The Interviews: Industry Leaders & Innovators

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.

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

I originally published this interview with LIMRA’s Bob Kerzner about 3 months ago. With the organization’s Annual Meeting taking place next week in Boston, I thought now would be a good time to share this in-depth conversation with one of the life insurance industry’s most senior leaders. Readership has more than doubled since its original publication so many may have missed the interview the first time it appeared:


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.

Interview with Dallas Salisbury: President & CEO of EBRI Offers Fascinating Historical Perspective on Today’s Retirement Security Challenges; Reveals Preference for Mandatory, National Retirement Savings Program in Addition to Social Security


dsOne of the most enjoyable and enlightening conversations I’ve ever experienced occurred recently with Dallas Salisbury, President & CEO of Washington-based Employee Benefit Research Institute. For someone like me who is “hooked” on everything retirement income, listening to Salisbury’s answers caused me to reexamine many of my own strongly-held views on retirement-related issues
.

Salisbury offers both a fascinating historical perspective as well as a vision for the future that contains views that may surprise some who work on contemporary retirement income solutions. He’s a font of knowledge, experience and keen judgment, a voice for change, motivation and action designed to address America’s retirement security challenges.

Macchia – Let me begin at the beginning, Dallas, and ask you if you’d be kind enough to describe to my readers the history of EBRI, as well as your present role and responsibilities in the context of heading-up the organization.

Salisbury – Well, EBRI has been functioning since December 4, 1978. That was the day that we opened the offices. If one has to say who is responsible for the creation of EBRI it’s really former President Jimmy Carter because President Jimmy Carter announced that he was appointing a Presidential Commission on Retirement Policy, which he did, which was chaired by the then Chairman and CEO of the Xerox Corporation, Peter McCullough.

The founding organizations of EBRI at that time were 13 large employee benefit consulting firms, many of whom in the 1960s had been asked by the Kennedy Commission on Retirement Policy to do studies. They, all thinking that they were the only ones that had been asked, diligently did their work and then found out that a whole lot of duplicate work had been done since they were all doing it for free. EBRI was a way for all of those firms to assist the new Commission with data and studies but only pay for it once. So, EBRI came about as an enterprise that was not to advocate, it was not to lobby, our bylaws and incorporation documents actually have a prohibition against doing either of those things, and to do data, to do basic research and education and to build databases over time that would allow anyone that had an interest in retirement programs to be able to track the effectiveness of those programs, what those programs were, what they were doing.

Initially it was principally focused on retirement, and then about 1982, after the commission had finished its work and the decision was made to definitely keep the institute going, that was the point in time when we made the commitment to extend our work to the health area and broaden our work to include employment based health benefits, general health costs and health management issues and research on the Medicare program. We’ve been doing all those things now since then and maintain two websites, www.ebri.org, where all of our research since 1978 can be found, and www.choosetosave.org, which fulfills the other piece of the original incorporation mission which was public education and worker education on what these programs were, how they could benefit from employer involvement and the ways in which individuals should be considering their own health and financial futures.

Macchia – When you mentioned Jimmy Carter, Dallas, it reminded me of my entry into financial services in 1977, through the insurance door. I can recall back then that to a great extent life insurers were the custodians of a vast amount of pension assets and that defined benefit pension plans were quite popular and typical. It occurs to me that since EBRIs formation in 1978 you’ve had a view, a consistent view, over a set of phenomenal changes that have taken place in the landscape of pensions and employee benefits, generally. You’ve seen and studied the transition from Defined Benefit to Defined Contribution, the emergence of 401k programs, all the way to today’s level of popularity, and now the effort to institute Defined Benefits into DC plans. I wonder if you see a cycle that’s emerging. How do you view this phenomenal transition that’s taken place since EBRI’s founding?

Salisbury – Well, you asked about my role in all of this. I was the first employee of EBRI and have been the Chief Staff Executive since we started. I came to EBRI from two years with the Pension Benefit Guarantee Corporation, which is principally a Defined Benefit oriented entity, and two years before that with the US Department of Labor in what is now the Employee Benefit Security Administration where I set up their first Office of Policy and Research. I’ve basically been doing on some level the same type of work since late 1974.

To your point, the original EBRI board was principally made up of people whose background was as pension actuaries. Those firms role in the retirement area was overwhelmingly related to Defined Benefit retirement plans and actuarial work for Defined Benefit retirement plans. There were obviously in many companies thrift savings plans and profit sharing plans on the side, but for the vast majority of what would have then been the Fortune 100 and even the Fortune 500 had a Defined Benefit plan as their primary retirement vehicle. And the only thing they did as a retirement plan was a Defined Benefit plan.

You had a handful of exceptions, Procter and Gamble stands out as a company that has always been a profit sharing and Defined Contribution company, and I mention them because if one talks about design of programs that would do what the good old fashioned DB plan did, you’d have to look at somebody like Procter and Gamble where essentially year in and year out the contribution to Defined Contribution accounts has ranged between 15% of pay and 25% of pay, as I stressed year in and year out. Procter and Gamble still does that. Procter and Gamble provides investment options in spite of a fairly heavy emphasis on Procter and Gamble stock.

There’s always been the alternative of people taking the lifetime income annuity if they did not want to take a single sum distribution. Because it was a profit sharing plan where the employer was putting money in regardless of what the employee did, that plan always basically assured 100% participation of everyone in the workplace which is one of the other traditional features of a Defined Benefit plan. So, a healthy enough contribution so that people can retire with an adequate retirement income, a set of managed investment options aimed at allowing people to build enough up over time with that substantial contribution and the opportunity for life income security protection through a pooled annuity arrangement if people did in fact want to know that they wouldn’t run out of money before they ran out of life.

If one takes that transition to what we’re seeing in the work world today as Defined Benefit plans have morphed themselves you really have to go back to the late 70s when Atlantic Richfield Company amended its traditional Defined Benefit pension plan to offer single sum distributions. That led the Internal Revenue Service to do something that in hindsight was a very significant decision. Atlantic Richfield had added single sum distributions for a participant with high income. If your pension is not more than $35,000 per year then you have to take the first $35,000 a year as an annuity. That was the late 70s and so the vast majority of people weren’t going to have that big of a pension and could not take a single sum distribution. One might say it was a balanced policy that would assure workers a base income for life on top of social security. The Internal Revenue Service went into Atlantic Richfield and said, “All get a single sum or none can have it.”

As I recall, the Chief Actuary at the IRS, at an Actuarial Society meeting said, “And we know that Atlantic Richfield will choose none, and so there will not be lump sum distributions.” They didn’t understand that CEO very well who wanted a single sum distribution and Atlantic Richfield says fine. The IRS says we have to let all of you have a single sum distribution. Now, some decades later nearly 55% of Defined Benefit plans that still exist offer a single sum distribution at the point of retirement. Essentially out of that Defined Benefits system of those 55%, generally a minimum of 80% of the participants take a single sum distribution. Generally you end up with a maximum of 20% taking a life income annuity. In many cases it’s only 4 – 5% that takes a life income annuity. In some Defined Benefit retirement plans of large employers and small employers no one takes the life income annuity.

