Exchange traded insurance funds may be the next big thing in VAs

May 15, 2006 @ 12:01 am

By Gary S. Mogel

NEW YORK - Exchange traded insurance funds may be available as a variable annuity subaccount investment option within six months, according to a firm that is seeking patent protection on the product.

ETIFs are exchange traded funds that could be used in insurer products, such as variable annuities, after approval by regulators.

"Currently, VAs aren't allowed to invest in individual ETFs, because federal regulations require that a VA investment option be available only to VA owners," said Perry Moore, chief executive of Advanced Sales Corp. in Oakbrook Terrace, Ill.

Individual ETFs haven't been "cloned" for use in variable annuities as mutual funds have, he added. However, variable annuities can invest in mutual funds that contain ETFs.

Advanced Sales has a patent pending on the ETIFs and a contract with the American Stock Exchange in New York to trade them if they are approved. It is seeking regulatory approval from the Securities and Exchange Commission and the Internal Revenue Service.

The SEC has "no issues with an ETIF going into an insurance product," according to Mr. Moore. But the IRS is concerned about the ETIF income being tax deferred if it is within a variable annuity, he added.

Advisers favor ETFs

Advisers seem to like the ETIF concept for their VA clients, as the fees would be considerably lower than mutual fund fees.

"ETFs in VAs would be fantastic, because it would take away the major beef that advisers - especially those that are fee only - have against VAs, which is their high underlying expense ratios," said Jim Reilly, a wealth manager for Regent Atlantic Capital LLC, a Chatham, N.J., firm that manages $1.3 billion.

"This is a train that's coming that will cascade throughout the entire industry," said John Duval, senior managing director of Duval Asset Management, a new firm in New York.

"ETFs are the least expensive way for VA clients to participate in sector investing. Our platform is based on the use of ETFs," Mr. Duval said.

"ETFs usually have 35 to 50 basis points, while VAs often have 150 basis points," Mr. Moore said.

"ETFs have become much sexier than mutual funds" said Dirk Speyer, vice president of national sales at Trust Co. of America, a custodian with $4 billion in assets, which is based in Centennial, Colo.

"Advisers with a heightened level of sophistication and savvy are migrating from mutual funds to ETFs," he said. "Using ETFs shows clients that the adviser is a true money manager and tactical asset allocator."

Insurers that offer VA guarantees - such as guaranteed minimum income and withdrawal - also would benefit, as ETIFs would be easier to hedge than mutual funds because their holdings would be fewer and more identifiable, and often would replicate a well-known stock index.

"There's been interest in ETIFs at fund companies and also at insurance companies," Mr. Moore said, though he declined to identify them.

"Creating an insurance subaccount employing ETFs is not common now, but it's coming next," said Mark Phelan, senior vice president of the individual investment business segment for Nationwide Financial Services Inc. in Columbus, Ohio.

"We're looking at creating a fund of ETFs for use in insurance products but haven't considered individual ETFs," said Bob Boyda, senior vice president of investment management services for John Hancock Financial Services Inc. in Boston.

"Out of our 96 VA funds, only one currently has ETFs," said a spokeswoman for Prudential Financial Inc. in Newark, N.J.

"ETFs aren't on our immediate radar screen for VAs," said a spokesman for The Hartford (Conn.) Financial Services Group Inc.

Integrity Life Insurance Co. in Louisville, Ky., has offered ETF funds as a VA investment option since last year, according to Barry Meyers, vice president of business development.

The insurer uses iShares from Barclays Global Investors in San Francisco, which are distributed by Cincinnati-based Touchstone Securities Inc. The funds have a fee of 0.6%.

It is easier for insurers to hedge an ETF, as they can short or buy puts for the stocks in the ETF, or for the index on which it is based, Mr. Moore noted. With a mutual fund - even one that's supposed to replicate an index - you don't really know what was in the portfolio until after the required statements and filings are made, he added.

"We haven't jumped on the ETF bandwagon, because we're not convinced that the costs would be that much lower," Mr. Boyda said.

"The spread between the ETF bid and ask prices is like a commission," he said. "Index mutual funds are relatively inexpensive and may be a better value."


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