Investment Vehicles: Insurance Based Products

A customer, age 60, has a fixed annuity contract with a value of $16,000. The cost basis in the contract is $10,000. If the customer withdraws $5,000 and the IRS taxes distributions on a LIFO basis, the tax consequence of a withdrawal will be: A $0 taxable/$0 penalty B $0 taxable/$500 penalty C $5,000 taxable/$0 penalty D $5,000 taxable/$500 penalty

answer: C) $5,000 taxable/$0 penalty Annuity contract contributions are not tax deductible, so the original contribution of $10,000 represents dollars that were already taxed. Any earnings in the account build tax-deferred. So the $6,000 excess value above the cost basis of $10,000 represents the untaxed build-up. IRS rules require that annuity distributions be taxed on a LIFO (Last In First Out) basis - with the build-up portion being the "Last In;" therefore these are the first dollars to be distributed. Thus, all $5,000 will be taxable. In addition, since this individual is over age 59½, there is no penalty tax on the distribution.

A customer owns a perpetuity that pays $400 per month. Assuming that the market rate of return is 6%, the value of the contract is: A $6,666 B $66,666 C $80,000 D $100,000

answer: C) $80,000 A perpetuity makes payments forever. To calculate the value of the contract, you take the annual (not monthly) payment received and divide it by the market rate of interest. $4,800 annual payment received / .06 = $80,000

An Equity Indexed Annuity tied to the Standard and Poor's 500 Index is sold with a participation rate of 90%, a 10% cap and a 0% floor. In a year when the S&P 500 Index increases by 20%, the principal will be credited with a: A 0% increase B 9% increase C 10% increase D 20% increase

answer: C) 10% increase Features of EIAs are a "participation rate" along with a cap (maximum) interest rate and a floor (minimum) interest rate. While some contracts have a participation rate of 100%, most have a participation rate of somewhere between 70%-90%. In this example, the S&P 500 index increased by 20% this year, and with a 90% participation, 18% would be credited to the account. However, the cap sets a maximum that will be credited, so in this example, the cap limits the credit to 10%. This limits the customer's upside, but, in return, in a down market, the customer will not lose any principal because of the 0% floor.

An Equity Indexed Annuity tied to the Standard and Poor's 500 Index is sold with a participation rate of 70%, a 10% cap and a 3% floor. In a year when the S&P 500 Index increases by 2%, the principal will be credited with a: A 1.40% increase B 2.00% increase C 3.00% increase D 10.00% increase

answer: C) 3.00% increase Features of EIAs are a "participation rate" along with a cap (maximum) interest rate and a floor (minimum) interest rate. While some contracts have a participation rate of 100%, most have a participation rate of somewhere between 70%-90%. In this example, the S&P 500 index increased by 2% this year, and with a 70% participation, 1.40% would be credited to the account. However, because of the 3% floor, this amount will be credited. The 10% cap is irrelevant here.

A viatical settlement will typically give the policyholder an immediate cash payment that is: I more than 100% of cash surrender value II less than 100% of cash surrender value III more than 100% of policy face value IV less than 100% of policy face value

answer: I and IV In a viatical or life settlement, a policyholder sells his or her life insurance policy to a third party, in return for an immediate cash payment. The third party now makes the life insurance payments and receives the death benefit upon the insured's death. This gives the policyholder cash now, typically used to pay for medical expenses. The cash payment received from selling the policy must be more than the policy cash surrender value in order for the transaction to make financial sense. Otherwise, the policyholder would simply surrender the policy. The policyholder typically gets around 80% of policy face value, but the actual amount paid depends on the expected life of the policyholder and market interest rate levels, among other items.

Which statements are TRUE about fixed annuity contracts? I The issuer assumes the investment risk II The issuer assumes the purchasing power risk III The purchaser assumes the investment risk IV The purchaser assumes the purchasing power risk

answer: I and IV With a fixed annuity, the issuer assumes the investment risk - the risk that the securities funding the annuity perform poorly. If the underlying securities perform poorly, the insurance company will not reduce the monthly annuity payment promised to the purchaser of the contract. With a fixed annuity, the purchaser assumes purchasing power risk - the risk of inflation. If there is inflation, the monthly annuity payments do not increase, so the annuitant's purchasing power declines over time.

During the annuity period of a fixed annuity, the insurance company assumes which of the following risks? I Mortality II Morbidity III Expense IV Investment

answer: I, III and IV only In a fixed annuity, the insurance company assumes mortality risk, expense risk and investment risk. Mortality risk is the risk that the purchaser lives longer than the insurance company expects, and the insurance company is obligated to pay for as long as that person lives. Expense risk is the risk that the insurance company's expenses increase faster than expected - the insurance company caps the expenses that it can charge against the annuity. If these increase beyond the capped amount, this is the insurance company's problem. Investment risk is the risk that the insurance company's return on its investments does not keep pace with its payment obligations to fixed annuity holders. If its investments fare poorly, the insurance company does not reduce the amount of the fixed annuity payments. The insurance company does not assume morbidity (the risk of getting sick), which only applies to various types of health insurance.

Which of the following terms describe Equity-Indexed Annuities? I Investment product II Insurance product III Principal protected IV Not principal protected

answer: II and III Equity Indexed annuities are an insurance product and are currently not defined as a "security." They give a return tied to the performance of the Standard and Poor's 500 Index, but this is subject to an annual cap of typically 7-9%. Thus, in a year of sharply rising stock prices, they will not give the return of the index. However, they are protected in a falling market and guarantee a yearly minimum return of 1-3%. Thus, they will give a better return than the Standard and Poor's 500 Index when the market is falling sharply.

Which of the following are associated with variable annuities? I Level benefit II Variable benefit payments III Benefit payments that will fluctuate based on stock market movements IV Benefit payments that are unaffected by stock market movements

answer: II and III The benefit payments from a variable annuity contract will fluctuate based on overall economic conditions. Variable annuity separate accounts are most often invested in equities. If economic growth increases, the performance of the equity securities held in the separate account will increase and so, the amount of the annuity payments will increase. In difficult economic times, the reverse is true.

Which statements are TRUE about variable annuity contracts? I The issuer assumes the investment risk II The issuer assumes the mortality risk III The purchaser assumes the investment risk IV The purchaser assumes the mortality risk

answer: II and III With any annuity, the issuer assumes the mortality risk. Mortality risk is the risk that the purchaser lives longer than the insurance company expects, and the insurance company is obligated to pay for as long as that person lives. Investment risk is the risk that the return on its investments held in the separate account declines. A decline in investment returns will reduce the annuity payments. This risk is borne by the purchaser of a variable annuity contract.

Annuity units

the fixed number of units upon which the pay-out from a fixed or variable annuity is calculated. The number of annuity units is fixed when the accumulation units are annuitized.

Accumulation units

the legal name for the "shares" that a customer acquires in the separate account when purchasing a variable annuity, since this is a "unit" trust form of investment company. The dividends and capital gains received during the investment period are reinvested in the separate account, purchasing additional accumulation units.

