Annuity writers are pulled into mutual fund investigation.

The U.S. Securities and Exchange Commission and New York Attorney General Eliot Spitzer have broadened their investigations into mutual-fund improprieties to include variable annuities.

Several large insurers have received a letter from the SEC requesting information from them, said Michael DeGeorge, general counsel with the National Association for Variable Annuities. According to published reports, Hartford Financial Services Group Inc., Lincoln National Corp. and others have also received subpoenas from Spitzer. The SEC letter is asking about procedures and policies that variable-annuity writers have in place and how their policies address the types of trading practices under scrutiny. "The SEC is gathering information, and I'm not surprised," he said. "It's a natural path for the investigation to take. It wants to look at purchases, redemptions and transfers."

Spitzer on Sept. 3 announced the first results of his probe of the investment industry, when he filed a lawsuit against mutual fund providers Janus International Holding LLC, Strong Capital Management Inc., Bank of America and Bank One for practices allowing institutional investors to make money at the expense of funds' individual shareholders. Funds can improperly help these large investors by allowing them to engage in after-hours trading or market timing/frequent trading, or by providing certain parties with special trading privileges.

Nothing in the law prohibits institutional investors such as hedge funds from buying variable annuities, but they aren't very likely to view them as practical investments, according to DeGeorge. That's because an institutional buyer would be considered a non-natural person and would not receive the benefit of tax deferral--but would still pay the mortality-and-expense fees and other charges that nearly always are greater than a mutual fund's expenses. Any gain in a variable annuity would be currently taxable, and the product would be less liquid than a mutual fund because of the surrender fees, he said.

UBS equity analyst Andrew Kligerman offered more reasons market timing is "probably not substantial" in variable annuities. One is the limited number of international funds. In a Nov. 3 report, he cited evidence from the Variable Annuity Research and Data Service that international stock funds comprised only 4.4% of some $880 billion in industry assets in the second quarter of this year, while international bond funds comprised only 0.3%. Comparable percentages were much higher among mutual fund assets, he said.