Variable annuities bounce back in time for boomers' retirement.

Variable annuities rode out the impact of poor equity performance in recent years, returning to profitability in 2003, just as the baby boomers started reaching retirement age.

Preliminary data in the study "Variable Annuities: An Industry in Transformation" by Conning Research & Consulting, show the individual annuity industry returned a profit of $7 billion in 2003, primarily due to the swing on variable annuities.

The variable annuity market bottomed out in 1999, but rebounded by 2003 and into 2004, the study reported.

In 2002, the combined individual annuity industry lost about $691 million on a statutory basis, mostly from variable annuity challenges. Better equity market performance led to a partial recovery of assets in 2003 and the early months of 2004, the study said.

Variable annuities are mutual funds with some wrappers on them, and are not immune to the examination that mutual funds have been experiencing recently, said Stephan Christiansen, director of research at Conning Research & Consulting. The study addresses both the challenges of the industry and gives warnings about the complexity of the environment, Christiansen said. The industry is complex in regulation, complex in buyer habits, complex in financial markets, and these products are weaving their way through all that maze, he said.

Historically, variable annuities have been positioned as a wealth-accumulation product and competed with mutual funds through a strong reliance on tax advantages, offsetting the lower costs of mutual funds, the study said. Variable annuity expenses average 2.3% per year vs. fund expense charges of 1.5%, the study said.

Tax law changes in 2003 regarding capital gains and dividends have removed tax preferences as a competitive advantage for variable annuities, the study said. Changing competitive and regulatory dynamics in the mutual fund industry and other alternative investment segments will also likely force changes in the variable annuity industry, the study said.

The 2003 tax change shifted the playing field, since the tax benefit was almost the entire product originally and now that aspect has been virtually eliminated, Christiansen said. The answer is to find ways to provide protection, which is what insurance is all about--protecting assets, protecting retirement benefits, protecting estates, he said. The evolution that variable annuities has gone through allows the industry to address those various kinds of protections, with the benefit of mutual fired-type equity investing, he said.

Ultimately, variable annuity programs may be forced to reduce expenses to be competitive with competing products, as increased capital and investment return targets are required to support the additional risk characteristics of the business, the study said.

In recent years, additional benefit riders not available to other competitive products have sustained the sale of variable annuities, but the uncertain ultimate costs of those riders may still affect the industry, the study said. Minimum death benefits riders, the first guaranteed benefits to be added to variable annuities, have expanded into a multitude of guaranteed benefits as standard contract features, the study said.