By Raising Its Voice, AARP Raises Questions

It vocally opposes private accounts. But could its commercial interests create a conflict?

In Washington, an entity's power can be measured by the vehemence of the attacks it draws. By that standard, AARP may be outmuscled only by the White House in the slugfest over restructuring Social Security. The 35 million-member seniors' lobby has put its credibility on the line by opposing Bush's call for individual investment accounts carved out of Social Security payroll taxes.

Its high-profile opposition to those accounts has put AARP in the political bulls-eye. In one far-fetched attempt to drive a wedge between AARP and its members, the conservative group USA Next has posted an Internet ad accusing the organization of endorsing gay marriage while failing to support U.S. troops. Some also see AARP's opposition to diverting Social Security funds to private accounts -- which it criticizes as too risky -- as the height of hypocrisy. Says American Enterprise Institute scholar James K. Glassman: "They are selling mutual funds, which by any conventional standard are far riskier than anything anybody has contemplated" for Social Security.

At the same time, AARP's role in the Social Security debate has focused new attention on the hundreds of millions of dollars the group makes by endorsing and co-branding health insurance, financial products, and travel services that are sold to its members. Some of those products suffer from lackluster performance, particularly the mutual funds it co-brands with Scudder Investments, a unit of Deutsche Bank. As a result, AARP is considering an overhaul of its mutual-fund program, BusinessWeek has learned. Sources say the group may even replace Scudder for some or all of its offerings.

Just as important is the question of whether a group that makes millions selling financial services to its members is quite as impartial a player in the debate over private accounts as it would appear. While wearing its policy hat, AARP, headed by CEO William D. Novelli, presents itself as a nonpartisan organization serving the interests of its over-50 members. And there's little doubt that most do not want to see any change to the current system for fear of benefits cuts.

But it is equally clear that AARP makes a substantial sum of money from its partners' sales of mutual funds and other investment products to members. That raises the appearance of a potential conflict of interest. Whatever version of reform passes -- whether Bush's accounts carved out from payroll taxes, or the "add-on" accounts that many liberals favor to encourage retirement savings -- the overhaul is likely to create new markets and opportunities for some suppliers of financial products and lead to diminished opportunities for others. AARP has a stake in that debate. Unlike financial firms, however, AARP has the flexibility to drop waning products and team up with other partners on any new alternatives that emerge.


AARP officials reject the criticisms. The organization's marketing "does not in any way influence AARP's public policy positions," says Dawn M. Sweeney, president of AARP Services Inc., the for-profit subsidiary that manages AARP's co-branding deals. And, Sweeney adds, while AARP objects to diverting payroll taxes to the stock market, it supports private investing outside of Social Security. "AARP is not opposed to private accounts," says Sweeney. "We are opposed to private accounts that drain money out of Social Security." AARP also says it pours all of its commercial profits back into advocacy and assistance for the elderly, providing member services such as driver's education and free legal and tax advice.

Still, the scale of AARP's commercial activities is enormous. The nonprofit is one of the nation's most aggressive in selling its name to marketers of financial and travel products. In 2003, the latest year for which financial reports are available, AARP collected $300 million -- or 39% of its $770 million in revenue -- by co-branding with companies such as Scudder (DB ), UnitedHealth Group (UNH ), and New York Life. AARP hauls in $142 million in fees from the sale of Medicare supplemental insurance, almost $76 million from the sale of auto and home insurance, and almost $12 million from life insurance, followed by about $7 million in mutual-fund fees.

This isn't the first issue in which questions have arisen over whether AARP's commercial interests may conflict with those of its members. In 2003 it backed Bush's controversial plan to remake Medicare. Liberals claimed AARP's support was driven more by its interest in selling Medicare insurance than by the interests of its members. AARP strongly denied the allegations.

If critics have focused on its policy role, AARP has received less scrutiny for the quality of its products. Many of the funds and insurance policies that AARP markets provide considerably less benefit than seniors could get on their own, a BusinessWeek analysis reveals. Some of its insurance products charge high premiums compared with those of rivals. And many of the 38 funds Scudder markets through AARP offer average performance at best. Over both the last year and the last three years, only one Scudder-AARP fund delivered returns ranked in the top 20% of its asset class, according to mutual-fund researcher Lipper Inc. Similar conclusions were reached by two other independent firms that rate mutual funds, Morningstar Inc. and Standard & Poor's, a unit of The McGraw-Hill Companies (MHP ), which also owns BusinessWeek.

The Scudder-AARP Standard & Poor's 500-stock index fund is typical, rated three stars by Morningstar and S&P. Relative to similar funds, "the fund has both fairly average returns and fairly average risk," says Morningstar. The fund's fee structure is also middle-of-the-road, with an expense ratio of about 0.4% -- twice that of rivals such as Vanguard Group Inc., which charges 0.18% for its S&P 500 index fund, but well below the 1.16% average for all similar funds.

Morningstar warns investors to avoid all Scudder funds, largely because of what it believes are unresolved issues around rapid trading of some of its global fund shares. (Morningstar notes that Deutsche Asset Management stopped the practice in 2003.) Deutsche Asset Management responded in a statement: "While we respect Morningstar, we disagree with their opinion in this instance."

The funds do have some advantages tailored to AARP's constituents, many of whom have limited assets. For instance, taxable accounts can be started with an initial investment of just $1,000, with minimum additional investments of $50, far below many funds. Still, sources say mediocre returns have AARP reconsidering its relationship with Scudder. AARP has asked an independent panel to review the funds. Sweeney will not comment on specifics. "We are constantly reassessing and looking at the competitive landscape," she says.

A much bigger source of AARP revenue is insurance. The group's supplemental Medicare "Medigap" insurance brought in $142 million -- nearly half of the total royalties Medicare received in 2003 for the use of its name and membership list. Those policies are widely regarded as good values. But many of AARP's other insurance products fall short of the industry's best. For example, the life policy that AARP co-brands with New York Life Insurance Co. provides a maximum $50,000 in coverage. The monthly premium for a 10-year term policy for a 54-year-old nonsmoking male who lives in Maryland is $49.52. Similar policies are available for less. AARP says its policies are designed for low-income people who have trouble buying life insurance. The New York Life policy has lower underwriting standards than most, making the policy easier to purchase but also a higher risk for the insurer -- thus, more costly.

AARP's Sweeney says the group is looking to extend its brand further by allowing outside partners to sell new services to members. But if AARP is going to avoid criticism, it will have to work harder to provide them with the best value for their money.

By Howard Gleckman and Mike McNamee in Washington and David Henry in New York

Before it's here, it's on the Bloomberg Terminal.