New sales of variable annuities reached $34 billion in the fourth quarter of 2005, a 2% increase over third quarter sales of $33.3 billion. The increase helped push total new sales to $131.7 billion, just above the high-end estimate of $131.6 billion in the December sales report and approximately 2.5% higher than 2004 new sales of $128.5 billion.

Aggregate assets under management in variable annuities also reached a new high thanks to positive market returns in the fourth quarter, totaling just over $1.2 trillion as of Dec. 31, 2005, a new high for the industry.

While sales and asset totals reach new highs, however, net flows continue to disappoint. Net flow based on survey results from more than 70% of the industry totaled just $5.8 billion in the fourth quarter of 2005, with 2005 total net cash flow ending up at $18.9 billion, less than half the $40.2 billion in positive net cash flow in 2004.

Among Top 25 companies, the leaders in year-over-year market share gain were John Hancock, 4.6% to 6%; Prudential/American Skandia, 4.5% to 5.4%; Ameriprise Financial, 3.4% to 4.6%; Jackson National, 2.8% to 3.6%; and Ohio National, 0.5% to 0.7%.

Outside of 403(b), the leaders in each distribution channel in 2005 were Hartford Life in the bank channel with a 25.8% share; MetLife in wirehouse sales with 17.0%; Lincoln National in the regional channel with 20.4%; Prudential/American Skandia with 11.4% of independent financial planner sales; and Ameriprise in the captive agency channel with a share of 12.2%.

There was very little year-over-year change in industry sales across distribution channels. The independent planner channel had 31% of sales in both years. Wirehouse and regional both ended up with a 10% share of industry sales in 2005, with wirehouse dropping from 11% and regional increasing from 9%. The bank channel’s share of sales dropped from 14% to 13%, while captive agency increased to 35% from 34%. Direct sales held steady at 1% of total industry sales.

Share class sales breakdowns displayed a bit more movement. L-share sales increased to 18.8% of total sales in 2005 from 16.4% in 2004, while C-share sales continued to fall, down to 3.5% of total sales in 2005 from 4.3% in 2004. Sales of B-share products without bonus options fell to 27% from 30.8%, while sales of VA products with included or optional bonus features fell to 25.9% from 27%.

Living benefits, particularly the Guaranteed Minimum Withdrawal Benefit (GMWB), continued to proliferate in 2005: The GMWB was available as an optional benefit in approximately 75% of variable annuity sales in 2005; the Guaranteed Minimum Income Benefit (GMIB) in approximately 46% of sales; and a Guaranteed Minimum Accumulation Benefit (GMAB) in 37% of sales (all estimates exclude 403(b) sales). In all, less than 20% of retail VA sales were in products not offering any type of living benefit.

Among Top 25 companies, the biggest year-over-year gains in assets under management were recorded for Jackson National, a 31.8% increase to $18.2 billion; Allianz Life, 26.7% to $17.2 billion; AXA Financial, 16.7% to $66.4 billion; Pacific Life, 16.4% to $35.9 billion; and John Hancock with a 16.2% gain to $38.8 billion.

Positive equity market returns helped drive variable annuity assets to new highs. The average return of 22,478 U.S. stock subaccounts, which collectively held just over 50% of total assets as of Dec. 31, 2005, was 6.2% in 2005. Allocation subaccounts, the second largest broad asset category at 8.8% of assets as of Dec. 31, 2005, saw an average return of 3.5% across 2,282 subaccounts, and international stock subaccounts, numbering 4,120 and holding 7.4% of variable annuity assets as of Dec. 31, 2005, had an average 2005 return of 15%.

Although 2005 saw a 7% increase in total assets under management, stagnation in sales growth and lower net cash flow remain nagging problems for the industry. It is natural to postulate immediately that a reduction in net cash flow must be the result of a drop in new dollars being attracted to variable annuities. While this certainly may be the case, there are also other factors contributing to the continued decline, such as increased withdrawals from variable annuities in qualified plans due to rollovers, particularly 403(b) and 401(k), and an increase in the dollar amounts of 1035 exchanges, due to account balances boosted by overall positive returns over the past few years.

The 1035 exchange issue is something of a double whammy from a statistical standpoint: Larger balances in 1035 exchanges fuel higher industry sales, while larger withdrawals reduce net cash flow, resulting in a smaller ratio of net cash flow to total sales.

As we start to move solidly into the baby boomer retirement years, the challenge for the variable annuity industry is to attract as much capital to VA-based retirement solutions as is lost when those who have accumulated assets in variable annuities for years seek out alternatives for their nest eggs.