Variable vs. Index Products: Recommend The One Thats Best For The Situation

It is not uncommon to hear people in todays market expounding on the virtues of variable products over equity index products and vice versa. Often these proponents tend to take the position that a single product is the only solution to the customers financial needs.

Given that the past few years have seen significant growth in popularity of equity index products (the annuity version in particular), this seems a good time to compare and contrast the indexed and variable designs (does this sound like a college essay exam?).

The discussion will attempt to reinforce a premise that we have long heldnamely, “one size does not fit all.”

Equity index products are often characterized as a “simple” approach to retirement savings. That is, they enable purchasers to participate in stock market performance without the need to study investment theory, with no need for a professional advisor to monitor the investments (as is necessary with variable products), and with a great hedge against market downturns.

On the other hand, variable product proponents say no other type of insurance product provides the inherent flexibility to enable contract owners to shift investment orientation in order to protect against market fluctuations while still providing a degree of protection against disasters in the stock market.

The truth? In our view, there is a good argument for both types of products.

Variable products do provide the greatest ability of any investment product to shift investment orientations without the disadvantages of owning the underlying investments directly.

As anyone knows who has attempted to lock in market appreciation on mutual fund shares by redeeming shares to protect against a declining stock market, such an action can easily result in capital gains taxes. This is so, even though the funds resulting from the redemptions are reinvested into other, less volatile mutual funds.

In addition, many mutual fund investors over the past few years have had to pay capital gains taxes resulting from “phantom” gains from specific sales by the mutual funds of portfolio assets, even though the value of the entire mutual fund itself has decreased. Needless to say, mutual fund owners are not happy to have to pay taxes on assets that have diminished in value, especially when the value of the total investment is below the investors cost basis.

Variable insurance products, by contrast, are the only product we know that permits investors to change their investment mix, often to totally different types of investments, without any recognition of gain for tax purposes.

This investment flexibility is one of the most important features of variable insurance products. And, speaking to the topic here, such flexibility is generally not possible with equity index products.

With the equity index productat least with those currently availablethe index linking originally purchased is the one the policy owner keeps for the life of the contract. This is regardless of changed economic or market conditions.

However, even though equity index products are less flexible in investment orientation than are variable products, they do provide a sense of security and a freedom from the necessity of having to monitor underlying investments and economic and market conditions.

Moreover, they afford contract owners with the ability to participate, albeit to a limited extent, in the economic results of popular equity indexes.

It is also possible to construct equity index products that permit some change in the selection of the index that will measure the value of the contract. There are some technical difficulties that have to be resolved in order to bring such products to market, but they should not be insurmountable.

Equity index products with the flexibility to change the index might well not only be more appealing, but would enable purchasers to hedge against long-term changes in the economy or the stock market.

Regardless of ones preference, for equity index products or variable products, financial professionals need to keep an open mind toward both.

Each type of product has unique uses. Each also requires the advice of a professional to enable the purchaser to understand how the products work, what the risks and rewards are, and how to make an intelligent choice.

In this context, we are aware that many people who sell equity index products do so because they believe the fixed version of the product can be sold without registering with the National Association of Securities Dealers.

In our view, using the equity index product in this waymerely to avoid NASD registrationhas the potential of depriving customers of complete choice concerning the best product to suit their needs. The product the advisor recommends should be the one that best suits the customer, not the advisors licensing capabilities.

And the product recommendations should be broached from people who are qualified to offer professional advice across the broad spectrum of financial options. This advisory element is critical in the sale of any insurance product, and the more complex the product, the more that professional advice is required.

Therefore, those selling fixed equity indexed products should give serious consideration to obtaining securities licensing as well as insurance licensingso they can recommend variable or index products as fits the situation. Either that or they should partner with professionals who have the securities licensing they themselves lack.

This will enable their customers to have a true choice from among the various products available to meet their unique needs, and the expert guidance to make the best decisions.

Norse N. Blazzard JD, CLU, and Judith A. Hasenauer, JD, CLU, are attorneys in the Pompano Beach, Fla., office of Blazzard, Grodd & Hasenauer, P. C. Judith A. Hasenauer chairs the Regulatory Affairs Committee of National Association for Variable Annuities. E-mail: Norse.Blazzard@bghpc.com.


Reproduced from National Underwriter Edition, April 30, 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.