Just a few years ago, variable annuities were so popular among insurance carriers issuing them and the wirehouses and other broker-dealer firms selling them, that some ended up getting slapped by FINRA and state regulators for pushing the products even to investors for whom they were inappropriate.

Now, in a turnaround, some major issuers of variable annuities (VAs) are pulling back, getting out of the business entirely, or in some cases even offering to buy policies back from clients who bought products with generous lifetime income riders.

"It's all about low interest rates and insurance companies trying to de-risk after some of the issuers got over-aggressive during a variable annuity arms race," Steven Saltzman, a research analyst with Kehrer Saltzman Associates, says.

Overall, annuity sales have been trending downward for more than a year, with monthly inflows falling to approximately $8 billion in June 2012 from just over $10 billion in June 2011, according to the Depository Trust & Clearing Corporation (DTCC). The primary channel for marketing annuities-accounting for 28% of annuity sales-remains independent agents, followed by wirehouses (17%), regional broker dealers (15%), banks (13%), and insurers (9%).

Independent broker-dealers have been gradually increasing their share of the VA market since 2006, when they accounted for 26% of the sales of that product line. By 2010, they had a 30% share, and have continued to gain since then, according to LIMRA data. Banks led in the fixed annuity category, with 40% of the market in 2011, but that is down from a high of 48% reached in 2008.

According to data from LIMRA, total VA sales through the first half of 2012 were $75.4 billion, down 6% from the $80.1 billion of VAs sold over the same period in 2011. Analysts say that the sales reported in the first six months of 2012 going from $38.6 billion to $40.6 billion (especially during the second quarter, which actually showed a slight increase over the first quarter), were boosted by clients trying to buy products with generous lifetime income riders before they were taken off the market.

Meanwhile, as the VA market has softened, indexed annuities, a sub-category of fixed annuities, have taken off. Overall fixed annuity sales for the first half of 2012 totaled $111.8 billion, down 8% from the year ago period when they hit $121.4 billion. However, while almost all categories of fixed annuities showed a similar drop in sales during that period, indexed annuities jumped 10%. They went from $15.2 billion in the first half of 2011 to $16.7 billion in the first half of 2012. Independent agents continue to be the primary sellers of indexed annuities, accounting for about 85% of the market in 2010 according to LIMRA, though that is down slightly from a high of 89% in 2006 and 88% in 2008.

Variable annuities are insurance products that offer the investor the option of choosing to link to some category of asset, such as the S&P Index, or bond index or some combination of assets. They then offer some minimum rate of return and a lifetime benefit payout rider, which could be higher depending on the performance of the underlying assets. Fixed annuities, unlike VAs, guarantee the full principal invested, and pay interest like a certificate of deposit, only often at higher rates, which can be paid immediately or deferred. An indexed fixed annuity tries to enhance that interest rate by linking to some equity index-say the S&P 500, which is used by 92% of indexed products. Indexed annuities typically pay a higher rate (less fees and subject to a cap) if that index does well, but guarantee some minimum rate even if the equity index were to tank.

Analysts say that while VA sales are slowing, and index annuity sales are rising, there is not necessarily a direct relationship between the two. As John McCarthy, an annuity analyst with Morningstar, explains, the two kinds of annuities are fundamentally different. "A variable annuity," he says, "is essentially a mutual fund. If the market does well, you get paid more. But if the market falls, you can lose your principal." The difference, he says, is that the issuer guarantees the investor in a variable annuity some base rate of return-typically 5% or higher-whereas a mutual fund guarantees nothing. Meanwhile, McCarthy says, an indexed annuity, while it may be linked to some index, is really more a higher yielding alternative to a CD, typically these days paying around 3% to 3.5% interest.

"A variable annuity is good for those people right close to retirement," McCarthy says. "That's the sweet spot for these products. They can be invested in equities, but the investors don't have to worry about a market collapse right when they are going to stop working." For example, he notes, if someone had invested their retirement assets in a variable annuity in the early fall of 2007, the equities market would have promptly dropped by 37%, but the VA holder would have seen his or her income from the product stay at 7% for the year."

