Variable, Indexed, and Market-Value Adjusted Annuities

Quiz

You answered 50% of the questions correctly Question 1 Which statement about variable annuity subaccounts is NOT correct? Subaccounts can range from conservative money-market portfolios to moderate corporate bond portfolios to risky and aggressive international and sector stock portfolios. Variable annuities typically offer the choice of 20 or 30 different subaccounts. -The insurer selects the variable subaccounts to which the contract owner's premiums are allocated. If subaccounts perform well, the contract owner is likely to realize a greater investment growth than possible with a fixed annuity. Variable annuities often offer 20 or 30 different subaccounts. Question 2 When Gary bought an equity-indexed annuity (EIA) with a $10,000 premium deposit, the S&P 500 Index was at 1000. At the end of the contract's first term one year later, this index was at 1100. Based only on this information, what is the basis for the amount of interest credited to Gary's contract? 5 percent 15 percent -10 percent 20 percent When Gary bought his EIA, the S&P 500 was at 1000. One year later it was at 1100: an increase of 10 percent. Thus, the basis for the amount of interest to be credited to Gary's EIA contract is 10 percent. Question 3 At the end of a contract period, market value adjusted annuity owners can do all of the following, EXCEPT stay with the same rate withdraw funds move to another contract period -convert to a variable annuity At the end of a contract period, an MVA owner can stay with the same rate, move to another contract period, or withdraw funds. Converting to a variable annuity is not an option. Question 4 Equity-indexed annuities are generally considered which of the following? -fixed annuities FINRA products life insurance variable annuities Life insurance pays a predetermined benefit at the insured's death. Annuities pay a benefit while the annuitant is alive. Question 1 Regardless of the interest earned by the index underlying an equity-indexed annuity (EIA), the actual amount credited is determined by the contract's: expense charge -participation rate and rate cap minimum guaranteed interest rate annuity purchase rate The actual amount credited does not depend on the contract's minimum interest rate but on the contract's participation rate and rate cap. Question 2 Equity-indexed annuities (EIAs) allow contract owners to participate in some of the growth in the stock market while avoiding possible losses of principal by which one of the following processes? -linking the interest to be credited to the contract to the growth of an equity (stock) index, while, at the same time, providing for a guaranteed minimum rate of return for the length of the contract crediting current rates of return, which the insurer declares and supports through guaranteed minimum rates linking the contract's accumulation units to the growth of an equity (stock) index, while, at the same time, providing for a guaranteed minimum death benefit for the duration of the contract linking to the performance of the underlying securities investment accounts, whose values are not guaranteed Equity-indexed annuities (EIAs) allow contract owners to participate in some of the growth in the stock market while avoiding possible losses to principal by linking the interest to be credited to the contract to the growth of an equity index while providing for a guaranteed minimum rate of return for the length of the contract. Question 3 At the end of an equity-indexed annuity (EIA) contract's term, what can the owner or annuitant do? take the accumulated values, unless the surrender charge has been deducted leave the accumulated values in the contract and the contract automatically continues for another term -take the accumulated values free of surrender charge or leaves them in the contract to continue for another term take the accumulated values free of surrender charges and the contract automatically continues for another term. The accumulated values can be taken free of surrender charge. Or, they can be left in the contract and the contract can be continued for another term. Question 4 Which one of the following is guaranteed under most variable annuity contracts? A death benefit is paid regardless of when the owner dies. -Minimum accumulation units are guaranteed regardless of how long the owner lives. Nothing about a variable annuity is guaranteed. A death benefit is paid if the owner or annuitant dies before the contract's funds are annuitized. Minimum accumulation units are not guaranteed.

Variable Annuities

A variable annuity makes no guarantee as to the annuity principal or the credited interest rate. As with variable life insurance, variable annuity premiums and contract values are invested in the insurer's separate account instead of its general account. The contract's values move up and down in response to the investment performance of the separate accounts and their associated stock, bond, and money-market portfolio subaccounts. Within the insurer's separate account are a variety of subaccounts ranging from conservative money-market portfolios to risky and aggressive international and sector stock portfolios. Variable annuities offering a choice of 20 or 30 different subaccounts are not uncommon. Variable contract owners select the subaccounts into which their premiums are allocated. They are free to reallocate premiums (and account values) among any of the insurer's available subaccounts. Variable annuity contract owners fully assume the investment risk of the annuity's contract value in the insurer's separate account. While they hope their subaccount choices will result in greater investment growth than would be realized with a fixed annuity, there is no guarantee of this. In fact, their account value may decrease. Variable annuities, like fixed annuities, can be bought as either immediate or deferred annuities. Most variable annuities sold today are deferred annuities.

