This year, variable annuities are a better deal for the seller than for the investor

By Scott Burns September 9, 2009

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This year, as with many preceding years, variable annuities are a good deal for insurance companies but a lousy deal for investors. This isn’t personal. It’s about numbers. Just as managed mutual funds have to swim against the tide of their own expenses, variable annuities swim against an even faster tide of expenses.

No one wants to pay for tax deferral and then have no gains to defer.

The idea here is simple. Each year we measure the return of an inexpensive, tax-efficient index fund against every variable annuity sub-account in its category. Then we figure the probability that you would have done better with the simple index fund than with a variable annuity.

Domestic equities: As of June 30 there were 6,689 variable annuity sub-accounts categorized as “large blend’’ with 10-year track records. The group had an average expense ratio of 1.97 percent a year and lost money at an annualized rate of 2.46 percent. The Vanguard 500 Index fund cost a mere 18 basis points, or 0.18 percent. It lost slightly less than the average sub-account, 2.29 percent a year. Ranked against all 6,689 sub-accounts, the index fund would have placed 2,505. So it beat 63 percent of all surviving competitors.

The word surviving is important. According to a recent report, only 61 percent of all large blend managed mutual funds survived the last five years. It’s a statistical leap, but it isn’t unreasonable to guess that the index would have beaten more than 80 percent of its original competitors over the last 10 years.

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International equities: The 2,071 surviving sub-accounts classified by Morningstar as “large cap blend international’’ had an average expense ratio of 2.10 percent and a 10-year return of 0.13 percent a year. Vanguard Total International Market fund had an expense ratio of 0.34 percent and an average annualized return of 2.18 percent. The index fund would have ranked 386, beating 81 percent of its surviving competitors.

Moderate allocation funds: The 3,279 surviving moderate allocation sub-accounts had an average expense ratio of 2.07 percent and a 10-year annualized return of 0.44 percent. The Vanguard Balanced Index fund has an expense ratio of 0.25 percent and a return of 1.86 percent. It would have ranked 693, outperforming 79 percent of rivals.

The insurance industry has countered statistical reality with “living benefits.’’ Pay an extra fee that takes the annual expense of the product to about 3 percent a year, and they guarantee you can withdraw 5 percent a year from your original investment as long as you live.

Sounds good, right? Think again. A $100,000 variable annuity contract with such a guarantee means a 65-year-old can have $5,000 a year, or $417 a month, for life. According to, a 65-year-old can buy a life annuity that will pay $417 a month for life for $61,000. That means he’d have $39,000 “left over.’’

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