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Annuities likely to be caught up in scandal

By Tami Luhby
Newsday

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Federal and state regulators have been gathering information about potential market-timing abuses in the mutual funds within variable-annuities accounts for months. They are getting ready to take their first action.

"We continue to be very interested in variable annuities and guarantee we will be bringing cases," said David Brown IV, who heads the investment-protection bureau at the office of New York state Attorney General Eliot Spitzer. "This is really a widespread problem, and we have a number of companies in our sights."

Variable annuities are often described as mutual funds in an insurance wrapper. Buyers can invest in mutual funds and select from a variety of guaranteed options, such as a death benefit for heirs or an income stream at retirement.

First on the target list may be Conseco, a life-insurance company that received a subpoena from the Securities and Exchange Commission (SEC) and New York regulators in October. The agencies are investigating transfers within variable-annuity accounts offered by a Conseco subsidiary, which was sold in 2002, shortly before Conseco filed for bankruptcy.

Regulators could take action against Conseco as early as this week, sources said.

Conseco officials declined to comment beyond a written statement: "We believe that CVIC (the subsidiary) violated no federal or state law before its sale."

More life-insurance companies, which issue annuity contracts, might follow.

"We have sought information from the largest insurance sponsors and are actively investigating a number of them," said Lori Richards, director of the SEC's Office of Compliance, Inspections and Examinations.

Among those being investigated are Manulife Financial, MetLife and ING Group. Manulife declined to comment, and ING did not return calls seeking comment. MetLife pointed to a statement in its SEC filings acknowledging the inquiry.

Details of the investigations remain scarce.
 
"At this point, no one knows the extent to which market timing may have occurred in mutual funds," said Michael DeGeorge, general counsel for the National Association for Variable Annuities, an industry trade group.

People usually buy variable annuities for retirement because of their tax-deferred benefit. The gains are taxed when the money is withdrawn.

These instruments have grown in popularity, especially during the bear market, when investors saw their 401(k) and individual-retirement-account balances wither away. Total assets in variable-annuity accounts topped $985 billion at the end of 2003, up 23.7 percent from a year earlier, according to the trade group. Variable annuities, however, have gotten a bad reputation, since their fees are higher than those for ordinary mutual-funds accounts.

Regulators are investigating whether variable-annuity companies allowed market timing in their mutual funds, which are often clones of funds available in brokerage and retirement accounts.

In market timing, large investors move rapidly in and out of funds, increasing costs for smaller shareholders.

While timing is not illegal, many financial firms have policies to thwart such activity. Regulators are looking into whether the firms improperly waived the rules for a select number of large investors.

Variable annuities come with strings that make market timing more difficult on one hand and more attractive on the other. Unlike ordinary mutual-fund accounts, variable annuities often carry surrender charges if cashed out within the first few years.

Some timers, however, may have been attracted by the ability to trade in and out of the funds in their account without paying taxes until they withdraw money from the annuity.

Like mutual-fund firms, variable-annuity issuers are imposing additional trading restrictions and are tightening their oversight, DeGeorge said.

Regulators are looking at ways to further prevent timing in the mutual-fund and variable-annuity industries. While some mutual-fund firms favor mandatory redemption fees as a solution, most variable-annuity issuers are opposed, because such fees would be hard to administer in the more complex variable-annuity account.

Copyright © 2004 The Seattle Times Company