Bushís proposed tax law could force major changes in their strategies.

When it comes to winning the hearts and minds of independent financial advisors, variable annuities seem to be in a never-ending uphill battle. Many advisors don't trust them, while others see only limited uses for them.

Now the variable annuity business is approaching its own High Noon. For years, marketers of these hybrid vehicles have stressed the benefits of tax deferral, often ignoring other more salient features for potential clients. If enacted, the new Bush tax law, with its potpourri of retirement savings alternatives, will render the tax deferral advantage of variable annuities almost moot, since investors will have other choices when it comes to tax-deferred investments.

To continue to enjoy the growth they have experienced in the past decade, annuity marketers will have to stress other features, such as the benefits of annuitization and minimum-income guarantees. Until now, they have opted to de-emphasize these benefits, reasoning that tax deferral held more appeal to potential investors.

Other challenges abound as well. The SEC and NASD also have stepped up enforcement of inappropriate variable annuity sales, often involving elderly people and others who may not be aware of the fees and illiquid nature of the products. The SEC, for example, issued an investor alert in 2000 that warned of high fees associated variable annuities. John Newcomer, managing partner of the law firm James, Hoyer, Newcomer & Smiljanich in Tampa Bay, Fla., says his firm frequently represents elderly clients in cases involving deceptive variable annuity sales.

"The typical cases we are handling are individuals who are well into their retirement years and have taken their entire nest egg, excluding their home, and thrown it into a variable annuity," he says.

The bad publicity, however, didn't stop variable annuity sales from climbing through the 1990s, finally dropping off at about the same time the equity markets collapsed. From 1991 to 2000, variable annuity sales went from $17.3 billion to $137 billion before dropping to $112.8 billion in 2001, according to the National Association for Variable Annuities (NAVA).

Through the first three quarters of 2002, variable annuity sales were down about 1.5%, according to NAVA. The longest bull market in U.S. history was one reason the products became more attractive. But other changes in the marketplace also enabled variable annuities to pick up some fans-in particular, the introduction of guaranteed minimum living- and death-benefit features that guarantee customers a return of not only their principal, but up to 6% annual interest on their money.

"Over that period of time, the benefit was improved dramatically," says Bob Cassato, president of Manulife Wood Logan Inc. In fact, advisors who do indeed make use of variable annuities for some clients will often say it's the guaranteed minimum benefits that they see as the primary attraction.

But now there's a new rub to these benefits: They may be diminished. Chalk it up as another ripple effect of the three-year slide in the stock market. Not all insurers, it turns out, backed up these enhanced minimum guarantees with adequate reserves or reinsurance. Financial problems at issuers such as Conseco and Allmerica Financial have underscored the concerns.

"Every day, the industry makes payouts on death benefits that are higher than account value," says Cassato. As a result, he and others in the industry expect the new trend will be lower guaranteed minimum-benefit levels, with added basis points attached to the features. The 6% guarantees on principal that are now common may disappear in favor of 4%. "I think we're going to see them continue to be a cornerstone; however, I think that they are going to be more expensive."

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