Variable Annuities CE

Material Fact

A fact that may reasonably be expected to affect the customer's decision concerning any transaction involving the product

Guaranteed Lifetime Withdrawal Benefit (GLWB)

A guaranteed living benefit that enables a variable annuity contract owner to withdraw funds at a specified annual rate from a variable annuity contract until the individual's death or until an amount equal to the contract owner's principal is received—whichever occurs later—regardless of the actual investment performance of the variable subaccounts to which the annuity's accumulated value is allocated.

guaranteed minimum withdrawal benefit (GMWB)

A guaranteed living benefit that enables a variable annuity contract owner to withdraw funds at a specified annual rate from an annuity contract until an amount equal to the contract owner's principal is received, regardless of the actual investment performance of the variable subaccounts to which the annuity's accumulated value is allocated.

guaranteed minimum income benefit (GMIB)—

A guaranteed living benefit that offers the contract owner a life annuity for one or two lives based on a hypothetical benefit base amount, without regard to the actual investment performance of the variable subaccounts to which the annuity's accumulated value is allocated. The annuitized benefit amount is based on net premiums paid for the annuity, accumulated at a specified interest rate and applied to conservative life annuity rates.

Exclusion Ratio

A percentage normally determined by dividing the cost basis of an annuity by the expected return. The result is the percentage of each periodic payment that is received income tax free as a return of cost basis until the entire cost basis has been recovered.

excess withdrawal

A withdrawal from a deferred variable annuity containing a guaranteed living benefit that exceeds the maximum permitted withdrawal dollar limit or percentage under the benefit.

guaranteed minimum accumulation benefit (GMAB

Also called a "guaranteed account value" (GAV) benefit, the GMAB is a guaranteed living benefit that offers a variable annuity contract owner principal protection by permitting him or her to surrender the contract after a specified number of years and to receive a lump-sum surrender amount equal to first-year net premiums, regardless of the actual investment performance of the variable subaccounts to which the annuity's accumulated value is allocated.

rollup annuity death benefit

An annuity death benefit equal to the greater of net premiums paid (plus hypothetical interest) or cash value on the date of death.

premature distribution tax penalty

An income tax penalty to which distributions of gain from a deferred annuity are subject if taken before the recipient's age 59½, unless a specific exception applies. The income tax penalty is equal to 10 percent of the amount of the distribution includible in income.

Accumulated Vlaue

Cash Value of a deffered annuity

Asset Allocation

Involves contract owner dividing hi or her portfolio into various asset classes in order to preserve capital by protecting against negative developments while still taking advantage of positive developments.

Annuitant

Natural Person whose lifetime is the measure of the duration of a life annuity.

Periodic Payments

Regular payments made under the systematic liquidation of proceeds being annuitized. The term "periodic payments" generally refers only to payments received under annuitization and not to payments received through withdrawals

Liquidity

The ability to convert an investment into cash. An investment that may be converted to cash easily and without loss is said to be liquid. To the extent an investment cannot be easily converted into cash or the conversion is costly, such an investment is deemed illiquid.

FIFO Tax Treatment

The deemed distribution of all tax-free principal before any taxable gain is deemed distributed

LIFO Tax Treatment

The deemed distribution of all taxable gain from a deferred annuity before any tax-free principal is deemed distributed

Tax Deferral

The income tax benefit associated with annuity products that postpones recognition of contract gain until it is distributed

Benefit Base

a hypothetical account on which vertain guaranteed living benefits are based.

Which of the following guaranteed living benefits involves using rates that assume the contract owner is younger than his or her actual age or that the insurer will credit interest at the annual rate of 1 percent to 2 percent? a. GMIB b. GMWB c. GMAB d. GLWB

a. A contract owner whose contract contains a GMIB must be willing to have the benefit determined on the basis of highly conservative rider annuity rates, which may involve a 1 percent to 2 percent interest rate assumption or an age set-back of six to seven years.

Which of the following is not a consequence of a step up under a GLWB benefit? a. Surrender charges are reset. b. The benefit base and total benefit guarantee are made equal to the accumulated value. c. The annual withdrawal amount is reset. d. The annual cost is reset.

a. As a result of a step up: The GLWB benefit base and the total benefit guarantee are reset to equal the variable annuity contract's accumulated value on the date of the step up. The annual GLWB withdrawal dollar limit is reset to equal the total guaranteed withdrawal amount multiplied by the annual withdrawal percentage. The annual cost of the GLWB is reset to the current cost level charged by the insurer, up to the amount of the maximum annual cost. Surrender charges, however, are not affected.

