Building a better mousetrap: product enhancements, including guaranteed benefits or rates, and education about immediate annuities point to increased sales.

Manufacturing products is the area over which the life insurance industry has the most control, and while the bear market that ended a year ago crimped profits, the variety of products in the industry's portfolio helped it survive.

In the bull market of the late 1990s, insurance buyers flocked to variable products, especially variable annuities and variable universal life insurance. According to Limra International, first-year premiums for VUL and its cousin, variable life, grew to more than $4 billion in 2000 from less than $1.5 billion in 1995, before tumbling to less than $3 billion in 2002 and continuing to drop in the first nine months of 2003. As variable-life sales fell, sales of less-risky universal life rose sharply to nearly $3.5 billion in 2002 from about $2 billion in 2000. Whole life, which had fallen out of favor in preceding years, and term life also recently registered gains.

Annuities generate far greater first-year premiums than life insurance does. Data published by the National Association for Variable Annuities show that total variable-annuity sales peaked at $137 billion before receding to $113 billion in 2001 and $113.8 billion in 2002. However, all but about $30 billion in each of those years was money that moved from existing annuities to new ones.

As the stock markets fell, fixed annuities in 2002 enjoyed their best sales year ever: $103.8 billion, up from only $32 billion in 1998. Fixed sales declined last year but still were the second-best ever, said John Fenton, a principal in the life insurance practice at Tillinghast Towers-Perrin. The fixed investment option helped keep sales up in variable annuities, with 34% of first-year premiums going into that kind of option, he added. NAVA reported that nearly 30% of money in variable annuities in 2002 was in fixed-account options, a record high.

The trouble for the industry was that the economy hurt the profitability of its products. Earnings on variable annuities are based on assets under management, and they fell from a high of $974 billion in 1999 to $796 billion in 2002, according to NAVA. Earnings on fixed annuities and fixed accounts in VAs are based on the difference between what insurers pay to customers vs. what they can earn with the invested money. That difference narrowed as interest rates fell and insurers couldn't reduce rates they paid to policyholders below guaranteed minimums, usually 3%. Insurers addressed that problem by getting state approvals to lower the minimums in new products.

So while the past two or three years have been difficult for insurers, their diversified lineups of products have helped them to survive and to provide the kind of financial protection their customers sought. "Customers got some margin of safety out of life products, and those that hung in with variable products are starting to see those balances come back," said Fred Donner, partner and insurance sector leader with KPMG LLP The bear market also provided the buying public and distributors with lessons about managing risk and the value that life products can provide, noted Eric Sondergeld, corporate vice president and head of Limra's Retirement Research Center. And thanks to the excellent rebound in stocks last year--"nothing to shake a stick at," noted Sondergeld--VA profits have improved.

The industry's problems in distribution, legislation and regulation, however, have had a negative impact on sales for many years. For example, the number of life insurance policies sold annually had declined steadily for almost 20 years, from about 18 million to about 10 million, until an uptick in early 2002 after the Sept. 11, 2001, terrorist attacks. But Elaine Tumicki, a corporate vice president heading Limra's Product Research Center, said sales fell in 2003. Face amounts mostly had risen during the past two decades before falling in 2001, jumping in 2002, then falling again last year. Annualized premiums for individual life mostly had stayed near $10 billion for more than a dozen years until the late 1990s, but Limra forecasts only minimal growth for the next several years from the more recent level of about $12 billion. These statistics indicate that as agents and brokers focused on affluent customers, they sold fewer but larger policies and that insurers lowered their prices to compete for business.

Legislation and regulation, meanwhile, have hurt in specific ways. Sales of term life had grown rapidly from 1995 to 2000, when state regulators began requiring higher reserves, causing alteration of the product and a slump in sales in 2001.A 2001 law reducing the estate-tax burden on wealthy Americans badly hurt the survivorship life business. Annualized premium had grown by around 10% in 1996, 1997 and 2000, and about 24% in 1999. But when Congress began to increase the size of exemptions, lowered estate-tax rates and planned to actually eliminate the tax for the year 2010--albeit for that single year--premium plunged by some 25% in 2001, 11% in 2002 and another 5% or so through Sept. 30, 2003. New regulations by the Internal Revenue Service similarly cast a big chill on sales of corporate-owned and bank-owned life insurance and on split-dollar plans. Tumicki said she doubts that COLI/BOLI has been killed, since regulators' focus has been on products written more than 10 years ago, not those sold in the past 10 years.

Statistics Shed Light

The economy, sales practices and legislation influence the sales of individual products.

Variable product sales grew during the bullish late '90s, but as prices fell, universal life sales grew ...

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A 2001 law reduced the estate-tax and weakened sales of survivorship life products ...

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Fewer policies are being sold but with greater face amounts, showing producers are focused on the affluent.

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Products

Trends

Cyclical rotation of demand for products, with buyers currently favoring protection over accumulation. Traditional products lead the way in life insurance, while guaranteed benefits help drive variable-annuity sales. Low interest rates remain a major stress on insurer profitability.

The Up Side

Booming stock market lifts variable annuity sales and increases fees from assets under management, improves product profitability. Buyers and producers rediscover the value of protection. Products on shelf allow insurers to adapt quickly to demand. Equity index annuities prove their worth; sales grow rapidly.

The Down Side

Sales of variable life products continue to drop, may have suffered lasting damage in eyes of producers. Survivorship life products continue sales decline. Split dollar, corporate-owned and bank-owned life insurance products hurt by IRS rulings. Variable-annuity net sales remain in 30% range. Future of long-term-care and critical-illness insurance remains questionable. Payout annuities are still a product of the future.

The Way Forward

Industry must find way to convince financial advisers to use payout annuities in retirement planning. Growth in individual products depends on renewing neglected ties with middle class.