling a much broader array of products than 30 years ago. They can sell annuities, mutual funds- and life insurance. So some of that decrease in productivity has to do with the producers’ ability to get to their income objective by selling investment products, which are easier. Certainly when I was President of the broker-dealer, I saw that when annuity sales skyrocketed, life insurance sales often went the other way. So I think, David, that today producers can get to their desired income level in different ways.

Macchia- I agree with what you say but I would also argue that simple inflation over a 30-year period would account for a large increase in the size of the life insurance policies sold.

Kerzner- You’re absolutely correct, in fact when you look at the industry on the life insurance side, in constant dollars we’ve actually been declining rather than increasing as the numbers suggest. That’s a fair point.

Macchia- Let me jump into another assertion I make which may be off-putting to some, but it’s something I believe to be true after many years of personal observation. And that is that the life insurance industry- somehow- simultaneously develops both the world’s finest sales people and the world’s worst marketers. And that the poor quality of marketing accounts to some extent- and maybe a large extent- for many of the industry’s contemporary challenges. Would you agree with this assertion?

Kerzner- I think that there’s been a history of us doing a good job on one-on-one sales but a far less effective job at building corporate images of marketing as other have done in other sectors of the financial services industry.

I actually am optimistic in that in the last 12 months I’ve seen a difference here. If you look at a number of companies and how they are positioning themselves in today’s environment, you see improvement. I even played segments of a number of companies’ commercials at one of our conferences last year to show how I felt that they were doing a far better job of marketing, on image, on outcome, and on getting people to think about the kind of retirement and lifestyle they want. I think that they are doing a much better job than a couple of years ago. There’s even one company that’s doing an outstanding job of creating emotion around our products, getting to the core triggers of why someone buys life insurance. So I think that the companies are getting better at marketing.

Macchia-I’m glad to hear that because I believe that to a great extent, the emotion component has been what’s missing from so much of the industry’s marketing initiatives. I’m happy that this is starting to happen now as the Boomer retirement opportunity begins to unfold. And I’d like to move our conversation in that direction, if I could.

Kerzner- Sure.

Macchia- One of the products that has emerged in recent years and has morphed considerably since its introduction is the variable annuity contract. The variable annuity is beset today with its own negative perceptions which, I would argue, derives from historically ill-conceived marketing strategies and poor positioning.

I say ill-conceived marketing and positioning because over recent years the VA product was showcased as an alternative to other investments such as mutual funds. This invited criticisms over comparative cost structures not to mention unfavorable income tax comparisons.

Now with the recent refocus on guaranteed withdrawal riders, it seems the variable annuity product can be re-characterized, repositioned as what it really is- an insurance vehicle capable of delivering a set of benefits that can be extremely beneficial to people needing a guaranteed baseline retirement income.

I wonder if you see the issue this way, Bob, in terms of my belief that there’s been an historical mistake made over the product’s positioning, and that now there’s an excellent opportunity to re-focus the insured aspects of the VA contract? And that these insured benefits have costs which are justifiable? I guess what I’m saying is, do you see this as a timely opportunity to correct past mistakes and set the stage for growth in the VA line?

Kerzner- I think that there are a lot of complexities in that proposition. Let me go at it this way. I was in the field. I used to talk with a client about the two lives of an annuity- the pay-in period and the pay-out period. I tried to make absolutely certain that clients understood that one of the significant advantages was the tax preference during the build-up years, and that they really understood why that was a benefit. And in the early years, that certainly was a key component of what got us the attention–the fact that you could get those gains in the market, you could supplement your retirement savings … and it was a good forced savings vehicle.

We spent hardly any time regrettably—and this is where I think we made the mistake— in talking about what annuities do best in terms of the pay-out phase. When we hit the downturn in the market, many were concerned that variable annuities would suffer a precipitous drop in sales. And here’s where I would take a slightly different perspective and say that I think the industry did a great job of determining what it is that the consumer really wants. LIMRA data suggested that more absolute certainty is what the consumer wanted. What people love most about our industry is our guarantees.

