New variable annuity sales rose 2.6% in the fourth quarter of 2009, to $31.4 billion from $30.6 billion in the 3rd quarter, but were down 3.8% from 4th quarter 2009 sales of $32.7 billion.

The year-over-year numbers, which of course encompass the early, pre-financial crisis months of 2008, show an almost 19% drop in new sales, from $151.6 billion in 2008 to a total of $123.1 billion in 2009. This is the lowest annual VA sales number since 2002, when sales reached $112.4 billion after bottoming out at just over $107 billion in 2001.

The asset picture was brighter, however, with total assets of $1,353.8 billion at the end of 2009, an almost 20% increase over year-end 2008 assets of $1,129.4 billion, driven primarily by improved equities markets.

Net flow of $17 billion for 2009 ($2.9 billion in the 4th quarter) was down 26.4% from 2008 net flow of $23.1 billion. This is low to be sure, but still in positive territory and there has yet to be a year, or even a quarter, where we have found the industry as a whole to be in net redemption.

A few of the top companies posted impressive year-over-year sales gains. Prudential, the industry leader with $16.1 billion in new sales and a 13.1% market share, saw a 58% rise in sales from 2008 total new sales of $10.2 billion. MetLife, in the number 2 spot, increased sales by 10%, to $15.4 billion from $14 billion in 2008, to end 2009 with a 12.5% share of the VA market. Jackson National was another big gainer in 2009, with new sales jumping from $6.5 billion to $10 billion, a 54.7% gain to end the year with market share of 8.1%.

For the rest of the top 10 the news was decidedly more negative–from ING plummeting 63% to AXA and John Hancock each ending 2009 with a 45% drop, 2009 saw marked reductions in sales and market shares across the board.

To some extent, however, comparisons to prior years are difficult to use as a measure of consumer interest in the product, as a key “normal” dynamic has fundamentally shifted. It is commonly held, though seldom and incompletely measured, that exchanges between VAs represent a significant percentage of sales in any given quarter. This is held true through both bull and bear markets (though bull markets certainly magnify the effect) largely because for the past decade or more each succeeding generation of benefits has been richer than the last: death benefits gave way to income benefits, which were largely trumped by return of principal withdrawal benefits, which in turn were eclipsed by lifetime withdrawal benefits (GLWBs), and ultimately GLWBs with step-ups, roll-ups, deferred withdrawal credits, and more aggressive permitted portfolio allocations.

In other words, investors were incentivized to trade in the old models. In late 2008 and 2009, however, de-risking led the industry in the opposite direction, leaving investors better off in their existing products. Locked-in high watermark benefit values and richer benefit provisions are powerful incentives to remain in an existing product, choking off the flow of sales driven by exchanges and dropping overall sales as a result.

The top selling product in 2009 was Jackson National’s Perspective II with $5.3 billion in sales, followed by Prudential’s APEX II with $4.6 billion in sales. Interestingly, a feature common to the lifetime withdrawal benefits available in these products is freedom in portfolio allocation when electing Prudential HD Lifetime 6 (requires 20% allocation to bond portfolios); and JNL Lifeguard Freedom and JNL Lifeguard Select (unrestricted) along with non-discretionary proprietary formulas that can systematically transfer cash from higher risk separate account investment options to a bond portfolio or fixed account based on the relationship between the benefit liability and the contract value (HD Lifetime 6 and JNL Lifeguard Select).

Judging by sales, investment flexibility is important to advisors and investors using VA products with lifetime withdrawal guarantees, as sales of these two products combined with the sales of the alternate product chassis JNL Perspective L and Prudential Xtra Credit accounted for over 15% of total retail (non-group) VA sales in 2009.

The crystal ball for 2010 VA sales is cloudy indeed. January estimates came in slightly higher than in January 2009, so the year is starting out on a positive note. Investor awareness of, and appetite for, products with guarantees continues to increase–a positive for an industry that has historically faced perception problems.

But as much as such things as awareness, positive press, and academic embrace are good things for the industry, they are unlikely to have significant influence this year given the degree of uncertainty around the future of the economy, financial markets and tax law. Variable annuities are, or at least are supposed to be, long-term investment vehicles, and uncertainty is not the friend of long-term decision-making.

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

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