Policy Loan

A feature only available on "cash value" life insurance policies, the policyholder can borrow cash value as a loan against the policy. Whole life and universal life permit 100% of cash value to be borrowed; variable life and variable universal life only permit a portion of the cash value to be withdrawn. Any policy loans reduce death benefit payments.

Variable Universal Life Insurance (VULI) / Flexible premium variable life / Variable universal life

A life insurance contract that combines the flexibility of premium payments of universal life with the investment features (separate account) of variable life.

Universal Life (UL) Insurance

A life insurance contract that permits the policy owner to change the policy's death benefit and premium amount. Premiums are invested in the general account. Universal life combines elements of term life and whole life policies. The premium is broken down into an insurance element (the term component) and a savings element that is invested in the insurance company's general account (savings component). This "cash value" is invested in the insurer's general account, and the policy owner's account is credited for the interest income earned on the general account. This rate of return can vary from year to year. The policy owner can use cash value to increase the death benefit or to skip some premium payments.

Whole Life (WL) Insurance

A life insurance policy whose death benefits and premium payments remain the same for the whole of the insured's life. Whole life insurance protects the purchaser from increasing premiums as that person ages, and there are no renewals - the policy is good for that person's life. With a whole life policy, the annual premium is level, and will start out higher than a term life policy. Part of the premium is invested in the insurance company's general account and is guaranteed to grow at a fixed rate. As the general account investment portion grows, the policy builds "cash value" - meaning that part of the investment value can be borrowed against the policy. Any borrowed funds reduce the benefit payment upon death.

EIAs base the annuity payments on the performance of a broad-based index, such as the S&P 500 Index. However, the return is capped and there is a minimum guaranteed return, regardless of the performance of the index. The most common methods of measuring index performance are the: 1. Point-to-point method; 2. Annual reset method; and 3. High-water-mark method.

Assume that a client buys an EIA that is based on a 7-year return. The "point-to-point" method compares the index value at purchase date to the value at the end date, 7 years later. Any value fluctuations that occur in-between the 2 measurement dates are irrelevant. Another common valuation method is the "annual reset" method, which would measure the return achieved each year over a 7-year life and add interest to the annuity based on the annual reset. The annual interest credit is based on the difference between the year-beginning index value and the year-ending index value. This risk here is that the market dumps at year end, so that the credit only equals the floor amount. The "high water mark" method avoids the "bad timing risk" that you can have with the "annual reset" method. Instead of basing the annual interest credit on year-beginning and year-ending index value, it bases the credit on year-beginning index value and the highest value that it had during that year.

Death Benefit

For variable annuity contracts, a benefit that is only available during the accumulation phase. If the contract holder dies prior to annuitization of the contract, the insurance company promises to pay a beneficiary the higher of premiums paid or net asset value. Once the contract is annuitized, there is no death benefit. For an insurance policy, the death benefit is simply the dollar amount that the insurer promises to pay upon.

Separate Accounts

Investment accounts kept separate from an insurance company's general investment account. Separate accounts may be invested under a different set of guidelines from those applicable to the insurer's general account assets. Typically, each separate account has a different investment objective, and buys shares of a designated mutual fund to reach that objective. Separate accounts must be registered as investment companies under the Investment Company Act of 1940. Insurance companies use separate accounts to back both variable life insurance and variable annuity contracts.

Variable Life Insurance (VLI)

Similar to conventional whole life insurance, however premiums are deposited to a separate account and not to the insurer's general account. The policy's death benefits and cash values vary with the market value of the assets in the separate accounts. The policy sets forth a minimum initial amount below which the death benefit will not decline, and it specifies the fixed premium for that benefit. Variable life products invest a portion of the premium in a separate account rather than the general account, and the investment return of the separate account will determine the amount of insurance coverage, which can vary.

General Account

The investment fund or investment assets supporting all of a life insurance company's contractual fixed annuity and term, whole and universal life insurance obligations. The insurance company creditors may make claims on this account. Assets backing variable annuity, variable life, and variable life policies are held in separate investment accounts against which the insurance company's creditors have no claim.

Term Life Insurance

The most basic type of insurance policy that, for a fixed premium, promises to pay the beneficiary a specified amount if the insured dies during the term of the policy. After the term is over, the insured can renew for a new term, usually at a higher premium because the insured has aged during the term of the last policy. Term life insurance is pure insurance with no investment element. For the premium paid, the purchaser is buying life insurance good for a fixed time period. At the end of that time period, the policy must be renewed to maintain coverage, typically at a higher premium as the insured individual ages (because of the greater mortality risk). When the purchaser of a term life policy is young, the premium is very low; as that person ages, the premium gets higher and higher.

Variable life policies are similar to whole life in that they: are permanent insurance policies; have fixed annual premiums: have an investment component that builds cash value against which owners may take policy loans.

Unlike whole life, which guarantees a fixed rate of return, variable life does not. The rate of investment return depends on the performance of the securities in the separate account that funds the variable policy. Term life offers no cash buildup - it is a pure insurance product without any investment features. Universal life policies are also similar to whole life, but in a different way. Universal policies allow the holder to increase or decrease the premiums to buy a different death benefit amount. These policies build cash value from the interest income of the insurer's investments. Insurers fund universal policies from their general account - not from a separate account. As with whole life, they guarantee a fixed rate of return. A fixed annuity offers an unchanging annuity payment - there is a guaranteed rate of return. Variable products offer a rate of return that will vary, depending upon the performance of the separate account.

A man invested $20,000 in a variable annuity purchased in a non-qualified account. At age 62, the account has grown to $35,000 and the man withdraws $3,000. The amount of the withdrawal is: A tax-free B subject to ordinary income tax but no penalty tax C subject to penalty tax but not to ordinary income tax D permitted to be rolled over to an IRA, if completed within 60 days

answer: B) subject to ordinary income tax but no penalty tax Contributions to variable annuities are not deductible. Earnings build tax-deferred. When distributions are taken, they are taxed on a LIFO basis. The first monies to be withdrawn represent the never-taxed build up. These are 100% taxable. This client invested $20,000, which has now grown to $35,000. At age 62, he withdraws $3,000 - all of which represents taxable build-up. However, there is no penalty tax because the client is over age 59½.

Mortality Guarantee

a guarantee made by an insurance company to an annuity purchaser that the annuitant will receive the annuity payments throughout his or her entire life, no matter how long he or she lives.

Expense guarantee

a guarantee that the expenses charged to the purchaser of an annuity contract will not rise above a certain level. If they do, then the insurance company agrees to absorb the excess.

AIR

abbreviation for "Assumed Interest Rate," the annual rate of return used in the prospectus of variable annuity that illustrates the compounding effect of contributions over the life of the contract and the resultant value of the annuity at retirement. The AIR is conservatively presented for illustrative purposes only; it is not a guaranteed rate of return.

