Variable Annuities (UITs)
Typically, accumulation units of variable annuities represent an investment interest in underlying: A. mutual fund shares B. life insurance policies C. direct participation programs D. pension fund investments
The best answer is A. To fund variable annuity contracts, the monies paid in by contract holders are invested in a separate investment account that buys designated mutual fund shares. Thus, the separate account "accumulation units" really represent an interest in underlying mutual fund shares. The contract holder has the choice of different types of mutual fund investments that can be made by the separate account.
Any changes in value of a variable annuity accumulation unit are directly related to changes in the: A. Standard and Poor's 500 Average B. Value of the securities funding the separate account C. Consumer Price Index D. Dow Jones Averages
The best answer is B. Since the separate account of investments funds a variable annuity, accumulation unit values are directly influenced by changes in the values of the securities in the separate account.
An annuitized account in a variable annuity is most similar to: A. a mutual fund B. a whole life insurance unit C. pension payments D. an individual retirement account
The best answer is C. 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). The payments continue for life. Thus, an annuitized account is most similar to pension payments.
Which is the BEST definition of an "annuity unit"? A. An accounting measure used to determine the number of units the contract holder may purchase in the separate account B. An accounting measure used to establish the contract holder's ownership interest C. An accounting measure upon which the amount of pay out is determined D. An accounting measure used to determine the contract holder's death benefit
The best answer is C. Once a variable annuity contract is annuitized, accumulation units are converted to annuity units. These determine the annuity payments to be made.
Which of the following annuity payment options will continue payments to another person for their life after the annuitant dies? A. Life Annuity B. Life Annuity with Period Certain C. Joint and Last Survivor Annuity D. Unit Refund Annuity
The best answer is C. A joint and last survivor annuity pays another person (usually a spouse) when the annuitant dies.
A variable life policy will remain in force: A. for the stated term of the policy B. as long as the premium is paid C. if the policy has depleted its cash value D. for the life of the insured individual
The best answer is B. An insurance policy remains "in force" as long as the premiums are paid. If the premiums are not paid, the policy will lapse and there is no more insurance! Because variable life is permanent insurance that build cash value, if the premium payment is not made, the insurance company will use the cash value (if any) to make the premium payment.
All of the following terms apply to a variable life policy EXCEPT: A. permanent insurance B. cash value C. general account D. level premium
The best answer is C. Any "variable" product, either a variable annuity or variable life insurance, takes the premium and invests it in a designated separate account, also called a subaccount, that invests in a specified mutual fund. The performance of the mutual fund builds cash value in a variable life policy. This cash value build can be borrowed from the policy. If the cash value grows to more than the death benefit and has not been borrowed, then the policy will pay the higher cash value on death. Variable life is "permanent insurance" - as long as the premium is paid, the policy is in effect. This contrasts with term insurance, which has a stated term, after which the policy expires and must be renegotiated. The premium amount is level - the same premium payment is paid periodically. What will vary is the cash value build and the amount of insurance coverage, based on the performance of the separate account. In contrast, whole life is another form of permanent insurance. It invests premiums in the insurance company's general account, which is typically invested safely, mainly in bonds. The cash value builds at a fixed rate, and the coverage amount does not vary.
Which statement is TRUE regarding variable annuity contracts? A. The principal amount is guaranteed prior to annuitization by the insurance company that issues the contract B. The principal amount is guaranteed after annuitization by the insurance company that issues the contract C. The contract holder loses control of the principal amount prior to annuitization D. The contract holder loses control of the principal amount after annuitization
The best answer is D. In a variable annuity contract, the principal amount is never guaranteed. The principal value may increase or decrease, depending on the performance of the separate account. The "investment risk" is borne by the contract holder, not the insurance company. Regarding the statement about the contract holder "losing control of the principal," this relates to the contract holder's ability to change the terms of the payout from the contract. Prior to annuitization, the contract holder is allowed to change his payout option, thus he has control over how the principal will be disbursed. However, once the contract is "annuitized," the contract holder cannot change the payout option - he or she loses control over the principal. (Please note that the term "losing control over the principal" does not refer to how the investment manager decides to invest the funds in the separate account.)
