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The mutual fund industry has seen a marked bounce-back in the last few quarters, but despite high hopes, 2003 has turned out to be another year that the annuity industry would prefer to forget. Variable annuity sales are starting to recover and fixed annuities sales finally started to decline because of poor yields, and variable life remains the runt of the litter that implacably suffers from failure to thrive.

This year has been about two words: guarantees and consolidation. They both address the fundamental viability of the business and the "rationalization" of the industry. Maybe the rush in the 1990s to manufacture variable annuities didn't make sense.

As for guarantees, they had the capacity to bring down entire companies -- for those who doubt this, remember Allmerica Financial in Worcester, Mass. In September of 2002, the company stopped selling its variable annuities because of insufficient capital, a problem that directly related to its inability to reinsure or hedge for high-flying guarantees attached to most of its contracts. Now, companies are scrambling for ways to back their guarantees without using reinsurance. However, guarantees also ameliorated the effects of the Job Creation and Worker Assistance Act of 2002.

For years, variable annuities relied upon tax benefits as a selling point. The downturn in the economy naturally shifted that focus onto guarantees, and most carriers discovered that investors cared more about protecting their assets than they did about hiding from the tax man.

Insurance companies don't pay a penny for the tax benefits of annuities, so the shift to provide meaningful and appropriately priced guarantees is, as Martha Stewart would say, a good thing.

As for consolidation, the question has been "when?" not "if?" and now the only problem is that the industry is running out of carriers with deep pockets. This leads a lot of executives to talk about organic growth, but this is still not the best environment to intrepidly push product.

Instead, most observers in the insurance industry see banks as the next likely buyers, as rumors have certainly flown about institutions like Wachovia Securities in Charlotte, N.C., prodding at "next to go" companies like Phoenix Wealth Management in Hartford, Conn. This summer's job-slashing reorganization at Lincoln Financial Group in Philadelphia has been seen by many as a balance sheet cheek-pinching to prep for a potential suitor.

Despite rock-bottom interest rates, investor skittishness continued to drive many towards fixed products. Carriers with variable annuities had already cut the cord on fixed accounts within C-share products, which carry no sales charge or back-end fee, but at the time offered better fixed-rate returns than money market funds. Those with fixed annuities were dropping rates closer to the 1.5% guaranteed minimum rates that many states had adopted. Also, short-term fixed products effectively evaporated from the market.

Perhaps most astonishingly in this situation, regulators were actually able to react in a timely manner. At least, that is something the National Association of Insurance Commissioners in Kansas City, Mo., would like everyone to remember. A new index for use in the model non-forfeiture law that governs minimum annuity rates was approved by the NAIC in a breathless race to a fast finish, and not without its own internal drama.

The NAIC needed to provide tangible evidence that it could effectively reach consensus and react to market conditions. With a congressional panel examining the issue of federalized regulation of insurance, the state commissioners are fighting for their lives.

Copyright 2004 Thomson Media Inc. All Rights Reserved.