In a matter of months, variable annuities went from hot item to dead weight for many insurance companies, which are now buckling under the weight of costly guarantees and overly optimistic risk assessments on those investments. Now, insurers are tackling an overhaul on variable annuities – that is, if they still want to be in the variable annuity business at all.

Only major insurers, such John Hancock Life Insurance or MetLife, are big enough to be in the variable annuity game, said Scott Hawkins, vice president and analyst with Hartford-based researcher Conning & Co. Of those, some are getting out and many are scaling back; those who stay are simplifying the product or being more selective about how they create and sell it, he said, speaking on a report Conning released on the topic this month.

Regardless, he said, the economic downturn has forced insurers to adapt – and this represents an enormous obstacle, both financially and logistically.

“For the financial and capital challenge, this is of an unprecedented scope,” Hawkins said, “Nothing we’ve seen in the past can compare to 2008 in a financial and capital perspective.”

Came Back To Haunt

Variable annuities, in which the policyholder pays a lump sum in return for periodic payments strung out over time, have already done very visible damage to major regional insurers such as The Hartford Financial Services Group.

The Hartford, like many insurers, created guaranteed minimum benefits that promised buyers that the company would always pay out a steady minimum on their investment, regardless of that investment’s performance – and in some cases, insurers offered a higher return if the investment did well.

This helped make variable annuities hot sellers in the boom times, but now insurers have to make good on those guarantees, and the results aren’t pretty to their bottom lines. The Hartford – along with other insurers – has been downgraded as a result of uncertainties about its annuity business, most recently by Moody’s Investor Services, which took it from A1 to A3 last month.

There’s little to be done about past products, but insurers are doing what they can to scale back on annuity business for the future. “Simplify” seems to be the mantra of choice for insurers looking to stay in the business.

“I can’t imagine a company out there that isn’t [changing its strategy],” said ING spokesman Phil Margolas.

ING, which has major operations in Connecticut, announced this year it would change its annuity products to be “simple, low-risk and primarily geared toward the rollover market,” Margolas said.

The guarantees will be lower and the fees will be higher to more accurately reflect the cost of hedging the product, he said – but the guarantees will not go away.

Buyers still want the security that comes with such a promise, he said, especially in the aftermath of the recent investment turmoil.

Return To Simplicity

The Hartford, for its part, announced in its quarterly conference call last week that it would re-launch variable annuities in the third quarter of this year founded on the “pillars of simplicity, competitive costs, and lower risk profile.”

But the Conning report also dealt with an overlooked challenge with regard to annuities: the logistics of selling them.

“The financial issues get so much play in the press, but that doesn’t mean the industry doesn’t face other challenges,” he said.

A major issue is distribution. Insurers had largely moved these products through independent distributors, Hawkins said, but now those distributors – such as Merrill Lynch or UBS – are reducing their own workforces or focusing on higher net worth customers, essentially paring down the number of people selling annuities.

In some cases, distributors have stopped selling products of certain insurers because those insurers suffered financial troubles and ratings downgrades, he said, indicating the recent trouble from Hartford-based The Phoenix Cos., which lost major distributors for those reasons.

Insurers are going to have to work harder to keep close relationships with those distributors or work to rebuild captive enterprises, according to Conning’s report, and Hawkins pointed out that some insurers, such as John Hancock, will have an advantage because they have long maintained a captive sales force.