A 50-year old man has purchased a variable annuity contract. He wants payments for his life, but wants to make sure that payments are made for at least 20 years, should he die prematurely. He should choose a: A. joint and last survivor annuity option B. systematic withdrawal plan that provides for 20 years of payments C. life annuity with a 20 year period certain D. unit refund annuity
The best answer is C. A life annuity with a 20 year period certain will pay for the life of the annuitant, but if the annuitant dies early, it will pay for a minimum of 20 years regardless. These payments will be made to a designated beneficiary.
During the accumulation phase of a variable annuity contract, reinvested: I dividends and interest are tax deferred II capital gains are tax deferred III dividends and interest are taxable IV capital gains are taxable A. I and II only B. III and IV only C. I and IV only D. II and III only
The best answer is A. During the accumulation phase of a variable annuity contract, all dividends, interest and capital gains earned from the securities in the separate account must be reinvested and build tax deferred. The tax deferral of the build-up is the major benefit of buying a variable annuity.
The "AIR" stated in a variable annuity prospectus is a: A. guaranteed fixed interest rate for the annuity B. guaranteed minimum interest rate for the annuity C. conservative illustration of an interest rate for the annuity D. guaranteed maximum interest rate for the annuity
The best answer is C. The Assumed Interest Rate shown in a variable annuity prospectus illustrates the annuity that will be available if the separate account performs at that rate. It is conservatively estimated, but is no guarantee of a specific return.
The separate account that the insurance company maintains for a variable annuity is: A. directly invested in common stocks B. invested in Legal List securities only C. invested in designated mutual funds D. invested in U.S. Government guaranteed securities
The best answer is C. The separate investment account buys shares of a designated mutual fund. The performance of the mutual fund shares held in the separate account determines the amount of the annuity to be received.
What does NOT have to be discussed with a customer when recommending a variable life policy? A. Probate fees B. State premium fees C. Mortality expense charges D. Administrative expense charges
The best answer is A. Probate fees are the fees charged by attorneys to process the estate of a deceased person through probate court in that state. They have nothing to do with the recommendation of a variable life policy. Insurance companies are state-regulated and the way that the state gets reimbursed for the cost of this is by imposing a premium tax or fee on insurance premiums. This cost should be disclosed to the client. The mortality expense charge is essentially the fee charged by the insurance company to pay for risk of death - the older the person, the higher the fee. This should be discussed with the customer. Finally, the insurance company can charge a fee against the policy for its administrative expenses - another fee to be discussed with the client.
If the actual interest rate earned in the separate account underlying a variable annuity contract is higher than the "AIR" the annuity payment: A. will increase B. will decrease C. is unaffected D. is capped to a maximum amount
The best answer is A. The "AIR" is the "Assumed Interest Rate." This is used as an illustration of the annuity payment that will be received if the separate account grows at the AIR. If the assets grow at an interest rate that is higher than the AIR, then the annuity payment will increase. Conversely, if the assets grow at an interest rate that is lower than the AIR, then the annuity payment will decrease.
The "death benefit" associated with a variable annuity contract means that if the contract holder dies: A. prior to annuitization, the amount invested in the contract is returned to a beneficiary B. after annuitization, the amount invested in the contract is returned to a beneficiary C. prior to annuitization, the insurance company will make a lump sum payment to complete the terms of the contract D. after annuitization, the insurance company will pay for the insured's burial expenses
The best answer is A. The "death benefit" of a variable annuity contract is not really much of one. If the contract holder dies prior to annuitization, the insurance company pays the greater of current NAV or the amount invested to a beneficiary. If the contract holder dies after annuitization, there is no more "death benefit."
