9.2 Fixed, Indexed, and Variable Annuities

Annuities are classified by how the contract value is invested and who bears the investment risk. The three core families are fixed, indexed, and variable. The exam tests the risk allocation, the guarantees, the regulatory framework, and the producer-licensing requirement for each.

Fixed Annuities

A fixed annuity credits a guaranteed minimum interest rate declared by the insurer. Premiums go into the insurer's general account, and the insurer bears the investment risk. The owner receives a predictable, stable return and a guaranteed minimum floor (for example, 1% to 3%). Because there is no securities risk to the consumer, fixed annuities require only a state life insurance license — no securities registration.

Current vs. Guaranteed Rates

Fixed annuities usually advertise a higher current (declared) rate that the insurer can adjust periodically, sitting above the contractually guaranteed minimum rate. The exam trap: the bonus or teaser rate is temporary; only the guaranteed minimum is contractually protected for the life of the contract.

Variable Annuities

A variable annuity invests premiums in subaccounts held in the insurer's separate account (mutual-fund-like portfolios selected by the owner). The owner bears all investment risk — there is no guaranteed return, and the contract value (and income payments after annuitization) rises and falls with market performance. Because the consumer assumes market risk, a variable annuity is a security as well as an insurance product.

Variable Annuity Dual Regulation and Licensing

To sell a variable annuity, a producer must hold both a state life insurance license and a securities registration (a FINRA registration, typically the Series 6 or Series 7, with the Series 63 state registration). Variable contracts are regulated by both the state insurance department and the SEC/FINRA, and the prospect must receive a prospectus before or at the time of solicitation.

Indexed Annuities (Fixed Indexed Annuities)

An equity-indexed annuity (EIA), now usually called a fixed indexed annuity (FIA), is a fixed annuity whose interest credit is linked to an external index such as the S&P 500, while guaranteeing the principal will not lose value to market declines. It is a hybrid: index-linked upside with a downside floor of 0% in a bad year.

Mechanics That Limit the Credited Interest

• Participation rate: the percentage of the index gain credited. If the index rises 10% and the participation rate is 70%, the credit is 7%.
• Cap rate: a maximum credited rate. With a 6% cap, a 10% index gain credits only 6%.
• Spread/margin/asset fee: a percentage subtracted from the index gain. A 2% spread on a 10% gain credits 8%.
• Floor: the guaranteed minimum, typically 0%, so the contract never credits a negative return.

Worked Numeric: Indexed Crediting

The index returns 12% in a contract year. The contract has a 75% participation rate and a 8% cap.

1. Apply participation: 12% × 75% = 9%.
2. Apply cap: 9% exceeds the 8% cap, so the credited rate is capped at 8%.

If the index instead fell 5%, the 0% floor applies — the contract credits 0% and loses no principal. *Most indexed annuities are filed as fixed (insurance) products requiring only a life license, but a producer must still follow suitability and disclosure rules and understand that index-linking is not direct stock-market participation (no dividends are credited).

Three crediting designs and where the risk sits

The key sorting question for annuity products is who bears the investment risk:

A fixed annuity credits a guaranteed minimum interest rate; the insurer absorbs investment risk and the owner's principal and a floor rate are guaranteed. A variable annuity invests in separate-account subaccounts (like mutual funds); values rise and fall with the market, so the owner bears all investment risk and there is no guaranteed account value.

Indexed crediting mechanics and the variable-licensing rule

An indexed (fixed indexed) annuity links interest to an external index with a 0% floor, using participation rates, caps, and spreads to limit how much index gain is credited.

Worked example: Index gains 9%; participation rate 70%, cap 8%, spread 1%.

• Apply participation first: 9% × 70% = 6.3%.
• 6.3% is below the 8% cap, so no cap reduction.
• Subtract the 1% spread (if the product uses one): 6.3% − 1% = 5.3% credited.
• The 0% floor guarantees the credit never goes negative in a down market.

Order of operations to memorize: participation rate → cap → floor (and subtract any spread).

Licensing rule (heavily tested): Selling a variable annuity requires both a state life license and a FINRA securities registration (Series 6 or 7 plus a state securities license), and the producer must deliver a prospectus. A fixed or indexed annuity needs only a life license because principal is insurer-guaranteed or floor-protected.