Which one of the following guaranteed living benefits is generally more suitable for customers who are conservative investors? a. GMAB b. GMWB c. GLWB d. GMIB

a. Customers for whom a guaranteed minimum accumulation benefit (GMAB) is suitable tend to be somewhat more conservative investors than customers for whom other GLBs may be appropriate.

The maximum annual withdrawal dollar limit under Carl's GMWB is $10,000. What would result if Carl took only $6,000 in the contract year? I. The period during which withdrawals may be taken would increase. II. The $4,000 withdrawal amount not taken during the year will increase the annual withdrawal amount to $14,000 in the succeeding year. a. I only b. II only c. both I and II d. neither I nor II

a. If a withdrawal taken under a GMWB during a contract year is less than the maximum annual withdrawal dollar limit, the benefit base will not be exhausted as quickly as it would be if the maximum permitted amount had been taken. As a result, the period during which withdrawals may be taken under the GMWB will be extended. The amount of permissible withdrawals not taken during any contract year does not increase the maximum annual withdrawal amount in a subsequent year.

John took a withdrawal of $10,000 from his variable annuity contract whose accumulated value on the previous anniversary was $50,000. To what amount would his $80,000 GMIB benefit base be reduced if the withdrawal received pro rata treatment? a. $64,000 b. $70,000 c. $75,000 d. $50,000

a. If the withdrawal is greater than the maximum specified percentage of the accumulated value as of the last contract anniversary, a pro rata reduction is made to the benefit base. In the case of a pro rata reduction, the benefit base is reduced by the same percentage that the accumulated value is reduced by the withdrawal. In this case, John's $10,000 withdrawal from his $50,000 account value (20 percent) would reduce the GMIB benefit base by 20 percent, or $16,000—from $80,000 to $64,000

What is the reason for the requirement that a specific asset allocation be maintained when a variable annuity contract contains a GMAB? a. to enable the insurer to manage its liability under the benefit b. to maximize the accumulated value c. to reduce transaction costs d. to take advantage of lower capital gains tax treatment

a. The requirement that a contract owner maintain a prescribed asset allocation is designed to enable the insurer to better manage its liability under the GMAB.

What tax treatment applies to annuitized payments under a variable annuity after the annuitant has recovered his or her cost basis? a. The periodic payments are fully taxable as ordinary income. b. The periodic payments are fully taxable as capital gains. c. The periodic payments are completely tax free. d. A portion of the periodic payments continues to be received tax free.

a. Under the rule applying to annuity contracts that provide a life income and that start after December 31, 1986, the tax-free treatment of each periodic payment through an exclusion ratio applies only until the annuitant has received an amount tax free equaling his or her cost basis. Any periodic payment received after that date is fully taxable as ordinary income.

Which of the following guaranteed living benefits offer(s) the contract owner some flexibility as to the amount and timing of benefit payments? I. GMWB II. GMIB III. GLWB a. I and II only b. I and III only c. II and III only d. I, II, and III Answers to Chapter 5 Review

b. A suitable customer for a guaranteed withdrawal benefit typically wants the safety net of a principal guarantee but also wants a flexible payment amount and schedule offered by accessing the benefit through withdrawals.

A GMIB may be terminated for any of the following reasons EXCEPT: a. The variable annuity contract is terminated. b. The contract owner requests termination of the benefit. c. The contract owner elects to annuitize the accumulated value under the annuity rates in the basic contract. d. A death benefit is payable under the annuity.

b. At any time, the contract owner can terminate most additional benefits provided by rider on a variable annuity contract by informing the insurer of his or her desire to terminate; however, this is not the case with a GMIB. A GMIB cannot normally be terminated before an event specified in the GMIB provisions occurs, although an insurer may permit rider termination in the event of a rider premium increase.