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 A. I and III B. I and IV C. II and III D. II and IV
The best answer is A. 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.
Investment risk in a variable annuity contract is carried by the: A. purchaser B. issuer C. custodian D. manager
The best answer is A. Variable annuities differ from other products sold by insurance companies in that the purchaser bears the investment risk; as opposed to the insurance company bearing the investment risk. For example, if an insurance company achieves poor investment results, this does not affect the amount of death benefit that one gets from a traditional insurance policy; if the separate investment account funding a variable annuity achieves poor investment results, the annuity payment will drop. Because the purchaser bears the investment risk in a variable annuity contract, these are defined by the SEC as a non-exempt security that must be registered and sold with a prospectus.
When comparing fixed annuity contracts to variable annuity contracts, the customer should be made aware that: I fixed annuities guarantee a rate of return that is not affected by investment risk II variable annuities guarantee a rate of return that is not affected by investment risk III fixed annuity payments depend on the performance of the securities held in the underlying separate account IV variable annuity payments depend on the performance of the securities held in the underlying separate account A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. Fixed annuities are an insurance product that guarantee a fixed return to the purchaser - here the insurance company bears the investment risk. On the other hand, variable annuities do not guarantee a fixed return - the annuity payment will vary with the performance of the underlying mutual fund investments that fund the annuity.
When comparing fixed annuities to variable annuities, which statements are TRUE? I A fixed annuity account grows at a guaranteed rate II A variable annuity account grows at a guaranteed rate III Fixed annuities are subject to investment risk IV Variable annuities are subject to investment risk A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. Fixed annuity premiums are invested in an insurance company's general account and grow at a guaranteed rate (which is usually fairly low). There is no investment risk. At retirement, the customer receives a fixed periodic payment for life. Variable annuity premiums are invested in an insurance company "separate account" which buys shares of a designated mutual fund. The account grows based on the performance of the underlying mutual fund, so the investor is subject to investment risk.
The "death benefit" associated with a variable annuity contract: I applies prior to annuitization II applies after annuitization III means that, upon death, the insurance company will make a lump sum payment to complete the terms of the contract IV means that, upon death, the insurance company will pay a beneficiary at least the amount invested in the contract A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. The "death benefit" of a variable annuity contract is not really much of one. If the contract holder dies prior to annuitization, the insurance company pays the greater of current NAV or the amount invested to a beneficiary. If the contract holder dies after annuitization, there is no more "death benefit."
Which of the following statements are TRUE regarding mutual funds and variable annuities that are in the accumulation phase? I Distributions to mutual fund shareholders are taxable to the holder in the year the distribution is made II Distributions to mutual fund shareholders are tax deferred III Distributions to variable annuity holders are taxable to the holder in the year the distribution is made IV Distributions to variable annuity holders are tax deferred A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. When a mutual fund distribution is made, tax liability arises, Thus, the distribution is taxable in the year the distribution is received. Dividends and capital gains in variable annuity separate accounts build tax deferred; no tax is due until the holder is retired and commences withdrawals.
A variable life policy will remain in force: A. for the stated term of the policy B. until the death of the insured C. if the policy has sufficient cash value to pay the premium D. as long as the insured individual does not exercise his or her nonforfeiture option
The best answer is C. An insurance policy remains "in force" as long as the premiums are paid. If the premiums are not paid, the policy will lapse and there is no more insurance! Because variable life is permanent insurance that build cash value, if the premium payment is not made, the insurance company will use the cash value (if any) to make the premium payment. "Nonforfeiture" in an insurance policy means the actions that an insured individual can take not to forfeit the policy if the premium cannot be paid. These typically include taking the full cash value and forfeiting future coverage or accepting a "reduced paid up option" where the policy death benefit amount is reduced.
