External managers dominate and will continue to dominate the variable annuity industry, according to a recently published report by Financial Research Corporation of Boston.

It is the firm's second annual report on the variable annuity industry and it analyzes the use of external investment management in the industry. FRC reviewed 7,234 sub-accounts and found that 4,787 of them are externally managed. This accounts for 66 percent of all sub-accounts.

A major finding of the study was that externally-managed sub-accounts continue to gain a significant share of variable annuity industry assets. Total externally-managed variable annuity assets have reached $307.3 billion or 40 percent of the total market.

The study found that asset and sub-account growth for the variable annuity industry remain strong, at 28.8 percent and 36.6 percent since 1996 respectively. The key driver of this growth, is the rapid increase in the use of external investment managers, the report said. Assets managed externally are growing 45.8 percent annually, with sub-account growth reaching 42 percent.

"The VA industry as a whole has gone through in the last couple of years a very dramatic change," said John Benvenuto, vice president of research with FRC. "They are in a heated product development phase. Instead of building just one product and planning to add a couple of features to it, we've seen them add features such as bonuses and asset allocation services and many other additional things."

One of the biggest areas of product development in the market has been the use of external managers, said Benvenuto. Companies are realizing that big name managers sell, he said.

"Without it, it's tough to sell the product," he said. "So you see more and more assets going toward external managers. You see asset growth much heavier, about 45 percent since 1996 versus internal or non-affiliated manager asset growth of 21 percent. Just in the last three years, growth has been more than double for the external managers."

External managers dominate industry net flows. In 1999, external managers attracted 80 percent of total industry net flows and achieved an external manager record for net flows of $31.5 billion. The study also found that through the first half of 2000, internally managed sub-accounts had net outflows of $2.5 billion while external managers attracted $24 billion. The $24 billion in assets flowing into externally managed sub-accounts this year is about 77 percent of net flows for all variable annuities in 1999, indicating a strong likelihood that external managers will top last year's record.

There are two main aspects of the external managers' appeal, according to the study. One is brand name.

"This is clearly very strong in the VA market," said Benvenuto. "The companies at the top of the list are the ones that everyone knows and loves." Performance, however, is even more important.

Annuity providers are focusing more on top performing funds and managers.

Most of the top selling external managers are well-known mutual fund managers.

Wellington Management of Boston remains at the top of the asset ranking, with $45.5 billion in assets. Janus Capital of Denver is the second largest external manager and has been the overwhelming leader for net flows in recent year. It has $40.5 billion in assets. Fidelity Investments of Boston is third with $35.3 billion in assets.

MFS Investment Management of Boston has risen very quickly and is in fifth place for external assets. It has risen from eleventh in 1997 and its assets have grown 84 percent.

Fidelity leads all others when ranked by number of sub-accounts currently offered with 518. MFS follows with 307, then Janus with 295 and T. Rowe Price of Baltimore, Md. with 247.

"MFS has shot through the roof," said Benvenuto. "The others really haven't changed much. Wellington has been one of the premier distributor of variable annuities through the 90s. Wellington's lead has slipped dramatically but it still maintains first place in market share because of the large gap between it and those that follow. From 1999 till year-end 2000, the gap between Wellington and the next largest competitor shrunk from $9.5 billion to $5 billion. Wellington has still a very strong position in the market overall and is very competitive. Its performance is very good but firms like Janus and MFS are really catching up quick."

One of the trends underscoring the competitive atmosphere in the variable annuity industry is the move toward sub-advisory relationships, said Benvenuto.

"Groups like American Skandia that have actually gone to the SEC to change the structure of the portfolio to make themselves the adviser so they can actually hire their own manager as opposed to using an outside manager," said Benvenuto. This will allow American Skandia of Shelton, Conn., to be more aggressive in hiring and firing. In the past, if a product was under-performing, the provider would have to have a shareholder vote or a full-blown review, said Benvenuto.

"Now what they will have to do is create their own product and hire (an external manager) as a sub-adviser so they can simply choose to replace them and bring in (a) new manager. It's a lot easier. All of that is a sign of the growing competition in the VA market."

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