Dealing With Negative Returns In VA Money Market Accounts

I never thought Id see a time where money market accounts were making headlines. Some of you have been around long enough to remember in the late 1970s when money market accounts were getting some headlines due to extraordinary interest rates, 15% and higher. But thats not the type of headline Im referring to here. Im referring to headlines about money market funds actually having negative returns. Yes, returns less than zero.

Ive read a few articles recently in the popular press about this phenomenon. One concentrated on money market subaccounts inside variable annuities and another one concentrated on money market mutual funds.

Ill focus here on the money market subaccounts inside VAs. That does not mean that the story of negative returns of money market funds is less interesting, its just that its far less prevalent since there are no mortality and expense (M&E) fees and fund companies have shown a propensity toward lowering management fees to keep the returns positive.

I also want to differentiate this discussion from the “break-the-buck” money market issue where the value of the account drops below the seemingly impervious $1.00 level due to credit or duration problems. Again, its not that this isnt interesting, its just that this is not a very prevalent issue. (Although it is worth noting that the ultimate result of this problem is similar to that of a negative return, i.e., the account holder loses money in the money market account.)

Okay, back to the issue– negative returns in VA money market accounts. Why is this happening and what can be done about it?

Short-term interest rates are at historic lows, with many short-term instruments yielding 1% or less. Six months T-Bills are currently yielding 1.23%. The average money market fund is yielding 0.73%. Now, when you take on M&E charges (typically 1.40%) you can see why VA money market funds are yielding in negative territory.

There are really two things that can be done about this. One would be for the money manager, who manages the account, to reduce fees, much as they would in a mutual fund. This is unlikely to occur, however, as subaccount managers usually have somewhat less control and less incentive to do so. After all, their account holder is the insurer. Which leads into the second alternative, the insurer could cut its M&E fees.

There is a strong argument that the insurers shouldnt even be charging any mortality fees on a money market account, since the probability of loss is so small. There are actually two flaws in this argument. First is that depending on product design, much of the M&E is not for mortality, but for expenses (including commission). Therefore, as long as the expenses of operating the annuity and paying commission are present, the M&E must be charged.

The second flaw is that given many of todays ratcheted death benefits, M&E charges on money market accounts are quite inadequate. Specifically, many death benefits are guaranteed to rise by a certain percentage each year (e.g. 5% or 7%).

In todays interest rate environment, its not possible to earn these yields in money market accounts. Therefore, the insurers risk on having to pay out a death benefit above the account value is actually increased with assets in the money market fund.

Well, this seems like all bad news. Except for some negative publicity, neither the insurer nor the underlying account manager has a strong incentive (or ability) to lower fees to create a positive return.

It seems the message here should be to ask yourself why your client is in the money market account to begin with. If its to escape market volatility and the product also offers a general account option (fixed-rate), consider switching to that. Rates arent high in these accounts either, but they are positive (usually 3% to 5%) and they may make for a better alternative.

Keep in mind that there can be more restrictions on switching back and forth, from the subaccounts and from the general account (including market value adjustments).

Also, your credit risk could increase as you enter the general account of the insurer. But even given these considerations, it makes sense to explore this as a viable alternative.

It pays to closely monitor your clients annuity holdings. Theyll enjoy a better retirement and so will you.

Thomas Streiff, CFP, CLU, ChFC, CFS, is director of investment solutions at UBS PaineWebber, responsible for

the separate accounts, mutual funds, insurance, and annuity product areas. He can be reached via e-mail at

thomas.streiff@ubspw.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, January 27, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.