Which of the following are purchase and payout options for variable annuity contracts? I Lump sum payment; Immediate annuity II Periodic payments; Immediate annuity III Lump sum payment; Deferred annuity IV Periodic payments; Deferred annuity A. I and II only B. III and IV only C. I, III and IV D. I, II, III, IV
The best answer is C. An investor can buy a variable annuity contract with a lump sum payment. Once the monies are used to purchase accumulation units, annuitization can occur immediately or can occur years in the future. An investor can also make periodic payments into a variable annuity contract, but cannot annuitize until payments stop. Thus, there is no option of periodic payments with an immediate annuity. The annuity must be deferred until the payments are completed.
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
The best answer is C. 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.
During the accumulation phase of a variable annuity: I funds can be distributed to unit holders II funds cannot be distributed to unit holders III as interest, dividends, and capital gains are received, the investor has the option of reinvesting in more shares IV as interest, dividends, and capital gains are received, these must be reinvested in more accumulation units A. I and III B. I and IV C. II and III D. II and IV
The best answer is D. As interest, dividends, and capital gains are realized from the securities held in the separate account during the accumulation phase, these must be automatically reinvested to buy more accumulation units for the contract holder. These cannot be distributed to the unit holders until the contract is annuitized. Thus, the accumulation phase allows payments to be made into the plan; requires that all dividends and capital gains be reinvested in the plan; and does not allow distributions to be taken out of the plan.
To sell a variable annuity, what license(s) is (are) needed? A. Series 6 only B. Series 7 only C. Series 6 or Series 7 D. Series 6 or Series 7 plus a state insurance license
The best answer is D. Because variable annuities are both a securities and insurance product, a State insurance license is needed, in addition to the Federal Series 6 (Investment Company Securities) or Series 7 (General Securities) license.
A registered representative that wishes to recommend a variable annuity to a customer must make reasonable efforts to obtain the customer's: I intended use of the variable annuity II investment time horizon III existing assets including insurance holdings IV liquidity needs A. I and II only B. III and IV only C. I, II, III only D. I, II, III, IV
The best answer is D. Consider this to be a learning question. To recommend a variable annuity, the representative should make reasonable efforts to obtain the customer's age, annual income, financial situation and needs, investment experience, investment objectives, intended use of the deferred annuity, investment time horizon, existing assets including life insurance, liquidity needs, liquid net worth, risk tolerance, tax status and any other information that is needed to make a recommendation to the customer. Just to make sure this happens, FINRA requires that the representative sign a statement that this was done.
All of the following statements are true about variable annuities EXCEPT variable annuities: A. must be registered with the Securities and Exchange Commission B. must be sold with a prospectus C. are a participating unit investment trust form of investment company D. are sold without a sales charge
The best answer is D. Variable annuities differ from other products sold by insurance companies in that the purchaser bears the investment risk; as opposed to the insurance company bearing the investment risk. For example, if an insurance company achieves poor investment results, this does not affect the amount of death benefit that one gets from a traditional insurance policy; if the separate investment account funding a variable annuity achieves poor investment results, the annuity payment will drop. Because the purchaser bears the investment risk in a variable annuity contract, these are defined by the SEC as a non-exempt security that must be registered and sold with a prospectus. Because these are structured as participating unit trusts, variable annuities are regulated under the Investment Company Act of 1940. Variable annuities are sold with a sales charge that must be "fair and reasonable" under FINRA rules.
Growth in the separate account of a variable annuity is: I guaranteed as to minimum rate II not guaranteed as to minimum rate III capped as to maximum rate IV not capped as to maximum rate A. I and III B. I and IV C. II and III D. II and IV
The best answer is D. Variable annuity separate accounts are subject to investment risk - there is no minimum guaranteed growth rate and no cap on the growth rate. Also note that the insurance company selling the annuity can offer a rider called a GMIB - Guaranteed Minimum Income Benefit - that will give a minimum guaranteed growth rate for an additional cost. However, this is an optional feature, and is not part of the basic variable annuity contract.