Which statement made by a representative when selling an EIA is NOT misleading? A "EIAs are regulated by the State insurance commission" B "EIAs give a minimum guaranteed rate of return at no cost to the purchaser" C "EIAs outperform variable annuities in a bull market" D "EIAs are guaranteed by the PBGC"

answer: A) "EIAs are regulated by the State insurance commission" Equity Indexed Annuities are regulated as insurance, so Choice A is true. They do give a minimum guaranteed rate of return, but this adds to the expenses of the product. In a bull market, EIAs are capped to a maximum return of around 9%, so a variable annuity equity separate account will do better. Finally, the only guarantee backing an EIA is that of the issuing insurance company. They are not guaranteed by the Pension Benefit Guarantee Corporation.

Which statement is FALSE about the purchase of a non-qualified annuity? A Amounts contributed are tax-deductible B Earnings are tax-deferred until withdrawal C Contributions may be invested entirely in mutual funds D There is no limit on the amount contributed each year

answer: A) Amounts contributed are tax-deductible Variable annuities are a non-qualified retirement plan. There is no deduction for amounts contributed, making Choice A false. Earnings build tax-deferred, making Choice B true. Contributions are invested in a separate account that buys shares of a designated mutual fund, making Choice C true. There is no limit on contribution amounts, making Choice D true.

During the annuity period of a fixed annuity, the insurance company assumes all of the following risks EXCEPT: A Purchasing Power Risk B Mortality Risk C Expense Risk D Investment Risk

answer: A) Purchasing Power Risk In a fixed annuity, the insurance company assumes mortality risk, expense risk and investment risk. Mortality risk is the risk that the purchaser lives longer than the insurance company expects, and the insurance company is obligated to pay for as long as that person lives. Expense risk is the risk that the insurance company's expenses increase faster than expected - the insurance company caps the expenses that it can charge against the annuity. If these increase beyond the capped amount, this is the insurance company's problem. Investment risk is the risk that the insurance company's return on its investments does not keep pace with its payment obligations to fixed annuity holders. If its investments fare poorly, the insurance company does not reduce the amount of the fixed annuity payments to be made. With a fixed annuity, the purchaser assumes purchasing power risk - the risk of inflation. If there is inflation, the monthly annuity payments do not increase, so the annuitant's purchasing power declines over time.

Which of the following would cause payment of a term life policy death benefit claim to be denied? A The insured person commits suicide during the first year of the policy B The insured person died in an aviation accident that is covered by airline-provided life insurance C The policy has completed the contestability period D The policy was in force at the time of death

answer: A) The insured person commits suicide during the first year of the policy Life insurance policies have a "suicide clause" that denies a claim payment if the insured person commits suicide within the first 1 or 2 years of the start of the policy. This makes sure that someone does not take out a policy, intending to then kill him- or herself and improve the financial situation of the named beneficiary. In this case, the insurance company will simply refund the premium payments to the estate of the deceased individual. If an individual dies in an airplane accident where the carrier provided life insurance coverage to the passengers, this has nothing to do with the coverage provided by that unfortunate person's own life insurance policy. This will pay as well. Most life insurance policies have an initial "contestability period" where the death benefit will not be paid if the insured dies within the first 1 or 2 years after the policy is issued and the insurance company believes that there was misrepresentation or fraud involved with the issuance of the policy. If death occurs during the contestability period, the insurance company has the right to investigate whether the information provided in the application was accurate. This is done to make sure that someone who is really ill (and who did not disclose this fact on the application) does not take out a policy in anticipation of imminent death, in order to improve the financial situation of the named beneficiary. As long as the premiums are being paid, the policy remains in force and will pay out if the insured individual dies. If premium payments are not made, the policy will lapse and no payment will be made upon the insured's death.

Funds deposited to purchase a fixed annuity contract are invested by the insurance company in its: A general account B separate account C investment account D annuity account

answer: A) general account The insurance company's "general account" of investments collects the premiums paid for traditional insurance policies and fixed annuities and invests them to provide a return that will fund these insurance company obligations. If the underlying investments underperform, the insurance company will not reduce the annuity payment. In contrast, premiums paid for either variable life policies or variable annuity contracts are invested in a legally separate entity called a "separate account." The performance of the securities held in the separate account will determine the amount of insurance benefit or annuity payment - so they will vary.

An investment would be made in a variable annuity in order to get: A market participation and tax deferred growth B market risk reduction tax and tax deferred growth C market participation and tax free income at retirement D market risk reduction tax and tax free income at retirement

answer: A) market participation and tax deferred growth The contribution to a variable annuity is not deductible, but the earnings build tax deferred. Income taken at retirement age is taxable on the portion attributable to the never-taxed build-up. Contributions are invested in a separate account holding shares of a designated mutual fund, typically an equity growth fund. If stock prices rise, the mutual fund shares will rise in value, which will increase annuity payments, so the investment offers market participation. On the flip side, equity values can also drop, which would reduce the mutual fund's value, which would reduce the annuity payments - so there is no market risk reduction.

As the economy fluctuates, the holder of a variable annuity contract should know that: A payments will fluctuate based upon the actual return that the separate account earns B payments will not fluctuate over time C during periods of recession, annuity payments are protected and will not be reduced D during periods of negative economic growth, it is likely that annuity payments will increase

answer: A) payments will fluctuate based upon the actual return that the separate account earns The benefit payments from a variable annuity contract will fluctuate based on overall economic conditions. Variable annuity separate accounts are most often invested in equities. If economic growth increases, the performance of the equity securities held in the separate account will increase and so, the amount of the annuity payments will increase. In difficult economic times, the reverse is true.

A customer buys an annuity requiring an initial payment of $100,000. The annuity offers a 4% Bonus Credit. This means that: A the insurance company will pay an extra $4,000 into the contract on top of the customer's $100,000 payment B the customer receives a guarantee that the separate account will grow at a minimum 4% rate per year C the insurance company will issue a check to the customer for $4,000 upon acceptance of the contract D the customer will receive a $4,000 credit from the insurance company that can be used to buy an additional life insurance policy offered by that company

answer: A) the insurance company will pay an extra $4,000 into the contract on top of the customer's $100,000 payment When a variable annuity contract offers a "bonus credit," the company matches any customer payment made into the contract with an extra payment of anywhere from 1-5% of the amount paid. Since this customer is paying $100,000, the bonus credit of 4% means that the insurance company will pay an extra 4% of $100,000 = $4,000 into the contract. Usually annuity contracts with a "bonus credit" have higher annual expense ratios - a classic example of the fact that "you don't get something for nothing."

A customer invests $100,000 in an Equity Indexed Annuity contract tied to the Standard and Poor's 500 Index. The contract has a 90% participation rate; a 15% cap and a 0% floor. Interest is credited to the contract under the annual reset method using the simple interest method. The performance of the Standard and Poor's Index over the next 3 years is: Year 1:+20% Year 2:-4.5% Year 3:+10% At the end of year 3, the customer will have a principal balance of: A $120,000 B $124,000 C $128,000 D $132,000

answer: B) $124,000 The first year increase in the index of 20% with a 90% participation means that 18% would be credited to the account - however, because of the 15% cap, this is the first year credit of $15,000. ($100,000 principal x .15) Under the simple interest method, the second year interest credit is still based on the $100,000 principal amount (there is no "interest on interest" as is the case with compound interest) and because of the 0% floor, there will be no credit. Under the simple interest method, the third year interest credit is still based on the $100,000 principal amount (there is no "interest on interest" as is the case with compound interest) and because of the 90% participation, 90% of the 10% index increase, or 9% will be credited. The credit will be $9,000. ($100,000 principal x .09). Thus, the principal value after year 3 will be $100,000 + $15,000 + $0 + $9,000 = $124,000.

