Chapter 9: Annuities

How can an annuity be received at the end of the accumulation period?

- Lump Sum - Periodic Payments, by using accumulation units to purchase annuity units.

How much cash value equals 1 vote in a variable life separate account?

$100

Can an annuity contract be exchanged for an insurance contract?

No

Can the payout option be changed once it is selected and payments have begun?

No; the settlement option is made at the beginning of the payout period and cannot be changed once payments have begun.

Sales Charge Types: Level

Variable Annuities can be sold on a level sales charge, or level load. Level sales charges are deducted from each installment made into the contract.

Who offers annuities?

Mostly by insurance companies; however, broker/dealers may also offer annuities.

Variable Life: Sales Charge Structure and Limitations

- The maximum sales charge allowed on a variable life insurance policy is 9% computed over a period of up to 20 YEARS. - Free Look Period: If the policy is surrendered during the first 45 DAYS, the contract holder is refunded all premiums paid. - During the first year of the policy, the maximum sales charge is 50% of the premium paid. - If a policy owner surrenders the policy within the first 2 YEARS, the owner is entitled to the NAV of their account plus a refund of any charge that exceeds 30% of the first year's premium plus any charge that exceeds 10% of the second year's premium.

Exchanging Accumulation Units for Annuity Units

Accomplished on the date of annuitization. The exchange rate is a combination of factors that consider: - Annuitant's Age - Life Expectancy - Settlement Option - Assumed Interest Rate (AIR)

Exchange Privilege: 1035 Exchange

Allows the policy owner to roll the cost basis from the first product into another, thereby deferring recognition and tax on any capital gain realized in the exchange. The following are allowable exchanges: - Life insurance to another life insurance. - Life insurance to an annuity. - An endowment to an annuity. - Annuity to another annuity.

Sales Charge Types: Deferred Sales Charge

Annuities can also be offered with a deferred sales charge to cover the operating expenses and commission. The charge to the contract owner is usually contingent on the length of time the contract is held, and is assessed at withdrawal.

Other Contract Provisions: Exchange Privilege

Annuities typically have loan provisions, partial redemptions, and exchange privileges during the accumulation period. These features vary from product to product.

Other Contract Provisions: Expense Guarantee

Annuity companies are required to project their admin expenses for annuity contracts. The expense guarantee establishes the max they can charge the contract. The company is responsible for any increase in expenses beyond the guaranteed amount. An operating expense fee is deducted from the separate account to protect the company against rising operating expenses.

Other Contract Provisions: Death Benefit

Annuity contracts also have a provision for a death benefit in the event the contract owner dies DURING the accumulation period; the beneficiary will then receive the greater of the gross payments made into the contract or the accumulated value at the time of death.

Payout Options: Life Annuity with Period Certain

Annuity payments are guaranteed for a minimum amount of time (10 or 15 years) during which a beneficiary will continue to receive payments should the annuitant die. Following the period certain, payments will continue until the annuitant's death

Variable Life Other Provisions: Expense Limitation

Any administrative expenses above the contractually stated maximum charges are the responsibility of the insurance company.

Variable Life Other Provisions: Termination

At termination, if a policyholder stops making premium payments into the policy, the owner is entitled to the surrender value.

When does the accumulation phase begin and end?

Begins on the date when the annuity contract becomes effective and continues until the payout period begins.

How are variable annuity payments made?

By the issuer to the annuitant in varying amounts in accordance with the performance of the separate account. There is no guarantee with a variable annuity, and the annuitant assumes all investment risks of the portfolio.

Variable Life Features: Voting Rights of Policyholders

Entitled to the same rights as shareholders in investment companies. The have voting rights in proportion to their cash value in the separate account. For every $100 in cash value, the policy owner has 1 VOTE. Issues requiring policyowners' approval include: - Changes in investment objectives - Election of officers or managers of the separate account.

Surrender Value

May apply if the owner decides to surrender the annuity prior to annuitization. If a deferred annuity is surrendered prior to age 59.5, income tax and a 10% penalty on the taxable portion must be paid on the gain. If only a portion of the annuity is surrendered, the IRS will assume LIFO, which means that any deferred gain will be taken out first and taxed at ordinary income rates.

Accumulation and Annuity Phases: Accumulation

Funded with after-tax dollars, establishing the investor's cost basis. Taxes apply only to earning on the after tax dollar investment. The real benefit is that the contract value of the annuities grows tax-deferred and annuitants are not required to pay taxes on the amount above their cost basis until the payout period begins or until the contract is surrendered. Annuities are also used for rollovers from qualified plans that result from job changes.

