9.2 Fixed, Indexed, and Variable Annuities
Key Takeaways
- Fixed annuities pay a guaranteed minimum interest rate from the insurer's general account; the insurer bears investment risk.
- Variable annuities invest in separate-account subaccounts; the owner bears investment risk and the producer needs a securities (FINRA) registration.
- Indexed (fixed indexed) annuities credit interest tied to an index using caps, participation rates, and a 0% floor while guaranteeing principal.
- Caps, participation rates, and spreads all reduce indexed credits below the raw index return.
- Variable annuities require a prospectus; indexed annuities are insurance products, not securities, in most states.
Three Product Families
Annuities are classified by how value grows and who bears the investment risk. The three families are fixed, indexed, and variable.
| Type | Where Funds Sit | Who Bears Market Risk | Growth |
|---|---|---|---|
| Fixed | General account | Insurer | Declared interest, guaranteed minimum |
| Indexed | General account | Insurer (principal protected) | Index-linked with caps and a 0% floor |
| Variable | Separate account | Owner | Subaccount (mutual-fund-like) performance |
Fixed Annuities
A fixed annuity credits a declared interest rate with a contractual guaranteed minimum. Funds are held in the insurer's general account, so the insurer bears the investment risk and must credit at least the minimum even if its own investments underperform.
Many fixed annuities use a two-tier rate: a higher current (teaser) rate for an initial period, then a lower renewal rate that can never drop below the guaranteed floor (often 1%-3%). Because returns are conservative, the chief client risk is purchasing-power (inflation) risk rather than market loss.
Trap: A fixed annuity protects principal and offers a guaranteed minimum, but it does not protect against inflation eroding the income's buying power.
Variable Annuities
A variable annuity invests premiums in separate-account subaccounts resembling mutual funds. The owner bears all investment risk: there is generally no guaranteed minimum on the account value, and the account can lose money.
Because the separate account is a security, a variable annuity is dually regulated by the state insurance department and the SEC/FINRA. To sell one, a producer needs both a life insurance license and a securities registration (FINRA Series 6 or 7), and the client must receive a prospectus before or at the time of sale.
| Variable Annuity Fact | Detail |
|---|---|
| Account type | Separate account (subaccounts) |
| Risk borne by | Owner |
| Required disclosure | Prospectus |
| Producer credential | Life license + FINRA registration |
| Regulators | State + SEC/FINRA |
To sell a variable annuity, a producer must hold which combination of credentials?
Indexed (Fixed Indexed) Annuities
A fixed indexed annuity (FIA) is a fixed annuity whose interest is tied to an external index such as the S&P 500. It blends a fixed annuity's principal guarantee with upside linked to the market. Funds sit in the general account, and the contract guarantees a 0% floor, so a down-index year credits no interest but never a loss.
The upside is limited by crediting controls that the exam tests heavily:
- Cap rate: the maximum interest credited in a period (e.g., a 6% cap means a 12% index gain still credits only 6%).
- Participation rate: the percentage of the index gain credited (e.g., 70% participation on a 10% gain credits 7%).
- Spread / margin / asset fee: a percentage subtracted from the index gain (e.g., a 2% spread on a 10% gain credits 8%).
Worked Example: Indexed Crediting
Assume an index rose 10% in the crediting period. Compare three contracts on a $100,000 account:
| Crediting Method | Setting | Interest Credited |
|---|---|---|
| Cap rate | 6% cap | $6,000 (capped) |
| Participation rate | 70% participation | $7,000 (70% of 10%) |
| Spread | 2% spread | $8,000 (10% minus 2%) |
If instead the index fell 8%, every contract credits $0 because of the 0% floor, but principal is unharmed.
Exam Tip: Indexed annuities are insurance products, not securities, in most states, so they do not require a prospectus or securities license. Suitability and replacement rules still apply.
An index gained 12% during the crediting period. A fixed indexed annuity applies a 70% participation rate and a 5% cap. On a $100,000 value, how much interest is credited?
Indexed (Fixed Indexed) Annuities in Depth
A fixed indexed annuity (FIA) credits interest tied to an external index (such as the S&P 500) but keeps funds in the general account with principal protection. Three crediting controls limit how much of the index gain is credited:
- Participation rate: the percentage of the index gain credited (e.g., 80% of a 10% gain = 8%).
- Cap: a maximum credited rate for the period (e.g., gains capped at 6%).
- Floor: the minimum, usually 0%, so a negative index year credits nothing rather than a loss.
Worked example: index rises 10%, par rate 70%, cap 6%. 70% x 10% = 7%, but the 6% cap applies, so 6% is credited. If the index falls 10%, the 0% floor means 0% is credited principal is preserved.
Suitability and the Regulator Map
| Annuity Type | Regulated By | License Needed to Sell |
|---|---|---|
| Fixed | State insurance dept | Life license only |
| Fixed indexed | State insurance dept (insurance product) | Life license only |
| Variable | State insurance dept + SEC/FINRA | Life license + securities registration |
FIAs are insurance products, not securities, so a life-only producer may sell them but suitability and replacement rules still apply, and disclosures about caps, surrender charges, and how index credits work must be clear.
Trap: Indexed annuities are NOT securities and do NOT require a securities license, even though their return is index-linked. Only variable annuities require the securities registration.
A fixed indexed annuity has a 0% floor, an 80% participation rate, and a 5% cap. The index gains 9% this term. What is credited?
Risk Comparison Across the Three Families
The exam wants you to rank the products by who bears risk and whether principal is protected:
| Annuity | Principal Protected? | Upside | Who Bears Market Risk |
|---|---|---|---|
| Fixed | Yes (guaranteed min) | Modest declared rate | Insurer |
| Fixed indexed | Yes (0% floor) | Index-linked, capped | Insurer (caps the upside) |
| Variable | No | Unlimited subaccount return | Owner |
Fixed annuities expose the owner mainly to inflation/purchasing-power risk, not market loss. Indexed annuities protect principal but cap gains. Variable annuities can lose value because funds sit in the separate account, and only they require a securities registration to sell.
Exam Tip: Only the variable annuity puts principal at market risk and requires a securities license. Fixed and indexed protect principal and are sold under an insurance license.