While the fixed indexed annuity doesn't offer that high an income stream, it does protect the investor's principal and guarantees a respectable yield over the five to eight year life of the product-one that with many indexed annuities can even increase if the market rises.

Last year, several insurers (Sun Life, Genworth and ING) signaled the turn away from VAs among carriers, announcing that they were exiting the business. MetLife and AXA, both major issuers, also said they were scaling back their issuance. AXA did so as early as 2008. Then early this year, Hartford Life, one of the largest issuers of variable annuity products, and one of the more aggressive players in the "arms race" to offer ever better guarantees of minimum returns, joined the list; saying it was also stopping the sale of new variable annuities.

Companies that are still selling VAs are now decreasing the withdrawal percentages offered to new annuity buyers, and are also making riders more expensive. A number of them are even offering to buy back certain benefits from existing variable annuity holders. Transamerica, for example, is offering to buy back, with a cash bonus, certain existing guaranteed minimum income benefits from its policy holders, hoping to reduce its long-term risks.

Not everyone is getting out of the VA business. New York Life, notably, is just entering the market, distributing its new variable products only through its own rep channel. Symetra is also starting to offer variable annuities for the first time. "Issuers are not all running for the hills," Saltzman says.

But the game has gotten tougher to play. AXA also decided in the first quarter of this year to re-enter the VA market with new products. It was a classic case of bad timing, however, with the 10-year Treasury hitting a record low, and the company ended up having to add $175 million to its reserves and record a charge to earnings to cover the losses in its U.S. business, according to Morningstar.

McCarthy of Morningstar says that the buy-back offers being made by some issuers for lifetime withdrawal guarantees could provide a good opportunity for some of the 90% of VA policy holders who bought guaranteed life withdrawal riders. But he stressed that such GLWB buy-back deals have to be examined carefully. "Obviously the companies are offering deals that are good for the company," McCarthy says. Still, in individual investors' cases, a buy-back deal may be coming at just the right time if a cash bonus could be needed, he says.

With the cutthroat competition over GLWB offers over, at least for now, among variable annuity issuers, a new VA offering from Vanguard may be worth a look. Relatively cheap, it is also simpler than many other issuers' offerings, too, and can be bought directly from the company, eliminating the broker commission. Aimed at people who are retired or approaching retirement who want to lock in payouts within five years, Vanguard's new GLWB rider, introduced late last year, costs just 1.45% to 1.55% including fees, well below the typical cost of 4% or more with most variable annuities. Buyers can choose to put 60% of assets in Vanguard stock index funds and 40% in bonds, or the reverse, or they can choose to have two-thirds of the assets in stocks managed by the Wellington Fund. This annuity has no surrender charge, either.

"There is no question, the proliferation of living benefits in the variable annuity space has faded," says Tom Pistole, a research consultant at DTCC, which is the clearing house for annuities through its National Securities Clearing Corp. unit.

"Equity markets have been doing fairly well, but as interest rates have declined to historic lows, it has become harder and harder for carriers to hedge the guarantees in these products, which is why many of the issuers are pulling back," DTCC's Lenny Schmitt, group director of relationship management, explains. "Meanwhile, fixed annuities are becoming a more important option."

Indeed, fixed indexed annuities are now leading the way in terms of new product innovation and development. Both The Hartford and Genworth, while exiting the variable space, are entering the indexed annuity market. Other carriers are reportedly also looking into indexed annuities as a less risky growth area, while still making use of their existing distribution networks. Indexed annuity issuers are also adding guaranteed lifetime withdrawal benefits, with some 20 issuers now offering some kind of lifetime feature.

The generally reduced benefits being offered by variable annuities, combined with the increased competitiveness in the indexed annuity area, plus a general concern among financial advisors and their clients about trying to lock in yield in a low-yield environment, are leading more and more advisors and advisory firms to look to indexed annuities.

"Traditionally, most fixed annuities, including indexed annuities, have been sold by independent agents," Saltzman says. "But more and more, with the living benefits feature being added to them, you're seeing broker-dealers and reps in the bank channel offering clients indexed annuities. LPL and others that wouldn't offer these in the past now do. I think it's because equity-indexed annuities are reducing surrender periods a little, and lowering their commissions, which has invited more aggressive sales practices." He adds: "The value of guaranteed lifetime benefits will continue to resonate with clients, too, but the terms won't be as good."

