What's New in Cybertalk?

by Jean Gora
January 1999

Note: CyberTalk is a column that appears monthly in LOMA's Resource, the magazine for insurance and financial services management. To see more contents of the magazine and to see how to subscribe, click on
RESOURCE.

Internet Investment Advisors Target 401(k) Plan Sponsors

Note to readers outside the U.S.: A 401(k) plan is a defined contribution pension plan under which employees can have a pre-tax portion of their salaries contributed to a plan. Employer sponsors of the plan can match employee contributions, also on a pre-tax basis for the employee. The money contributed to 401(k) plans is invested in a series of mutual funds that represent subaccounts of the plans. An employee can select the funds to receive his/her contribution and can transfer money from one fund to another as needs change. According to Sean Hanna, assets in 401k plans reached $1 trillion in the fall of 1997.

At the end of the third quarter of 1998, millions of individuals covered by 401(k) plans received not-so-good news about the impact of the stock market's decline on their retirement savings. Those who monitored their plans' performance on the Internet or via automated voice response systems received the news somewhat earlier. Irrespective of when they received the news, these people learned that their retirement savings could decline as well as increase. In a country where the savings rate is as low as it is in the U.S., this situation is a cause of concern. One consequence of this situation is that millions of people now know that saving for retirement is likely to be somewhat more complicated than they had previously believed. The question is what to do about the problem.

If these individuals turn to their plans' sponsors for advice, they will usually receive very little. If the Internet sites of insurers in the 401(k) business are any evidence, plan sponsors provide employees with questionnaires that elicit the employees' attitudes toward risk and return. On the basis of this information, the Internet sites recommend mutual funds grouped by investment instrument and objective (and therefore, by risk and possible return). This recommendation represents only advice in its most basic form.

The Department of Labor, which regulates employee pension plans, has begun to indicate concern with the "adviceless" state of most covered employees. Olena Berg, a former Assistant Secretary of Labor in the Pension and Welfare Benefits Administration, has been quoted as saying, "At the Department of Labor, we're very concerned about the widespread misunderstanding among 401(k) plan sponsors regarding investment advice for participants. Let's clear this up once and for all: investment advice is perfectly legal. In fact, the DOL wants participants to have as much assistance as possible, and we encourage plan sponsors to offer participants investment advice if that's what they determine their participants need to make informed decisions."

Anyone who utters the "advice" word within shouting distance of the insurance industry attracts attention. If the Department of Labor begins to push plan sponsors to offer advice to covered employees, the market for this advice will be gigantic. This fact has not gone unnoticed in other quarters—among them the Internet investment community. That community is already providing individual investors a smorgasbord of investment-related information and advice beyond the wildest dreams of most investors several years ago.

Internet Investment Advice

The Internet community has begun to turn its considerable attention to bringing the same benefits to individuals covered by 401(k) plans. Evidence of this fact is the appearance of Internet sites operated by Internet-based investment advisers and targeted at plan sponsors. As might be expected, the advisers want plan participants to be able to access this advice on the Internet.

One of the most interesting of these advisers is a company called Financial Engines LLC (http://www.financialengines.com). The chairman of this company is William F. Sharpe, a professor at Stanford University, winner of the Nobel Prize in economics in 1990, and one of the developers of modern portfolio theory. Another player in the firm is Joseph A Grundfest, also a Stanford University professor and a Commissioner of the Securities and Exchange Commission from 1985 to 1990.

Olena Berg, quoted above, serves as a board member and senior advisor. Frederick Goldberg, a former Commissioner of the Internal Revenue Service, is an advisory board member. Investors in the venture include Henry Kravis and George of Kohlberg, Kravis and Roberts, and Joseph Hardiman, a former president of the National Association of Securities Dealers. In sum—an impressive group of people—even more impressive than the two Nobel prize winners in economics and one former vice chairman of Federal Reserve Board who run the hedge fund, Long Term Capital Management. Long Term Capital Management was recently rescued by a group of its lenders—major U.S. and European financial institutions—after its automated investment techniques led it to incur billions of dollars of investment losses.

Financial Engines says it provides the following:

• This software-based service incorporates methods used by professionals to invest billions of pension dollars and employs the Internet to deliver the benefits of this analysis to individuals. Financial Engines expects to change the economies and quality of investment advice by making institutional-quality financial counsel available to individuals.

• The system assists users in setting a specific goal for the income they will need in retirement. The service also incorporates personal information such as a user's age, income, savings level, and investment information including assets held in both taxable and non-taxable accounts.

• Based upon the user's specific information, Financial Engines uses advanced mathematical and financial techniques to generate a forecast showing the chance that the user will reach his or her goal with the total household portfolio of assets currently held.

• After analyzing a user's total household portfolio, Financial Engines applies patent-pending analytic techniques to product specific fund recommendations for investing his or her 401(k) assets. This recommended portfolio of funds provides our projections of the highest expected return given the user's risk preferences, retirement age, and savings level.

• When changes in the market significantly affect a user's forecast, Financial Engines' software advises the users on what they should do to keep their financial plan on track.