A lot of very creative people, David, did a great job in saying, “how do we make this product, which is about risk and upside in the market, how do we take some of that sting out of it?” Many of the riders we have today grew out of that.

But also during that period, I believe, companies—because of the downturn—did a much better job of making people understand that the death benefit really was extremely valuable. I’d agree, however that there was a period of time that we didn’t sell that benefit well and didn’t make people understand its true value.

Let me conclude with this. The industry has enjoyed seven consecutive quarters of record-breaking sales of variable annuities. That’s in large measure due to the creativity, to the improvement in positioning and the creation of these riders, which gave American consumers more of what they said they wanted.

Macchia- Well I agree with much of what you say. And you should know that I’m a strong advocate of the variable annuity. I believe it’s underutilized. But I would… not challenge… but remind you of the fact that while sales growth has been obvious, there are still inherent weaknesses in those results in the sense that approximately two-thirds of those sales derive from 1025(a) (1035?) exchanges, and we still have a situation where four fifths of advisors shun the variability annuity contract.

And to me this goes back to historical ineffectiveness on properly positioning the product. This is the challenge going forward, in my judgment. We’re talking about a unique type of product with a solid and valuable benefit structure, but minds have to be changed. And often the insurance business doesn’t get the benefit of the doubt…

Kerzner- And I think, David, we absolutely agree, and I’m not suggesting we can’t do much better—that there isn’t tremendous upside opportunity, and that there doesn’t need to be some different alternatives made available—to get those other advisors in the game. We also have to do a better job of using the product with younger clients in their forties, as a systematic tool for savings.

You’re right. But I can’t buy into “ineffective: which suggests that they did everything wrong. But I certainly concur on a lot of the issues you’ve raised. We could do a lot better. That would be where even more growth could come from.

Macchia- Yes, and you could argue that given the amount of money that’s going to be moving in the future, that, wherever VA sales are today they could be five times greater in the future.

Kerzner- And that actually gets to the next topic of Boomer retirement, where the ultimate war will be won or lost by each segment of the industry. It is about retaining the asset. That is the next battleground and frankly, the one for the next 20 or 30 years that really matters a lot. Clearly, annuities’ offer the potential to provide periodic payouts like no other financial vehicle can. And therein lies one of the great opportunities and still unresolved challenges for our industry: can we be the one to really get the income phase right? To take advantage of the unique structural, financial leveragable opportunities- and all that we do best- to really capture our share of the assets in the payout phase?

Macchia- That’s the key question. I think you’re exactly right. There are many elements to answering that question. Communications is a big part of it, technology is a part of it, competition is a part of it. Let me focus on competition. In the current issue of National Underwriter there’s an article written by Norse Blazzard and Judith Hasenhauer which talks about copycats eying the development of variable annuity type features. Here’s a quote: Most likely, every major investment firm is busily working on providing a GMWB to customers by mutual funds, managed separate accounts and even hedge funds, all without requiring the clients to become involved with a VA.”

I also recently noted an article which addresses the growth of structured products. And I’ve written myself about structured products and the fact that large asset management firms which have traditionally aimed structured products at the institutional markets are now aiming them increasingly at the high net worth market and, potentially, the mass market, with intention of replicating some of the core benefits found in traditional annuity contracts. In a recent interview at this Blog I asked Professor Moshe Milevsky about this very issue. Moshe predicated that within two years we may see a dozen major, new players- in terms of major asset management firms- coming to market with structured products for consumers that target what is inherently and traditionally the insurers’ playing field. I wonder if this is something that you and LIMRA think about and what the impact of new competition may pose in the way of challenges for life insurers?

