Morningstar’s tale of two data displays

Morningstar Inc. may consider reviewing the way it displays information to financial advisers and their clients about returns on variable annuity subaccounts.

The issue came up last week when an adviser reported that the way Morningstar depicts the VA subaccount returns on customer reports differs from the way the same funds’ performance is presented in the Morningstar Principia program, which advisers use.

“We would show someone actual year-by-year performance versus the other investment, but [the report] doesn’t show it to them in a cumulative way or in the form that they’re most used to,” said Mark Cortazzo, a principal of Macro Consulting Group. “It requires more explanation.”

Responding to questions about the discrepancy, Brian Cullen, product manager for Principia, said that the information on the client report and Principia is the same but merely is displayed in a different manner.

Point-to-point performance over one, three, five and 10 years is displayed numerically for advisers, while clients see the same performance — without the deduction of fees — in graph form, he said. Clients see performance net of fees in a table adjacent to the graph.

When measuring fund performance, the customer reports for trailing returns assume liquidation at the end of the one-, three-, five- and 10-year intervals, and take into account surrender and annual fees.

The performance report in the Principia program doesn’t assume liquidation and doesn’t show those fees. As a result, the fund performance seen on the client report is different from what the adviser sees on his or her Principia report.

The Financial Industry Regulatory Authority Inc. and the Securities and Exchange Commission require that client communications depict returns adjusted for loads and surrenders, Mr. Cullen said.

Trailing-return data also assume a $1,000 investment into the variable annuity, per SEC guidelines for depicting subaccount performance.

“This can be used in sales situations and with prospective clients, so it’s important to show them this information,” he said.

Advisers contacted, however, said that the two displays make it difficult for them to explain to clients how a subaccount is expected to perform.

“It inhibits our job that they have data that has impractical assumptions,” said Mitchell Kauffman, principal at Kauffman Wealth Services Inc., an affiliate of Raymond James Financial Services Inc. “I’ve had to work around it; it really renders the data useless.”

Mr. Cortazzo said: “The first thing I look at is a one-year, three-year and five-year snapshot. Do I count back three years on the graph? It’s not a clean start and it doesn’t show me performance for a three-year period.”

Advisers also found fault with the fact that the non-standardized trailing returns depicted in the client report assume that clients cashed out their annuities one, three or five years after purchasing them. They said that that assumption isn’t realistic, as clients typically don’t cash out annuities so quickly.

“To say nonchalantly, “Here are your returns, including a surrender charge,’ isn’t practical for most people who bought variable annuities; it doesn’t make sense,” said Richard Dragotta, a branch manager with LPL Financial. “Most people buying them do it for a longer-term perspective. Sales charges and surrenders should be included — but not with the assumption that the client has inherited them.”

Adviser Jim Saulnier agrees.

“An annuity is a long-term hold,” he said.

“Why show clients reports that show that at the end of the first year, the client sold it?” Mr. Saulnier added.

“We’re really trying to make the investor aware of what would happen if they wanted to surrender early,” said Marco Chmura, operations manager for Morningstar’s VA and life insurance data.

“We’re not taking part as to whether advisers ignore that information, but it’s our desire to let the client know what would happen if that occurred in the future.”

As a result, some advisers have adopted strategies to compensate for these issues when they explain VA performance to clients.

Mr. Kauffman decided to use data from C-share variable annuities when explaining subaccount performance to clients, as that share class doesn’t have surrender charges.

“If your assumption is that there’s a surrender charge in the first year, then the data is useless,” he said. “C shares don’t have a surrender charge, so in that sense, you get a more realistic perspective.”

Kevin VanDyke, president of Bloomfield Hills Financial, said that he always explains to investors that the client snapshot doesn’t show exactly what the fees are. He also noted that at times, the mortality and expense fees for variable annuities on Principia may be off by 15 to 20 basis points.

As a result, while Mr. VanDyke still uses Principia as a research guideline, he consults the insurance company issuing the variable annuity before any communication goes to his client.

“In this day and age, there’s this emphasis on fees and disclosures. They’re muddying the waters,” Mr. VanDyke said.

“People don’t want to get variable annuities, because they think they’re too complicated. You’d think Morningstar would make it nice and clean for you, and they don’t,” Mr. VanDyke said.

Mr. Cullen said that Morningstar will review adviser feedback on the issue. Making a change in the way that the data are displayed “is something we’d consider, but it’s not necessarily a priority,” he said.

E-mail Darla Mercado at [email protected].