As the economic earth continues to quake underfoot, unsexy insurance products with guarantees, such as variable annuities, are getting a second look from advisors.

Advisors have traditionally steered clear of these products because of their complex, difficult-to-understand contracts and, lately, a bad reputation with regulators. But a relatively recent innovation—a type of living benefit rider that guarantees a minimum amount of income—has made these products more popular with advisors and, now, with investors suddenly hungry for safety.

Paradoxically, now that annuities are returning to their originally intended use—providing a combination of protection and income—observers are describing them as new and exciting. Lisa Plotnick, an analyst at Cerulli Associates, says, "These are not the variable annuities [that] advisors saw when they started their careers." She says that positioning variable annuities as income vehicles (as opposed to accumulation vehicles) will help drive growth. Cerulli predicts that assets in all annuities, variable and fixed, will climb to $2.9 trillion by 2012 from $2.1 trillion today.

Another driver for the popularity of annuities is product developers' growing awareness that the annuity will be just part of an overall portfolio. "They are building products that will complement other products in that portfolio, such as mutual funds, stocks and bonds, and bringing the annuity product back to its roots, which is to provide an insurance element to the portfolio," Plotnick says.

She notes that one new way to use variable annuities is in a stretch Individual Retirement Account (IRA), which allows the funds to be paid out over the lifetime of a beneficiary, rather than the lifetime of the original owner. "We've seen, in research, people are using them as part of a wealth transfer in which they like to have some sort of spendthrift protection for heirs. So it's not so much the products themselves, but the application of the products that [is] different."

Accumulation to Income

For many years, as baby boomers and others worked to save enough to retire, variable annuities were used primarily as an accumulation tool. This was especially true during the early 1990s, when tax rates were high and tax management became a key concern. At the time, advisors used variable annuities to defer taxes and maximize wealth accumulation, similar to the way they use IRAs.

But today, as tax rates have declined and the oldest of the baby boomers hit retirement age, variable annuities' ability to provide steady income is drawing attention again.

As these investors retire, advisors say they should consider converting a large lump sum from their 401(k)s—or other retirement vehicles—into a monthly check. And obviously they want that check to be as big as possible. Living benefit riders, addendums to a variable-annuity policy, are one way to achieve that.

A relatively new type of living benefit rider, the guaranteed minimum-withdrawal benefit (GMWB), has quickly become the most popular. The GMWB gives the investor the ability to protect against the risk that his account will lose money in a down market, and works by allowing the withdrawal of a capped percentage of the entire investment each year until the initial investment amount has been recovered. This shields the investor from market losses while protecting any market gains.

Say the investor initially puts in $100,000. After the market declines, the investment loses 25% of its value, falling to $75,000. If the rider the investor bought guaranteed an income rate of 10%, the investor can withdraw $7,500 a year until he has recouped the entire original $100,000.

Living benefit riders started to gain popularity around 2001-2002, the previous, very weak equity market in the U.S. Then, as now, investors were looking for ways to protect their investment and income stream. The GMWBs have been the most popular of the living benefit riders in terms of product development over the last five years. John Diehl, a certified financial planner and vice president of the retirement wealth consulting group at insurance giant, The Hartford, attributes this popularity to the fact that the GMWB gives the investor the choice of withdrawing the whole amount of money on offer each year, or a smaller portion. "You have flexibility in terms of how much income you take," Diehl says.

A new version of The Hartford's GMWB rider is relatively easy to understand, at least by industry standards. It guarantees the investor not only a minimum, but a rising income for the rest of his life—a feature made possible by asking the investor to hold off taking any income for the first five years of the contract. This works best with investors who are using the variable annuity as a portion of their overall portfolios, and either do not need the income for the first five years, or are drawing income from another source. With such deferral benefits, the insurance company makes a deal with the investor: The investor puts off taking money from the annuity, and the insurance company figures out a way to enhance the benefit every year afterwards.