New sales of variable annuities fell 10% in the 3rd quarter, to $37 billion from $41.1 billion in the second quarter of 2008. On a year-to-date basis, sales were also off 10%, dropping to $119 billion from 2007 3rd quarter year-to-date sales of $132.1 billion.

Fourth quarter sales are likely to be lower still. VA sales have been trending downward since May, and if the slide continues 4th quarter sales may fall to $30 billion. The last time variable annuity industry sales were below the $30 billion mark was 6 years ago, in the 3rd quarter of 2002. This would mean closing 2008 with total new VA sales under $150 billion, lower than 2006 total new sales of $154.9 billion.

MetLife took the top spot in the sales rankings in the third quarter with a 10.2% share of the market. TIAA-CREF followed closely with 9.8% of total new variable annuity sales, and AXA Financial/MONY was 3rd in the rankings with an 8.6% market share. ING fell to fourth with an 8% share of the market, and Lincoln National held at fifth place with 7.5% of 3rd quarter variable annuity sales.

The number one and number two non-group products in terms of sales in the 3rd quarter were ING GoldenSelect Landmark and AXA Equitable Accumulator Elite 2007, both L-share products distributed through all third-party channels, with the strongest sales through independent financial planners and wirehouse firms. Landmark ranked 2nd in the independent channel and 4th in the wirehouse channel, while Accumulator Elite 2007 was in the number two spot in wirehouses while ranking 12th in independent planner sales.

The top 5 products in the wirehouse channel and the 2nd, 3rd, and 4th ranked products in the independent planner channel were L shares; the top ranked products in the independent planner channel, Jackson National Perspective II, offers an optional bonus feature as well as a buy down to a 5-year surrender charge.

Assets under management also dropped significantly, falling to $1,295.3 billion from $1,497.2 billion at the end of 2007. Assets dropped across all companies and ranged from a nearly 30% decline in Hartford Life’s VA assets to a modest 6% decrease in assets held in TIAA-CREF variable annuities.

The change in VA assets under management is a function of both the returns of the underlying investments and net cash inflow or outflow, but the majority of the impact in the past few months has of course been due to negative returns. With the S&P 500 down approximately 21% for the year as of 9/30/08, and down another 26% since that time for a whopping 41%+ drop as of this writing near year-end, it is quite likely that total industry variable annuity assets under management will finish the year below the $1 trillion mark, a level not seen since the 4th quarter of 2003.

The modern variable annuity industry has never traversed a market and economic environment like this one. Not only is the industry faced with devastating losses in virtually every asset class, the volatility of returns is in uncharted territory as well. With volatility increasing the cost of options and ever greater numbers of VA investors with “in the money” guarantees, the future looks challenging.

The cost of living benefits will increase and the value of the guarantees will decrease (for example, lower roll-up and withdrawal rates and/or tighter restrictions on asset allocation), but if there is a silver lining it is the opportunity to put renewed vigor into raising investor awareness of the valuable role variable annuities can play in protecting wealth.

Nobody can predict when the market will recover or whether or not this will be a “lost decade” (though that doesn’t seem to stop pundits from doing just that), but it is hard to imagine a better time for an advisor to discuss investment strategies that might have been objected too out of hand a few months ago.

When market recoveries happen they tend to happen quickly, and investors on the sidelines all too often miss out entirely, or worse, get back in at a market peak and accomplish nothing more than providing liquidity to others. The year 2009 will be an interesting one for the variable annuity; this may prove to be the year that the product finally resonates with large numbers of investors and becomes a “mainstream” financial product in terms of the way it is thought of, sold, and written about in the popular press.

Frank O’Connor is product manager, VARDS, at Morningstar, Inc. He can be reached via email at frank.oconnor@morningstar.com.