The biggest selling variable annuity sub-accounts still don't cut the mustard when measured against a simple, low-cost index fund alternative.

Yes, I finally got around to doing it again.

The last time I reported on the performance of variable annuity sub-accounts was in early 1999. Now, after two years in which the S&P 500 Index under performed the average managed fund, you might think variable annuities would do better.

But they don't. Over-marketed, commission rich variable annuity investments still did poorly. If you had simply put your money in the Vanguard 500 Index fund you'd have more money in the index fund than in all but three or four variable annuity offerings. This applied whether the measuring period was 5, 10, or 15 years.

Even with complete tax deferral.

Even with expert fund management.

Even with skilled advice from a sales consultant

To learn this, I used the Morningstar Principia Pro database to find the largest variable annuity sub-accounts with 15-year histories. I learned that there were only 22 VA funds with assets of at least $500 million under management and 15 year track records. Then I checked their annualized rates of return over the 5, 10, and 15 year periods ending April 30, 2001. In this group, 17 were pure equity funds, 4 were balanced funds, and one was a bond fund.

What did I learn?

Just as regular mutual funds have big differences in performance, so do the variable annuity sub-account funds. Over the last 15 years the best VA sub-account (Anchor Pathway Growth, assets $837 million) brought in an annualized return of 17.11 percent. The worst (IDS Flexible Annuity AXP Bond fund, assets $1,053 million) came in at 6.75 percent. Over the last 5 years the spread was even greater. The top VA sub account (Anchor Pathway Growth again) returned a whopping 20.43 percent annually while the worst (Equitable Equi Vest S200-100 Aggressive Stock fund, assets $1,656 million) actually lost money with a minus 0.04 percent annual return.

The second part of the exercise is to invest the same amount, over the same periods, in the Vanguard 500 Index fund and see how it would have performed after paying taxes each year. The assumed tax rate was 31 percent for dividends and 28 percent for capital gains. (Yes, I know the current rate is only 20 percent but during a large part of the period it was 28 percent.)

How did the humble index fund do?

Quite well. In each time period it placed 4th for absolute accumulation. That means it beat 86 percent of the most popular VA funds. If we eliminate the 4 balanced funds and the lone bond fund, the simple equity index still beats 14 of 17 or 82 percent of the variable annuity equity funds. (Measured against the entire universe of VA equity sub accounts, regardless of asset size, the index fund does even better.)

More important, this ranking understates the true position of the taxable index fund because the accumulations in the variable annuity accounts are taxable at 31 percent. The accumulation in the index fund is all capital gains, taxable at 20 percent. When the after-tax money is measured, the index fund gains a position in each period, placing third.

Whether we are measuring 5, 10, or 15-year periods, the low cost alternative beats 20 of the 22 largest variable annuity offerings--- all funds investors were presumably led to by the superior insight and fortune telling ability of a variable annuity salesman. The table below shows the results for the last 15 years. The complete results will be posted on my website.

Is this entire exercise based on the superiority of a single fund? Absolutely not. There are now 68 mutual funds with expense ratios under  ½ of 1 percent that duplicate the performance of large capitalization stocks. In addition, you can buy an exchange-traded fund (ETF) that will do the same thing.

Just don't expect to hear about the alternatives from a variable annuity salesman.

Index Fund Versus Major Variable Annuity Funds

Sub account Name Morningstar Category Tot Ret Annlzd 15Yr Total Exp Subacct Net Assets $MM
Anchor Pathway II Growth Large Growth

17.11

1.84

$837.44

NE Zenith Accum Cap Growth Large Blend

15.95

2.01

$634.41

Lincoln Director Lrg Cap Eq(23) Large Growth

15.84

1.12

$553.10

Vanguard 500 Index fund Large Blend

13.26

0.18

NA

Equit Equi-Vst-S100-200 Common Large Blend

13.25

1.84

$5,341.48

TIAA-CREF Stock Large Blend

13.03

0.31

$130,710.23

Lincoln Director Core Eq (11) Large Blend

12.85

1.12

$565.05

Anchor Pathway II Growth-Income Large Value

12.48

1.84

$753.04

Penn Mutl Divsfr 2 Flex Managed Domestic Hybrid

12.39

2.08

$537.69

Travelers UA/Fund U Cap App Large Growth

12.23

2.08

$1,049.43

Lincoln Multi-Fn VA Lin Grw&Inc Large Blend

11.97

1.36

$3,531.23

Travelers UA/Trvlrs G&I Stock Large Blend

11.68

3.10

$849.05

Man Vent VA ManInTr MidCap Blnd Mid-Cap Blend

11.48

2.28

$1,207.02

Hartford DCPlus-Q Advisers Domestic Hybrid

10.72

1.56

$558.10

Lincoln Multi-Fn VA SpecialOppr Mid-Cap Value

10.67

1.49

$505.74

Security Variflex Equity Large Blend

10.62

2.03

$808.11

IDS Flexible Annty AXP Cap Res Large Blend

10.51

1.77

$3,217.47

Equit Equi-Vst-S100-200 Aggr St Mid-Cap Blend

10.44

1.91

$1,656.20

Best of Amer IV/Nwde Tot Return Large Value

9.87

2.02

$503.78

Security Variflex Lg Cap Value Large Value

9.74

2.03

$606.60

Lincoln Multi-Fn VA Lin Managed Domestic Hybrid

9.16

1.44

$752.74

Equit Equi-Vst-S100-200 Bal Domestic Hybrid

8.50

1.94

$1,050.20

IDS Flexible Annty AXP BOND Long-Term Bond

6.75

1.79

$1,053.04

Source: Morningstar Principia Pro, April 30 data