The notion of Defined Benefit plans that I was introduced to in 1974, frankly, began to be deserted by the largest Plan Sponsors in the United States before we’d even turned the corner into the 1980s. By 1984 when Kwasha Lipton, then a consulting firm, one of the founding firms of EBRI, in a consulting relationship with Bank of America, moved Bank of America to what is popularly known today as a Cash Balanced Defined Benefit plan. A second trend moved forward because part of that transition included a standard reversion of assets to the Plan Sponsor. A process of workers seeing very small balances upon the conversion relative to what they thought they ultimately were supposed to be getting out of that pension plan, and the decisions which Congress and PPA just finally dealt with after the IBM suits.

It took until 2006 for some resolution in 2007, of essentially issues that began to be implemented in the Defined Benefit system in 1984. You then add on top of those combined actions the total restructuring, if you will of the largest enterprises in America. Microsoft didn’t exist in 1974, and today it’s one of the nation’s largest employers. Outside of the state of Arkansas Wal-Mart did not exist in 1974, and today it’s the largest single employer in the world. We have basically seen a growth of enterprises dominant in marketplaces, Starbucks didn’t exist in 1974 that have grown up as Defined Contribution only companies.

Those Defined Contribution plans have another very different mix than what the profit sharing plan than Proctor and Gamble did. In those plans the employer automatic contribution has always been diminumus. Large percentages of workers have not chosen to participate and even when they did participate the amount that the employer would contribute has generally been quite small relative to what we can describe as the Proctor and Gamble standard. If we then go to the final, if you will, today’s transition point as very large American companies, the IBMs, the Verizons, the Lockheed Martins, that were originally tradition Defined Benefit companies and have gone through a morphing process and are now at the final stages of essentially saying that we will no longer have Defined Benefit plans. In the case of IBM, no one will be in those plans post 1/1/08. For companies like Lockheed Martin and Verizon there will be continuation for some that were already there and just transitions for new workers. So, we’re seeing different varieties, but what we’re seeing when they put in the Defined Contribution plan that goes to your comment of “making them look like Defined Benefit plans”, I stress that they don’t in any way, shape or form look like traditional Defined Benefit pension plans, if you will, my father’s Defined Benefit plan.

Pop died in July months short of turning 94. He retired in 1978. He wasn’t given a single sum annuity option; it was a final pay plan, etc, etc. This transition is that we will have automatic enrollment, but you can still opt out. The result found in the data is that between 10 – 30% do opt out, even with the automatic enrollment. We might do automatic contribution escalation. So far that data is that a minority of firms will do that. We might do an automatic employer contribution. A very small percentage of firms are doing that. Those that are doing it are doing it generally with an employer based contribution of 2 – 5%. For most individuals that will not be enough, even if the employee contributes the same amount. If they started saving at 20 the needed rate would be at least10%, and if they didn’t start contributing until 35, the required annual amount would be closer to 23% per year.

So you end up having gone from a Defined Benefit and in a Proctor and Gamble case, a profit sharing plan where the employer was putting in enough money to provide a full career worker with true retirement income adequacy, to what has come to be termed a Defined Benefit/Defined Contribution system where most employers automatically put in nothing, where a large portion of employees can fail to participate and where still only about 20% even offer an annuity, life income annuity situation. Essentially none require a mandatory annuitization.

If we look at the experience of the last 30 years where Defined Benefit plans have offered the option, very few people will chose to do what my father had to do, which is take that life income annuity. It’s the morphing that changed over that 30, nearly 35 years has been dramatic and I think so dramatic that we really do need to underline that even with all of the changes that are now being talked about and undertaken for Defined Contribution plans, that even if all of those changes take place those programs, in the absence of aggressive individual savings that exceeds anything individuals have done in modern history, will never accomplish or achieve what Defined Benefit plans did, or what profit sharing plans of the Proctor and Gamble variety did. That says, even with that redesign that the principal shift of all of this is that even the best off workers will have to do far, far more for themselves than was the case under those old systems.

Macchia – You know that’s a fascinating historical perspective that explains the implications of many changes over the past 30 years. It reminds me of the countless seminars I’ve presented over the years to audiences of consumers. I can recall about 10 years ago making comments about the transition to the 401k plan that 401k essentially was one of the greatest financial foibles ever foisted on the American public. Back then I might have said that the transition away from DB was motivated by greedy corporations that wanted to improve their balance sheets and free themselves of long-term obligations. I wonder if there’s a more sophisticated answer to that, and I wonder if your dad’s own experience offers the pristine example. Where having retired in 1978 and now still receiving benefits at age 94, if that singular example crystallizes the larger phenomenon, that it’s simply impossible for those types of plans to be financially viable over the long term.

Salisbury – Well, to respond to two pieces of that. Maybe people today would stop and say the Employee Retirement Income Act of 1974 did great things without commenting on whether that’s true or not on a net net basis. The greatest unintended consequence of that law has been the demise of Defined Benefit pension plans and the rise of Defined Contribution plans. Because one of the principal issues, and I’ve gone back and read all of the prehistory and there’s a very fine book that was published some years ago, a couple of years ago, on the history of the enactment of ERISA called “The Employee Retirement Income Security Act of 1974.” It was a history, a political history written by a guy named Jim Wooten and published by the University of California Press. It was telling in a cover quote by a guy named Dan Halperin, who was a tax staffer at the time that ERISA was passed and is now a Professor of Law at Harvard, when he said, “This book is a wonderful, detailed, intensive description of the history of an important piece of social legislation.”

The social legislation, part of that legislation was that leading up to ERISA all of the focus was on the absence of benefit portability. It was a focus on these programs doing amazingly positive things for people like my dad who did spend 30 years with one company. But there was a lot of analysis in the 60s about so-called portability losses and one of the most intense debates and also reasons for ERISA was to put into the law vesting standards and to say that these programs that only pay benefits to people that have been there for 20 or 25 or 30 years, well, that’s wrong. As you know the most recent legal changes, there are cases now that go all the way down to 3 year vesting and immediate vesting. The moment you went with that change you assured a shift in plan design as you fundamentally changed the cost equation. There is a notion and a mythology out there that in the good old days everybody used to work for one company for a full career, yet, if that had been true, you would not have needed faster vesting. You would not have had portability losses.

When my dad retired in 1978 at that point in history 16% of all workers in the private sector and going into retirement, 16% had been with one employer for 25 years of more. At the most stable, the very most stable companies, you will find of the oldest workers today, maybe 25% of the oldest cohort has been with the company for a full career, but when you look at 1952 to present median job tenure the total labor force has always been about 4 years. That’s a long way of saying that we’ve always been a very high turnover society and a long way of saying that very few of us have ever spent one career, had one long career with any employer. Put that in the sense that you’re describing.