An Equity Indexed Annuity tied to the Standard and Poor's 500 Index is sold with a participation rate of 70%, a 10% cap and a 3% floor. In a year when the S&P 500 Index increases by 5%, the principal will be credited with a: A 3.00% increase B 3.50% increase C 5.00% increase D 10.00% increase

answer: B) 3.50% increase Features of EIAs are a "participation rate" along with a cap (maximum) interest rate and a floor (minimum) interest rate. While some contracts have a participation rate of 100%, most have a participation rate of somewhere between 70% -90%. In this example, the S&P 500 index increased by 5% this year, and with a 70% participation, 3.50% would be credited to the account. The 10% cap is irrelevant here, as is the 3% floor.

An insurance company that sells an Equity Indexed Annuity (EIA) would use which method to credit the change in investment value? A Breakeven B Point-to-point C Monte Carlo D Moving average

answer: B) Point-to-point

Which of the following is NOT an advantage of owning a non-qualified variable annuity? A Payments are guaranteed to be made for the life of the contract holder B The amounts contributed are tax deductible to the contract holder C The separate account growth is tax-deferred until distributions commence D There are no limits on the amount that an individual can invest

answer: B) The amounts contributed are tax deductible to the contract holder Contributions to non-qualified variable annuity contracts are not deductible. The other 3 choices are advantages. The purchaser is guaranteed income for life. There is no limit to the amount that can be contributed, Reinvested dividends and capital gains grow tax deferred - tax is due only when distributions commence.

Which of the following would cause payment of a term life policy death benefit claim to be denied? A The policy names a minor as the beneficiary B The policy has lapsed because of non-payment of premiums C The policy has completed the contestability period D The policy was in force at the time of death

answer: B) The policy has lapsed because of non-payment of premiums A life insurance claim will not be paid out if the policy has lapsed because of non-payment of premiums. The insurance company sends the policyholder multiple advance notices when premiums are not paid regarding the fact that the policy will no longer be in force and that any claims would be denied. If a minor is named as a beneficiary on a life insurance policy, the proceeds cannot be paid upon the insured's death to a minor. This will cause a delay in the payment, but payment will not be denied. A court must appoint a guardian over the minor in order for the death benefit to be paid to the "guardian for the benefit of the minor." Most life insurance policies have an initial "contestability period" where the death benefit will not be paid if the insured dies within the first 1 or 2 years after the policy is issued and the insurance company believes that there was misrepresentation or fraud involved with the issuance of the policy. If death occurs during the contestability period, the insurance company has the right to investigate whether the information provided in the application was accurate. This is done to make sure that someone who is really ill (and who did not disclose this fact on the application) does not take out a policy in anticipation of imminent death, in order to improve the financial situation of the named beneficiary.

Premiums deposited to purchase a variable annuity contract are invested by the insurance company in: A the general account B a separate account C an investment account D an annuity account

answer: B) a separate account The premiums paid for either variable life policies or variable annuity contracts are invested in a legally separate entity called a "separate account." The performance of the securities held in the separate account will determine the amount of insurance benefit or annuity payment - so they will vary. In contrast, the insurance company's "general account" of investments collects the premiums paid for traditional insurance policies and fixed annuities and invests them to provide a return that will fund these insurance company obligations. If the underlying investments underperform, the insurance company will not reduce the insurance benefit or annuity payments.

A customer buys a variable annuity and elects a payout option of Life Income with a 20 year period certain. This means that: A payments will continue for the annuitant's life, not to exceed 20 years B payments will continue for the annuitant's life, but if he dies before 20 years elapse, payments continue to his heir(s) C payments continue for the life of the annuitant and then cease D payments continue for 20 years to the annuitant or beneficiary

answer: B) payments will continue for the annuitant's life, but if he dies before 20 years elapse, payments continue to his heir(s) An annuity payout option of Life-with Period Certain means that the annuity continues for the customer's life, but if he dies before the "period certain" (20 years in this case) is completed, payments will continue to a beneficiary until the 20 year period is completed.

When comparing a mutual fund purchase to a variable annuity purchase, the main advantage of investing in a variable annuity is the fact that: A the contribution to a variable annuity is tax deductible while the contribution to a mutual fund is not tax deductible B the dividends earned in the variable annuity subaccount grow tax deferred while the dividends earned in a mutual fund are taxable annually C annual expenses charged against a variable annuity holding are lower than the annual expenses charged against a mutual fund holding D the dividends earned in the variable annuity subaccount must be reinvested prior to annuitization while the dividends earned in a mutual fund can either be reinvested or withdrawn

answer: B) the dividends earned in the variable annuity subaccount grow tax deferred while the dividends earned in a mutual fund are taxable annually The main advantage of a variable annuity over a mutual fund is the tax-deferred build-up in the separate account. In contrast, mutual fund distributions are taxable annually, whether reinvested or not. Contributions to both variable annuities and mutual funds are not deductible (unless they are purchased in a qualified retirement plan). Variable annuity expenses are higher than mutual fund expenses, because there are insurance company expenses charged to the account, as well as the underlying mutual fund expenses. Distributions from a variable annuity subaccount must be reinvested until annuitization - they cannot be taken out unless tax is paid (plus a 10% penalty tax if the account holder is under age 59 ½). In contrast, mutual fund distributions can either be reinvested or taken out - so this flexibility is a benefit for a mutual fund investment as compared to a variable annuity.

Level premium and permanent are terms associated with: A term insurance B whole life insurance C universal life D fixed index universal life

answer: B) whole life insurance Both whole life and universal life are "permanent" insurance policies, meaning that they cannot be canceled as long as the premium is paid. In contrast, term life is only good for the term of the policy and the insurer does not have to renew. Level premium is only associated with whole life - the premium paid is the same annual amount each year. The level premium pays for both the cost of insurance and also includes a portion that is invested by the insurance company to build "cash value." In contrast, a term life premium, which only buys pure insurance without an investment component, increases as the policyholder gets older (greater risk of death). Universal life policies break apart the premium of a whole life policy into the insurance component and the investment component. These are "flexible policies" because if the policyholder pays both parts, the policy operates much like whole life; however, the policyholder can elect to only pay the insurance component, paying a lower amount (for example, when times are tough) and then only buys pure insurance without any funds added to the investment component. The investment component of both whole life and universal life policies is invested in fixed income securities, which are safe. A variation on a universal life policy allows the holder to invest the cash build-up in either a fixed account or an equity index account, such as one that mirrors the S&P 500 Index, or a combination of both. This variant is "FIUL" - Fixed Index Universal Life.

