MY VARIABLE ANNUITIES Flashcards
What are VARIABLE ANNUITIES:
Variable annuities are annuity contracts which allow the accumulation of earnings based on subaccounts that are similar to mutual funds.
In regards to Variable annuities, explain the function of “subaccounts”:
Like mutual funds, each subaccount has a specified objective, such as growth, capital appreciation, aggressive growth, income, etc. Within the subaccount, securities are selected by the insurer or and investment manager to meet the subaccount’s objective. The risk and opportunity for growth in each subaccount varies based on the types of securities utilized. The insurer does not guarantee the return on subaccounts, although the insurer may offer some guarantees by pegging the value of the annuity every serval years or by guaranteeing the death benefit amount. The policyholder selects the subaccounts into which he or she places her annuity contributions.
Regarding Variable annuities, explain a policyholder’s choice of systemic withdrawal plans:
Variable annuity policyholders often choose systematic withdrawal plans. The reason this option is chosen is because they have the flexibility of being able to be stopped and started. However, the systematic withdrawal plans do have different tax ramifications than do annuitization payouts.
Because these products utilize securities and the risk of return is borne by the policyholder and not the insurer, variable annuities are considered securities products. Producers offering them must be licensed for selling securities products as well as being life insurance producers.
Regarding Variable Annuities, what is the insurer’s “SEPARATE ACCOUNT”?
Variable annuity insurers establish a “separate account” in which the contributions made to variable annuity subaccounts by insureds are held. The “separate account is different from the insurer’s “general account”.
The separate account is registered as an investment company under the Investment Company Act of 1940, like mutual fund companies which also must be registered under this same Act.
Regarding Variable Annuities and the insurer’s “SEPARATE ACCOUNT”, which is registered as an investment company under the Investment Company Act of 1940, what happens to the income, gains and losses from assets allocated to the “SEPARAT ACCOUNT”?
The income, gains and losses from assets allocated to a separate account are credited to or charged against the account, without regard to other income, gains or losses of the company. According to the NAIC’s Variable Annuity Model Regulation which is the basis for many state’s laws related to variable annuities, amounts allocated to a separate account and their accumulations:
- may be invested and reinvested without regard to any requirements or limitations prescribed by the laws of the state governing the investments of life insurance companies, and
- the investments in the separate account are not taken into account in applying the investment limitations otherwise applicable to the investments of the company.
Regarding, a Variable Annuities, the separate account is different from the insurer’s GENERAL ACCOUNT. What is the GENERAL ACCOUNT?
The “general account” is the account used to hold funds contributed to non-variable products and to the fixed accounts included in some variable annuity products. The general account is governed by very specific investment requirements, since it backs the insurer’s guarantees to meet policyholder obligations in guaranteed products, such as to pay the fixed rate on annuity products and to pay death benefits on life insurance products.
How are assets in the separate account valuated?
Assets allocated to a separate account are valued at their market value on the date of valuation. Generally, assets are valued each day the markets are open. If there is not a readily available market, the assets are valued as provided under the terms of the contract or the rules or other written agreement applicable to such a separate account. Guaranteed benefits are valued in accordance with the rules that normally pertain to valuing company’s assets backing guaranteed benefits.
Is there are prohibition against transfers between separate accounts?
Generally, yes. There is a prohibition against transfers between separate accounts.
The funds held in separate accounts cannot be moved around to other separate accounts owned by the insurer. The sale, exchange or other transfer of assets may not be made by the insurer between any of its separate accounts or between any other investment account and one or more of its separate accounts unless, in case of a transfer into a separate account:
-the transfer is made by a transfer of cash; or
-the transfer is made by a transfer of securities having a readily determinable market value, and the Commissioner approves the transfer.
The state insurance commissioner may authorize other transfers if the commissioner finds they will not be inequitable.
Policy Disclosures:
The NAIC’s model regulation also states that contracts that provide variable benefits must contain a statement of the essential features of the procedures to be followed by the insurance company in determining the dollar amount of such variable benefits. Any contract under which the benefits vary to reflect investment experience, including a group contract and any certificate in evidence of variable benefits, must state that the dollar amount will vary. It must contain on its first page a statement to the effect that the benefits are on a variable basis.
Subaccounts
The solicitation of variable annuities requires the use of a prospectus. The prospectus describes the investment objectives, the types of securities within the subaccounts and the investment strategies allowed within a subaccount.
For example, for a government bond subaccount, a prospectus will state the subaccount objective, such as to “provide a high level of current income with liquidity and safety of principal.” Then, the types of securities used within the subaccount are stated, such as “this subaccount invests primarily in bonds issued by the U.S. government and its agencies and instrumentalities.” The investment strategy is also described: “This subaccount is managed to maintain an average weighted maturity between three and 15 years, taking into account expected prepayment of principal on certain investments. Individual securities are selected by the subaccount that are believed will perform well over market cycles.” If this subaccount had a more aggressive objective, the prospectus would also disclose the utilization of options or derivatives by the subaccount managers, as applicable.
The prospectus also includes the returns over a past period and the subaccount’s annual operating and other expenses.
