Declining annuity premiums mean insurers may have to rethink their annuities products in order to survive, according to a report by Scott Hawkins, vice president and insurance analyst at Conning Research & Consulting in Hartford, Conn.

Annuity premium inflows have been steadily dropping since 2000. From the mid-1990s up until the dotcom bubble burst, insurers flooded the market with then-innovative variable annuities, but when the market crashed in 2001, many players quit the market as annuity owners held tight to what they had, Hawkins said. The infamous arms race between annuity providers was, in part, an effort to get those holders of old annuities to move their premiums to new, more exciting products via 1035 exchanges. While this strategy worked, it also meant that recycled premiums often took the place of new ones as advisors scrambled to sell the attractively commissioned products.

Now, insurers are in a bit of a scrape. It’s clear they can’t support all the bells and whistles that made annuities so popular prior to 2008, and annuities owners won’t ditch their lavish old variable annuities for stripped-down new ones, especially when their guarantees are worth more than their cash balances. This means insurers, which have struggled since 2000 to bring in new premiums, are now struggling to generate premiums from 1035 exchanges as well. This premium drought will continue at least through 2012, Hawkins said, causing some insurers to quit the annuities market altogether and forcing the survivors to reinvent the wheel.

Hawkins said insurers basically have two choices, to build products for retiring baby boomers and/or to develop products for Generation X and Y as they approach their prime earning years.

On the baby-boomer front, Hawkins said that he suspects that Hartford Financial may be on to something with its Personal Retirement Manager annuity, in which a market-linked account feeds a fixed-income component, which in turn creates retirement income. A popular product in the U.K. links an immediate annuity to the consumer price index in order to keep up with inflation, he points out. While this product isn’t particularly exciting, it at least provides baby boomers with guaranteed income for life, an issue of particular concern right now.

Hawkins also said that he likes the look of another annuity in the U.K., which, unlike immediate annuities in the United States that pay out the same for everyone, base payouts on life expectancy. The unhealthier you are, the higher your payout, a factor that could boost sales among the infirm.

For Generations X and Y, Hawkins said that he thinks annuities that, in effect wrap retirement savings in an insurance blanket, could be annuity providers’ most lucrative area of opportunity. “The sizzle is in annuity benefits within 401(k) plans,” he said.

However, “there is a certain risk if these products take off post 2012. There will be fewer competitors, albeit large ones, and fewer insurers supporting the nation’s retirement risk would raise regulatory scrutiny,” Hawkins said.

If the government gets involved, and it probably would if annuities within 401(k)s take off, insurers would have to maintain huge reserves to cover the risk, and the subsequent increase in pricing could sink these products before they start.