Life insurance companies developed variable life policies from the: A term life policy B whole life policy C universal life policy D fixed annuity

answer: B) whole life policy

A customer invests $100,000 in an Equity Indexed Annuity contract tied to the Standard and Poor's 500 Index. The contract has a 90% participation rate; a 15% cap and a 3% floor. Interest is credited to the contract under the annual reset method and is compounded annually. The performance of the Standard and Poor's Index over the next 3 years is: Year 1:+10% Year 2:-5% Year 3:-10% At the end of year 3, the customer will have a principal balance of approximately: A $95,000 B $100,000 C $116,000 D $121,000

answer: C) $116,000 The first year increase in the index of 10% with a 90% participation means that 9% would be credited to the account. The 15% cap is irrelevant. Thus, at the end of the first year, the $100,000 balance is worth $109,000. Because of the 3% floor, even though the index fell in each of the next 2 years, the account value increases to $109,000 x 1.03 = $112,270 at the end of year 2; and $112,270 x 1.03 = $115,638 at the end of year 3.

A customer owns a perpetuity that pays $500 per month. Assuming that the market rate of return is 5%, the value of the contract is: A $10,000 B $100,000 C $120,000 D $150,000

answer: C) $120,000 A perpetuity makes payments forever. To calculate the value of the contract, you take the annual (not monthly) payment received and divide it by the market rate of interest. $6,000 annual payment received / .05 = $120,000

A customer invests $100,000 in an Equity Indexed Annuity contract tied to the Standard and Poor's 500 Index. The contract has a 90% participation rate; a 15% cap and a 3% floor. Interest is credited to the contract under the annual reset method and is compounded annually. The performance of the Standard and Poor's Index over the next 3 years is: Year 1:+20% 2:-5% Year 3:-10% At the end of year 3, the customer will have a principal balance of approximately: A $100,000 B $105,000 C $122,000 D $125,000

answer: C) $122,000 The first year increase in the index of 20% with a 90% participation means that 18% would be credited to the account - however, because of the 15% cap, this is the first year credit, so the $100,000 balance is worth $115,000 after the first year. Because of the 3% floor, even though the index fell in each of the next 2 years, the account value increases to $115,000 x 1.03 = $118,450 at the end of year 2; and $118,450 x 1.03 = $122,004 at the end of year 3.

A customer invests $100,000 in an Equity Indexed Annuity contract tied to the Standard and Poor's 500 Index. The contract has a 90% participation rate and a 15% cap. Interest is credited to the contract under the annual reset method and is compounded annually. The performance of the Standard and Poor's Index over the next 3 years is: Year 1:+20% Year 2:-5% Year 3:+10% At the end of year 3, the customer will have a principal balance of: A $100,000 B $115,000 C $125,350 D $128,620

answer: C) $125,350 The first year increase in the index of 20% with a 90% participation means that 18% would be credited to the account - however, because of the 15% cap, this is the first year credit, so the $115,000 balance is worth $115,000 after the first year. Because this is an insurance product, the customer does not bear investment risk, and the "floor" rate is 0% (unless the product offers a higher floor rate). Because of the 0% floor, the balance stays at $115,000 as of the end of year 2. In year 3, the $115,000 balance will grow by 9% (90% of the 10% growth rate) for a balance of $125,350 at the end of year 3.

Which of the following risks does the purchaser of a variable annuity assume? A Expense B Mortality C Investment D Credit

answer: C) Investment The purchaser of a variable annuity assumes the investment risk because the premiums are deposited in the insurance company's separate account, not to the general account. The performance of the securities held in the separate account determines the amount of the annuity payment. Mortality risk and expense risk is borne by the insurance company for any annuity - fixed or variable. Mortality risk is the risk that the purchaser lives longer than the insurance company expects, and the insurance company is obligated to pay for as long as that person lives. Expense risk is the risk that the insurance company's expenses increase faster than expected - the insurance company caps the expenses that it can charge against the annuity. If these increase beyond the capped amount, this is the insurance company's problem. Credit risk is not associated with a variable annuity because the assets of the underlying separate account are not available to insurance company creditors if the insurance company fails. The separate account assets remain the property of the variable annuity purchaser.

Which of the following is associated with fixed annuities? A Voting rights B Federal regulation C Level payments D Equity investments

answer: C) Level payments Fixed annuities are an insurance product - they are not defined as a "security." The purchaser will receive a fixed annuity amount. The level payments do not vary with the performance of the investments funding the annuity. Fixed annuities are invested in the insurer's general account, which is required to be invested primarily in fixed income investments. Insurance products such as a fixed annuity are only subject to State regulation. There is no Federal regulation of insurance products. Finally, purchasers of insurance products do not have voting rights; in contrast, purchasers of common stock (a security), including purchasers of mutual fund shares under a variable annuity contract, do have voting rights.

Which annuity payout option usually results in the largest periodic payment? A Unit Refund Annuity B Joint and Last Survivor Annuity C Life Annuity D Life Annuity-Period Certain

answer: C) Life Annuity The shorter the expected annuity period, the larger the payment. A life annuity lasts only for that person's life - this is the shortest expected period of those given. A life annuity with period certain continues to pay for a fixed time period if the person dies early; a joint and last survivor annuity pays a spouse when one person dies; a unit refund annuity pays a lump sum if a person dies early.

Which action taken regarding a universal variable life insurance policy will NOT result in tax liability? A Cash surrender B Partial withdrawal C Loan of up to 95% D Payout of death benefit

answer: C) Loan of up to 95% Proceeds distributed from a variable life insurance policy are taxable income if there is a distribution of benefits above the amount invested (tax basis) in the separate account. This would include a cash surrender (surrender of the entire policy for its current cash value, terminating the policy) or making a partial withdrawal from the policy. The payment of a death benefit from the policy, while not taxable income to the recipient, is included in the taxable estate of the deceased individual. If the aggregate value of the estate exceeds the estate tax exclusion, there will be estate tax liability. The only way to get cash out of a variable policy without a potential tax consequence is to borrow against the policy. In general, most "cash value" policies only permit a loan of up to 75% of cash value; but if the policy is fully paid, often the loan amount is raised to 95%.

Which of the following are attributes of Equity Indexed Annuities? A Participation rate and market cap B Index crediting method and market cap C Participation rate and floor D Market cap and dividends

answer: C) Participation rate and floor An "attribute" is a feature or characteristic. Equity Indexed Annuity (EIA) features include interest credited yearly based on the return of a reference equity index (such as the S&P 500 Index), but the annual credit is subject to a cap and a floor. In addition, the interest is credited based on a "participation rate." Say that it is an EIA linked to the S&P 500 Index, with a cap of 10% and a floor is 1%. Assume that the participation rate is 80%. If the S&P 500 Index rises by 5% in a year, the interest earned will be credited at 80% participation = 4%. In a year when the S&P 500 Index declines, there will still be a 1% interest credit because of the floor. Therefore, the participation rate, cap, and floor are all attributes of an EIA. The actual index crediting method used is another attribute of an EIA (such as point-to-point, annual reset, or high-water mark). However, market cap is not an attribute, and since this is in Choices A, B, and D, these must be incorrect answers.

