New sales of variable annuities continued their decline in the 4th quarter of 2008, falling to $32.6 billion from 3rd quarter sales of $37.0 billion, an 11.9% drop. More alarming is the 30.2% drop from the $46.7 billion reached in the 4th quarter of 2007.

On a full-year basis, sales were down 15.3% in 2008, dropping from 2007 full-year new sales of $178.8 billion to finish the year at $151.5 billion, slightly above our third quarter forecast of $151 billion.

Assets under management (AUM) saw another precipitous drop, falling to $1,123.6 billion from September AUM of $1,295.3 billion and December 2007 AUM of $1,497.3 billion, or a 13.3% drop for the quarter and a nearly 25% year over year reduction.

Absent a recovery of the additional 22% loss in the S&P 500 since 12/31/08 (or further losses) we expect total industry assets to finish the first quarter right around the $1 trillion level, in other words dropping to 2003/early 2004 asset levels.

Not surprisingly, given the sharp drop in retail product sales in the latter half of the year, TIAA-CREF led the sales rankings for 2008, followed by MetLife, AXA Equitable, ING Group and Lincoln National. Together these top 5 companies accounted for 43% of VA sales in 2008. Prudential, John Hancock, AIG Sunamerica, Hartford, and Pacific Life were the next 5 in the rankings, respectively, with a combined 29% market share.

The top selling non-group product in 2008 was ING GoldenSelect Landmark, an L-share product with $4.09 billion in sales. While not the top selling product in any one distribution channel, it sold well in the bank channel and was ranked 2nd and 4th, respectively, in the independent and wirehouse channels.

John Hancock Venture III, also an L-share VA, ranked second in total new sales at $4.07 billion. Venture III was actually the leading product sold in the wirehouse channel in 2008 with 7.2% of sales, but its 5th place ranking in the independent channel allowed the Landmark product to edge it out of the overall number one spot.

Leaders in other channels were as follows:

–Pacific Life’s Pacific Voyages dominated the bank channel with a 5.6% market share.

–Jackson National’s Perspective II took the top position in the independent channel with a 4.7% share.

–Polaris II A-Class Platinum led the regional channel with a 7% share.

–Riversource RAVA4 Advantage was the top selling non-group product in the captive agency channel, capturing 8%.

From time to time I am asked for VA sales projections for periods as far out as 10 years. I have long believed that any projection of industry VA sales beyond the current year is inherently flawed and that any resemblance between such projections and actual sales data is purely coincidental. That said, I think it is conceivable to at least postulate a brighter picture for variable annuity sales in 2010 than we observe today, assuming some level of stabilization and signs of positive returns in equity markets.

Non-qualified VA sales have slowly lost ground to qualified sales as qualified sales reached a new high, comprising over 67% of total sales in the 4th quarter of 2008; in the 4th quarter of 2006 the percentage of sales attributed to qualified plans was about 59%.

This trend may reverse as advisors discuss two important topics with their (relatively) affluent clients this year: investment risk and taxation. Protecting against the former when positioning assets to participate in market gains when they do happen–and they will happen–while mitigating the potential reversion to a pre-1997 tax structure is a job neatly suited to the variable annuity; it is hard to imagine we won’t see some momentum in sales building from the confluence of these factors.

While our expectation for 2009 is for VA sales in the $130 billion range, to paraphrase Warren Buffet the “best days may lie ahead” for variable annuities.

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