Pre-ERISA if 12% of the people that I ever hire will retire from me and I’m doing a Defined Benefit plan and I’m promising 60% income replacement if you spend a full career with me and I fund it over time and everybody that leaves, meaning over time 80 plus percent of the people leave, every dime that I in theory contributed for all of them is going to pay the benefits of that small group that stays. ERISA comes along and says all those people that are leaving and not getting anything are losers and that’s wrong. The economist entered, bless them, and said this is a denial of deferred compensation. These plans are deferred compensation which isn’t how the companies ever thought about them in any individual worker sense, only in the aggregate. The companies thought about them as something to make sure that people that are still with us after a full career can afford to retire or we can retire them and it’s an expense and we’re paying people over here and over here on the side, if we do well with investment returns we don’t have to make any contributions, so how can there be an ikndividualized deferred wage?

But Congress keeps bringing down the vesting period and what do you keep on doing? More and more and more of the money that’s going in is being paid out in small lump sum distributions to this huge number of people who leave between 3 years and 15 years or 20 years, the vast majority of the workers. So the majority of the money in a post-ERISA world, particularly a post-GAT amendment 1990s world, and the vast majority of the money going into a Defined Benefit plan gets allocated to short service people. It is not that my dad lives to nearly 94 or that somebody else lives to 100 that makes a Defined Benefit plan a financing, if you will, problem. If the money going in is going in to pay for those long service people the contribution cost can be low, but if I have the kind of leaking problem that fast vesting introduces, then I end up with a real challenge which requires higher contributions or a reduction in future benefits. That ends up when you think of 1984, the movement to cash balance, that the legislative decision to move the system to fast vesting, essentially imposed on an employer a career average type of contribution with a so-called final pay design. By moving to cash balance and defined contribution or lower benefit formulas cost could be kept low, the money was spread to more people, and the long service worker of the future would get a lot less.

Suddenly I say, well what’s that interpret into? For an old fashioned pension plan for somebody who’d been with me for 25 years and was approaching retirement age, if I were to actually put enough money in this year to pay for this year’s additional accrual, I’d be contributing 25-30% of their salary in their final pay formula. In this new world of equality you go to 1984 we’ll just tell everybody you’re all going to get 4.2% and you’re going to get 4.2% each and every year. Here’s the account and we’re going to tell you that’s what it is. We’ve got very fast vesting, and we need to put in money for everybody, and there’s very little redistribution of money from the leavers to the stayers, so there is not reward for tenure. Why not just do a Defined Contributions plan rather than all of the expenses and legal requirements tied to the Defined Benefits plan.

So, as opposed to the notion that this change has taken place due to greed or anything else, I look at it backward over my 33 years of involvement and say basically what we’ve done with the law is we’ve simply designed something legally that is totally and completely in conflict with what the plans were originally intended to do, which was to provide lifetime income security to the people that were still working for you at retirement age. If I was to put that in a contemporary debate, it is the equivalent to the contemporary debate that President Bush has been most vehement on which is changing part of Social Security from Defined Benefit to Defined Contribution which is the equivalent of saying we really aren’t interested in lifetime income security being achieved at the lowest possible cost thorough a group pool that redistributes across individuals depending upon life expectancy.

We’re interested in capital accumulation and at the end of the train we want to hand the individual that capital accumulation and give them individual choice and ownership and basically say you decide. This is no longer about lifetime income security in the sense that if we’re going to make you take an annuity so there is no conceivable way that you can run out of money before you run out of life. We’re saying instead we’re going to give you money and you can spend 100% of it in the next 12 months and have 30 years where you’re living off of supplemental income and Medicaid, your choice. I don’t even view it as a corporate ideology issue if I put it on the President, what we’re talking about, has been a general movement away of a theory of community and risk pooling and if you will the redistribution that is implicit in an insurance type of arrangement which is what a traditional DB plan was.

Moving to the individual fight, at this point, in that sense if the only true Defined Benefit plan to be pejorative is the traditional old Define Benefit plan that was an annuity only plan then essentially at the moment there are no Defined Contribution plans that are attempting to mimic the true Defined Benefit plan and in fact a growing proportion of the remaining Defined Benefit system is no longer made up of true Defined Benefit plans. It is made up of hybrid programs that in most cases will produce single sum distributions and will put the decision risk of whether money runs out before life or vice versa on the individual as opposed to that being institutionally protected. You then add a component to that which is what I was getting at with the new company phenomenon. If ERISA had been in effect in 1950 traditional Defined Benefit plans never would have come into existence. The huge growth of Defined Benefit plans that took place in the 50s and 60s would not have occurred because if ERISA’s funding standards, most particularly if one were to say what if PPA, the PPA amended ERISA had been in effect in 1950 there would be no Defined Benefit system.

It wouldn’t have happened because what the genesis of those Defined Benefit plans was the ability to take people who were at retirement age and give them past service credit of 10, 20, 30 years, accept a huge unfunded liability, and to be able to amortize that unfunded liability over an almost infinite time period and to be able to manage exit of a large number of people, so the people coming back from the war could take jobs, and doing all of it with borrowing against the future cash streams of the firm. Today’s PPA would say to those companies, you do that and you’ve got to fund it off within 7 years and within 7 years you’ve got to be 100% funded. The economic capacity just would not have been there…wouldn’t be there today. If you take that environment and say what started happening in post-1974 and you start looking at those enterprises now on the Fortune 100 and 500 that came into existence post 1974, and I don’t mean by renaming or merger, I mean companies that actually grew and came into being through new technology, those companies basically to overstate it, it didn’t even occur to them to put in a Defined Benefit plan because they didn’t have the primary motivation of the 50s which is a whole lot of existing older workers that we want to entice out the door with a pension.

Macchia – This is again a fascinating historical perspective which is very helpful. I’d like to go back to Social Security for a moment if I could, Dallas, because that is a Defined Benefit structure that is fraught with challenges, as you know. We’ve seen clearly in terms of President Bush’s efforts to introduce privatization and other conversations around Social Security in recent years that any talk of changing that system becomes immediately highly political and polarizing. I wonder what you feel will be the implications of politicians not being able to transcend that, continuing to arguably show a lack of political will, what happens if there isn’t the capacity to address some of Social Security’s inherent weaknesses?

Salisbury – If we limit Social Security as you’re using the words to the retirement program, totally separate and apart from Medicare and the health side of it, the reality which is recognized by the administration and is documented by the actuaries is that the social security retirement program has very little problem. The change in payroll tax that would be necessary to have the program be fine for 75 years is di minumus. The change in benefits that would be required of the change in retirement age, the changes that would be necessary to have the current program sustainable into infinity, are minor changes.

Macchia – Can I just stop you there and explore one aspect of that. If the Social Security surplus is being invested in long term treasuries isn’t there a sharp implication for the future in terms of redeeming those and potentially having to lower benefits and raising taxes?

Salisbury – You’re describing a general fiscal issue as opposed to an issue of Social Security.

Macchia – But aren’t they interlocked to some degree?