A married couple, ages 29 and 31, have approached an IAR about planning for their children's college education. They are interested in purchasing mutual funds and have heard about 529 plans, which they want to learn about. The IAR explains that 529 plans are not appropriate since the mutual fund investment options are limited and instead, recommends the purchase of a variable life policy, since the separate account invests in mutual funds. The IAR also discloses that he earns a higher commission when he sells a variable annuity than when he sells mutual funds. The couple already has life insurance policies that cover their needs. Which statement is TRUE about this situation? A The IAR has not breached his fiduciary responsibility because he has disclosed the fact that he earns a higher commission when selling variable life policies B The IAR has not breached his fiduciary responsibility because he has recommended a product that offers tax benefits C The IAR has breached his fiduciary responsibility because he has recommended an unsuitable investment D The IAR has breached his fiduciary responsibility because he is prohibited from selling life insurance

answer: C) The IAR has breached his fiduciary responsibility because he has recommended an unsuitable investment This couple does not need additional insurance - plain and simple. Insurance is not an investment, though it may have some "investment features." The IAR has breached his fiduciary duty to the client.

All of the following statements concerning universal life insurance are correct EXCEPT the: A policy owner can skip some premium payments after cash value builds B cash value is invested in the insurer's general account C cash value increases at a fixed and guaranteed rate of return D policy owner can use cash value to increase the death benefit

answer: C) cash value increases at a fixed and guaranteed rate of return With a universal life policy, any cash value is invested in the insurer's general account, and the policy owner's account is credited for the interest income earned on the general account. This rate of return can vary from year to year. The policy owner can use cash value to increase the death benefit or to skip some premium payments.

The Assumed Interest Rate (AIR) associated with variable annuities is the: A rate at which the annuity payments are scheduled to increase each year B interest rate paid to the annuitant C estimated future earnings rate needed to maintain level payments to the annuitant D average of past and assumed future rates of return earned by the annuity

answer: C) estimated future earnings rate needed to maintain level payments to the annuitant AIR stands for Assumed Interest Rate. It is a conservative estimate of annual return needed for the insurance company to maintain a constant annuity payment amount. The AIR is chosen by the customer at the beginning of the payout period, based on an interest rate range set by the State. It is an estimated interest rate that the separate account investments must earn to maintain payment amounts. Once the first annuity payment is made based on the chosen AIR, if the earnings in the separate account are greater than the AIR, the next payment increases. If the earnings in the separate account are less than the AIR, the next payment decreases. Variable annuities do not provide scheduled increases in payment amounts. The insurance company bases payouts on the value of annuity units when it pays them out.

All of the following statements concerning a variable life insurance policy are correct EXCEPT: A premium payments are level and fixed for the insured's lifetime B the cash value increases based on equity investments C the death benefit is fixed and guaranteed for the insured's entire life D policy loans will reduce the amount paid at death

answer: C) the death benefit is fixed and guaranteed for the insured's entire life Whole life insurance protects the purchaser from increasing premiums as that person ages, and there are no renewals - the policy is good for that person's "whole" life. With a whole life policy, the annual premium is level, and will start out higher than a term life policy. Part of the premium is invested in the insurance company's general account and is guaranteed to grow at a fixed rate. As the general account investment portion grows, the policy builds "cash value" that can be borrowed. Any borrowed funds reduce the benefit payment upon death. Variable life is a variation on whole life where a level annual premium is invested in a separate account, typically invested in equities. Better performance of the securities in the separate account will increase the death benefit, hence the term "variable life," - so the death benefit is not fixed. The policy builds cash value similar to whole life, but the amount of cash value depends on the performance of the separate account. Part (but not all) of this value can be borrowed, since the separate account performance will vary. Any borrowed funds reduce the benefit payment upon death.

A customer has a young disabled child with multiple sclerosis and wishes to invest enough money to provide $5,000 a month in perpetuity to pay for ongoing medical expenses. Upon the death of the disabled individual, the principal amount will be left to a charity searching for a cure for the disease. Assuming that the principal can be invested at a 6% annual rate of return, the required principal amount is: A $50,000 B $100,000 C $500,000 D $1,000,000

answer: D) $1,000,000 A perpetuity is a "perpetual payment" - so it is an annuity that goes on forever. If $1,000,000 is invested at 6%, it gives annual income of 6% of $1,000,000 = $60,000 without eating into the principal amount. $60,000 annual income / 12 months = $5,000 month income. The best way to deal with this type of question is to take 6% of the principal amount given in each choice to get the annual income and divide it by 12 months a year.

A customer invests $100,000 in an Equity Indexed Annuity contract tied to the Standard and Poor's 500 Index. The contract has a 90% participation rate; a 15% cap and a 3% floor. Interest is credited to the contract under the annual reset method using the simple interest method. The performance of the Standard and Poor's Index over the next 3 years is: Year 1:+20% Year 2:-5% Year 3:+10% At the end of year 3, the customer will have a principal balance of: approximately: A $100,000 B $105,000 C $124,000 D $127,000

answer: D) $127,000 The first year increase in the index of 20% with a 90% participation means that 18% would be credited to the account - however, because of the 15% cap, this is the first year credit of $15,000. ($100,000 principal x .15) Under the simple interest method, the second year interest credit is still based on the $100,000 principal amount (there is no "interest on interest" as is the case with compound interest) and because of the 3% floor, the credit will be $3,000. ($100,000 principal x .03). Under the simple interest method, the third year interest credit is still based on the $100,000 principal amount (there is no "interest on interest" as is the case with compound interest) and because of the 90% participation, 90% of the 10% index increase, or 9% will be credited. The credit will be $9,000. ($100,000 principal x .09). Thus, the principal value after year 3 will be $100,000 + $15,000 + $3,000 + $9,000 = $127,000.

A grandfather wishes to provide a perpetuity for his 2 grandchildren. He wants to give them the amount of $1,000 a month. How much principal is required assuming that it is invested at a 3% rate of return? A $33,333 B $40,000 C $333,333 D $400,000

answer: D) $400,000 A perpetuity is a "perpetual payment" - so it is an annuity that goes on forever. If $400,000 is invested at 3%, it gives annual income of 3% of $400,000 = $12,000 without eating into the principal amount. $12,000 annual income / 12 months = $1,000 month income. The best way to deal with this type of question is to take 3% of the principal amount given in each choice to get the annual income and divide it by 12 months a year.

A customer, age 57, has made payments into a non-tax qualified variable annuity contract totaling $10,000. The investment in the separate account is now worth $16,000. The customer wishes to withdraw $5,000 from the account. The tax implications of the withdrawal are: A $5,000 non-taxable return of capital and $0 penalty tax B $5,000 taxable ordinary income and $0 penalty tax C $5,000 taxable long-term capital gain and $0 penalty tax D $5,000 taxable ordinary income and $500 penalty tax

answer: D) $5,000 taxable ordinary income and $500 penalty tax Distributions from non-tax qualified retirement plans are accounted for on a LIFO - Last-In; First-Out basis. The first item that went into the plan was the original non-tax deductible contribution. The next item than went into the plan was the reinvestment of dividends, interest, and capital gains over time - all of which have been building tax deferred. When distributions commence, the first dollars out of the plan are accounted for as the return of the "build-up" - which was never taxed. The last dollars out of the plan are the original investment (cost basis) which was made with after-tax dollars and hence is not taxed. Thus, in this plan $10,000 was invested; and it built up to $16,000. Thus, the first $6,000 out of the plan is taxable ordinary income; the remaining $10,000 is a non-taxable return of capital. In addition, since this customer is under age 59½, a 10% penalty tax must be paid on any distribution, since this is a premature distribution. The customer withdrew $5,000, all of which is taxable as ordinary income, plus an additional 10% ($500) penalty tax is due on the distribution.