Annuity Units

After calculating the first month's payment amount (using the selected AIR), the payment amount is converted into annuity units. This is essential to determining future payment amounts and is done by dividing the initial payment by the contract's current accumulation unit values. To illustrate, assume that a variable annuity contract owner recently annuitized the contract and the first monthly payment was $2,000. Further assume that the annuity unit value at the time of annuitization was $10. The $2,000 first payment, divided by $10, equates to 200 annuity units. This number stays constant—this contract will forever have 200 annuity units as the basis of future annuity payments. While the number of annuity units is fixed, their value will vary over the annuitization period just as the net asset value of each subaccount continually changes. All future income payments amounts are determined by multiplying the annuity units (200 units in this example) by the current NAV. That revaluation—and how that revaluation compares to the AIR—is the basis for all future monthly payments. Continuing our example from above, if the annuity unit value in the second month is $10.15, then the annuitant will receive a payment of $2,030 (200 units × $10.15). However, if the unit value decreases to $9.75, then the payment will be $1,950 (200 units × $9.75).

EIA Participation Rates and Caps

An EIA participation rate is the percentage of the index increase that is actually credited to the annuity. These rates typically range from 60 to 90 percent. Returning to our example, the increase in the S&P 500 during the contract's term was 10 percent. If the participation rate for Earl's contract is 75 percent, then 75 percent of the 10 percent index increase (7.5 percent) is the amount of interest that is credited to his contract. For that period, Earl's contract was credited with $750 ($10,000 × .075). In addition, an EIA may have a rate cap. A rate cap is the maximum interest rate that is applied to the funds in the EIA if the percent of change in the index is greater than the cap. A cap of 14 percent, for example, limits the amount of interest credited to an EIA to 14 percent. This is true regardless of whether the participation rate applied to the index increase produces a higher rate.

quiz

Gives owners more growth potential with risks. -Assumed Interest Rate (AIR)= Determines the monthly payment that the annuitant will receive. --The rate of return that the contract's values are *assumed to earn* over the annuitization period. - With Variable annuity their is no guaranteed interest. Insurance company has to make an assumption of what that money will earn overtime with the insurance company in the process of being paid out. Selected by the policy holder. Usually 2-3 options. Could be a 3% or a 5% AIR. --More money the insurance company can make the higher the payments will be in the distribution. Higher Interest rate can make more money but if the Variable annuity does not earn enough to support that AIR then the insurance company will adjust future payments to the reflect the actual earnings. --- EX. You select one thats 5% interest returned. It only grows 4% since last annuity payment then the insurance company will have to reduce that payment to the actual growth. HOWEVER if a 3% was selected and that month was actually earns 4% then that next month's monthly payment will increase to show they actual earnings exceeded the AIR. -Key questions --do you want the assurance that fututre payment will remain level and possibly increase or are you willing to gamble that future earning will exceed even the higher AIR and allow payment --If a decrease in monthly income is going to be something not appreciated by the annuitant then selecting a lower AIR is the best option

Variable Annuity Accumulation Units

The growth of a variable annuity's account value during its accumulation period is measured in terms of accmulation units. When the annuity owner makes premium payments and allocates them among the contract's subaccounts, they are used to buy accumulation units. (Accumulation units are equal to the subaccount's net asset value, or NAV.) These purchases are then credited to the owner's contract. Like all forms of securities, net asset values change on a daily basis. As the NAV rises, fewer accumulation units are purchased for any given premium amount. Conversely, if the NAV decreases then more accumulation units are acquired with any given premium amount. At any point in time, a variable contract's account value is equal to the total number of accumulation units multiplied by the NAV at that moment. A simple example will illustrate this important aspect of variable contracts. Jean buys a variable annuity and directs her $2,500 premium deposit into the contract's blue-chip stock subaccount. She does this at a time when each accumulation unit (i.e., NAV) in that subaccount is valued at $10. This means that Jean bought 250 accumulation units of that subaccount ($2,500 ÷ $10 = 250). One year later, because of the positive performance of the stocks in that subaccount, the NAV of the blue-chip stock accumulation unit rises to $12.20. As a result, the value of Jean's investment in that subaccount is now $3,050 ($12.20 × 250). If Jean decides then to invest her $2,500 annual premium into that subaccount, she would acquire 205 accumulation units ($2,500 ÷ 12.20). She would then own a total of 455 accumulation units in the blue-chip stock subaccount for a current value of $5,550.