Salisbury – The degree to which I personally don’t believe that they are ultimately interlocked is that ultimately Social Security benefits being paid on a continuing basis is going to be the difference for almost every working American of whether they watch their parents or their grandparents continue to live decently. Or, they welcome their parents and their grandparents into their home and they start supporting them directly. Then adding a second component. In the last Presidential election, approaching 45% of all votes cast were cast by people over the age of 65. By the next Presidential election it will be pushing 50%. By another 2 – 3 it will be nearly 60% of all votes cast in elections will be cast by people 65 plus, unless ounger voters start voting at much higher participation rates. Older voters and one looks at the polling, older people even less than their kids don’t want to be dependent upon their kids, they don’t want to move back in with their kids.

You end up with this dynamic of will there be the political will even with all of the balancing, will Social Security benefits be paid? Call me an optimist or pessimist or fatalist even with the Social Security trust fund being federal debt securities is I believe that those benefit promises will in fact be paid just given the dynamic of the population and the implications of them not being paid. Especially, and I underline the especially since relative to other issue areas, and I’ll use medical as the example, is everybody and it’s the majority, about 95%, everybody gets a Social Security check.

Listening to a Congressional hearing yesterday 6% of Medicare beneficiaries account for 50% of Medicare spending. If you end up in a dynamic, a political dynamic of the overage 65 population and their children being put up against the wall and the choice is we can continue to promise you health benefits in the event you get sick or we can continue sending you a Social Security check. Which do you want? Income or a promise of health benefits if you get sick? That’s like my trying to convince my employees to take no salary and to take health benefits. Do they want health benefits on top of salary? Absolutely, but if the choice is between income or health benefits, base income, they take income. This year 38% of the nation’s retirees have on single income source, it’s called Social Security. 64% of today’s retirees have a primary income source.

More than half of their income is called Social Security. Retirees 85 plus 62% of their income on average comes from Social Security. If one looks the old curves of health expenditures and health benefits is if you’ve put it in the terms you’re putting it in, ultimately the ultimate trade off decisions of the government, let’s assume they were going to filch on the dead, but can we filch on the benefits. If given what the options are, now defense is important to me, but is it more important to me than bread on the table. The health insurance promise is important to me, but am I willing to live in the gutter or in a box in order to have health insurance? No, I’m not, thank you very much. Putting it starkly in your push comes to shove type issue, relative to honoring the Social Security benefits promise, could Congress at some point end up saying okay, beginning 44 years from now benefits will be axed. Conceivable. We’re going to raise the retirement age, we’re going to match it to life expectancy, and we’re going to have CPI minus one. It’s what I mean by the issue that the adjustments they could make are relatively minor that would secure the program. I’ll use President Bush as the example. If President Bush wanted to secure Social Security as part of his legacy, he could get that through Congress before the end of this calendar year if he was willing to accept changes that did not include individual accounts.

Macchia – By doing what?

Salisbury – By simply going to the hill and saying no individual accounts, no fundamental restructuring of the program, here’s the list that we all agree from the Social Security actuaries are the things that we just have to basically fill a shopping cart off of in order to make the adjustments. Retirement age tied to increases in life expectancy, slight adjustment in the benefit formula for high income individuals will move the maximum wage base from roughly 100,000 to 125,000 or 150,000. Pick your level. Oh gee, we only had to do four things and the program is fine forever. Great. Done. Let’s go home. Let’s go worry about the big issue called Medicare. But because the actual Social Security problem is so small, there is not a feeling of true necessity to fix Social Security, therefore one can spend all one’s time having an ideological argument about I want Defined Contribution, I want fundamental change.

Macchia – Let me take us back into the commercial pension world where we have obviously a voluntary system. Do we need to have a universal mandate for, say, 401k?

Salisbury – It all depends on what the objective is. I was moderating a panel yesterday at a conference that looked at just that issue and what was striking from panelists from the right, the Heritage Foundation, and then the left, the Brookings Institution and Pensions Rights Center, along with the person that was there speaking from the World Bank. If you’re objective is individuals definitely having income in retirement and not being able to run out of the money before they run out of life, the consensus along that ideological spectrum was: that can only be achieved with mandates, it can only be achieved with mandatory contributions, it can only be achieved with mandatory rollovers or basically you can never borrow and spend the money, and it can only be achieved with mandatory life distribution.

I choose life distribution versus annuity because there are different ways to get there, but it’s a guaranteed payout over your lifetime. That represents a whole bunch of changes that everybody at the panel table that I was moderating agreed were the components that would be necessary if your objective was real income security in retirement. Every single one of them then said: none of those changes are politically feasible. This is the descriptive versus the normative. The descriptive is what you see happening in the private sector today in planned design decisions. It’s what defaults are all about. But it is a default rather than a mandate because of he fear of backlash. Do we know what we would have to do with these programs to have them actually achieve the objective of lifetime retirement income security? Yeah, we all know that. Are we willing to do that? No, because we don’t want to be dictatorial.

We think a lot of people would be upset with whatever the list of issues is. Everybody is trying to do it with defaults, with tricks, with incentives, you name it, but what we know at this point based on at least the 35 years that I’ve been in this field, for any bit of research that anybody’s done, regardless of their perspective, is that in the absence of that type of structure, which pejoratively speaking is the traditional Defined Benefit pension plan, the true one, or a slight modification of the Proctor and Gamble profit sharing plan, meaning the company putting in plenty of money, and then paying life income annuities indexed for inflation, to get to the objective, or in a governmental sense Social Security setting aside a method of true advance funding. Those are the things ultimately that will be needed if we want people to be able to retire and we don’t want to be back in the 1930s where most elderly Americans are in poverty.

Macchia – You recall that a couple of a minutes ago I mentioned years ago commenting in seminars on 401k plans. In another series of seminars I commented about the relatively low personal savings rate in the US. At the time about 4% in contrasting to Germany’s 8% and Japan’s 12.5%, and we’ve seen in the US that the personal savings rate has consistently come down and down and down. We also have another behavioral issue where people make poor investing decisions based upon emotions. We have seen the ascendancy Defined Contribution plans to a state where many would agree that participation levels are insufficient and deferral levels are too low. We have this confluence of facts that together, arguably, serve to substantially reduce retirement security.

In my commercial life I all the time think about the fact that the key to changing behavior and helping people make better decisions that more appropriately serve their long term financial interest is that we must to a much better job communicating around these issues in a world that’s very complex, in an industry that has its own jargon and can seem unfriendly. I often liken it to medicine where if I’m listening to a conversation between two physicians that are talking about my health or potential health problem it’s very hard for me to understand their conversation because it’s got its own unique vocabulary and I think that some of that analogy carries over to our business where we can communicate in a way that is not easy for people to understand. I’m wondering if you agree with me that communication is a big part of helping people make better decisions and ultimately strengthen their retirement security?

Salisbury – I think that communication is a key component, but I’ll then put in the caveat that we published earlier this year an issue brief on the role behavioral finance and behavioral economics. David Leibsonson from Harvard did a luncheon presentation yesterday on those topics. Most of the behavioral finance experiments that have been done to date end up documenting that at the margin, meaning with the best intended, best educated, highest income people, education and communication can be shown to have success. But all of the research that he was going over from the behavioral economist is that with the bulk of the population it’s largely lost on them no matter how much effort goes into it and how good a job an enterprise tries to do. One on one counseling has the best results, but that is both expensive and limited. If one uses the health field as like a case manager, if you use this field it’s then like everybody having a truly objective and independent financial manager, planner that is actually worrying about everything and doing everything and budgeting for you.

