In the 1st quarter of 2006, new sales of variable annuities at $37.6 billion fell just short of their all-time high.

The 1st quarter total was a 9% increase over 4th quarter 2005 new sales of $34.5 billion and just shy of the previous high water mark of $38 billion reached in the 1st quarter of 2000, just prior to what we now know was the beginning of the bear market.

Mutual fund flows reached a new high in the 1st quarter as well, with $116.5 billion in net new cash flow, $93 billion of which went to stock mutual funds, according to Investment Company Institute statistics. There has always been a high correlation between equity market returns and flows into (and out of) stock mutual funds and variable annuity products, and 1st quarter sales data certainly reflects this.

The hope is that the industry is also seeing the beginning of the influence of variable annuity sales to the largest generation of retirees in history, but it is worth noting that record mutual fund and variable annuity flows and an inverted yield curve have all occurred recently, and all are infrequent events that were last observed in early 2000, just prior to the start of a multiyear bear market.

The question is whether hindsight will identify the significant increase in variable annuity sales in the 1st quarter as the beginning of the boomer-driven boost the financial services industry has been awaiting, or the all too often observed increase in inflows at a market high point followed by a period of declining returns.

Variable annuity sales increased quarter over quarter in all channels except regional. Bank sales of VAs increased 12.8%, from $4.5 billion to $5.1 billion. Wirehouse sales were up 27.1%, to $4.6 billion from $3.6 billion. The regional broker/dealers saw the only decrease in overall sales, dropping from $3.4 billion to $3.1 billion, a 9.3% decline. In the independent financial planner channel, sales increased 12.7% to $12.1 billion, a $1.4 billion increase and the largest increase in dollar terms. Captive agency sales posted a modest 2.5% improvement, from $12 billion to $12.3 billion. Finally, the direct response channel posted the largest percentage increase, rising 29.1% to $526 million from $407 million.

Net flows finally posted an increase in the 1st quarter, reaching $7 billion, after a full year of quarterly net cash flow in the $4 billion to $5 billion range. This represents a 21% increase over 4th quarter net flow of $5.8 billion, and a 46.8% increase over 1st quarter 2005 net flows of $4.8 billion. While not a tremendous increase in dollar terms, it is nevertheless possibly indicative of at least some new money flowing into VA products, although a decrease in surrenders may also be a contributing factor.

Assets under management continued their rise owing to positive equity market returns, reaching a total of $1.26 trillion, a 4.5% increase over 2005 year-end assets of $1.21 trillion, with all top sellers seeing increases.

While the rising tide lifted most boats in the 1st quarter, a few Top 25 companies stood out. Fidelity’s VA sales increased a whopping 149% over the 4th quarter. Security Benefit was up 64%; Pacific Life VA sales increased 62.6%; John Hancock sales posted a 61% increase over 4th quarter; and Genworth was up 53%. Several other Top 25 companies saw quarter over quarter sales increases of over 30%, including RiverSource Annuities (52%), Jackson National (52%), Prudential/American Skandia (47%), Ohio National (37%), and AXA Financial (35%).

Looking for a common thread among the best-selling products of these top performing firms is a bit of a challenge. The VAs with the largest increases in sales from all save Fidelity offer Guaranteed Minimum Withdrawal Benefit (GMWB) features, but then most of the top variable annuity manufacturers include a GMWB option on their products.

Aside from that commonality, the products with the highest sales momentum are as varied as the industry: the basic, low fee, no guarantee structure of Fidelity’s Personal Retirement Annuity; relatively high fee and surrender charge, guarantee and premium bonus laden products such as Retirement Advisor Advantage Plus from RiverSource, Xtra Credit 6 from Prudential/American Skandia; a standard B-share with GMWB for Life, Genworth’s RetireReady Choice; and the middle ground of the L-share products, such as Pacific Life’s Innovations Select, John Hancock’s Venture III and AXA Equitable’s Accumulator Elite 2004, all also offering GMWB. The availability of asset allocation Lifestyle or Life Cycle subaccounts is likely influencing sales as well, but it does appear, at least among the top issuers, that there is not yet any obvious polarization–low cost variable annuities, higher cost products packed with guarantees, and L-share products with lower surrender charges than the traditional B-share products are all finding their markets.

Should another bear market be on the horizon, the value to the consumer and risk to the insurer of the innovations in guarantees, particularly living benefits, developed over the past few years will be tested, and the long-term result may be to finally give the industry solid direction in the battle between simple and low cost vs. expensive and complex.