Calculating annuitant's interest in a separate account

Multiply the number of accumulation units owned by the value of each unit. 1,000 Units x $6.00 per unit = $6,000 Separate account interest

Payout Options: Unit Refund Life Annuity

Provides periodic payments during the annuitant's lifetime. If the annuitant dies prior to receiving an amount equal to the annuity units, the remaining portion will be paid in installments or lump sum to the beneficiary

Accumulation Unit

The accounting measure used to identify the contract owner's interest in the separate account during the accumulation period. During the time the owner is depositing money into the contract, the annuity's valuation is expressed in an increasing number of accumulation units.

Variable Life Other Provisions: Surrender Value

The cash value of the policy minus any outstanding loans or unpaid interest charges. The nonforfeiture clause provides that the policyholder receive the accumulated cash value should premium payments cease and the policy is surrendered.

Assumed Interest Rate

The investment portfolio of the variable annuity is assigned an assumed interest rate. This rate is assigned as an assumption of a reasonable rate of return on the investments in the separate account, and is NOT guaranteed. Registered Reps are prohibited from making a statement that can be interpreted as a guarantee.

Is an annuity an insurance product?

Yes; An individual must hold an insurance license to sell annuities, and must also hold a securities registration in order to sell variable annuities.

Are variable life premiums fixed?

Yes; It's universal life that has flexible premiums

Procedure to Convert Units: Step 1

- Calculate annuitant's interest in the separate account by multiplying the number of accumulation units by the current value per unit.

Procedure to Convert Units: Step 2

- Calculate the first monthly payment. Based on age, life expectancy, and settlement option. If the annuity contract is worth $100,000 and the actuarial rate is $5 per $1,000 in the account, the first monthly payment is $500.

Disadvantage of fixed annuities?

- Does not keep pace with inflation

Deferred Annuities: Characteristics

- Dollars invested are generally after-tax dollars - Tax-deferred growth - Income payments begin after the contract is annuitized and the cost basis is divided over the number of years of life expectancy. - Often used to accumulate funds for retirement.

What has authority over variable life insurance?

- FINRA - State Insurance Departments

Two Categories of Annuities

- Fixed: Guarantee a certain amount of income based on the purchase payments deposited. The insurance company assumes the investment risk. - Variable: The annuitant assumes the investment risk in the separate account. The separate account performance will determine the amount of income the annuitant will receive.

Fixed/Variable Annuity Common Characteristics

- Guaranteed payments for life - Tax Deferred Earnings - Professional Management - Lose control of principal upon annuitization

What must the separate account be registered under?

- Securities Act of 1933 - Investment Company Act of 1940, unless the account is used to fund a tax-qualified annuity.

Variable Annuity Separate Account

A pool of securities, much like a mutual fund. It MUST be registered under the Securities Act of 1933, and its units must be sold with a prospectus. The prospectus for the account must include: - Securities held in the account - Policies for transferring between different investment selections - Sales charges and other expenses

Other Contract Provisions: Surrender Value

An annuity can be terminated anytime during the accumulation period for its surrender value, which is the current value of the assets held in the separate account less any surrender charges. Contracts with high and/or long-term surrender charges may not be suitable for older investors. These charges should be factored when considering a 1035 exchange. NO termination may occur after payments begin

Other Charges and Expenses

An annuity has other expenses that are not part of the sales charge. These expenses are deducted from the assets or income of the separate account. These additional expenses include: - Investment Management Fee - Mortality Risk Fee - Expense Risk Fee - Premium Taxes - Admin Expenses

Immediate vs. Deferred Annuities: Deferred

An annuity that is either purchased with a lump sum (single premium deferred) or is purchased through periodic payments (flexible premium deferred). In a deferred annuity, payout is delayed until the contract is annuitized at some point in the future.

Procedure to Convert Units: Step 3

Calculate the value of future payments. This is based on the value of each annuity unit. Assume that each annuity unit is worth $2.50 at the first monthly payment. In order to receive $500, 200 units mist be liquidated. At this time, the number of annuity units is fixed. Each future monthly payment will be the redemption value of 200 annuity units.

Immediate vs. Deferred Annuities: Immediate

Can be funded ONLY with a single lump sum payment because the contract begins making payments to the annuitant on the first interval after the deposit is made. The income amount is based upon the annuitant's life or the settlement option. Begins ONE payment period after a lump sum deposit into the contract.

Other Contract Provisions: Voting Rights

Contract owners of variable securities have voting rights in the separate account. Votes can be cast in person or by proxy. Voting privileges include: - Board Member Election - Changes in Investment Policies of the Separate Account And other issues defined in the ICA of 1940. Votes are similar to mutual funds, except the votes are based on units instead of shares.

Variable Annuities

Objective is to be provided with a lifetime income that will likely keep up with inflation. Because the issuer invests the monies in a separate account into a securities portfolio that consists mainly of common stocks, the annuity keeps pace with inflation but also risks being affected by a declining market.

If the payments are to be made monthly in a immediate annuity, how long until the first payment is made? Annually?