You only have to talk to the planner twice a year and we know that when an enterprise will do that, the people they do that for, it leads to a pretty high success rate. When I want to be optimistic about this and the changes that are taking place what I frankly focus on is the reality of the world that is what led to the concerns when ERISA came into being. The year that ERISA was enacted, the first year that we have good data on after that was 1977 and of everybody that was retired over the age of 65 in 1977 could come out of private sector employment less that 10% of them were getting pension income. 90% were not. 2001 was as good as it ever got coming out of the private sector.

Just under 24% of those over age 65 in 2001, the high point; just under 24% had income coming from a private pension plan. That’s now come down. By 2005 it was approaching 23%, we see it’s going to come down progressively at this point. The dynamic of the existing system, the reality of the system is that when we historically suggested everything’s okay because we have Defined Benefit plans, that system was still not doing anything for 75% of the people in the private sector, yet they all had this notion that they read in the press and they heard on TV that everybody works a full career, everybody gets a gold watch and a pension. You look at old survey data and people believed that they would eventually get a pension.

Now we know from the data, the historical stuff we do for a living at EBRI, it never really was the case and the reality of today’s world what people read about, they think, they say, well, I’ve got to worry about myself, the fact of it is that most of them always did. If you then look at it and say, okay, in the good old days 10% had pension income, meaning pre-1977 the really good old days. In the somewhat good old days, the period through 2001, coming out of the private sector less than a quarter did, three quarters didn’t. We’re morphing forward and from the existing voluntary system it looks like it’s going to stay below a quarter fr some time unless we make some fundamental changes in the system that go beyond frankly what anybody right now is advocating, whether Democrat or Republican, Liberal, Conservative.

Macchia – Let me ask you this. If we know that the idealized notion of retirement of years spent lounging by the pool was never quite true, then knowing all that you know about what’s happening and how you conceive the implications of all of this for the future, at the gut level do you find yourself personally optimistic or pessimistic or perhaps vacillating between the two?

Salisbury – I guess that depends on what I’m being optimistic or pessimistic about. Take your communications point. I subscribe to anybody that says transparency is what people need. I subscribe that communications, the way where communications can be most effective is if it’s transparent communication that says to people, most people won’t get X, most people won’t get Y, most people aren’t going to have pension income, most people won’t have retiree health benefits, most people, most people, most people. The fact is that could have been said for the last 100 years, it just wasn’t being said. So, transparency and that communication is going to take everybody and put them in a mode of thinking that says, good gosh I wasn’t going to think about this until I was 50, maybe I’d actually better think about it at 25 or 30 or 35, hoping that the sooner they wake up the better.

Macchia – What you’re implying is that transparency equals candor.

Salisbury – Transparency equals candor by all parties.

Macchia – One of my big frustrations as somebody whose life’s work is in communications is that at least in the initial phases, the advertising for instance that we see from big financial services companies has framed retirement in this idealized manor. You’re 65 and now is the time to learn to parachute or snowboard. And we’re going to help you take you through this delightful, ideal, next 35 or 40 years.

Salisbury – I think to your point that the huge challenge to the degree this imaging is imaging that to use your phrase comes from the financial services industry; the financial services industry for very understandable business reasons is focusing all of that advertising on a small number of people that have money. If one looks at the population demographics and the number of people who actually have anything resembling a meaningful amount of money you’re down in the single digit millions. All of that is directed at that single digit millions of people that from whatever set of sources have reasonable assets.

All of those financial services companies are competing for the attention of that small number of people. In essence for the bulk of the people that don’t have the means and I know friends that are in the focus group business who pull people in and check this, the people that don’t have anything know that’s not going to be what they are talking about. It’s one of the reasons that the most recent date year from the Bureau of Labor Statistics is 2006 and in 2006 of those between 65 and 69, 34% still had income from earnings.

In 2006 of those 85 plus, 8% still had income from earnings. In the last 7 years for the first time we’ve seen a straight move up the percentage of individuals over 60, 65, 70, 75, the proportion of those populations continuing to work is going up. Ironically this combination of transparency in communications of what you may not have, what you need to double check maybe if you go confirm, you have it or you don’t have it. Then you see this picture from the ads and you say well, I know I’m not going to have that. What George Bush has managed to do, along with many others, over the last 20 years, is convince Americans under the age of 40 that they are not going to get Social Security.

So, in this communication they have convinced people that the floor won’t even be there. What that’s interpretation into in the surveys is more and more and more younger people saying, well, I know that I’m going to have to keep working. So where’s then the challenge? The challenge then is the number one financial problem the Social security program does have. It’s called a disability income program. It’s called the explosion of disability claims and it’s the 40% of those that retire before they wanted to that retire because of health reasons that keep them from working. That’s the component of this that is the other need for transparency in education which is he no ability to work and earn risk for people.

Macchia – I don’t even know where to begin to complement you on the insights. If I may I’d like to transition to a couple of questions that are personal in nature. Here’s the first one, Dallas. If I could somehow convey to you a magic wand, and by waving this wand you could affect any two changes, anything at all that you’d wish to change particular to the financial services industry, what two changes would you make?

Salisbury – Well, the financial services industry would end up being secondary to my two primary changes. They would, however, be dramatically affected by them. I’ve been doing what I’ve been doing for 35 years because what I believe in is the whole notion of a retirement system as a retirement system that on some level assures that people run out of life before they run out of money. It’s why I took the job; it’s why I’ve stayed with the job. That’s my normative objective and EBRI is not in the normative business, but you’re asking me a personal question. If I were King we would have a system like some have proposed in the past, the first one from the private sector was one of my founding trustees, the late Bob Paul, who at the time was running the Segal Company, and that’s a notion of a national mandatory savings requirement where there is savings where that money is in fact invested in the private sector, but it’s invested on pool basis on a very, very low fee basis, on a default diversified investment basis, but I’ll repeat, very low fee.

It would have a mandatory annuitization on a life income survivor benefit inflation index basis where the measure is not “adequacy” which for most is never achievable, where the measure is a fully prefunded supportable supplement on top of Social Security. That creates a pool that allows the entire financial services industry to go about doing what they are doing at the high end if you will, but it would for most working Americans that system would end up absorbing money that they are now putting into IRAs and frankly in many cases that they are putting in 401k plans and other places. It would be at a di minimus fee level compared to what many financial service providers now charge in that system. If what I just described happened it would have some fairly dramatic implications for the financial services industry, what they offer, the nature of how they offer it, and the nature of what they are able to charge for it. It would clearly primarily benefit the low cost provider.

Macchia – Your answer reminds me of when I entered the insurance business in the 70s, the very first thing that I was taught was the great importance of the notion of forced savings. Of course, the cost structure of the products back then was very different than what you describe.

