6.4 Variable Annuities
Key Takeaways
- Variable annuity premiums go into the insurer's separate account and the owner bears the investment risk; there is no guaranteed minimum on the basic contract.
- A variable annuity is both an insurance product and a security, requiring a life license plus a FINRA securities registration and delivery of a prospectus.
- In accumulation, the number of accumulation units varies with deposits while unit value floats; in payout, the number of annuity units is fixed but the dollar payment varies.
- The assumed interest rate (AIR) is the payout benchmark: earnings above the AIR raise the next payment, equal keeps it level, below lowers it.
- Variable annuities help offset inflation risk but expose the annuitant to loss of principal, the opposite trade-off of a fixed annuity.
What a Variable Annuity Is
A variable annuity (VA) is an annuity in which the contract value and the payout amount fluctuate with the performance of underlying investment subaccounts (similar to mutual funds) chosen by the owner. Premiums are placed in the insurer's separate account, not the general account, and the owner — not the insurer — bears the investment risk. There is no guaranteed minimum interest rate on the basic contract; values can rise or fall.
Because the consumer assumes investment risk, a variable annuity is regulated as both an insurance product and a security.
Dual Licensing Requirement
To sell a variable annuity a producer must hold:
- A state life insurance license, AND
- A FINRA securities registration (e.g., Series 6 or Series 7, plus the appropriate state securities/blue-sky registration).
The insurer must also deliver a prospectus before or at the time of sale, because the SEC regulates the security component. This is the single most-tested fact about variable annuities.
Accumulation Units and Annuity Units
Variable annuities measure value in units rather than dollars:
| Phase | Unit | Behavior |
|---|---|---|
| Accumulation phase | Accumulation units | Premiums buy a variable number of accumulation units; the unit value changes daily with subaccount performance |
| Payout phase | Annuity units | At annuitization, accumulation units convert to a fixed number of annuity units; the unit value still varies, so each payment varies |
Key Distinction
- During accumulation, the number of accumulation units the owner owns grows with each premium, while the value per unit floats.
- During payout, the number of annuity units is fixed at annuitization. Each periodic payment then equals that fixed number of units multiplied by the current (fluctuating) annuity unit value. As a result, the number of units stays constant but the dollar amount of each check goes up or down with the market.
Trap: Students reverse this. Remember: accumulation = variable number of units; payout = fixed number of units, variable dollar payment.
Fees, AIR, and Risk
Variable annuities carry layered fees: mortality and expense (M&E) charges, administrative fees, subaccount management fees, and charges for optional riders (e.g., guaranteed minimum income or death benefits). High fees are a frequent suitability and complaint issue.
Assumed Interest Rate (AIR)
The assumed interest rate (AIR) is a benchmark used only during the payout phase to calculate the first variable annuity payment and to determine whether subsequent payments rise or fall:
- If actual subaccount performance exceeds the AIR, the next payment increases.
- If performance equals the AIR, the payment stays the same.
- If performance is less than the AIR, the next payment decreases.
Worked example: AIR is 4%. If the subaccount earns 6% this period, the next annuity payment rises (6% > 4%). If it earns only 3%, the next payment falls (3% < 4%). The AIR is a hurdle, not a guarantee.
Because the owner bears market risk and there is no guaranteed floor on the basic contract, variable annuities address inflation risk (potential growth) but expose the annuitant to loss of principal — the opposite trade-off from a fixed annuity.
To sell a variable annuity, a producer must hold which of the following?
During the payout phase of a variable annuity, the assumed interest rate (AIR) is 4%. If the separate account actually earns 6%, the next annuity payment will:
Suitability, Disclosure, and the Separate-Account Risk Picture
A variable annuity is the only annuity where the owner bears full investment risk, so it carries the heaviest disclosure and suitability burden on the exam. Premiums flow to the insurer's separate account (the variable subaccounts), not the general account, and a prospectus must be delivered at or before sale because the SEC regulates the security component.
| VA requirement | Reason |
|---|---|
| Life license + FINRA registration | Product is both insurance and a security |
| Prospectus delivered at/before sale | SEC disclosure of the security |
| Suitability/best-interest analysis | Owner bears market risk |
| Separate account custody | Subaccount values float daily |
Worked example on the unit mechanics, the most-reversed VA fact: during accumulation, each premium buys a variable number of accumulation units while the unit value floats daily. At annuitization, the contract converts to a fixed number of annuity units; thereafter the number of units is locked but the dollar value of each payment floats with the subaccounts. So a payout of 100 annuity units at $10.20 pays $1,020 this month and, if the unit value rises to $10.50, pays $1,050 next month — same units, different dollars.
The assumed interest rate (AIR) governs whether those dollars rise or fall. If subaccount performance exceeds the AIR, the next payment increases; if it equals the AIR, the payment is unchanged; if it trails the AIR, the payment drops. With a 4% AIR, a 6% return raises the next check and a 3% return lowers it. The AIR is a benchmark hurdle, not a guarantee — there is no minimum floor on the basic contract. This is the precise mirror image of the fixed annuity: the VA accepts principal risk in exchange for an inflation hedge, while the fixed annuity guarantees principal but exposes the owner to inflation.
Quick Recap: Dual Regulation and the AIR Direction
The two facts the exam tests most are the variable annuity's dual regulation and the AIR direction. Because the owner bears market risk through the separate account, a VA is both an insurance product and a security: the producer needs a life license and a FINRA securities registration, and a prospectus must be delivered at or before sale. During payout, the assumed interest rate is the hurdle — actual subaccount performance above the AIR raises the next payment, equal to the AIR leaves it unchanged, and below the AIR lowers it.
There is no guaranteed floor on the basic contract, the mirror image of the fixed annuity's guaranteed principal but inflation exposure.