Tim Novatnack, an advisor at Fulton Bank in Danville, Pa., fondly remembers the good old days of the variable annuity business. "I can remember a few years ago when carriers like AXA and MetLife were in a rider war, seeing who could offer the most generous guaranteed lifetime benefits at the lowest cost," he says. It was a time when advisors could cherry pick the best deal and clients could walk away with assured pensions on the cheap. "Those days are gone now," he says wistfully, noting that today it feels like the industry has made an about-face. That is, the insurance carriers that offer variable annuity products are competing "to see who can lower their rider benefits and raise the cost the quickest."

Numbers tell part of the story. Variable annuity sales, according to the insurance industry research outfit LIMRA, fell by about 4% to $35.5 billion between the first quarter of 2012 and the first quarter of 2013 (though they actually rose a nominal 1% from the fourth quarter of 2012 to the first quarter of 2013). That year-to-year drop marked the sixth consecutive quarter of year-to-year declines for variable annuities.

Meanwhile, Steve Saltzman, managing principal at research firm Kehrer Saltzman & Associates, says that bank advisors have seen the share of their revenues coming from annuities of all types fall by about 20% to $4.6 billion in 2012. A big part of that drop, he says, is declining variable annuity sales. And he adds, "The variable annuity business in 2013 is going to be even more constrained as carriers continue to reduce the benefits offered."

Scott Stolz, senior vice president, Private Client Group Investment Products at Raymond James, says the actual picture is worse for variable annuities than the statistics might suggest. This is because some $20 billion of the money invested each year in variable annuities is going to two entities—TIAA-CREF and AIG's Valic—both of which have clients who, along with their employers, keep investing into their annuities "no matter what."

So a drop in sales in the remaining part of the market, with TIAA-CREF and Valic taken out of the equation, is a larger percentage decline.

A problem for advisors is that while the VA product line has been getting decidedly less attractive, the demand from clients for some kind of guaranteed income in retirement, particularly after the shock that their portfolios endured over the last decade, is unabated.

"Clients still like variable annuities. Baby boomers especially know that they need to generate lifetime income," says Joe Montminy, assistant vice president and director of annuity research at LIMRA. He notes that even with the guaranteed lifetime benefit riders to variable annuities being made much less generous, and more costly, 84% of people buying variable annuities are still electing them. That's not a much lower than the 88% to 90% who were doing so back in 2011, when the deals were more advantageous.

Of course, when clients really want these riders, the advisors have to let them know that the deals are not that great. And they have to work hard to find the best deals among riders still on offer. "That's the biggest impact of the cutback in guaranteed lifetime benefit riders," says Novatnack. "I have to spend a lot more time checking out and researching the riders—what the carriers are paying, what the percentages are, and what the costs are to the client. I find myself writing cheat notes and keeping them on my desk: Nationwide does this, Prudential does that. And I'm calling the Raymond James annuity office much more." (Raymond James is the third-party marketer for Fulton Bank.)

Novatnack says he often finds himself steering clients away from the variable annuity products, proposing either index annuities or a combination of an immediate annuity and a fee-based account.

New Strategies

Higher costs aren't the only issue at hand, says John Burdette, an advisor at Fourth Avenue Financial Bank in South Charleston, W. Va. Some of the carriers are also adding restrictions that require a certain percentage allocation into bonds and that's a cause for concern. "Certainly I'm doing fewer annuity cases. I don't feel they are quite the value they once were." (National Planning Corp. is the TPM for Fourth Avenue Financial Bank.)

As an alternate option, he has instead turned to unit trusts. "It's really tough, though," he says. "In a bank or a credit union, you're dealing with a lot of people who aren't really investors, so I try to work through it all and explain that every investment has a positive and a negative attribute, so I try to blend them and get a little of both. That means a lot of education and trying to get people to diversify."

He says he likes unit trusts as an alternative "because you have packaged investments where you know exactly what you own."

Brian Allsop, an advisor at the Bank of Canton in Massachusetts, says with the carriers tightening up on variable annuity benefits, he's had to "go back to the drawing board." As recently as a few years ago, "you could double a client's income from a variable annuity in 10 years," he says. "Now you can't do that." (Infinex is the TPM for Bank of Canton.)

Indeed, his variable annuity volume has fallen dramatically from a range of $5 million to $8 million annually a few years ago to $2 million to $3 million now. Lately, he has shifted to recommending more index annuities, which he uses instead of fixed annuities, and "stripped down" variable annuities without the income rider. And then? "I hate to say it, but hope for the best."