Salisbury – My very first job was at the age of 14 and I worked for a savings and loan organization. One of the things that I went out and “marketed” by handing out brochures was their Christmas club.

Macchia – I remember Christmas clubs.

Salisbury – My grandfather was the second person in the United States to get the Certified Life Underwriter (CLU) designation, so while this is only 35 years for me, the notions of financial security, the notions of protection against risk, are something that between my dad having spent his whole career in different realms of insurance, my grandfather having spent decades in the insurance business, it’s something that I’ve had sort of water dripped into me if not genetically then by every other means my entire lifetime.

Macchia – Let me ask you another personal question. If you were not the head of EBRI but instead could have any other job in any industry or field, what would you choose to do?

Salisbury – Can I become a dictator for about 6 months? If I can become dictator for 6 months then I’ll just fix all of this stuff and then I’ll retire.

Macchia – I like your answer. Speaking of retirement, and because retirement is central to the last question, I’d like you to imagine your own retirement in its most idealized form. Where will you be and what will you be doing?

Salisbury – The thing I’ve always, and it’s advice that my family has given me since very early ages, is always try to find something that you love doing and that every single day you’re having fun. That’s why I’m still doing what I’m doing because every day I come and do this and I still have fun doing it and I still find it interesting and challenging and energizing. Whether I’m going to EBRI or “retired” or whatever, it will be just that, it will be to have fun in what I’m doing, what I’m thinking about, what I’m writing each and every day. It’s never been possession oriented, it won’t be possession oriented. It’s never been toy oriented, it won’t be toy oriented. It will be just trying to do things where I feel like I’m contributing and I’m having a good time doing it.

Macchia – I would say there’s no question that you’re contributing and you’ve certainly contributed to my understanding of the issues we’ve addressed. Dallas, is there anything that you’d like to talk about that I have neglected to mention?

Salisbury – Just the one component that we’ve only slightly touched on is I guess a closing note on the level of what people should have before they make the retirement decision and it’s just, I think, the degree to which if there was a single notation that the financial services industry could do as an extreme public service, we try to do this through our choose to save public education and public service announcement program, is just to absolutely convince people don’t sign up for Social Security benefits the day you turn 62, and don’t make the fateful decision to retire, unless you’ve sat down alone or with someone that’s an expert and worked through whether it’s the intelligent thing to do.

With life expectancy and all that it is, and as you’ve noted the long term issues of what will happen to Social Security, what will happen to Medicare, what will happen in job markets, etc. it’s a decision that most people spend almost no time thinking about. The majority of people in surveys report that the basis of the decision was, I’m eligible. A minority of Americans still ever report by the time they retire ever having done even a calculation of how much they needed in order to retire. In setting aside how much you need to save or investing or anything else if we could just manage to get people to at least not retire until they have sat down and made sure that they actually should be doing it would be the single greatest public service anybody could do.

Macchia – Here, here.

Salisbury – Good to talk to you.

Macchia – I can’t thank you enough. This conversation has been illuminating and rewarding, Dallas. Thanks a million.

Salisbury – Good to talk to you. Take care.

***

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

Interview with Phil Eckman: President & CEO of Transamerica Retirement Management Cites Lack of Insurance Industry Progress Despite Years of Intense Product Focus; Calls for New Communications Strategies

philipeBack in April when readership of this magazine was much less than it is today, I published this interview with Transamerica’s Phil Eckman. Because many may have missed the opportunity to gain from Eckman’s vision and insights, I thought I’d share it with you today:

In this wide-ranging interview, Phil Eckman, CEO of Transamerica Retirement Management, talks about Transamerica’s view concerning the importance of the Boomer retirement income business as evidenced by the company’s decision to create an entirely new business unit. Eckman also addresses the challenges arising out of the inherently greater degree of complexity of insurance products, and stresses the need to develop superior, consumer-facing communications strategies in order to overcome that complexity.

Macchia – Phil, let me begin by asking you about your work. Please begin by telling us your title, your role and your responsibilities.

Eckman - My title is President and CEO of Transamerica Retirement Management, which is a new business unit that we’ve created within the AEGON USA/Transamerica Companies. My responsibilities center around building a new business unit that is solely focused on the unique needs of the boomers as they move into this transition called retirement. We’re leveraging what we have to offer from our various companies across AEGON/Transamerica family to help with these unique issues that folks are facing.

Macchia - Okay. I understand. Now, the progression of developing a retirement income solution at a large company can sometimes, if not often times, get bogged down with conflict among silos. Sort of the belief system that it’s my solution…no it’s my solution…no it’s my solution. Is what you’re doing at Transamerica an effort to cross silos in an effort of incorporate the best of all silos?

Eckman - Exactly. I believe that while it may not be an explicit objective, I think implicitly as we build out our group, we will cross silos and take ideas that have been working in one area of the company and have them cross over that line and bring them forward in another part of the company to reach a new consumer base. So absolutely, practically what’s going to happen is we will be taking ideas across silos and exposing them to mew markets that otherwise would not have the opportunity to see them.

Macchia - In terms of Transamerica Retirement Management and how it was developed, what thought process led to the creation of this entirely new business unit?

Eckman - Our CEO of AEGON USA, Pat Baird, about 2 ½ years ago challenged the management team of the organization to look ahead, think forward about this large retirement market that’s going to be coming upon our industry; to think hard about how we as a company can best serve the group, putting aside some of the typical issues around silos and short-term business objectives. A task force was put in place to look into these questions. One of the recommendations was to start a new business unit.

Macchia – And I gather the decision to start a new group implies that the entire retirement income business is deemed to be something of a very high strategic priority for the corporation.

Eckman – Absolutely. It has not been a cultural business strategy within the AEGON group to start new business units like this. We have strong, autonomous growth targets and we have a history of acquisitions, so to start a new group like this was entirely new.

Macchia - Phil, would you describe the introduction of Transamerica Retirement Management as an incremental change to the existing business model, a moderate change to the existing business model, or even, potentially, a large change?

Eckman - I think it’s a potentially large change. If we wanted to take an incremental approach, we would get working groups together, we would have senior management from the different divisions collaborate and then go back to their day jobs.

Macchia – As I observe it, Phil, distribution strategies seem to be evolving along somewhat philosophically- based lines. I often liken this to religions, in the same manner that we have various religions in the world. So, we have religions of distribution planning popping up, such as the religion of systematic withdrawal programs, the religion of laddered strategies, the religion of time-weighted strategies, the religion of lifetime annuitizatioin. Do you buy into this description what’s developing in the marketplace, and if you do- or if you don’t- explain how you see it, and where Transamerica Retirement Management might play in this context.

Eckman – You and I have talked about your description of this sort of religion analogy, and I think it’s a pretty good one. Each manufacturer or advisor is going to have a core philosophy around income management. Just like there are many ways to invest and accumulate assets, there are many ways to convert these assets into income. Some are simple, some are complex. Some are product based, some are planning based. Some offer guaranteed lifetime income, some do not.

