More than two years after the launch of the first variable annuity based on exchange traded funds, VA providers and financial advisers are still ap-proaching the product with caution.
As separate products, ETFs and variable annuities are increasingly popular. Total assets of the 546 ETFs in the United States jumped to $507.11 billion in August, an in-crease of 3.7%, according to the Investment Company Institute in Washington. Net assets of variable annuities grew to $1.5 trillion in the second quarter, according to Reston, Va.-based NAVA, also known as the Association for Insured Retirement Solutions.
Put the two together, and you get a product with lower fees and more transparency than a mutual-fund-based variable annuity, said Melvin S. Herman, chief executive of XTF Global Asset Management LLC, a New York-based firm that specializes in actively managed asset allocation portfolios that use use ETFs.
“Mutual funds have administrative fees, which don't apply to ETFs, where you always know what the funds are holding,” he said. “I think they'll become a staple in the variable annuity market.”
Late in 2004, Integrity Life Insurance Co. in Louisville, Ky., became the first insurer to package ETFs into a variable annuity. Its offerings are based on Barclays Global Investors' iShares and are sub-advised by Todd Investment Advisors Inc., also of Louisville.
The products have been well received by advisers, according to Mark Caner, president of Western and Southern Financial Group Distributors in Cincinnati, which handles marketing and product development for Integrity.
“Clients can get a diversified mix of assets. The asset allocation of the ETF mitigates risk, while the guarantees eliminate it,” Mr. Caner said.
Meanwhile, the funds allow advisers to manage the investment passively, he added.
But major variable annuities providers aren't jumping on an ETF bandwagon. In 2005, Lincoln Financial Group of Philadelphia and The Hartford (Conn.) Financial Services Group Inc. said that they were considering an ETF option for their variable annuities, but as yet, neither offers the investment vehicle.
“With respect to ETFs, we're looking at this as we would any other trend,” said Tim Benedict, a spokesman at The Hartford. “There's just not enough information to provide insight.”
Providers may be concerned that the products are still too new, said Michael DeGeorge, general counsel at NAVA. The association considers ETF-based variable annuities a niche product and doesn't track sales data for them.
For advisers, many of whom use ETFs, an ETF-based variable annuity is still a variable annuity, with their relatively high fees and lack of flexibility.
“The variable annuity industry is embedding these gimmicks and promoting insurance for a cost,” said David Demming, principal of Demming Financial Services Corp. in Aurora, Ohio. “This won't be a straight-line evolution, but you'll see new generations of VAs that are lower cost because they're just out of line.”
While David Yeske, a certified financial planner at Yeske & Co. Inc. in San Francisco, said that lower internal expenses, better portfolio transparency and a portfolio that is friendly to passive management are all fine attributes. However, he thinks that embedding ETFs in variable annuities still makes no sense in terms of taxes.
An ordinary mutual fund or a normal ETF will have returns taxed as capital gains at a 15% rate, but withdrawals from a variable annuity — re-gardless of the investment — will get hit with taxes at ordinary in-come rates, which can reach 35%, Mr. Yeske said, offsetting any of the -variable annuity's tax deferral benefits.
Mr. Herman expects rising demand over the next few years from both providers and advisers as familiarity with and trust in ETFs grows.
“It's a slow transition, but as ETFs become more popular, and benefits are widely known, you'll see more products in that space,” he said.
But Mr. Demming said he isn't likely to put new money into such investments.
“An ETF in conjunction with a variable annuity would be anathema to us fee-based planners,” he said. “You can paint a pig a prettier color, but that won't make the pig anything different.”
Darla Mercado can be reached at [email protected].
