6.4 Variable Annuities

What Makes a Variable Annuity Different

A variable annuity (VA) lets the owner direct premiums into subaccounts — mutual-fund-like portfolios of stocks, bonds, and money-market instruments held in the insurer's separate account. Returns are not guaranteed; values rise and fall with subaccount performance, so the owner bears the investment risk and benefits from any growth. This is the defining contrast with fixed annuities, where the insurer bears the risk and guarantees the value.

Because a VA exposes the owner to securities risk, it is regulated as both an insurance product and a security.

Dual Licensing and Regulation

To sell variable annuities a producer must hold:

• A life insurance license (state insurance department), and
• A FINRA securities registration (typically the Series 6 or Series 7), plus the firm's broker-dealer affiliation.

Variable contracts are regulated by both the state insurance commissioner and the federal SEC/FINRA. The insurer must deliver a prospectus before or at the time of solicitation — a defining feature absent from fixed products. The separate account is itself registered as an investment company.

Separate Account vs. General Account

The separate account is kept apart from the insurer's general assets and is not chargeable with the insurer's other liabilities.

Accumulation Units and Annuity Units

During accumulation, premiums (net of charges) buy accumulation units, whose value floats with subaccount performance. The number of units stays fixed as you stop buying; the unit value changes daily.

At annuitization the contract converts accumulation units into a fixed number of annuity units. From then on the number of annuity units is fixed, but the dollar value per unit varies with the separate account, so the income check changes each period.

The assumed interest rate (AIR) is the benchmark used to value annuity units in payout: if actual separate-account performance exceeds the AIR, the next payment rises; if it underperforms the AIR, the next payment falls.

AIR Worked Example

Suppose the AIR is 4%.

• If the separate account earns 6% (above AIR), the next variable payment increases.
• If it earns exactly 4%, the payment stays level.
• If it earns 2% (below AIR), the next payment decreases.

The AIR is a conservative pricing assumption, not a guarantee. A common trap: a higher AIR produces a larger initial payment but makes future increases harder to achieve, because actual returns must beat the higher benchmark to push payments up.

Suitability, Sales Conduct, and Common Riders

VA sales carry heightened suitability duties: the producer must reasonably believe the contract fits the client's age, time horizon, liquidity needs, and risk tolerance, and must disclose fees (mortality & expense charge, administrative fees, subaccount expenses, surrender charges). Misrepresenting a VA's guarantees or omitting the prospectus is a serious market-conduct violation.

Common optional living/death benefit riders:

• Guaranteed Minimum Income Benefit (GMIB) — guarantees a minimum annuitization income floor.
• Guaranteed Minimum Withdrawal Benefit (GMWB) — guarantees a minimum stream of withdrawals.
• Guaranteed Minimum Accumulation Benefit (GMAB) — guarantees a minimum account value after a set period.

Variable Annuity Regulation and the Risk Shift

A variable annuity (VA) places premiums in separate-account subaccounts selected by the owner, who bears all investment risk — the accumulation value (and, in a true variable payout, the income amount) rises and falls with subaccount performance. Because the VA is both an insurance product and a security, it is dual-regulated: the producer must hold a life insurance license AND a FINRA securities registration (Series 6 or 7), the insurer must register with the SEC, and a prospectus must be delivered. This is among the most-tested facts on the exam.

Accumulation Units vs. Annuity Units

• During accumulation, premiums buy accumulation units; the number of units grows with each deposit and the value per unit fluctuates with the subaccounts.
• At annuitization, accumulation units convert to a fixed number of annuity units; thereafter the unit value floats, so each payment varies with market performance. Some contracts use an assumed interest rate (AIR) as a benchmark: if actual separate-account performance exceeds the AIR, the next payment rises; if it lags the AIR, the payment falls.

Worked AIR Logic

With a 4% AIR, if the subaccount earns 7% in a period, the annuity-unit value (and the next check) increases; if it earns 2%, the next check decreases; if it earns exactly 4%, the payment stays level. This is the mechanism behind a variable payout — guarantees apply to the number of units, not their dollar value.

Combination Annuity and Suitability

A combination annuity splits premiums between a general-account (fixed) portion and a separate-account (variable) portion, letting the owner blend guarantees with growth. Optional living benefit riders (GMIB, GMWB, GMAB) add guarantees for extra cost. Because VAs carry market risk plus high fees, suitability review is mandatory, and recommending a VA to a conservative senior seeking guaranteed principal is a classic unsuitable-sale exam trap.