Series 6: Variable Products (Annuity Overview)

As the economy fluctuates, the holder of a fixed annuity contract should know that:

payments will not fluctuate over time Fixed annuities are just that - fixed. No matter how well or poorly the insurance company's general account performs, or how much the economy fluctuates, the annuitant receives a fixed monthly amount.

During the payout period of a variable annuity, which risks does the insurance company assume?

Mortality risk Expense risk In a variable annuity contract, the insurer assumes mortality risk (the risk that the annuitant may live longer than expected, causing the insurer to make a larger than expected payout) and expense risk (the risk that the expenses of operations may exceed the maximum limit set in the policy). However, the insurer does not assume investment risk. The insurer invests variable annuity premiums through a separate account. If the account performs better than expected, the annuity increases. If it performs worse than expected, the annuity decreases. Thus, the investment risk is borne by the annuitant.

Premiums deposited to purchase a variable annuity contract are invested by the insurance company in:

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.

An annuitized account in a variable annuity is most similar to:

pension payments Once a variable annuity separate account interest is "annuitized," the holder gets a fixed number of annuity units. Each month, the holder gets a payment equal to the fixed number of units x the unit value (which varies based upon the performance of the underlying investments held in the separate account). The payments continue for life. Thus, an annuitized account is most similar to pension payments.

As the economy and the stock market fluctuate, which of the following can the holder of a variable annuity expect to occur during the payout years?

Benefits will fluctuate according to the return 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.

Investments made prior to annuitization of a variable annuity contract are legally owned by the:

purchaser of the contract held in the 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. The separate account is typically invested in mutual fund shares designated by the contract purchaser; and until the contract is annuitized, the investor has legal ownership of the separate account units. In contrast, the insurance company collects the premiums paid for traditional insurance policies and fixed annuities and invests them in its general account to provide a return that will fund these insurance company obligations. The insurance company is the legal owner of general account assets - not the policyholder. If the underlying investments held in the general account underperform, the insurance company will not reduce the insurance benefit or annuity payments.

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

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.

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

I, III & 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 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 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

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.

Which term describes an Equity-Indexed Annuity?

Principal protected 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. Note that the insurance company does not actually own the underlying securities that are in the reference index. It is simply promising to give a return that is based on that index. If the insurance company fails, the purchaser of the annuity will now have nothing!

During the payout period of a fixed annuity contract, the annuitant assumes:

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. 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 statements concerning investment of premiums for fixed and variable annuities are correct? I Premiums for a fixed annuity go into the insurer's general account II Premiums for a fixed annuity go into the insurer's separate account III Premiums for a variable annuity go into the insurer's general account IV Premiums for a variable annuity go into the insurer's separate account

I and IV only The insurance company invests premiums for fixed annuities in its general account, and it invests premiums for variable annuities in separate accounts. The insurer's general account is invested primarily in fixed-income investments, while separate accounts are usually invested in equities.

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

II and III only 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 statement is TRUE about variable annuity contracts?

The purchaser of a variable annuity contract bears the investment risk 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.

Premiums paid to purchase a fixed annuity are deposited to the insurance company's:

general account When an insurance company collects premiums from the purchasers of a fixed annuity, it invests the premiums in its general account. On the other hand, the insurer invests premiums for a variable annuity in one or more separate accounts. While the insurer must invest the assets in its general account mostly in fixed-income investments, it can invest a separate account in equities to obtain greater returns. The investments of a separate account take greater risk for increased returns.