How does a GMAB increase the inherent illiquidity of a deferred variable annuity? a. by increasing the income tax liability resulting from a withdrawal b. by requiring the contract to remain in force for a specified period for any GMAB benefit to be payable c. by changing the LIFO tax treatment to FIFO d. by increasing surrender charges for withdrawals taken during the GMAB benefit period

b. Deferred annuities, mainly because of their surrender charges and taxation—including LIFO tax treatment and possible premature distribution tax penalties—are inherently illiquid. A GMAB tends to increase that illiquidity by requiring that the variable annuity contract of which it is a part be kept in force until the end of the holding period—usually eight to ten years—to receive any benefit from it.

Bob's variable annuity contract contains a GLWB under which the maximum annual withdrawal dollar limit is $10,000 and excess withdrawals reduce the benefit base pro rata. By what amount would the benefit base be reduced if he took a withdrawal of $15,000 during the contract year at a time when the accumulated value was $150,000 and the benefit base was $200,000? a. No reduction would occur. b. $20,000 c. $15,000 d. $11,250

b. If a GLWB contract owner takes a withdrawal that exceeds the maximum annual withdrawal dollar limit—an excess withdrawal—the benefit base and the guaranteed withdrawal amount will be reduced on a pro rata basis. In other words, both the benefit base and the guaranteed withdrawal amount will be reduced in the same proportion that the withdrawal reduces the variable annuity's accumulated value. In this case, Bob's benefit base would be reduced by $20,000 ($15,000 $150,000 = .10; .10 × $200,000 = $20,000).

The annual current premium cost for a GMAB benefit generally ranges from ________ of the accumulated value allocated to the separate account. a. 1 to 2 percent b. .55 to 1.30 percent c. .1 to .3 percent d. 3 to 3.5 percent

b. In general, annual premium costs for a GMAB involve both a current premium rate and a guaranteed premium rate. The current premium rate varies from 55 basis points to 130 basis points, or .55 percent to 1.30 percent.

For which one of the following guaranteed living benefits is the contract owner less likely to be required to maintain a specific asset allocation? a. GMAB b. GMIB c. GLWB d. GMWB

b. Of the guaranteed living benefits, only the guaranteed minimum income benefit (GMIB) may not require the contract owner to maintain a specific asset allocation.

What is the function of the benefit base under a guaranteed minimum income benefit? a. It is the minimum amount to which the underlying variable annuity contract's accumulated value will be allowed to decline. b. It is the basis for calculating the annuitized income benefit. c. It is the minimum amount payable if the contract owner surrenders the variable annuity in the tenth contract year. d. It is the basis for determining the maximum amount of annual withdrawal permitted.

b. The GMIB uses a hypothetical benefit base to calculate the benefit. At the time the contract owner elects to access the GMIB benefit, annuitization factors are applied to the hypothetical benefit base to determine the periodic payments to be received. The GMIB benefit base is not available to the contract owner on surrender of the variable annuity contract.

Which of the following guaranteed living benefits protects the contract owner's principal by guaranteeing the payment of a lump-sum amount equal to the first year net premiums paid? a. the guaranteed minimum income benefit b. the guaranteed minimum accumulation benefit c. the guaranteed minimum withdrawal benefit d. the guaranteed lifetime withdrawal benefit

b. The guaranteed minimum accumulation benefit, or GMAB, protects a variable annuity contract owner's principal by permitting him or her to surrender the contract after a specified number of years and to receive a lump-sum surrender amount equal to first-year net premiums, regardless of the contract's actual surrender value.

Which of the following is a suitability factor for a GMAB? I. The customer is a conservative investor. II. The customer has no need for income for ten years. a. I only b. II only c. both I and II d. neither I nor II

c. A GMAB is most suitable for conservative investors. In addition to being a conservative investor, the suitable customer should have no need for income—either by way of annuitization or withdrawals—until the holding period ends (which is usually eight to ten years).

Which of the following settlement options is not normally permitted under the GMIB guarantee? a. a straight life annuity b. a life annuity with a period certain c. a temporary annuity d. a joint and survivor life annuity

c. Although any insurer may expand the settlement option choices available to a contract owner who is accessing the GMIB guarantee, those choices are normally limited to a straight life annuity, a life annuity with a period certain, and a joint and survivor life annuity. A temporary annuity is not generally available under the GMIB guarantee.

