ANNUITIES MAY HEED WADDELL & REED: OTHERS WEIGH ADDING FEE FOR MARKETING, À LA MUTUAL FUNDS

Waddell & Reed Financial Inc. is slapping a new 0.25% service and marketing fee on its variable-annuity portfolios in an unusual move that others in the annuity business are considering.

The $23 billion mutual fund firm recently filed a proxy with the Securities and Exchange Commission asking shareholders to approve the so-called 12b-1 fees, charges far more commonly imposed by mutual funds than variable annuities.

Only a few other annuity providers charge these fees, which typically go to compensate brokers who sell the products.

One of these is Scudder Kemper Investments Inc., which two years ago added a share class to its Scudder Variable Life Investment Fund that includes a 12b-1 fee. Though a few insurance companies sell that version, most outside distributors opt for the share class without the 12b-l, a Scudder Kemper spokesman says.

‘A FAIRLY RECENT DEVELOPMENT’

By and large, though, 12b-1 fees are a rarity in the annuity field.

“It’s a fairly recent development,” says Mark J. Mackey, president of the National Association of Variable Annuities in Reston, Va. “I think it probably is a little early to identify this as a ‘trend.’ ”

Still, as competition for shelf space continues to intensify, some annuity providers are looking into the fees as a way to offset increasing marketing and distribution costs, as well as provide a clearer price comparison with mutual funds.

“I think more and more companies within the industry are considering this type of thing as a way of helping investors understand the variable annuity and its relationship with a mutual fund,” says Jan Holman, vice president of investment services for American Express Financial Advisors in Minneapolis. “It’s just a way to reshape the pricing so (annuities) can be compared with mutual funds.”

Variable annuities in essence are mutual funds with insurance features that provide for tax-deferred accumulation of assets and a death benefit. Like mutual funds, annuity providers charge a money-management fee that goes to the portfolio manager. But, unlike mutual funds, annuity investors pay an additional “mortality and expense” charge -usually 1% of assets or more – to cover broker commissions and the cost of the insurance features.

Ms. Holman expects that most firms adding 12b-1 fees will simultaneously reduce M&E charges to ensure the ultimate fee for investors stays the same. American Express does not charge a 12b-1 on its variable annuities.

In Waddell & Reed’s case, however, the fees will take another 25 basis points out of investors’ wallets, confirms Robert Hechler, the Overland Park, Kan., firm’s president. With about $2.2 billion in the firm’s TMK/United annuities (to be redubbed Target/United later this year), the fees will generate another $5.5 million a year to pay the firm’s 2,200 financial planners, who are the sole distribution outlet.

That will compensate them year in, year out, for the advice they offer clients after putting their assets in the annuities, Mr. Hechler says.

“It’s all to compensate our investment advisers for the time they’re already spending (with clients),” he says, adding that his sales force pushed for the fees. “I don’t think clients expect them to do that without being compensated.”

CHARGE IS BELOW AVERAGE

Cushioning the blow is the fact that Waddell & Reed’s M&E charge is a below-average 90 basis points. Also, as with most variable annuities, the investment management fees on Waddell & Reed’s underlying portfolios – up to 85 basis points, depending on the type of fund – are below the mutual-fund industry’s average, which exceeds 1%.

Still, the move flies in the face of the industrywide trend toward reducing fees on variable annuities, which many investment advisers and others criticize as too costly. Potentially, it also complicates an investment vehicle that the average investor already finds hard to understand.

“The last thing variable-annuity investors need is another breakout of a fee,” says Patrick Reinkemeyer, publisher of Chicago-based Morningstar Inc.’s Variable Annuity/Life Performance Report. “It’s another layer of fees that adds more complexity to the product.”