6.4 Variable Annuities

A variable annuity (VA) transfers investment risk from the insurer to the owner. Premiums are invested in subaccounts (similar to mutual funds) held in the insurer's separate account, not the general account. Because the value rises and falls with the subaccounts' performance, neither principal nor return is guaranteed - the owner can lose money.

Dual Regulation and Licensing

Because a VA is both an insurance contract and a security, it is dually regulated:

• The state insurance department regulates it as insurance.
• The SEC and FINRA regulate it as a security.

To sell a variable annuity a producer must hold BOTH a life insurance license AND a FINRA securities registration (typically Series 6 or 7) with Series 63 where required. A prospectus must be delivered to the prospect.

Separate Account and Accumulation Units

During accumulation, premiums purchase accumulation units whose value fluctuates daily with the subaccounts. Because the separate account is not part of the insurer's general assets, it is insulated from the insurer's creditors and is not subject to the same conservative investment restrictions as the general account.

Annuity Units

When the contract is annuitized, accumulation units convert to a fixed number of annuity units. The number of annuity units stays constant for life, but the dollar value per unit varies, so the monthly income rises and falls with subaccount performance.

The AIR and How Payments Move

Variable payout uses an Assumed Interest Rate (AIR) - a benchmark the insurer uses to set the first payment and to gauge whether the account is over- or under-performing.

• If actual net return exceeds the AIR, the next payment rises.
• If actual net return equals the AIR, the payment stays the same.
• If actual net return is below the AIR, the next payment falls.

This is the single most heavily tested mechanic of variable annuities. Memorize: the comparison is always actual performance versus the AIR, not versus the prior period's performance.

Worked Example: Annuity Unit Value

Suppose at annuitization the owner is allocated 100 annuity units and the AIR is 4%.

• Month 1: unit value = $50.00, payment = 100 x $50.00 = $5,000.
• Month 2: the subaccount earns 6% net, beating the 4% AIR by 2%. The unit value rises (roughly +1.9% above the AIR-adjusted base) to about $50.95, payment = 100 x $50.95 = $5,095.
• Month 3: the subaccount earns only 4% net, exactly the AIR. The unit value holds near $50.95, payment = $5,095 (unchanged).

The number of annuity units never changes; only the value per unit moves. This is why income is variable.

Fixed vs. Variable: The Core Comparison

The exam repeatedly contrasts the two product families on who bears risk and where money is held.

The variable annuity's chief advantage over the fixed annuity is its potential to keep pace with inflation through subaccount growth - the trade-off for accepting market risk.

Suitability, Charges, and Traps

Variable annuities carry mortality and expense (M&E) charges, administrative fees, and subaccount management fees, making them expensive. Common suitability concerns:

• Replacing an existing annuity without net benefit (unsuitable churning).
• Selling a VA inside an IRA solely for tax deferral - the IRA is already tax-deferred, so the VA's tax advantage is redundant and the extra fees may be unjustified.
• Selling to elderly clients who need liquidity and cannot tolerate market loss.

Optional living benefit riders such as a Guaranteed Minimum Income Benefit (GMIB) or Guaranteed Minimum Withdrawal Benefit (GMWB) can guarantee a floor of income or withdrawals regardless of subaccount performance, but each rider adds annual cost and must be justified by the client's needs.

Common Trap

Variable annuities are NOT guaranteed against loss of principal; only optional living/death benefit riders (at extra cost) provide guarantees. A fixed annuity guarantees principal; a variable annuity does not.

Why Variable Annuities Are Securities

The variable annuity is the one annuity that places the investment risk on the owner, because contributions buy accumulation units in separate-account subaccounts whose value rises and falls with the markets. That single fact produces the most tested rule in the section: a variable annuity is a security as well as an insurance product, so the producer must hold both a life license and a FINRA securities registration, and a prospectus must be delivered. The separate account is held apart from the insurer's general account and is not exposed to the insurer's creditors.

Compare the guarantees directly. A fixed annuity guarantees principal and a minimum interest rate, and the insurer bears the investment risk. A variable annuity guarantees neither principal nor a minimum return; the account can lose value, and only optional living-benefit or death-benefit riders, purchased at extra cost, add any guarantee. Units come in two kinds: accumulation units during the build-up phase and annuity units during the payout phase, when the number of units is fixed but their value still varies.

Exam Trap: A variable annuity is not guaranteed against loss of principal. If a stem says the contract protects the owner's principal, it is describing a fixed annuity. Any principal protection on a variable annuity comes only from an optional rider that costs extra.