Kerzner- Yeah, it’s a great question and it’s something that we think about a lot. We have begun working on what we call Phase Five, which predicts the future of the industry. And, in fact, what we say that it is highly likely that there will be other new players—different forms of competition—than exist today. We also did another study with a group called DSI, which is linked to Wharton, and we looked at four possible future scenarios of what the life insurance industry could look like in 2016. The two major axes that we thought would alter most the future of the industry were first, “will there or will there not be high demand?” And second, “what will the environmental climate for competition be?”

In the last five years, we’ve begun to use dynamic hedging. We’ve used financial tools from other large financial institutions that have made many of these guarantees that we’ve associated with our products possible and have made their success. Others, who accumulate assets are envious of our success and will look to emulate what we’ve done successfully to broaden their offerings. Americans have demonstrated that they are willing to pay an extra charge for that guarantee. So I do think that you are going to see new forms of competition from non-traditional sources. And as I say, this is one of the things that we are talking about and predicting. It’s highly likely.

Macchia- Bob, next I’d like to delve into one of my favorite topics and that is the issue of communications. Basically, I ask everyone I interview the same question on this topic. And I’m interested in the various responses I receive.

I believe quite strongly- and have stated publicly- that the high stakes business opportunity wrapped around Boomer retirement will prove to reveal winners… and losers. And to an extent-not exclusively, certainly- but to arguably a significant extent- the winners will not be those with the so-called “best product”, but rather will be those which excel at compliantly communicating their value to a large and fluid marketplace. I wonder if you agree with this assertion?

Kerzner- I’m not at all suggesting that’s not important but I think there are a couple of other issues. Number one, I believe that innovation is important. If you look at the leaders, you’ll note that they are often very early to market with major innovations and are constantly innovating. The bigger companies that are well positioned and are innovative, will be the most successful. That’s one of the things that will remain important.

I still believe that distribution is critical. The companies that have the best distribution will have one of the important keys to success. And finally, this issue we talked about earlier- execution- is important. Who will be able to put all the pieces together and deliver across a platform?

I’m not suggesting that communications isn’t crucial because, as you pointed out, more of the producers are independent. You’re going to have to communicate why you’re better, how you’re bringing more value. Not just to consumers but also to other distribution channels—and in a way that’s superior to competitors.

So I think you’re right, it’s one of the elements but to say which is most important is difficult.

Macchia- I think that’s very fair. I want to ask you about a quote that I saw recently from Mark Timergien of Moss Adams, who made some comments indicating that there’s going to be far too many consumers for the amount of available advisors. He also stated that 70% of the industry is made up of solo practitioners who don’t want to grow. I wonder what changes you envision that may have to emerge for companies to get to the effective distribution that you just described as being so important?

Kerzner- In fact, we just completed and released joint work with Mark and Moss- Adams on this very subject last week. We believe distribution will have to be substantially different in the future. That doesn’t mean that existing distribution goes away—but I will talk at length at our annual meeting about why we believe that technology is a game-changer. We expect technology will have a material change on how distribution could look in 5 to 10 years.

Just like we couldn’t have envisioned the impact that the iPod would have on the music industry, I think we could see distinctly new forms of distribution because of technology. Technology that makes the ability to purchase our products easier, as well as technology that allows us to get our message to consumers in new and different ways.

Macchia- OK, you know that I agree with that.

Now I’d like to end by asking you a couple of personal questions. And the first is this: If you were not the CEO of LIMRA but instead could have any other occupation in any other field, what would you choose to be?

Kerzner- I tell you, I ask that question when I interview people. I’ll be very candid with you. I’m enjoying this immensely and as corny as it may sound, there’s nothing I’d rather be doing.

Macchia: Last question. I want you to visualize your own retirement in its most ideally, perfect form. Where would you be and what would you be doing?

Kerzner- Retirement for me in its totality will be an oxymoron if I have good health. I need to be engaged, I need to be doing something. Retirement, as most people think of it, is an end point where I begin a different lifestyle without any responsibility. It’s hard for me to conjure up.

Macchia- I want to thank you for your time and your answers. This has been great,

Kerzner- I’ve enjoyed it, David.

Macchia- Thanks, Bob.

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