Fixed Annuities

Fixed Annuities.

Another way annuities are identified is by the nature of their underlying investment platform. On this basis there are four basic product designs: -fixed annuities -variable annuities -equity-indexed annuities -market-value adjusted annuities This lesson focuses on fixed annuities. Variable annuities, equity-indexed annuities, and market-value adjusted annuities are discussed in another lesson.

Fixed Annuity Accumulation

Fixed annuities may either be immediate or deferred contracts. Fixed deferred annuities can be funded with either fixed premiums (so-called retirement annuities) or flexible premiums. The annuity contract guarantees a minimum rate of interest to be credited to the account for a specified period. To be market competitive, most fixed annuities today credit deferred annuities with the higher of the contractually guaranteed rate or a declared rate that reflects current market rates. The contract will never be credited with less than the guaranteed interest rate.

For test

-Investment platform is similar to life insurance -fixed annuities (think: Whole Life Insurnace) --both have guaranteed death benefit (for annuities its the deferred annuity death benefit is equal to the net contract value: formula above) -- Contract values are invested in the insurance comapny's general account, which means: ---Contract values are guaranteed ---Contract values my be credited with the greater of a guaranteed or current declared rate of interest which would be higher. --Significant difference in the two: Tax treatment of withdrawals. ---Whole Life insurance is based on favorable FIFO. First in First out. ---Deferred annuity is treated as a less favorable LIFO= You start taking money out of the deferred annuity for tax purposes it's treated as first a distribution of taxable gain and only after that gain is distributed are any subsequent distributions treated as a tax free return of principle. other way for Whole Life Insurance.

Guaranteed Minimum and Current (Declared) Interest Rates

Insurance companies that offer a declared-rate fixed annuity manage two interest rates with their fixed deferred annuities: 1. a guaranteed minimum rate (which is stated in the annuity contract) 2. a current declared rate (which is subject to change periodically) Guaranteed minimum rates, which are usually in the range of 2 to 3 percent compounded annually, exist for the life of the contract. The current declared rate, based on the insurer's investment results and economic conditions, is subject to change periodically and is based on the insurer's investment results and on the economic climate. When the annuity is first issued, this declared rate is called the contract's initial interest rate. The annuity contract usually stipulates a minimum period of time the current rate will remain in effect (e.g., one or two years) before the insurer declares a new current rate (called a renewal rate).

Insurer General Account

Fixed annuities guarantee -principal protection, -minimum interest rates, -a fixed level of lifelong annuitized payments, and -a death benefit. The insurance company's general account makes these guarantees possible. It holds the funds that support the contractual obligations of the insurer's fixed and guaranteed products, notably nonvariable permanent life policies and fixed annuities. Premiums for a company's guaranteed products are deposited into the insurer's general account. The premiums, in turn, are invested by the company in safe, secure investments, such as long-term bonds and mortgages

Key Points

-Like whole life insurance, fixed annuities provide the peace of mind that comes with knowing all future values are guaranteed. -Fixed deferred annuities can be funded with either fixed premiums (so-called retirement annuities) or flexible premiums

Fixed Annuities

A fixed annuity is an annuity contract in which the insurer guarantees both the annuity principal and a specified rate of interest to be credited to the contract. These guarantees are backed by the financial strength and claims-paying ability of the insurer issuing the contract. Like whole life insurance, fixed annuities provide the peace of mind that comes with knowing all future values are guaranteed. Also like whole life insurance, fixed annuities are able to guarantee the interest rate because premiums are invested in the insurer's general account.

Two-Tiered Fixed Annuities

A variation on the standard fixed annuity product design is the two-tiered fixed annuity. A two-tiered fixed annuity has a higher level of interest crediting than most declared-rate fixed annuities, provided the contract owner keeps the product and chooses to annuitize it. However, a lower rate is applied if the contract owner surrenders the annuity and takes its values in a lump sum instead of annuitizing. If the owner does that, this lower rate of interest is retroactively applied back to the date the contract was bought.