Market-Value Adjusted Annuities

Another annuity design with a market-linked rate feature is the market-value adjusted (MVA) annuity. Unlike an EIA, a market-value adjusted annuity offers an interest rate adjustment feature that makes it possible for the MVA contract value to lose money if the contract is surrendered before the end of its term. Recall that equity-indexed annuities can only increase in value; they cannot lose value. MVAs are issued with a fixed current interest rate that is set for a specified period of time (or term) that may range from one to ten years. During the contract term, all contract funds (and premiums paid into the contract) earn the declared rate of interest. At the end of the term the contract owner may -renew the contract term to stay with the same rate (likely if the contract rate is higher than current rates), -move to another contract period with an adjusted current rate (likely if the contract rate is lower than current rates), or -withdraw funds without a surrender charge. Funds withdrawn before a contract period ends are subject to a market-value adjustment as well as a surrender charge. The result may be a net surrender charge that is higher or lower than the surrender charge alone. To understand the market-value adjustment, first understand that insurers want to discourage contract owners from surrendering their contract when current rates have increased. So, if an MVA owner surrenders the contract before the end of the contract term and current rates are higher than the rate being credited in the contract, the market-value adjustment will be negative and the net surrender charge will be higher. On the other hand, if current interest rates are lower than the declared rate in the contract, the market-value adjustment will be positive and the net surrender charge will be lower. The MVA is an investment vehicle that exposes contract owners to investment risk, so it is classified as a security. As such, producers who sell MVAs must be registered with FINRA.

Variable Annuity Death Benefits

Like fixed annuities, variable annuities provide for a death benefit if the owner or annuitant dies before the contract's funds are annuitized. This is the one aspect of variable annuities that, under most contracts, is guaranteed. Under most variable annuities, the death benefit equals the greater of -the premiums paid into the policy (less any withdrawals) or -the contract's accumulated value at the time of death. Many variable annuity contracts offer the option of increasing the death benefit as the contract's values grow. This feature requires a higher M&E charge.

Producer Qualifications to Sell Variable Contracts

To be properly registered to sell variable insurance contracts, producers must hold either a FINRA Series 6 or Series 7 registration, obtained by passing a FINRA exam. They must also hold a valid life insurance license in the state(s) where they do business. Some states also require a state-issued variable life or variable producer's license. If your state requires a license, you will find more information about it in the state law units of this course

Equity-Indexed Annuities (Indexed Annuities)

Equity-indexed annuities (EIAs), or indexed annuities, are tied closely to the performance of a stock index, but they are not variable contracts. EIAs allow contract owners to participate in some of the growth in the stock market while avoiding possible losses to principal. They do so by -linking the interest return to the growth of an equity (stock) index, and -providing for a guaranteed minimum rate of return for the length of the contract. EIAs are commonly linked to the S&P 500 or a Dow Jones Index. While EIAs are fairly complex products, the basic concept is simple: the percent of change in the selected stock index forms the basis for determining the percentage interest rate credited to the funds in the EIA. For example, let's say that Long Life Insurance Company's equity-indexed annuity is tied to the S&P 500. When Earl bought his EIA with a $10,000 premium deposit, the S&P 500 was at 1000. At the end of the contract's first term one year later, the S&P was at 1100. This is an increase of 10 percent in the index. Therefore, the basis for the amount of interest to be credited to Earl's contract is 10 percent. However, the actual amount credited depends on the contract's participation rate and rate cap

Variable, Indexed, and Market-Value Adjusted Annuitiest

Key difference between fixed and variable annuities: -Fixed= Principle and interest are guaranteed as are the amount and duration of income. Premiums are invested in the insurer's general account. Increases in value overtime. Not subject to market downturn. But may not keep pace with inflation. -Variable= Neither the princple or the interst rate are guaranteed. Premiums invested in the insurer's variable sub accounts, May increase or decrease depending on investment results in the variable sub accounts. Two annuities give owners a chance to participate in market growth while reserving principle. 1. Equity Indexed Annuities guarantee a minimum interest rate with a potential of higher earnings through the stock market. 2. Market-Value Adjusted Annuities also offer a guaranteed minimum interest rate but have an additional option to credit the market interst rate at the end of the contract period. Early withdrawal results in an adjusted payout.

EIA Death Benefits

Like declared-rate fixed and variable annuities, equity-indexed annuities provide a death benefit if the annuitant or contract owner dies before the contract annuitizes. The death benefit is usually specified as either the contract's accumulated index value or the guaranteed minimum value—whichever is higher. The death benefit is payable to the contract's beneficiary

EIA Minimum Interest Rates

Underlying an EIA contract for its entire term is a minimum guaranteed rate of interest. At the end of the term, the greater of the index performance (modified by the participation rate and cap rate) or the minimum guaranteed rate is credited to the contract. The minimum interest guarantee (which is usually around 3 percent) provides the assurance that EIA's principal is secure and the account value will grow by a minimum amount. (Because of this protection of principal, most EIAs are classified as a form of fixed annuity.) The typical term of most EIAs on the market today is five to seven years. At the end of the term, the accumulated values can be taken free of surrender charge. Or, they can be left in the contract and the contract can be continued for another term.

