Dynamic Asset Allocation:

Its For Variable Products, Too

BY

Professional and dynamic asset allocation strategies that have been very successful in the money management business are slowly coming into insurance products. This will become a tremendous benefit for customers.

This article traces the roots of the trend and also the benefits.

First, a look back. Variable annuities saw an 11% increase in sales in 2003 compared to 2002, according to LIMRA International. That certainly makes VA providers happy for the first time this century. And, although variable universal life sales dropped by 30% compared to 2002, according to the LIMRA figures, many companies saw VUL sales increase in the 4th quarter of 2003.

Since VUL sales tend to lag the market by 6-9 months, industry VUL sales are expected to continue to increase. In fact, both VA and VUL sales should see sales increases in 2004.

However, the 2004 environment is a different marketplace than in the past few years. What has changed? Where “greed” (always a part of human nature) was synonymous with the late 1990s, now “fear” and “greed” control just about every investment decision made.

Specifically, customers now are more aware of variable risks, fee structures, mutual fund scandals, etc.but theyre once again willing to trade off some guarantees for upside potential.

But consider this: Over an 18-year period (January 1984-December 2002), the S&P 500 Index had a net average yield of 12.22% with investors only earning a paltry average net yield of 2.57%, according to the DALBAR Quantitative Analysis of Investor Behavior in July 2003. Fixed income investments would have easily beaten that 2.57%.

So, it is clear the average customer hasnt benefited from the sharp rise in the equity markets over the past couple of decades. Now that variable products are being purchased again, the insurance industry needs to make sure it addresses this problem head on.

What causes the problem? One or more of the following:

The customer selects an asset allocation that is inappropriate for his/her situation. This selection may occur because: a) the customers have selected subaccounts based on very recent performance results; b) they recognize the advisors name from advertising; or c) they are so overwhelmed with all the choices that they just pick a group of subaccounts. They do this without recognizing the importance of picking the right asset allocation up front.

The subaccount allocation is static, meaning the customer never changes the allocation based on needs and/or the general economic environment. In the past 20 years, according to the Callan Periodic Table of Investments from Callan Associates (www.callan.com), various indices have been the leading performer one year and dead last the next year. Its tough to keep up with such changes, but I have to believe thats been the reason for some unhappiness in performance.

The customer never does a portfolio rebalancing. Most, if not all, companies offer this feature at least annually, but how many customers take advantage of it?

A solution is available on the mutual fund side of the marketplace. In the past few years, development of fee-based asset allocation strategies for customers has been exploding, and with multiple benefits.

One benefit is that the objectively chosen subaccount allocations conform to the customers personalized asset allocation model.

Another and perhaps more important benefit is that this approach is not static. It uses continuous portfolio monitoring. This continuous monitoring ensures that the allocations and holdings continue to match the customers personal risk profile and investment objectives. Also, customers enjoy the confidence that comes with professional subaccount selection and portfolio management by independent professionals. And, for agents, the selling point is they dont need to become mutual fund expertsbecause the portfolio maintenance is done by independent third parties.

Will dynamic asset allocation of this kind emerge on the VUL and VA side of the financial business? A few insurers already are offering this featuresome for a charge and some at no cost. Certainly, it is the wave of the future, because professional and dynamic strategies can address some of the causes of the performance problems that variable product investors experienced in the past.

Michael S. Pinkans, CFA, CFP, CLU, ChFC, is a registered representative and investment advisor with Equity Services Inc. and vice president-sales and promotion at National Life Insurance Company, Montpelier, Vt. His e-mail address is mpinkans@nationallife.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, March 25, 2004. Copyright 2004 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.