Mutual fund/insurance hybrid on the horizon

As early as next year, retirees may see a new hybrid investment product that blends mutual funds with insurance guarantees, possibly signifying an alliance between the two industries.

“[Asset managers and insurance companies] are trying to provide guarantees in mutual funds but without the cost and complexity of a traditional variable annuity product,” said Avi Nachmany, director of research at Strategic Insight Mutual Fund Research and Consulting LLC in New York. “It’s a hot topic on the agenda of more than one company.”

The most recent investment-and-insurance hybrid came about last month, when Barclays Global In-vestors of San Francisco released SponsorMatch, an investment option with an annuity component.

The product turns the employer match of a 401(k) plan into an annuity. There are three components: an annuity portfolio to provide an in-come stream, a beta portfolio for market returns and an institutional alpha portfolio.

But now chatter about even more matching strategies is swirling around some big-name insurance providers as they search for another way to tap into the retirement industry. For one thing, it is a way to keep the mutual fund relevant as an investment option for a growing number of retirees.

“I think the prospects of [the industries] coming together are very strong, because when it comes to providing guarantees the public will look to an institution that is known for that,” said Michael J. Gilotti, vice president of new business development at General Re-New England Asset Management Inc. in Farmington, Conn.

Such a vehicle would be a boon to both industries, especially in a qualified plan, he added. Some 33.1 million U.S. households own mutual funds inside a retirement plan, according to the Investment Company Institute of Washington.

That is a large spectrum of clients and cash for the insurance companies to tap into and mutual fund companies will want to protect that retirement money against loss, industry experts said.

Several executives said that their companies are working on such a product, but they declined to reveal the specifics of the structure.

However, executives from an-other company said that they expect to release a product next year.

And executives at another major firm that already works in both the asset management and insurance industries said that it is exploring the option.

All the executives asked that neither they nor their companies be identified for this story.

A possible reason for the vow of silence within the two industries could be the hurdles that the hybrid vehicle would have to overcome in order to hit the market.

“We would have seen many of these products by now if it were easy,” Mr. Nachmany said.

One problem is how the developers will determine how much of the principal is covered by the insurance.

Mr. Gilotti pointed out that there are also questions about the distribution and delivery.

There are many different entities that can sell, but he wondered whether the sales push would come from the money-managing end or the insurance-agent end.

There is also the matter of how the broker or planner would get paid and the impact that would have on the price of the product in terms of whether there is a commission, Mr. Gilotti said.

Other pricing problems include the cost of the benefits, an issue that the mutual fund industry hasn’t adequately addressed, he added.

When the products are unbundled, a tangle of fees attached to each component is revealed.

“You have different asset managers [for the mutual fund] and someone else with the guarantee,” said Bill Lowe, president of ING U.S. Wealth Management in Hartford, Conn., a division of Amsterdam, Netherlands-based ING Groep NV. The total fee the consumer would pay isn’t immediately clear.

Taxation would also be affected in terms of whether the products are taxed like a mutual fund or an insurance product.

“It always looked like guarantees and living benefits would be something that would be easy to approach, pursue and accomplish,” Mr. Gilloti said. “But many people found that when you did pricing outside of the annuity, the cost wasn’t as good as they thought it would be.”

Regulation of this hybrid product is another roadblock. Mutual funds are subject to oversight by the Securities and Exchange Commission and the Financial Industry Regulatory Authority Inc. of New York and Washington.

Insurance products fall under the watch of state commissioners.

“FINRA already has an eye on the insurance industry for equity index annuities,” said Dan Kinney, an independent retirement consultant with Sommers & Danforth Financial LLC of West Des Moines, Iowa. “The regulations will probably be the biggest problem.”

Advisers, hearing that the hybrid product was on the drawing board, were skeptical of how and if they would offer it to their clients.

For Robert J. Kuehl, a certified financial planner and vice president of HC Denison & Co. of Sheboygan, Wis., the new product is reminiscent of the principal-protected mutual fund, which guarantees the principal before fees and invests in a combination of stocks and bonds.

“We try to keep it as simple as possible, but you’re getting layers of complicated transactions and introducing more fees,” he said. “If you want a guarantee, buy a [certificate of deposit]; if you want growth, get a mutual fund.”

Mr. Kinney echoed that sentiment.

“Most agents look for the product’s sizzle,” he said. “I have to do what’s in my client’s best interest, and if the fees are too high — if we’re not getting a return on the expense — I’ll have to say ‘no.’”

Mr. Kinney wondered aloud whether the product is a way for the insurance companies to escape the stigma attached to variable annuities. “They’d love to create a product that walks and talks like a duck but isn’t really a duck,” he said.

But as asset management links with insurance and the hybrid vehicle gets its details worked out, the two industries are stepping into an expanded arena of wary investors and possibly into the cross hairs of regulators.

“There’s a big bet on whether those who go in first will be successful,” Mr. Lowe said. “You’re taking a bet that could cannibalize your business by going outside of what your core engine is designed to do.”

Darla Mercado can be reached at [email protected].