Fixed Annuity Death Benefits

Fixed annuity contracts provide for a death benefit if the contract owner or annuitant dies during the accumulation period. The death benefit equals the contract's accumulated value when the death occurs. The formula for calculating the death benefit is as follows: total premiums paid into policy + credited interest earnings - withdrawals and contract charges Unlike life insurance death benefits, annuity death benefits are not received tax free. Any amount the beneficiary receives that exceeds the sum of the premiums paid into the contract is taxable to the beneficiary.

Quiz

Question 1 Which statement about current declared interest rates on deferred fixed annuities is NOT correct? They are based on the insurer's investment results and on the economic climate. They remain in effect for a limited period, such as one or two years after the rate is declared. -They extend for the life of the contract. They are subject to periodic change. Current declared interest rates are subject to change periodically. Question 2 When a person buys a fixed immediate annuity or when a fixed deferred annuity is annuitized, the funds are converted into fixed payments. They are then distributed based on the payout option the owner has selected. Which of the following options most correctly describes the basis upon which the annuity payment amount is determined? the cash accumulated in the policy divided by an indexed amount provided by the insurer the owner/annuitant's age and sex -dollars per $1,000 of accumulation, based on the payout option dollars per $10,000 of accumulation, based on the settlement option selected The payments are defined in terms of dollars per $1,000 of accumulation, based on the payout option. Question 3 In a fixed annuity, what is the second interest crediting rate called? interest schedule -renewal rate secondary credit amount interest amount The second interest crediting rate is called a "renewal rate." The same applies to all future renewal rates. Question 4 A two-tiered fixed annuity will pay a higher level of interest than the standard declared rate fixed annuity under which of the following conditions? Only if the annuity owner makes periodic payments into the annuity. Only if the annuity owner surrenders the annuity and uses the proceeds to purchase a new deferred annuity. Only if the annuity owner elects a lower initial rate than currently being credited to the insurer's standard declared-rate fixed annuity. -Only if the annuity owner annuitizes the contract. The higher rate is not dependent on a lower rate being applied initially to the contract. Question 1 All of the following statements about the interest rates on deferred annuities are correct EXCEPT: The guaranteed minimum rate extends for the life of the contract. -The guaranteed minimum rate is usually 5 to 6 percent. The current declared rate is subject to change. The annuity contract usually stipulates a minimum period the current declared rate will remain in effect. The guaranteed minimum rate is usually 2 to 3 percent, compounded annually. Question 2 Which type of annuity guarantees both the annuity's principal and a specified rate of interest to be credited to the contract? consumer-based annuity equity-indexed annuity variable annuity -fixed annuity Fixed annuities guarantee both the annuity principal and a specified rate of interest to be credited to the contract. Question 3 All of the following statements about an insurance company's general account are correct EXCEPT: Premiums deposited to the general account are invested by the company in safe, secure investments, including long-term bonds and mortgages. -The investment of funds from the general account allows the insurer to guarantee all of its products, both fixed and variable. Premiums in the general account are invested in fixed interest securities, enabling the insurer to predict its level of investment returns and earnings. Premiums for a company's guaranteed products are deposited into the insurer's general account. Those invested securities carry a projected earnings rate, enabling the insurer to predict its level of investment returns and earnings. Question 4 Al is a 60-year-old male. His $100,000 fixed annuity can provide $5.50 per $1,000 of accumulated value under a straight life payout option. How much income can Al expect and for how long? $550 a month for the period selected by the annuitant $450 a month for the period selected by the owner $450 a month for life -$550 a month for life Fixed annuitized amounts do not change over the term of the annuitization period. Under a straight life payout option, Al's $100,000 annuity fund would generate $550 a month for as long as he lives.

Fixed Annuity Annuitization

When a person buys a fixed immediate annuity or when a fixed deferred annuity is annuitized, the funds are converted into fixed (level) periodic payments. They are then distributed based on the payout option the owner selected. Annuity payments are calculated by dividing the accumulation funds by the insurer's annuity purchase rate. Different for every age and annuity settlement option, annuity purchase rates are defined in terms of income dollars per $1,000 of accumulation. For example, a contract might provide a 60-year-old male with a fixed annuity monthly payout of $4.50 per $1,000 of accumulated value under a straight life payout option. This means that a $100,000 annuity fund would generate $450 a month guaranteed for as long as this annuitant lives. Regardless of the annuity settlement option selected, fixed annuity income amounts do not change over the term of the income period.