The latest generation of variable annuities offers more investment options with new wrinkles, such as nursing home waivers, and a formidable array of cost structures that only actuaries could devise.

Difficult as the annuity market is, brokers need to be aware of whats available and whats a fair price.Regulators, for example, are watching 1035 tax-free exchanges for possible abuses. Thus brokers need to carefully comparison shop and be familiar with contract options that will cut clients costs or give them other benefits.

Total ongoing annuity expenses include both insurance fees and investment-related charges on the underlying mutual fund subaccounts. On average, total expenses for variable annuities run 2.08% a year, according to Morningstar.

But at the high end, certain contracts from firms such as Prudential and Anchor Polaris top out above 3% a year, Morningstar says. Conversely, the most penny-pinching products come from Vanguard, Fidelity and Northwestern Mutual. A Vanguard S&P 500 VA portfolio has total costs of just 61 basis points a year and no front-end or surrender fees. Some fee-only advisers sell a low-cost Fidelity Retirement Reserves VA, with 1.08% in ongoing costs plus a surrender charge.

Then theres the Lincoln National Multi Fund, which offers several equity-oriented options with total costs in the range of 1.4%. It comes with a 7% surrender charge. According to Morningstar, the Lincoln National product is one of the lowest-cost VAs sold by brokers.

We pay close attention to total fees because thats what investors really pay, says Patrick Reinkemeyer, editor of Morningstars Variable Annuity/ Life publication in Chicago. My basic guideline [on annuity costs] is that anything above average is too much to pay.

Annuity expenses have been rising slowly over the years, reflecting new contract enhancements, higher distribution outlays and costlier investment options such as small stock, junk bond or foreign subaccounts. Another inflationary factor has been the growing tendency of insurers to cement subadvisory deals with big-name money management firms, according to a December 1997 report on the variable annuity business by Cerulli Associates of Boston.

Insurance charges are what really run up annuity costs. In fact, investment-related charges on annuities--an average of 81 basis points a year--are comfortably below those of mutual funds; its the insurance component that tips the scale.

Insurance fees primarily reflect mortality and expense risk (M&E) outlays. The mortality portion covers the modest death benefit on annuities along with the perils of annuitants outliving the amount of money that they paid into the contract. The expense portion ensures that investor-borne costs will never exceed a specified amount. The M&E charge also is the source of insurance company profits as well as broker compensation.

M&E expenses weigh in at 111 basis points of the 1.27% in average insurance charges, reports Morningstar. Administrative fees account for most of the rest.

If theres a gimmick to variable annuities, it may be the death benefit. This feature ensures that annuity beneficiaries receive, at a minimum, the original investment made by the contracts owner. Many products gradually increase this value over time.

If the death benefit allows [an investor] to go a couple steps up the risk ladder, then its a very positive feature, says Ryan Johnson, a senior vice president at Guardian Investor Services Corp. in New York.

Yet critics complain that the death benefit typically isnt needed--because an accounts value will grow over time anyway. The expected value of the death benefit is pretty low, says Reinkemeyer. Cerulli observes that the principal guarantee is the second most popular feature on variable annuities, behind tax deferral. But Cerullis report questions whether investors have their priorities straight.

The comfort of having a principal guarantee comes at a cost, both in the form of higher ongoing expenses and in more restrictive liquidity, Cerulli says.

Surrender charges range from zero to 9% and last as long as 16 years, according to Reinkemeyer. The typical charge is 6%, phasing down and out over six years.

A key reason people liquidate their annuities, triggering surrender charges, is because of poor-performing investments and a lack of choices. Curt Olson, annuity products manager atDain Rauscher in Minneapolis, cites growth, growth and income, small stock, international, high-yield and investment-grade bonds as mandatory options.

The better plans also include funds differentiated according to investment styles, says Joe Duran, director of marketing and sales at FundMinders in Sherman Oaks, Calif. Probably 80% of variable annuity companies dont provide enough diversification choices, he says.

Duran favors contracts with makeup provisions to minimize surrender charges in cases where exchanges are justified. Insurance companies offering such contracts agree to reimburse investors for any back-end loads incurred in making the switch to their products. American Skandia, Shelton, Conn., is one of the firms offering this.

Even so, a makeup clause wont prevent the insurer from setting its own surrender-charge clock on the new contract. And Duran notes that brokers typically see their commissions on the new products reduced by whatever amount the insurer pays to clients.

Some of the more interesting product wrinkles aim to make it easier for investors to get at their principal without facing a surrender charge. These provisions offer penalty-free access in case of problems ranging from placement in a nursing home or terminal illness to disability, job loss and even divorce.

These waivers dont add that much more in cost, and youre seeing more products including them, Olson says.

The Cerulli report noted that most of the new bells and whistles on annuity contracts focus on the accumulation phase, with scant attention paid to the distribution phase. Purchase decisions seem to be made primarily for peace of mind considerations such as a guaranteed income, death benefits, nursing-home riders and the like, according to Cerulli. Only about one in 20 annuity purchases are of no-load contracts, and many of the best-selling contracts are higher-cost products.

Information about VA purchases reveals that they do not appear to be based on educated decisions and in reality, price consideration occurs very late in the purchase process--if at all, the Cerulli report concludes.

Its generally accepted that variable annuities are more costly than mutual funds. Whats not always understood is that they also deliver less service for the buck.

The variable insurance business has been more difficult to automate than the mutual fund business, reads a report from Cerulli Associates in Boston. The company attributes this to more complex products and licensing processes, and the fact that variable annuities are priced in units, while the underlying subaccounts are valued at NAV.

Services long taken for granted on mutual funds, such as daily pricing, quick trade confirmations and dollar cost averaging, are less widely available on annuities. The new Travelers Marquis Portfolios product is one of the first to offer daily pricing.

And annuity values dont show up on brokerage statements. Information is cumbersome to obtain, Cerulli reports. Part of the problem involves a lack of standardized links provided by insurance companies. Although the National Securities Clearing Corp. is working on bringing functionality to the levels enjoyed by mutual funds through its Annuity Processing Services, completion of this effort may still be a couple of years away.

On another service topic, Curt Olson at Dain Rauscher in Minneapolis, prefers wholesalers who specialize in annuities, rather than sell the tax-deferred products as an afterthought to their regular fund business. Annuities have unique complexities and may require different marketing strategies, says Olson, annuity products manager for the firm. Id like to see more annuity-only wholesalers.