We generally believe retirees should build two income streams. The first is guaranteed for life and is made up of Social Security, pensions, and some form of lifetime annuity income. This income stream covers the basic living expenses around food, housing, health care, etc. As retirement may last over 30 years for some couples, they have the piece of mind knowing that these essential expenses are always covered. The second income stream is not necessarily guaranteed and made up of a systematic withdrawal strategy, possible ongoing employment and possible home equity release strategies. This income stream covers the discretionary expenses of travel, entertainment, etc. Of course, the art is working with the customer first to build a plan that meets their unique situation and, second to support them over time to execute and tweak the plan. I guess you could say this is our religion.

Macchia –I did some searching on the internet and read where one of the missions that Transamerica Retirement Management has undertaken is to leverage AEGON’s extensive network of internal and external distribution partners in order to deliver solutions. Is that, in fact, true? And if it is, can you comment or go a little bit deeper into the strategy?

Eckman – Sure. We have to prioritize the opportunities before us as we build this group and march it forward. We’re starting in terms of distribution by connecting with our pension organizations, Diversified Investment Advisors and Transamerica Retirement Services. We are bringing product development, marketing strategies, and an advice platform to these organizations that leverage some of the capabilities across AEGON.

Macchia – I can look back over the period since I came into financial services inn 1977 through the insurance door, and I can remember that the pension business back then was pretty much owned by life insurance companies. Over the course of my career, during the last three decades, we’ve seen life insurers cede away that business to the mutual fund complexes. I wonder if when you look at the distribution opportunity, you see insurers as ready to or potentially able to take back those pension assets, or do you think that there are some fundamental challenges that insurers face that will conspire to hinder their progress in reaching that goal?

Eckman – I think your premise is true. The asset management industry certainly has done a fantastic job serving customer needs within the 401K and general savings space. It’s not surprising because the primary need through the working years is accumulation and investing. But as these investors age and get closer to what we call the third stage of life known as retirement, their priorities and needs change. While investing and accumulation is still important to them, they need to understand the new risks associated with income planning such as longevity and healthcare.

Those sorts of issues obviously play into insurance industry strengths, and our capacity to build solutions to help these folks manage these risks that now have come and moved up the list of priorities as they have moved along in their own life. The insurance industry is in a position to certainly help folks with these important issues.

It’s going to be a lot of work for us, particularly on the marketing side and on the education side. These types of issues, these risk management issues, by their nature are more complicated. So, how can we help people understand the issues and questions? How can we help them make the right choices? Those are going to be the key issues that will determine how the insurance industry, as a whole, and how individual insurance companies will succeed in this opportunity ahead.

Macchia - I think that’s a very insightful observation. You indicated that the very nature of the products that are going to have to be distributed and explained in the future are more complex by definition. Does this make you think that new strategies for communication are going to be in order, and if it does, where does technology play into that? How important do you think technology will be in the coming months and years? How do you see the whole customer communications issue fleshing out in the future?

Eckman – I think it is going to more complicated and it’s going to be challenging. Whether we in the insurance industry are trying to come up with new ideas to help advisors carry the load and get this point across with their customers, or, whether we’re talking to a customer directly. We have to make it clear, transparent and understandable.

Trying to reach people differently, trying to leverage technology to help explain products is definitely an opportunity for the industry. The other point that we haven’t talked about are the compliance issues. With the more complicated suite of products that need to come of the fore, we need to make sure that advisors are able to clearly explain what they need to with their customers. We must have the right tools in place to deliver compliant, clear presentations so that customers fully understand the issues and the options available.
Leveraging technology to help with this challenge is a real opportunity. Video, electronic presentations, those sorts of things, by their nature, can be controlled more effectively.

Macchia – Phil, when I think about the role of consumer-facing technology in the future, one of the issues aside from compliance, and aside from consistency in message- and a myriad of other advantages- when you get down to the very basic question, you realize that there are gigantic numbers of individuals that are going to need to be contacted and provided guidance in the distribution phase of their lives, with a relatively small base of advisors to reach them. Is this something that you at Transamerica Retirement Management have thought about and if it is, what do you foresee as potential strategies that you may use to address this very issue?

Eckman - It is something we’ve thought about and wrestled with. We are like a lot of companies in our position. We have a large advisor community that we distribute through, and they are always looking for help in good, compliant presentation and educational programs that allow them to bring value to their customers.

We’ve got work to do with some sister groups to put that type of tool together in the short and long term. I think that companies like us are going to have to be very successful on that front if we are going to get the time and the attention of the advisor base moving forward. Beyond the advisors there is certainly an opportunity to more effectively reach those individuals that either are not working with an advisor today, or prefer to just do it themselves.

There’s a chunk of the Baby Boomer population that are going to want to do it themselves, and providing more avenues for them via the web and other technological tools so that they can understand, become educated and ultimately make the right decisions for themselves, is going to be an opportunity for the industry, for sure

Macchia – Phil, I’d like to ask you next about products. In our industry there is no end to the talk about new types of products that are being developed, may be debuting in the near future, and may transform the way that products work. It’s stated by many that these new products are going to be very important in meeting Boomer needs.

There is another philosophy that’s sort of out there in parallel that says- and this was reflected to me most recently in an interview that I hadwith Jeremy Alexander- that we’ve got longevity insurance, we’ve got lifetime annuitization, we have products that guarantee principal and simultaneously provide upside potential, we have lifetime annuitization products, and guaranteed withdrawal riders. We have mutual funds, we have equities, we have bonds. In other words, the products are already there. It’s a matter of figuring out how you package them to work synergistically to deliver good long term results for the consumer. I wonder how you feel about this issue.

Eckman – I would agree with it. The product innovation on behalf of the insurance industry is never going to stop, and I don’t know if it will ever slow down. But I think we’ve seen, looking back over the last five years or more, that most of us in the industry are not terribly happy with the results that we’ve had in really driving the growth in all of the income product innovation that’s taking place.

We’re making progress, but in the big picture of things, relative to the mutual funds and other more traditional accumulation focused investment solutions, I don’t think any of us are comfortable with where we’re at. Which then leads you to the question as to yes, products are important, but is it the communication, is it the method or context in which we’re describing them. Do we need to look harder at that?

Macchia – You bring up something that I’ve talked about and written about a great deal. In fact, I’ve said quite publicly that the winners in Boomer retirement are not going to be those companies that necessarily even have the best products, but rather will be those companies that are the best at communicating their value to a large and fluid market place. Does this strike you as true?

Eckman - It does. I’ve heard you say it a couple of times and every time I hear it it rings very true to me. It’s something that is easy to say, harder to do, but the more I think about it the more I realize we must become better communicators.

I think this is coming back to us as feedback from a lot of advisors that we work with in this organization. They want to be more effective in the way that they communicate to their end customer. Let’s not over complicate the product so that we can’t clearly explain its value and ability to solve a customer’s need.

Macchia - When you look forward in the context of your position of heading up this business unit, what do you define as your greatest challenges?

Eckman – I think there’s an inherent education gap that we as an entire industry need to focus on. It’s making a connection between savings and income. In all of the focus groups we’ve done, every consumer understands the notion of a nest egg.