Variable Annuity Annuitization

Variable annuity contracts usually give contract owners the choice of annuitizing the contract under a fixed or variable settlement option. Variable annuitization under a variable annuity contract provides for income payments that are not fixed, like a fixed annuity. Instead, these income payments change in response to the performance of the contract's underlying subaccounts. The payout options for a variable annuity are the same as for a fixed annuity: -straight life -life with period certain (Guarantees that income for length of the annuitant's life. However, income is paid but for less than a certain number of year. So if the annuitant dies before the before chosen term period ends, then income payments continue to his or her beneficiary for the balance of the period. -joint life -fixed period/fixed amount and so on --Annuitization= process on which the funds in an annuity are turned into a series of ongoing, periodic income payments. However, determining the payment amount of each payment is very different with a variable annuity and involves four steps: 1. Determine the assumed interest rate (AIR). 2. Use the AIR to calculate the first annuity payment amount. 3. Convert the first annuity payment amount into a set number of annuity units. 4. Determine future annuity payment amounts by multiplying annuity units by the current NAV. This process is further explained below.

Key Points

-Variable annuity contract owners fully assume the investment risk of the annuity's contract value in the insurer's separate account. -The growth of a variable annuity's account value during its accumulation period is measured in terms of accumulation units. -At any point in time, a variable contract's account value is equal to the total number of accumulation units multiplied by the NAV at that moment. -Insurers use an assumed interest rate (AIR) when annuitizing a variable annuity. The AIR is the rate of return that the contract's values are assumed to earn over the annuitization period. -A higher AIR produces a larger initial payment but requires a higher investment return to maintain the payment amount. -A lower AIR produces a lower initial payment but more easily enables the contract to generate the same or higher future payments. -Equity-indexed annuities (EIAs), or indexed annuities, are tied closely to the performance of a stock index, but they are not variable contracts. EIAs allow contract owners to participate in some of the growth in the stock market while avoiding possible losses to principal. -Unlike an EIA, a market-value adjusted annuity offers an interest rate adjustment feature that makes it possible for the MVA contract value to lose money if the contract is surrendered before the end of its term

The Assumed Interest Rate

A basic factor in any annuity's calculation of the payment amount is the interest rate at which the undistributed funds will grow while income payments are being distributed. With fixed annuities the contract's guaranteed interest rate is the basis of this calculation. With variable annuities it is more complicated. Since investment returns are not guaranteed and can fluctuate widely, the insurer has to make an assumption of the rate of return the fund will earn during the distribution phase. To solve this problem, insurers use an assumed interest rate (AIR) when annuitizing a variable annuity. The AIR is the rate of return that the contract's values are assumed to earn over the annuitization period. Insurers let the contract owners select the rate, and usually offer a couple rates to choose from (e.g., 3 percent and 5 percent). Based on the AIR and the payout option selected, the annuity purchase rate is determined. (Recall that the annuity purchase rate is the amount of ongoing income that every $1,000 of a contract's accumulated value provides.) The annuity purchase rate is divided into the annuity contract value to determine the first month's income payment amount.

Impact of AIR on Future Annuity Payment Amounts

Future changes in the annuity payment amount are influenced by the assumed interest rate as well as changes in the subaccount net asset value. If the NAV change equals the AIR, then there would be no change in the annuity income amount (since the actual rate of return equals the assumed rate). If the NAV rises greater than the AIR (meaning actual performance exceeds assumed performance), then there would be an increase in the annuity income amount. If the NAV decreases (or increases less than the AIR), the result will be a decrease in the annuity income value. This emphasizes the importance of selecting a realistic AIR: -A higher AIR produces a larger initial payment but requires a higher investment return to maintain the payment amount. -A lower AIR produces a lower initial payment but more easily enables the contract to generate the same or higher future payments.

Regulation of Variable Annuities

The Securities Exchange Commission (SEC) is responsible for regulating the securities that make up an insurer's separate account. The Financial Industry Regulatory Authority (FINRA), formerly known as the National Association of Securities Dealers (NASD), regulates producers who sell variable insurance products. FINRA also regulates companies that sell investment products, including insurance companies that sell variable contracts.

Variable Annuity Contract Charges and Fees

Variable annuities impose several charges and fees unique to the product. Depending on the fee and the terms of the contract, these costs are handled in one of two ways: 1. They are either deducted from the premium payments before the payments are deposited into the separate subaccounts. 2. They are deducted from the values in the subaccounts. The types of charges and fees common to variable annuities include: - mortality and expense (M&E) costs—These are the insurance-related costs for a variable annuity. They cover the cost of the contract's death benefit. -fund management fees—These charges cover the cost of managing and administering the separate subaccount investment portfolios. -annual contract fee—This charge is assessed every year by the insurer. It covers the cost of administering and handling the contract.