A customer, age 49, invests $30,000 in a variable annuity contract as a lump sum. After 10 years at age 59, the customer wishes to withdraw $20,000 from the contract. At that point, the separate account is valued at $50,000. The withdrawal is: A non-taxable B 100% taxable as a capital gain C 100% taxable at ordinary income rates D 100% taxable at ordinary income rates plus is subject to a 10% penalty tax

answer: D) 100% taxable at ordinary income rates plus is subject to a 10% penalty tax Distributions from non-tax qualified retirement plans are accounted for on a LIFO - Last-In; First-Out basis. The first item that went into the plan was the original non-tax deductible contribution. The next item than went into the plan was the reinvestment of dividends, interest, and capital gains over time - all of which have been building tax deferred. When distributions commence, the first dollars out of the plan are accounted for as the return of the "build-up" - which was never taxed. The last dollars out of the plan are the original investment (cost basis) which was made with after-tax dollars and hence is not taxed. Thus, in this plan $30,000 was invested; and it built up to $50,000. Thus, the first $20,000 out of the plan is taxable ordinary income; the remaining $30,000 is a non-taxable return of capital. In addition, since this client is under age 59½, a 10% penalty tax must be paid on any distribution, since this is a premature distribution. The customer withdrew $20,000, all of which is taxable as ordinary income, plus an additional 10% penalty tax is due on the distribution.

Which statement concerning the AIR of a variable annuity contract is TRUE? A It is the insurer's best estimate of the future performance for accumulated income retained in the separate account B It applies during the accumulation period C It must be adjusted annually for inflation D It applies only during the annuity period

answer: D) It applies only during the annuity period AIR refers to the assumed interest rate used to determine the initial monthly payment to the annuitant - it is set when the contract is annuitized and only applies during the annuity period. Once the first annuity payment is made based on the chosen AIR, if the earnings in the separate account are greater than the AIR, the next payment increases. If the earnings in the separate account are less than the AIR, the next payment decreases. The AIR has no meaning during the accumulation period. Also note that the prospectus has an "AIR Illustration" that is an estimate of the annuity to be paid based on a conservative growth estimate, but the actual AIR is not set until the contract is annuitized.

Which statement concerning variable universal life policies is correct? A Premium amounts are fixed and coverage amounts can vary B Premium amounts can vary and coverage amounts are fixed C Premium and coverage amounts are fixed D Premium and coverage amounts can vary

answer: D) Premium and coverage amounts can vary Universal life policies allow the policy owner to change premium payments up or down to buy a higher or lower death benefit. With a variable universal life policy, the insurer invests premium dollars in a separate account to provide the death benefit. These policies offer a minimum guaranteed death benefit; however, the death benefit will increase if the separate account investments perform better than anticipated. Thus, premiums may vary, and the death benefit may vary, depending upon separate account performance.

All of the following would be included in the evaluation of the amount an investor would pay for a viatical or life settlement EXCEPT: A Life expectancy of the viator B Amount of discount from policy face amount C Availability of investors D Tax consequence to the viator of selling the policy

answer: D) Tax consequence to the viator of selling the policy A "viatical settlement" is a contract between a life insurance policyholder (the "viator") and a viatical settlement provider, where, the policyholder gets an immediate cash payment in exchange for transferring ownership of the policy to the viatical settlement provider - the purchaser of the policy. These typically appeal to insured individuals who are terminally ill, who can get immediate cash to pay for medical and support needs by selling the policy. The policy is sold at a discount to face value, and the purchaser assumes the responsibility for making the premium payments until the insured individual/viator dies. When the insured person dies, the purchaser of the policy (the viatical settlement provider) who now owns the policy gets the policy face amount. The discount to policy face value is based on the estimate of the remaining life of the insured/viator. The shorter the expected life of the insured, the less the discount to face that will be paid for the policy. The viatical settlement provider can then sell interests in the policy to investors - and a readily available pool of investors will increase the amount that would be paid for the policy. The fact that the sale of the policy might result in taxable income to the viator/policyholder is a consideration for the insured person; not for the investor who is paying for the policy.

Which statement concerning term life insurance is TRUE? A The cash value is invested in the insurer's general account B The representative must have a Series 6 or Series 7 license to sell the policy C The policy owner can skip premium payments in some years D The premium is much lower than for whole life while the insured is young

answer: D) The premium is much lower than for whole life while the insured is young Term life insurance is pure insurance with no investment element. For the premium paid, the purchaser is buying life insurance good for a fixed time period. At the end of that time period, the policy must be renewed to maintain coverage, typically at a higher premium as the insured individual ages (because of the greater mortality risk). When the purchaser of a term life policy is young, the premium is very low; as that person ages, the premium gets higher and higher. An individual does not need a Series 6 or Series 7 license to sell insurance products. The Series 6 license is needed to sell investment company securities offerings, while a Series7 allows an individual to sell any type of security.

Which of the following annuity payment options will pay the estate of the annuitant if the full value of the account was not received? A Life Annuity B Life Annuity with Period Certain C Joint and Last Survivor Annuity D Unit Refund Annuity

answer: D) Unit Refund Annuity If the holder of a unit refund annuity dies before receiving the full investment value from the separate account, his estate gets a "refund" of the remaining value.

Which of the following guarantees do insurance companies typically give with BOTH fixed and variable annuities? I Mortality guarantee II Expense guarantee III Investment return guarantee IV Benefit amount guarantee

answer: I and II only Insurers give mortality and expense guarantees for both fixed and variable annuities. Only issuers of a fixed annuity guarantee the investment return and the benefit payment amounts. The investment return and benefit payment amounts from a variable annuity contract are not guaranteed by the issuer - the actual amount to be paid depends on the performance of the underlying securities held in the separate account. Thus, the purchaser of a variable annuity contract assumes the investment risk.

Which statements are TRUE when comparing a 15-year period certain annuity to a life annuity with a 15-year period certain? I The purchaser of 15-year period certain annuity will only receive payments for 15 years and can outlive the annuity payments II The purchaser of a 15-year period certain annuity will receive payments for life, but for no less than 15 years III The purchaser of a 15-year period certain annuity will receive larger payments than the holder of a life annuity with a 15-year period certain IV The purchaser of a 15-year period certain annuity will receive smaller payments than the holder of a life annuity with a 15-year period certain

answer: I and III A 15-year period certain annuity is only available as a fixed annuity. The purchaser makes a payment (or payments) to the insurance company, which when annuitized, will pay for 15 years. There is no life annuity feature associated with this. It only pays for a stated time period - in this case 15 years. These are used most often to bridge a gap between early retirement and when social security payments start. For example, if an individual retired at age 55 and full social security payments started at age 70, he or she could buy this contract to provide payments for that 15-year gap. In contrast, a life annuity with a 15-year period certain will pay for the annuitant's life, but for no less than 15 years (if the purchaser dies before this time - the contract will continue paying to a beneficiary). This has a longer expected payout time period than a 15-year period certain annuity, so the monthly payment will be less than would be received with a simple period certain annuity.