Which of the following is typically different between a guaranteed minimum withdrawal benefit and a guaranteed lifetime withdrawal benefit? I. the annual percentage of the benefit base that may be withdrawn II. the duration of withdrawals a. I only b. II only c. both I and II d. neither I nor II

c. The fundamental differences between the guaranteed minimum withdrawal benefit and the guaranteed lifetime withdrawal benefit relate to both the annual percentage of the benefit base that may be withdrawn and the duration of withdrawals.

Which of the following is/are normally based on a GMWB benefit base? I. the amount that may be withdrawn annually under a GMWB II. the total amount guaranteed under a GMWB a. I only b. II only c. both I and II d. neither I nor II

c. The methods specific insurers use to calculate their GMWB benefit base vary considerably. Despite that variation, however, the application of the GMWB benefit base is the same: this hypothetical amount determines the maximum annual withdrawal dollar limit and the total guaranteed amount

Carl's deferred variable annuity contract provides a guaranteed death benefit his agent referred to as a "rollup." Which of the following death benefits does his contract provide? a. a death benefit equal to the greater of net premiums paid or cash value on the date of death b. a death benefit equal to the sum of the net premiums paid plus cash value on the date of death c. a death benefit equal to the greater of net premiums paid, plus hypothetical interest, or cash value on the date of death d. a death benefit equal to the greater of net premiums paid or cash value at specified anniversaries

c. The variable annuity death benefit known as a "rollup" is equal to the greater of (1) net premiums paid, plus hypothetical interest or (2) the contract's cash value on the date of death.

Accessing a __________ requires that the contract owner annuitize. a. GMAB b. GLWB c. GMWB d. GMIB

d. A suitable GMIB customer must be willing to accept certain conditions that apply to the benefit, including the requirement to annuitize.

Which of the following advantages of investing in a variable annuity are not generally found in mutual funds? I. tax deferral II. guaranteed death benefits III. guaranteed settlement option rates a. I and II only b. I and III only c. II and III only d. I, II, and III

d. In addition to the diversification and professional management characteristics of variable annuities and mutual funds, variable annuities also provide tax deferral, a guaranteed death benefit, and guaranteed settlement option rates.

What is the earliest point at which a contract owner may annuitize under the GMIB? a. at any time b. within 30 days of reaching age 59½ c. within 30 days of reaching age 65 d. within 30 days following the end of the contract's holding period

d. Under typical GMIB provisions, a contract owner may annuitize under the benefit within 30 days following the end of the GMIB holding period or within 30 days following any GMIB anniversary after the holding period.

Audrey's deferred variable annuity contains a GMAB. Assuming her insurer used a pro rata approach to withdrawals made during the holding period, by what amount would her GMAB benefit base be reduced if she took a $10,000 withdrawal during the holding period at a time when the accumulated value was $50,000 and the benefit base was $100,000? a. $0 b. $5,000 c. $10,000 d. $20,000

d. When the contract owner takes a withdrawal from a variable annuity contract containing a GMAB and the insurer imposes a pro rata approach, the withdrawal may reduce the benefit payable under the GMAB by an amount greater than the sum of the withdrawal if the contract's accumulated value is less than the benefit under the GMAB immediately before the withdrawal is made. That increased benefit loss is because the benefit base is reduced in the same proportion as the accumulated value. In this case, because the $10,000 withdrawal reduces the accumulated value by 20 percent, it also reduces the benefit base by 20 percent, or $20,000.

Withdrawals taken under a guaranteed withdrawal benefit may be subject to which of the following? I. surrender charges II. LIFO tax treatment III. premature distribution tax penalties a. I and II only b. I and III only c. II and III only d. I, II, and III

d. Withdrawals—whether taken through a GMWB or GLWB guarantee—are subject to: surrender charges, if taken during the surrender charge period transaction charges, if imposed by the insurer LIFO tax treatment premature distribution penalty taxes, if taken before age 59½

Life Annuity

life annuity—An annuity whose periodic payments continue for the life of the annuitant.

Settlement Option

settlement option—An alternative method of receiving a lump-sum cash amount under which an individual may receive periodic payments.

Step Up

step up—When used in connection with guaranteed living benefits, a step up, or reset, is a transaction under which the benefit base is increased to equal the variable annuity's accumulated value on the date of the step up or reset.

Temporary Annuity

temporary annuity—Any annuitizing arrangement other than a life annuity under which an individual receives periodic payments.