From the February 2006 issue of Boomer Market Advisor • Subscribe!

February 1, 2006

Sub-account stress


The sheer number of sub-account choices can easily overwhelm clients and advisors alike. Products are now available to accommodate nearly every investment style and risk tolerance. According to Morningstar, there are 23,000 sub-account options for close to 500 variable annuities. But the resulting confusion should be viewed as an opportunity to demonstrate expertise and concern for boomer clients, while building greater loyalty and long-term relationships.

Before making any recommendations, James Duffy, chief executive officer of Cutchogue, NY-based Granite Financial, performs an in-depth analysis of available selections to mitigate risk and maximize potential return.

"Selecting sub-accounts is all about managing risk," Duffy says. "We'll look back at a 20-year performance history and ascertain how it may fit with other components of the client's portfolio. The aim is to get the desired return but also enable the client to sleep at night."

The explosion in the number of sub-account options first occurred in the mid-1990s, when investor interest in variable annuities gained traction. Because annuitization payment schedules are based on sub-account performance, carriers increased their offerings to better market their products.

"Boomers nearing retirement are concerned about two things," says Steve Mannato, an advisor with William Tell Financial Services in Latham, NY. "Income to support their retirement lifestyle and protection in the event of their death. Our role as advisors is to provide sensible investment management and asset allocation. All of this can be packaged in a variable annuity."

While variable annuities offer benefits such as tax-deferred investments, lifetime income, extended care provisions and guaranteed features, one of their key attributes is professionally managed sub-accounts. Energy, technology, health care and financial services are all sectors that are currently available. A carrier presenting more than 50 sub-account choices is not uncommon. The advisors interviewed for this piece averaged between five and eight sub-accounts per variable annuity. Some went as high as 16 and one went as low as one.

"I prefer the asset allocation models produced by most of the insurance companies," says Raymond Jacques, CFP, president of New England Schooner in Peabody, Mass. "After assessing a client's risk tolerance you can choose an allocated portfolio to mirror it. These models --usually created by Ibottson and Morningstar -- are automatically allocated across the funds available in the variable annuity."

"Once a selection of sound companies has been [identified], an advisor should then pay detailed attention to the contract's terms," Duffy adds. "Many variable annuity contracts have excellent investment choices whose contract terms, when analyzed, far outstrip the advantages of the 'exciting' investment choices within. It's the advisor's responsibility to be fully versed in the underlying expenses, penalties and lock-up provisions of the contract."

Selecting the appropriate sub-accounts is only part of the equation. Managing a portfolio is a dynamic process and risk is inevitable. Fortunately, most variable annuities allow for 20 tax-free transfers among sub-accounts per year. No taxes are due when sub-account funds are transferred but other charges may apply. This tax-free transfer feature gives the advisor added flexibility when managing the account, especially when there's significant change in the client's personal or financial life.

"VAs can be rebalanced on a regular basis," Jacques says. "Because they are tax deferred there are no immediate tax consequences to the client. This process ... removes the emotion and second guessing from the equation."

And while sub-accounts usually offer a variety of mutual funds as their designated investment vehicle, and are generally designed to mirror mutual fund performance, they're actually considered different instruments in the eyes of the NASD. Due mainly to fee differences, their performance is almost never identical to their underlying mutual fund models.

"There is no 'one-size-fits-all' sub-account, [but] many boomers are effectively using managed growth funds in variable products," says Keith Steidle, president of Springfield, NJ-based Steidle Financial Group. "Since turnover does not cause a current tax liability, boomers may find variable products useful as they add diversification to tax efficient index funds that may be held in other parts of their portfolio."

"If the sub-account selection gets overwhelming, most companies offer some form of managed portfolio to reduce the investment selection burden," adds Scott Kramer, an advisor with Advanced Wealth Solutions in Woodland Hills, Calif. "At the end of the day, these investments should be managed as all investments should, with proper due diligence, attention to contract and investment detail and a keen eye on client risk management."

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