He adds that his biggest struggle these days is keeping track of all the changes in variable annuities. "A guy will come to my office from one of the carriers and explain all the terms. And I'll say, ok, I get it, and then two weeks later, I get a call saying the fee has been raised."

Cathy Weatherford, CEO and president of the Insurance Retirement Institute, agrees that advisors have a big job in just keeping track of the changes in the variable annuity industry offerings. "This industry is in a state of flux," she says. "It is re-setting itself and cutting back." But she says there is also "product innovation like we've never seen before." She notes that between Jan. 1, 2012 and March 31 of this year, the industry added 530 new annuity products, many of them in the variable annuity area. "We've seen people like MetLife and Prudential pulling back, and we're seeing new entries coming in." She says the new products "won't be as rich and won't have the wide array of assets to invest in," but she says clients will still be interested in them, "because there's no other alternative in the marketplace."

She notes that even today, 73% of annuity owners and 17% of non-annuity owners said that annuities are an important part of a retirement strategy. She notes that this is up from the year before. Moreover, 71% of advisors in another survey reported having a client come to them about having an annuity component included in their retirement plan.

Raymond James' Stolz says that there are a lot of new entries in the VA area being offered by smaller carriers that are not already saddled with a big pile of variable annuity obligations. But the challenge for them is still making it work in such a low-interest-rate environment. Many Raymond James FAs have shifted away from a variable annuity strategy to other annuity products; for example, a single-premium immediate annuity, and an index annuity with a living benefit rider.

These shifts in strategy, at Raymond James and elsewhere, are leading to a decline in compensation for advisors. In the past, variable annuity fees accounted for about a quarter of advisor revenues. "We're seeing a decline in advisor compensation," reports Stolz, "but less than you might expect." One reason, he says, is that insurance carriers are reluctant to cut compensation, because "that's a sure way to sell less."

That said, advisors report that their annuity income is indeed down.

Bank of Canton's Allsop says, "My compensation hasn't fallen, even though some carriers have been pulling back on the compensation, but it's because the way I built my practice was to take the least amount up front to get more in the end."

Fourth Avenue's Burdette agreed, saying that his revenue isn't down, but the reduction in compensation has made it a challenge just to stay even. "My AUM is up, but not my revenue," he says.

He says he never took the 7% up-front commission he could have collected, preferring to get 4% up front with the tail. "So it works out," he says.

Raymond James' Novatnack noted: "There's no question we've been hit by lowering of variable annuity compensation, but we've been transitioning to a fee-based environment. The fee book has been growing and that's offsetting the cuts caused by a decline in annuity sales." But he adds, "For someone without a fee-based book, it would be a big-time hit."

Advisors who had a big variable annuity business are also getting impacted by the industry's change of strategy on these products in another way.

Industry buyback offers, such as those being promoted by The Hartford, AXA, Transamerica and some other carriers, are forcing many advisors to devote a lot of time to analyzing each client's situation to see whether a buyback makes sense.

Researcher Saltzman says that buybacks are difficult for advisors because they had sold clients on the value of these programs and had planned on having clients continue to invest in them as part of their retirement strategy. On the other hand, he says, "It does present some opportunity for advisors to get back in touch with their clients, even if it does change the client's perception of them."

He adds, "This is entering new territory for the advisor. They have to help the client consider the value of a buyout."

Raymond James' Stolz says, "Our experience with the buyback offers is that they make sense for about 15% of clients—people with shortened life expectancies whose income needs have changed, or who have a changed financial situation, like maybe getting a new income stream they didn't expect." He adds, "Our rule of thumb with the buyback offers is if it makes sense for the insurance company to offer you cash to buy back your policy, it probably is a bad deal for you."

Most people in the financial advisory industry say they don't expect to see carriers come back with more attractive variable annuity products any time soon. "I think we've moved into a new 'normal' in terms of the use of these GLB products," says Saltzman.

"I think eventually the carriers will come back with more lucrative variable annuities," predicts Stolz. "But interest rates will have to rise first, and the equity markets will have to remain strong for a while. It will take time for the carriers and analysts to get comfortable enough again to take on that risk. I'd bet on perhaps an 18-month lag after the markets are right."

Meanwhile, advisors looking for ways to lock in lifetime retirement income for their clients will just have to be creative.