Even Raymond James, which has allowed its advisors to sell indexed annuity products for the last six years, reports that there has been a pick-up in the business this year. "We will be doing between $190 million and $195 million in indexed annuity sales this year, ending Sept. 30th," Scott Stolz, president of Raymond James Insurance Group, says. "That will be a record amount for us and will be about 20% more than last year." He notes that these products were not being marketed by Raymond James advisors as replacements for VAs in the equity allocation of client portfolios. "Our people are selling these as products that provide yield for a portfolio," he says.

The top 10 variable annuity issuers in 2011 by market share were TIAA-CREF (25.2%), MetLife (9%), Prudential Financial (7.2%), AXA Equitable (5.7%), Lincoln Financial Group (5.4%), SunAmerica (4.7%), The Hartford (4.7%), ING Group (4.3%), Jackson National (4.2%), and Ameriprise Financial (4.1%). With The Hartford, SunAmerica and ING Group now out of the picture as new VA issuers and Prudential Financial and MetLife scaling back, that's half of the top issuers and about 30% of the total market that is either no longer selling the product or selling less of them.

Among fixed indexed annuity products, the number one issuer in the fourth quarter of 2011 when a total of $8.7 billion worth of indexed annuities were sold, was Allianz Life, with a 17% market share, according to AnnuitySpecs.com. Allianz Life's MasterDex X indexed annuity was the top-selling annuity overall in the fourth quarter of 2011-a position it has held unchallenged for 12 consecutive quarters. The MasterDex X annuity features a 10-year surrender period, a lifetime income guarantee, a bonus on premiums received during the first three years (fully recoverable at surrender), and locked-in interest rates once credited, all fairly common terms with these types of annuity. Aviva was the second biggest issuer of indexed annuities in the fourth quarter of 2011, followed by American Equity, Great American and Midland National.

While the VA market has been shaken up, that hardly means that these products are history. Individual investors are still shying away from equities markets, after being burned by the last crash and high volatility. As a result, VAs continue to be seen as a way of guarding against some of those headaches. Last year, of the more than $231 billion that investors put into equities, two-thirds of the money went into variable annuities, according to the Insured Retirement Institute. That kind of interest is not going to go away, analysts say, nor is the insurance industry going to walk away from such a huge market. Instead, while some carriers may drop out, others will be making their products a bit less generous, for example reducing lifetime income guarantees from last year's average of 6% to closer to 4.5% for a 65-year-old investor. They will also raise the cost for the guaranteed income rider, which now typically costs about 1% of assets, plus fees.

Some issuers are also cutting the number of investment options offered to VA buyers. Lincoln National, for example, is offering its buyers a 5% lifetime withdrawal rate, instead of just 4%, if they choose to invest among a certain group of selected mutual funds. Lincoln's head of annuity solutions explains that that helps the company reduce the cost of hedging. Other insurers like MetLife, RiverSource and AXA Equitable are reportedly also acting to limit investment options in their variable annuities.

These changes appear to be having an impact. Variable annuity sales were up 12% to $155.5 billion in 2011, the highest they've been since the record $183 billion reached in 2007. But they fell 7% in the first quarter of this year. Yet, the diminished interest in and investor demand for VAs may be even more serious than the statistics would indicate. Consider the view of Mark Thompson, a Raymond James advisor in Melbourne, Florida. With some of his favorite issuers having quit the business, and with those that are left, pricing their benefits much higher, "it has become hard for us to justify variable products to our clients," he says. Thompson adds that even index products are less attractive because of low interest rates. "We are just using them as a niche product," he says.

While the allocation of client funds to variable and fixed annuities has remained relatively flat, advisors are continuing to use both, says Meredith Rice, senior project director at research firm Cogent. Investors, particularly those investing for retirement, continue to be concerned about market volatility and about protection of principal, she says. And, "no other products beside annuities offer that" level of safety, Rice points out. "Eventually, the market will turn around, and then the competition to offer better GLWB risers will pick up again. And those issuers who stayed in the variable annuities market will be positioned to pick up market share."