One month after the lump sum payment; One year

Variable Life Insurance

Owners of variable life contracts seek greater death benefits and higher cash values than traditional whole life and universal life. They anticipate that over time the performance of the separate account will produce investment returns that are superior to those of traditional life contracts and will offset inflation.

Payout Options: Joint and Last Survivor Life Annuity

Payments are made to 2 people. If one annuitant dies, payments continue to be made to the surviving annuitant. All payments cease upon the death of the last annuitant.

Fixed Annuities

Payments received remain constant for the life of the contract. The performance of the insurance company's portfolio has no effect on the payments made to the annuitant. They are guaranteed a minimum rate of return, which is stated in the contract.

Variable Life Other Charges and Expenses

The variable life contract also indicates the current and max policy charges for: - Mortality Costs - Investment Management Fee - Admin Expenses - Cost of Insurance

Variable Life Other Provisions: Cash Value

There is NO minimum guaranteed cash value in a variable life policy. The cash surrender value can be less than the amount that was available when the policy was issued. The actual amount available is the value calculated at the time of surrender.

Expression of a Variable Annuity

Units, with the unit values determined by the performance of the separate account. The value of the portfolio in the separate account is recalculated each day when the NYSE closes.

Sales Charges and Expenses

Variable annuity contracts have sales charges that are similar to those of mutual funds. FINRA conduct rules state that sales charge on a variable annuity is FAIR AND REASONABLE over the life of the contract. Sales charges pay for sales and marketing expenses, admin expenses and other costs of distribution.

Annuity (Def)

A contract with an insurance company that provides for payments to the annuitant over the life of the contract term. These payments are made by the insurance company. Purchasing deposits are made either in a lump sum, or periodic payments.

The Separate Account

Defined by The Investment Company Act of 1940 as an account established and maintained by the insurance company under which income, gains and losses are credited or charged against the account without regard to other income, gains or losses of the insurance company.

Valuation of a Variable Life Insurance Policy

Directly related to the performance of the separate account. Fluctuations in the separate account will affect both the policy's cash value and death benefit. The cash value is usually calculated daily, but MUST be calculated at least monthly.

Where are breakpoints and rights of accumulation stated?

In the prospectus

Payout Options: Period Certain, or Fixed Period

Periodic payments are made to the annuitant for a specified number of years (usually 10 or 15). If the annuitant dies before the period end, a lump sum or installment payments will be made to a beneficiary. There is NO life guarantee with this option.

Variable Life Other Provisions: Exchange Privileges Among Investment Alternatives

Policyowners are entitled to exchange all or potions of their assets held in the separate account among alternative investments available in the account. These exchanges are FREE of charge and DO NOT create tax liabilities.

Who manages the separate and general accounts?

The insurance company's investment manager

Payout Options: Straight-Life Annuity

Gives the annuitants the highest periodic payment but carries the most risk. Annuitants receive payments as long as they live. Annuitants risk dying too soon and losing the entire investment. This option is also called Life Only or Life Income.

Variable Life: Death Benefits

Have a guaranteed minimum death benefit. This minimum is the face amount of the policy at the time of issuance. Most states allow a suicide clause (you know that). If the suicide clause is in force, all premiums paid to date of suicide will be refunded if occurring during the first two years. Death benefits are paid at death or age of 100. The actual death benefit is determined by the separate account performance. The death benefit MUST be recalculated at least annually.

Variable Life Features: Loans

Permit loans against a percentage of the cash value in a policy. The insurance company must allow a loan of a minimum of 75% of cash value after the policy has been in place for 3 years. Loans are subject to annual interest rate, and are subtracted from the death benefit if not repaid. If the separate account under-performs and cash value declines below the minimum required, the contract holder has 31 DAYS to repay enough of the loan to make the cash value positive.

Variable Life Other Provisions: Conversion Privilege

Policyowners have the right to exchange one form of permanent insurance policy for another type of permanent policy. In the case of a variable life policy, the conversion could be to either a traditional whole life or universal policy. The company must allow the conversion to a more conventional whole life policy for the first 2 YEARS without having the insured provide proof of insurability.

Purchase of Accumulation Units

Purchased at the separate account's NAV, after deducting any sales charges or other fees. New accumulation units are purchased using forward pricing in the same manner as mutual fund shares are acquired.

1035 Suitability Concerns

Suitability concerns should be reviewed by the principal. These include the consequence of surrender charges of an old policy, the initiation of new surrender period on the new policy, and sales charges assessed on the new product.

What is used to calculate the amount of each annuity payment over time?

The AIR

Other Contract Provisions: Mortality Guarantee

The annuity company guarantees that it will make payments as long as the annuitant lives. The company uses a mortality expense risk fee from the separate account to protect itself against an annuitant outliving their expected mortality.

Annuity Units

The annuity period begins at the conclusion of the accumulation period. The measure used in the determination of the payment amounts to an annuitant during the payout, or annuity period, if referred to as an annuity unit