But, when you start asking questions about, “How are they going to put that nest egg to work to replace an income stream or how will they develop an income plan to manage a 30 year retirement?” They have no answer. They have not thought about it. We, I think, have a big job to just close that educational gap and help people to think about income earlier on as they approach this transition so they can start to plan and really understand the issues at stake, and sort of change their way of thinking. They’ve got to begin to think, “Now, I need to move into more of an income management and financial risk management mindset.” That’s a big task.

Secondly, I think it really gets back to your communication point that our products within the insurance industry are going to be more complicated, making it even more critical for us to succeed on the communication front. Finally, we have to understand that to the end consumer, retirement isn’t in their minds primarily a financial event. We come from the financial services industry, so we think of it as a financial event, but they don’t. First and foremost, it’s a life event to them.

We need to understand that reality, and help them with this whole life transition, and help them understand how the financial part of it is certainly an important component, but it doesn’t start with that. When they come to a meeting with an advisor, when they are talking with an advisor on the phone, or when they are going online to a website, they are coming to that meeting or they are coming to that website not wanting to jump right into financial planning, but to just get some general perspective around this life event that’s coming their way. Once this context is laid, it’s easier to weave in the financial aspects of the transition.

Macchia - That’s a very… reality-based take on the issue. Which reminds me of advertising. The advertising that’s been done to date to the Boomer audience has struck me as very odd and, arguably, disingenuous. On the one hand you have all manner of statistics that indicate that the typical Boomer is not well positioned to generate a significant retirement income over a retirement that may last a very long time. Social security is uncertain in terms of what may happen to it in the future, the national savings rate is very low, and typically Boomers have more debt than net assets.

So this is a mixture of facts that doesn’t bode well for mass market retirement security. At the same time, we’ve seen advertising that consistently describes retirement as a time to enjoy all of the exotic activities that you’ve never been able to previously enjoy; that retirement is the time to learn to snowboard, for instance, or parachute, or take an around-the-world cruise. I’m wondering if you feel that financial services companies, thus far, have been real and candid? If you feel that the current trend in advertising is misguided? I’m wondering how Transamerica Retirement Management will view the issue in terms of its own advertising?

Eckman - Within our organization we have made it a point to be realistic with all of the content and images we use in our literature and on our website.

It’s possible to be both realistic and optimistic. From a planning standpoint, our group is committed to helping the middle market/mass affluent retiree understand how Social Security, possibly a pension, supplemented by some other form of ongoing lifetime income, and, realistically for a lot of people, some sort of ongoing employment on their terms, can all work together to form a sound income plan.

Let’s face it; the typical picture of the couple on the yacht or in front of the second home on the beach is not realistic for a lot of people. Nonetheless, these folks have the potential, if they do the right kind of planning up front, to have an incredibly fulfilling and financially secure retirement, which is what it’s really all about.

Macchia - Phil, I’d like to ask you three questions that are entirely personal in nature. I’m going to, starting with this interview, include these questions in every interview going forward. The first one is this: if I could somehow convey to you a magic wand, and by sweeping this magic wand you could instantly institute any change that you want to see occur in this industry, what are the first two changes you would make?

Eckman – that’s a tough one. So any two changes within the industry…

Macchia - Anything, this is virtually the power of God I’m describing.

Eckman - Other than tripling everyone’s investible assets to put towards retirement, I presume that’s off the table!

I think number one….I just think a general increase in awareness of the issues and risks- and I don’t mean risks in that scary, negative sense- but just an awareness of the issues that people need to be thinking about when it comes to retirement.

If we can wave the wand and implant that knowledge in peoples’ minds, I think that obviously would be an enormous benefit for all of us.

Secondly, I think there are a lot of things, clarifications that need to be addressed from a regulation standpoint between the groups that govern equity products, insurance products and pension products. There’s a lot of confusion and red tape that needs to be resolved, that slow us down from putting the right kind of education and solutions and guidance in place to help people. So, if I could wave the wand and clarify a lot of issues and get some consistency across all of these different regulatory organizations that govern the various parts of our business, I think that would ultimately be a big help to the end consumer.

Macchia - Good answer. Next question: If you were not CEO of Transamerica Retirement Management but you could have any job at all, in any other industry, doing anything you wished, what would it be?

Eckman – I think that I look back at my career and experiences, some of the most rewarding work I’ve done involves working individually with people on their own issues. Honestly, if I could actually get into the chair of the advisor and truly help individual retirees successfully plan and make this transition into retirement, I think that would be incredibly rewarding.

Macchia - Lastly, I would like you to imagine your own retirement in its most conceivably perfect form, where perfection is anything you want it to be. Tell me what you’d be doing.

Eckman – I think I would be engaged with my kids’ and grandkids’ growth and lives, hopefully in a very active way. I would be enjoying, certainly, time with my wife doing the things we like to do together. I think I would also be engaged in some kind of ongoing professional endeavor or volunteer work.

Macchia - Sounds like a pretty nice vision. I want to thank you for your time and for your answers. I’ve enjoyed it.

Eckman – I have too, David. Thank you.

©Copyright 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.

* * *

©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.

Structured Products Association Founder & Chairman, Keith Strykula, To Be Subject of Leaders & Innovators Interview

keith_styrculaI am pleased to announce that Keith Strykula, Founder and Chairman of the non-profit Structured Products Association (SPA) has agreed to an in-depth interview as part of the Industry Leaders & Innovators series. I’ll explore a variety of issues with Strykula including his vision for the scope of structured products in the consumer market and specifically their future utilization in Boomer retirement security. Sales of structured products, which historically have occurred primarily in the institutional markets, are expected to reach $100 Billion in 2007.

With more than 2,000 members, the New York based SPA is an organization whose mission includes positioning structured products as a distinct asset class; promoting financial innovation among member firms; developing model “best practices” for members and their firms; identifying legal, tax, compliance and regulatory challenges to the business. With more than 2000 members, the Association has members from the exchanges, self-regulatory bodies, legal compliance community financial media, investor networks, family offices, and both buy-side and sell-side structured product firms.

Strykula founded SPA in 2003. His career started in 1991 when he joined CSFB’s Legal Department from Fordham University School of Law to oversee legal, regulatory and compliance issues related to First Boston’s derivatives effort. While practicing as a derivatives attorney, he was a member of the FIA Law & Compliance Executive Committee, the SIA Options and Derivatives committee and served on the Business Conduct Committee of the Philadelphia Stock Exchange.

He moved to the business side of equity derivatives in February 1997, reporting to the head of equity derivatives at SBC Warburg (renamed UBS following the merger). At UBS, he created the first structured product linked to the Dow Jones Industrial Average (issued by IBM). He returned to CSFB in July 2000 to launch the structured products platform for the newly acquired DLJ Private Client Services group, which placed $1.2 billion in its first year.

He is frequently quoted in the financial media as an authority on derivatives, structured products and the next generation of investments for U.S. and was profiled in the February 2004 issue of Risk magazine on his vision for the future of structured investments. The March 2006 issue of Structured Products Magazine interviewed him on his groundbreaking new structured products platform he launched in the U.S.