Annuity Selection Strategies and Performance Evaluation

by Rob Phillips, CPA

It’s important to evaluate your variable annuity options

The prospectus is one of the most important ways to evaluate the investment portfolios within an annuity. You can review the types of investments it makes, the way it allocates its overall holdings, and the strategy of its portfolio manager. An equity portfolio that buys large cap U.S. company stocks could generate slower but steadier earnings than a portfolio that buys stocks of small companies in emerging nations. Overfunded pension plans can be an issue.

It is true that your assessment is still a judgment call but it’s more than a stab in the dark. The more consistent you are in your evaluation methods, the more patterns you’ll begin to recognize. That’s what financial professionals do in drawing their conclusions about the potential success of various investments.

What to Look For

Evaluating past performance is an important step in selecting an annuity, and choosing your individual investment portfolios. Past performance is no guarantee of how well a portfolio will do in the future, but it is one of the accepted measures that’s used in assessing investments. The longer the history the better idea you will have of what might happen in the future because you can see how the portfolio has performed in different economic conditions.

You should look at the total return of the investment portfolio over specific periods of time. Total return is the annual profit after operating expenses for the portfolio, including any increase in price plus dividends or interest.

For those periods that are shown longer than a year, the return is annualized. This means it is converted to an annual basis. For example, if a portfolio’s three year return is reported as 8.5%, that’s the average of the returns for a three-year period. In this example, the three years might be made up of 7%, 9.5% and 9%, which will average 8.5%. Performance reports will often report total returns for one, three, five, and ten year periods as well as the most recent month and the year-to-date.

Importance of Making Comparisons

A primary reason to check an investment portfolio’s performance is to compare it to the performance of other portfolios in the same category. You can also compare a portfolio’s performance to one or more benchmarks, or industry standards, such as the Lipper Annuity Indexes, provided by Lipper Analytical Services, Inc.

By using performance data, you can determine how the investment portfolio you are thinking of buying measures up to what other; similar portfolios have done during the same period. Even though it doesn’t make sense to demand the top performer (since it is unlikely for a portfolio to be #1 year in and year out), what you’re looking for are those that are consistently above average.

How to Research Portfolio Managers

The investment strategy of the portfolio manager is described in the prospectus. The prospectus also explains the various tactics that the portfolio manager might adopt to offset the risks.

Even though investment strategies or philosophies don’t provide a measure of performance, they can often help explain why a portfolio performs the way it does. If an equity-fund manager concentrates on value stocks—which are typically stocks whose prices are currently lower than expected—the performance of the portfolio will follow a different pattern than that of a portfolio where the manager focuses on rapid growth.

Many people are drawn to well-known, brand name portfolios because their managers are often the subject of feature articles in the financial press, and are sometimes quoted as experts on current economic trends. Putting your money into an investment portfolio run by a well-recognized manager can provide an extra measure of comfort; however it’s no guarantee of a strong performance.

The Press

There are a number of newspapers and periodicals that report the performance of some of the variable annuity portfolios. Barron’s, a weekly publication, lists the unit value, the four week total return, and one-year total return for hundreds of major insurers.

The Wall Street Journal reports on variable annuity performance every Monday. WSJ’s coverage includes unit price, as well as one week and year-to-date total returns and the expense ratios for the variable annuities it covers.

 Expanded Coverage

You can get more detailed reports on investment portfolios by checking the reports provided by professional information services.

Even though subscriptions are available, you can usually find the materials in public libraries, online or your financial planner or broker should also have access to these reports and be able to provide copies of the specific sections you want to read.

  • Variable Annuity Research and Data Service (VARDS), a service of Pivot/Info-One.
  •  There are four components of The VARDS Report, which provides comprehensive monthly performance analysis on more than 22,500 investment portfolios, including risk-adjusted performance rankings. In addition, the report summarizes the content and pricing details of more than 740 variable annuity contracts, and provides research-based articles on subjects of current interest. There are also special reports on comparative contract expenses, sales and asset surveys, and other related subjects. For further information, you can visit www.vards.com.
  •  Morningstar
  •  Morningstar publishes the Variable Annuity Performance Report monthly. It posts performance figures for roughly 700 investment portfolios, with data going back as far as ten years. The report includes useful information, such as the advisor’s name and phone number, fee structure information, net assets, and risk ratios
  • Lipper, Inc.
  • In addition to providing industry performance averages by portfolio category, the firm publishes the Lipper Variable Insurance Products Performance Analysis Service. That publication provides total return data for investment portfolios over different periods of time.

The Effect of Fees and Charges

It’s important to remember that variable annuity performance is affected by fees and expenses such as the mortality and expense risk fee, administrative charges, and surrender fees.

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