At least one other firm, 401(k) Forum, has also entered the 401(k) advice market with a product that performs many of the same functions described above. The accounting firm of Arthur Andersen is reportedly a minority owner of 401(k) Forum. The value of all of these products depends on the degree to which their predictive software takes into account the major variables driving the market. Certainly, the products are likely to take into account more variables than the average investor usually does.

Who Buys Them?

The announced buyers of the products of Financial Engines and 401(k) Forum include both 401(k) plan providers and plan sponsors.

Purchasers of Financial Engines' products include State Street Global Advisors (SSgA), Ernst & Young LLP, and Hewitt Associates. SSgA will equip its human advisers with Financial Engines' software. Participants in SsgA-provided plans will use the telephone to contact the advisers. Ernst & Young will incorporate the software into a fee-based service it offers to human resource departments. Hewitt will incorporate the product into a new service called its Financial Security Platform.

Purchasers of 401(k) Forum's product include the Southwest Airlines Pilots' Association and Blue Shield of California. 401(k) Forum also has an agreement with the Individual Investor Group to offer 401(k) Forum's content on the Individual Investor Web site.

The Individual Investor Group also has the right to that content to its alliance partners, which include CNET, AltaVista, PointCast, AOL's Digital City New York, Quote.com, Cox Interactive Media, Hoover's InvesTools, WhoWhere?, and Planet Direct. 401(k) Forum's management hope that individuals who see this content will persuade their employers to offer the service. Arthur Andersen is a minority investor in 401(k) Forum.

Standard and Poor's is also preparing to offer a similar service incorporating financial advisory software.

Raising New Issues

The incorporation of financial and investment advice tools into 401(k) plan offerings raises a number of interesting issues. At present, within the insurance industry, the business of providing advice to individual customers is largely the province of individual agents. In the case of investment advice, it is the province of agents who are also registered representatives.

Many believe that agents will continue to have an important role in the individual market, irrespective of increasing use of the Internet, because agents provide advice. Some believe that the average person will be unwilling to use an online provider to do anything as sensitive as preparing a financial and investment plan.

What happens when many individuals who are participants in 401(k) plans begin to receive personalized advice through their employer (via an organization with which the employer contracts)? What happens if the average person receives coaching from his/her employer's human relations department? LIMRA statistics have shown in the past that individuals who receive group life insurance coverage through their employers are less likely to own individual life insurance. With the advent of employer-sponsored financial planning, an additional migration from the individual channel to the employer channel could occur.

The incorporation of investment advice tools into 401(k) plan offerings also raises some interesting issues for the retail securities brokerage industry. Some plan providers now offer self-directed securities brokerage accounts within 401(k) plans. For example, more than seven percent of the 401(k) assets held at Charles Schwab are in such self-directed accounts.²

The full-service securities brokerage industry relies on human investment advisers; the provision of advice is what theoretically distinguishes full-service brokers from discount brokers. What happens if individuals invest directly in securities through their employers and receive comprehensive online financial and investment advice as part of the arrangement? Their need for full-service brokers for their non-401(k) plan investments diminishes. In effect, the investment relationship they begin through their 401(k) becomes the dominant investment relationship in their lives. Retail securities brokers could feel the same adverse impact the traditional agents are likely to feel.

Thus, the incorporation of advice functions into 401(k) plans by providers has enormous long-term potential impact on both the insurance and the securities industries.

401k Wire.com, an Internet site devoted to news concerning the 401(k) industry, represents an excellent source of information on these developments. One-month free trial subscriptions are available. A yearly subscription costs $1,195 for 249 daily issues. Qualified plan sponsors whose business is not in the retirement market are eligible for individual memberships at a cost of $299.

Endnotes:
¹401(k) Alert: Special Issue on Advice, May 1998, as quoted on http://www.financialengines.com/news/poll.html
²Sean Hanna, http://www.401kwire.com, February 6, 1998.

 LifeCAD/MP Supports eAnnuity Launch

In last month’s issue of CyberTalk, Jean Gora discussed the launch of Lincoln Financial Direct’s eAnnuity, the first variable annuity sold exclusively on the Internet (see December Resource, page 18). Lincoln Financial Direct (LFD) is a unit of Lincoln Life, the 12^th largest life insurance company in the United States based on assets. The eAnnuity is a high performance, low cost variable annuity available through a Web site that puts the consumer in complete control of the transaction process online. All the information a consumer needs to make a wise investment decision is on the Web site, including performance comparisons with other investment products.

More recently, NaviSys, St. Louis, MO, announced that their LifeCAD/MP system is the one that is being used to administer the eAnnuity. The eAnnuity Web site (www.eAnnuity.com) uses LifeCAD/MP’s distributed computing architecture, LifeCAD/Strata, in a Sybase environment on an NT server. In addition to Web pages, LifeCAD/Strata architecture facilitates connectivity to a variety of software packages.

For more information about eAnnuity or the LifeCAD/MP administration system, call 314-963-8114, or see the NaviSys Web site at www.navisys.com.

See previous issues of CyberTalk in the CyberTalk Archives.