9.2 Fixed, Indexed, and Variable Annuities

Classifying Annuities by Investment Risk

Annuities are grouped by how interest is credited and who bears investment risk. This is one of the most heavily tested distinctions on the exam.

Exam tip: "General account" signals guarantees and insurer risk. "Separate account" signals investment risk passed to the owner and a securities license requirement.

Fixed Annuities

A fixed annuity guarantees both principal and a minimum guaranteed interest rate. Premiums go into the insurer's general account, where the insurer invests conservatively (bonds, mortgages) and bears all investment risk.

• Current rate — the actual rate credited, often higher than the guaranteed floor; resets periodically.
• Guaranteed minimum rate — the contractual floor (commonly 1%–3%) below which crediting cannot fall.
• Payout — fixed-dollar payments that do not change.

The trade-off is inflation risk: a level fixed payment loses purchasing power over a long retirement. Only an insurance license is needed to sell fixed annuities — no securities registration.

Market-Value-Adjusted (MVA) Fixed Annuities

A variation, the Market-Value-Adjusted annuity, applies a positive or negative adjustment to the surrender value if the owner withdraws before the rate-guarantee period ends. If market interest rates have risen since purchase, the MVA reduces the surrender value; if rates have fallen, it can increase it. The owner shares interest-rate risk in exchange for a higher guaranteed rate. The principal is still guaranteed if the contract is held to the end of the term.

Variable Annuities

A variable annuity places premiums in subaccounts within the insurer's separate account. Subaccounts resemble mutual funds (stock, bond, money-market). The owner bears all investment risk — values rise and fall with the markets and principal can be lost.

Because it is both an insurance product and a security, the producer must hold a state insurance license AND a FINRA securities registration (Series 6 or 7), and the buyer must receive a prospectus. Variable annuities carry layered fees:

• Mortality and expense (M&E) charge — typically ~1.25% annually.
• Administrative fees and subaccount management fees.
• Surrender charges during the surrender period.

The separate account is not part of the insurer's general creditors' claims, protecting subaccount assets if the insurer fails.

Two Sub-Phases of a Variable Annuity

Variable annuity values are measured in accumulation units during pay-in and annuity units during payout. During accumulation, each premium buys a number of accumulation units whose value floats daily with subaccount performance. At annuitization, the units convert to a fixed number of annuity units; the number of annuity units stays constant, but each unit's value changes with the market, so income payments vary up or down.

Many variable annuities offer an Assumed Interest Rate (AIR) benchmark. If actual subaccount performance exceeds the AIR, the next payment rises; if it lags the AIR, the payment falls.

Exam tip: In a variable payout, the number of annuity units is fixed and the value per unit varies. This is the reverse of the fixed annuity, where the dollar payment is constant.

Indexing Methods and Crediting Period

Indexed annuities also differ by how the index change is measured over the crediting term:

• Annual point-to-point — compares the index on two dates one year apart.
• Monthly averaging — averages monthly index values, smoothing volatility.
• High-water mark — credits based on the highest index value reached during the term.

Many contracts let the insurer reset the cap or participation rate each term, so a 6% cap today can drop at renewal. Buyers also forgo dividends, since most indexes used are price indexes that exclude dividend reinvestment.

Indexed (Fixed-Indexed) Annuities

An indexed annuity is a fixed annuity whose interest is linked to a market index such as the Standard & Poor's 500 (S&P 500). Funds sit in the general account, so principal is protected by a floor (often 0%), but crediting is limited by:

• Participation rate — the percentage of the index gain credited. At an 80% participation rate, a 10% index gain credits 8%.
• Cap rate — the maximum credited rate. With a 6% cap, a 12% index gain credits only 6%.
• Spread/margin — a percentage subtracted from the index gain. A 2% spread turns a 9% index gain into 7%.

Worked Example

Index returns 10%. With an 80% participation rate and a 6% cap: 10% × 80% = 8%, but the cap limits credit to 6%. If the index instead falls 10%, the 0% floor credits 0% — principal is preserved.

Suitability and Securities Status

Most indexed annuities are fixed products regulated by the state insurance department, so a securities license is not required to sell the typical fixed-indexed annuity. However, the layered caps, spreads, surrender schedules, and renewal resets make them complex; states impose heightened suitability documentation. Because the buyer can misunderstand that the index gain is capped and dividends are excluded, the producer must clearly disclose how interest is credited. A small number of registered index-linked annuities (RILAs) that expose the owner to limited downside are treated as securities and do require a registration.