Which statements are TRUE regarding variable annuities during the annuity phase? I The annuity unit value fluctuates II The annuity unit value remains the same III The annuity check received may be for a different amount at each payment IV The annuity check received will be for the same amount at each payment

answer: I and III Once the separate account interest is "annuitized," the accumulation units are turned into a fixed number of annuity units. Since the earnings in the account vary, each payment based on a fixed number of annuity units also varies (hence the term variable annuity). So, when the investor receives proceeds from the account each month as an annuity payment, the annuity check can be for a different amount, all depending on the performance of the securities in the separate account.

Which of the following statements are TRUE regarding a life annuity? I The shorter the expected annuity period, the larger the monthly payment II The longer the expected annuity period, the larger the monthly payment III A life annuity usually pays the largest amount of all of the annuity payment options IV A life annuity usually pays the smallest amount of all of the annuity payment options

answer: I and III The shorter the time period to "expected death" when the separate account is annuitized, the larger the monthly payment will be; conversely the longer the time period to "expected death" when the separate account is annuitized, the smaller the monthly payment will be. Regarding annuity payment options, this must be looked at from the standpoint of the insurance company, that has a large pool of annuitants to cover. The insurance company can afford to pay a larger payment to those persons who it expects will be paid for the shortest time period; it will make smaller monthly payments when it expects to pay for a longer time period. A life annuity lasts only for that person's life - this is the shortest expected period of the annuity payment options. A life annuity with period certain continues to pay for a fixed time period if the person dies early; a joint and last survivor annuity pays a spouse when one person dies; a unit refund annuity pays a lump sum if a person dies early.

Which statements are TRUE regarding the annuitization of a variable annuity contract? I A Life Annuity payout option may be elected by the policy holder II Life Annuity-Period Certain is the preferred payout option III The number of annuity units is fixed; the annuity payment may vary IV The annuity payment is fixed; the number of annuity units may vary

answer: I and III Variable annuity contracts allow the holder to elect a payout option that meets that person's individual requirements. The statement that a life annuity-period certain is a preferred payout option is erroneous - the choice of payout method depends on the needs of the annuitant. Once the contract is annuitized, the number of annuity units is fixed. However, the value of each unit varies with the performance of the underlying securities, hence the monthly annuity payment may vary.

Which statements are TRUE about fixed annuity contracts? I A fixed annuity contract is defined as an "insurance" product II A fixed annuity contract is defined as a "security" product III The issuer of a fixed annuity contract bears the investment risk IV The purchaser of a fixed annuity contract bears the investment risk

answer: I and III With a fixed annuity, the insurance company collects a premium from the purchaser and invests it in its general account (which holds the investments made by the insurance company). The performance of the investments held in the general account does not affect the amount of the annuity promised to the purchaser. Thus, the insurance company bears the investment risk - which is the risk that its investment value does not grow as fast as its obligations to fixed annuity holders. The insurance company promises to pay a fixed annuity amount for the purchaser's life, regardless of how well, or how poorly, the investments in the general account perform.

Which statements are TRUE when comparing Equity Indexed Annuities to Variable Annuities? I In a year of sharply rising stock prices, variable annuities will outperform equity indexed annuities II In a year of sharply rising stock prices, equity indexed annuities will outperform variable annuities III In a year of sharply falling stock prices, variable annuities will outperform equity indexed annuities IV In a year of sharply falling stock prices, equity indexed annuities will outperform variable annuities

answer: I and IV Equity indexed annuities have a cap on their maximum annual return, while variable annuities do not. Thus, in a year of sharply rising stock prices, variable annuities will outperform equity indexed annuities. In a year of sharply falling stock prices, equity indexed annuities will do better, because they protect their positions with put options. This is one of the reasons they have higher annual expenses than variable annuities. In contrast, variable annuity separate accounts can lose sharply in a bear market, unless they offer a principal protection feature, which would increase expenses.

Which of the following risks do the issuers of variable annuities assume? I Investment risk II Expense risk III Mortality risk IV Credit risk

answer: II and III only The purchaser of a variable annuity assumes the investment risk because the premiums are deposited in the insurance company's separate account, not to the general account. The performance of the securities held in the separate account determines the amount of the annuity payment. Mortality risk and expense risk are borne by the insurance company for any annuity - fixed or variable. Mortality risk is the risk that the purchaser lives longer than the insurance company expects, and the insurance company is obligated to pay for as long as that person lives. Expense risk is the risk that the insurance company's expenses increase faster than expected - the insurance company caps the expenses that it can charge against the annuity. If these increase beyond the capped amount, this is the insurance company's problem. Credit risk is not associated with a variable annuity because the assets of the underlying separate account are not available to insurance company creditors if the insurance company fails. The separate account assets remain the property of the variable annuity purchaser.

Premiums are invested in an insurance company separate account for which of the following policies? I Whole life II Variable life III Universal life IV Flexible-premium variable life

answer: II and IV Variable contracts (either variable life or variable universal life) have the premiums deposited to a separate account. The performance of the separate account determines the ultimate death benefit, so the policyholder bears the investment risk. Flexible premium variable life is another name for variable universal life, which gives policyholders the right to skip a premium payment. Term life, whole life, and universal life premiums are deposited to the insurance company's general account. The death benefit is fixed based upon premium contribution and is not subject to investment risk. The insurance company invests the premiums collected through its general account and bears the investment risk.

Which statements are TRUE about variable annuity contracts? I A variable annuity contract is defined as an "insurance" product that is regulated under State insurance laws only II A variable annuity contract is defined as a "security" product that is regulated under both Federal securities laws and State insurance laws III The issuer of a variable annuity contract bears the investment risk IV The purchaser of a variable annuity contract bears the investment risk

answer: II and IV With a variable annuity, the insurance company collects a premium from the purchaser and invests it in a "separate account" (a legally separate account of investments that is segregated from the insurance company's general account). The separate account buys shares of a designated mutual fund. The performance of the investments held in the separate account determines the amount of the annuity that the purchaser will receive - the annuity payments will vary. Thus, the purchaser bears the investment risk in this product, which is why it is defined as a "security" under Federal law. Also note that because insurance companies are regulated separately by each State, their products, including variable annuities, are also subject to State insurance regulation.

In which of the following do investors have investment options available? I Whole life II Variable life III Universal life IV Variable universal life

answer: II and IV only Investment options are available to persons who hold separate account interests. They can choose the type of separate account to fund either variable annuities or variable life policies (e.g., common stock, bonds, money market instruments, and other securities). With these products, the purchaser bears the investment risk. Policies funded by the general account, which are whole life and universal life policies, do not offer investment options. The reason is that these policies guarantee an investment rate of return.