Regarding a deferred variable annuity SUBACCOUNT FEATURES, what makes it more tax appealing than the tax features of mutual funds?
When a deferred variable annuity is purchased, the policyholder selects from the product’s menu of subaccounts and selects the percentage or amount to be placed in his or her selected subaccounts. For example, policyholder Jeff has $100,000 to place into a deferred variable annuity. He opts to place $25,000 in the government bonds subaccount, $25,000 in the small cap aggressive growth subaccount, $25,000 in the high-tech subaccount and $25,000 in the fixed account. After three years, Jeff contacts the insurer and decides to transfer half his funds in the small cap aggressive growth fund to the global health services fund.
Transfers are allowed among the subaccounts and are not taxable, since the subaccounts are part of the deferred annuity. This is one of the features that make variable annuities distinct from mutual funds.
For example, Jeff has $100,000 in a growth mutual fund, which we will call FUND A. He receives a 1099-DIV each year from FUND A that provides him the information he needs to pay taxes on distributions from FUND A. Mutual FUND A also has growth within its underlying investments - i.e., the stocks it invests in are worth more - since the time Jeff joined FUND A. This appreciation in value has not been paid out in distributions and has not been taxable to Jeff. When Jeff transfers $50,000 of FUND A into FUND B with the same mutual fund company, the appreciation within the $50,000 worth of FUND A that has not been taxed and is being moved to FUND B becomes taxable to Jeff. It may be taxed as short-term capital gains or long-term capital gains, depending upon how long Jeff has held the shares in FUND A.
In contrast, when Jeff transfers money from Variable SUBACCOUNT A to Variable SUBACCOUNT B, the transfer is not a taxable transaction.
The use of subaccounts within a variable annuity shields the policyholder from current taxation related to transferring money from subaccount to subaccount.
Valuation of Subaccounts: /subaccount values are allocated into “units”. The policyholder’s account value is based on the value of these units. Explain:
Subaccount values are allocated into “units”. The policyholder’s account value is based on the value of these units.
For example, when Jeff places $25,000 into a small cap aggressive growth subaccount, he buys a specified number of units. Let’s assume he places the money in the subaccount on April 5, and purchases 2500 units in this subaccount, with each unit being worth $10. Each day, the subaccount’s value is calculated based on the market value at the end of the day of the securities within the subaccount. On April 6, the value of his units in this subaccount is $25,625, because the unit value of the subaccount, based on the value of the securities within it, went up by 25 cents. On April 7, his 2500 units have a value of $24,925 because the unit value went down to $9.95, based on the market value of the securities underlying this subaccount.
Variable annuity products are for consumers who understand the risks of the securities market. They are not for the consumer who wants a guaranteed fixed rate with no fluctuation. They are not for the consumer who is not willing to risk a loss in value.
Just like fixed deferred annuities, variable annuities come in single premium and flexible premium forms. What are the differences between the two premium forms?
Single premium variable annuities typically have a minimum contribution limit of $10,000 or $25,000.
Flexible variable annuities may have smaller minimum contribution requirements.
The fact that a variable annuity accepts smaller minimum opening requirements does not mean it is automatically suitable for a person with a small amount available to contribute. The suitability requirements for a variable annuity include ensuring that the applicant has sufficient resources to risk in the securities market and the producer must take care before recommending any securities product. No variable annuity should be recommended solely because of a low contribution requirement.
Variable annuities have surrender charge periods. Explain this:
Variable annuities also have surrender charge periods. They may have a surrender charge that “follows” each contribution. For example, if a variable annuity product has a five-year surrender charge period, each contribution made may be subject to the five-year surrender charge. When the units applicable to that contribution are withdrawn within that five-year period, the surrender charge for that contribution applies. This type of surrender charge structure is sometimes referred to as a “rolling surrender charge”.
We are pointing this out because fixed flexible premium deferred annuities, even when they allow additions, often have a surrender schedule that has a term that begins with the first opening premium - i.e. when the annuity is purchased - and ends at a specified number of years after the annuity open date, even if additions are made. In other words, a fixed deferred annuity opened on April 1, 2023 that has a ten-year surrender schedule term will no longer charge a surrender fee after April 1, 2033, even if additions were made after April 1, 2023 to the annuity. As has been noted, it is important to read the contract carefully in order to understand specific product surrender charge provisions. Some fixed flexible premium deferred annuities use a surrender charge structure that “follows” each premium payment, like the structure we described for variable annuity products.
Explain the dynamics of contributions to a fixed account that is within the confines of a variable annuity product:
Some variable annuity products include the ability for the policyholder to make contributions to a fixed account. This is not a money market subaccount, but is an account backed by the insurer’s general account. It is not part of the insurance company’s separate account. In other words, the policyholder may make contributions to a fixed deferred annuity within the umbrella of the variable annuity product.
Insurance companies have different fixed account provisions. For example, with some companies, there may be no transfers from the fixed account without a surrender charge during the surrender charge period. The fixed account may be structured exactly like a separate deferred annuity, with all the penalty and free withdrawal privileges of a fixed deferred annuity product. In other variable annuities, the fixed account is provided with more flexibility to act more like a separate account in terms of transfer and contribution privileges.
