9.2 Fixed, Indexed, and Variable Annuities

Classifying Annuities by Investment Risk

The most heavily tested annuity distinction is who bears the investment risk and how interest is credited. Three product types span the risk spectrum.

Fixed Annuities

A fixed annuity guarantees the principal and a minimum rate of interest. The insurer invests premiums in its own general account (bonds and conservative assets) and assumes the investment risk. The owner receives a guaranteed minimum interest rate stated in the contract and may receive a higher current rate the insurer declares.

Because the insurer guarantees the outcome, no securities registration is required — a producer needs only a life insurance license. The downside is purchasing-power (inflation) risk: a fixed payout's real value erodes over a long retirement. A market value adjustment (MVA) may raise or lower surrender value if the owner cashes out early while rates have moved.

Variable Annuities

A variable annuity places premiums in a separate account composed of subaccounts that resemble mutual funds (equity, bond, money-market). The owner bears all investment risk — values rise and fall with the subaccounts, and there is no guaranteed accumulation rate.

Because the return depends on securities, a variable annuity is itself a security. To sell it a producer must hold a life insurance license AND a FINRA securities registration (commonly Series 6 or 7) with a registered firm, and must deliver a prospectus. The separate account is regulated by both the state insurance department and the SEC/FINRA.

Exam tip: "Owner assumes investment risk" + "separate account" + "prospectus required" = variable annuity, every time.

Fixed Indexed Annuities

A fixed indexed annuity (FIA) is an insurance product (not a security) that credits interest linked to an external index such as the Standard & Poor's 500. It blends a downside guarantee with limited upside:

• Floor (0%): in a year the index falls, the credited rate is no less than zero — principal is protected.
• Cap: the maximum credited rate. If the cap is 9% and the index gains 14%, only 9% is credited.
• Participation rate: the percentage of index gain credited. A 70% participation on a 10% index gain credits 7%.
• Spread/margin/asset fee: an amount subtracted from the index gain. A 2% spread on a 10% gain credits 8%.

Worked Example: Indexed Crediting

Assume an index rose 10% this term. Compare three crediting designs:

If instead the index lost 8%, every design credits 0% because of the floor — the owner loses no principal to market decline (though fees and surrender charges still apply). The trade-off is clear: the floor that protects principal is paid for by caps, participation rates, and spreads that limit upside.

Index Crediting Methods Over Time

FIAs also differ in how often index gains are measured and locked in. The exam tests the names more than the math.

• Annual point-to-point: compares the index at the start and end of each year; a common, simple method.
• Monthly averaging: averages the index across the year, smoothing volatility.
• High-water mark: credits based on the highest index value reached during the term, rewarding mid-term peaks.

Credited interest is locked in (annual reset) at the end of each crediting period and cannot be lost later, even if the index falls next year. This reset feature is a key selling point: each year starts a fresh floor at the locked value.

Variable Annuity Fees and Guarantees

Variable annuities carry layered fees that reduce returns and must be disclosed in the prospectus:

Despite market risk, variable annuities usually include a guaranteed minimum death benefit (GMDB) that pays beneficiaries at least total premiums paid (less withdrawals) even if subaccounts fell. The AIR (assumed interest rate) set at annuitization determines whether variable payments rise or fall as actual returns beat or trail the AIR.

During payout, if the subaccounts earn more than the AIR, the next variable payment rises; if they earn less, it falls; if they earn exactly the AIR, the payment is unchanged. The AIR is therefore a benchmark, not a guarantee — a higher AIR produces larger early payments but makes future increases harder to achieve.

Indexed Annuity Crediting Mechanics

A fixed indexed annuity (FIA) credits interest tied to an index (often the S&P 500) but protects principal with a 0% floor so a down market credits zero, not a loss. Insurers limit the upside with a cap (maximum credited rate), a participation rate (percentage of index gain credited), and sometimes a spread/margin (a percentage subtracted from the gain). Example: a 10% index gain with a 60% participation rate credits 6%; with a 4% cap it credits 4%. The exam tests that FIAs trade upside for downside protection.

Variable Annuities and Securities Regulation

A variable annuity invests premiums in subaccounts (separate account) chosen by the owner, who bears all investment risk — values can fall below principal. Because the owner bears market risk, variable annuities are securities requiring a prospectus, FINRA registration, and a suitability analysis; the producer needs both an insurance license and a securities (Series 6/7) registration. Fixed annuities, by contrast, guarantee principal and a minimum rate and are not securities.