Series 6 - Unit 6 - Variable Insurance

6.1 - Characteristics of Variable Annuities

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"Variable" refers to

separate accounts

separate accounts are further divided into

subaccounts

annuitization period last either (3):

1. Until death

2. Until they reach a certain age

3. Until a specific number of years have passed

If funds withdrawn before 59.5 (2):

1. 10% penalty

2. Income tax on gains

how does a fixed annuity work?

investor pays premiums, insurance company invests the money and guarantees a fixed (monthly) payout

why is a fixed annuity not a security?

Insurance company carries the investment risk

biggest risk that fixed annuities face

Inflation/Purchasing Power risk

How does an index annuity work?

tracks performance of the S&P 500 (or other index) to allow the investor to benefit from stock market growth, but offers protection from losses

Are index annuities considered fixed or variable?

Technically fixed, and not a security even though there is a variable aspect to it. Insurer still protects against losses

Participation rate

in index annuities, when index goes up and annuitant receives % of the gain

(Index Annuity) if the index goes down, annuitant still receives….

minimum GTD interest rate (1%-2%)

Cap Rate

limits the maximum amount an investor can earn  from the index annuity. If cap rate is 12% and the S&P grows 30%, you only get 12%

Surrender Charge

a fee you pay when you pull money out of an annuity early

each VA subaccount has a different….

investment objective

FINRA rule 2330

 establishes suitability, principal review, and supervisory requirements for BDS when they recommend deferred variable annuities

Rule 2330 applies to (3)

1. Recommended purchase of deferred variable annuities

2. 1035 exchanges

3. Initial subaccount allocations

1035 Exchange

tax-free switch from one annuity/life insurance policy to another

NOTE: a 1035 wouldn't be able to switch from annuity to life insurance and vice versa

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Test topic alert: 1035 exchange abuses

FINRA is concerned that sales reps only highlight the tax-free nature of the exchange, and not the potential downsides:

• surrender chagres

• loss of higher death benefits

• tax penalties on early withdrawals

• costs for added features

• market risk

Both Fixed and Variable annuity payments are made with…

after-tax dollars

Combination Annuity

investor can split their money between the general account (for fixed GTD payments) and the separate account (for market-based variable growth)

any time you hear the word “Variable”, remember (3)

1. insurance and security license required to sell

2. suitability must be determined before recommendation

3. prospectus at/before solicitation

(2) payment options when buying an annuity:

1. Lump-sum

2. Periodic payments (monthly, quarterly, yearly)

Single Premium Deferred Annuity

investor makes one lump sum payment, they receive payouts at a later date of their choosing

Periodic Payments Deferred Annuity

investor makes periodic payments and receives payouts at a later date of their choosing

immediate Annuity

investor makes one lump-sum payment, then payouts starts within 60 days

Bonus Annuities

insurance company contributes extra 3%-5% on initial investment in exchange for higher fees and surrender periods

When recommending Bonus Annuities, reps MUST explain…

both benefits and costs

(3) things to remember about Annuity Sales Charges

• There is no max sales charge, unlike 8.5% on mutual funds

• SEC requires FINRA ensure they are fair and reasonable

• Annuities have low or no sales charge, instead having surrender charges

Annuities ranked by shortest to longest surrender periods (3):

1. Standard

2. Bonus annuities

3. Index annuities (longest, always)

(2) phases of variable annuity:

1. Accumulation phase

2. Annuity phase

(3) ways to receive money from an annuity:

1. Random withdrawals

2. Lump-sum withdrawal

3. Annuitization (guaranteed monthly payments

SAAPI - (5) factors that determine monthly payment amount

1. Sexual orientation

2. Amount

3. Age

4. Payout type

5. Interest rate

(4) payout options

1. Life Annuity (Straight Life / Life only)

2. Life Annuity with Period Certain

3. Joint Life with Last Survivor Annuity

4. Unit Refund Option

Life Annuity (Straight Life / Life Only)

largest monthly payment, but they end when annuitant dies

Life Annuity with Period Certain

second largest monthly payment, specifies a period (10-20 years) of gtd payments. Once annuitant dies, payments go to beneficiary

Joint Life with Last Survivor

Third largest monthly payment, covers 2 people. Payments continue to survivor, buy may be reduced

Unit Refund Option

can be tacked on as a "rider" with other annuity types, lowest monthly payment, ensures a minimum amount of money is paid out. Once annuitant dies, beneficiary receives lump sum payment

Assumed Interest Rate (AIR)

from the insurance company, a benchmark rate that estimates future growth

• If AIR = 4% and investment returns are 6%, the monthly check goes up

• If AIR = 4% and investment returns are 4%, monthly check amount stays the same

• If AIR = 4% and investment returns are 2%, monthly check goes down

If an annuitant under 59.5 cashes out (surrenders) instead of annuitizing, (3) things happen:

1. Receive total value of their investment

2. Growth is taxed as income

3. Under 59.5 - 10% penalty on growth

If annuitant dies during accumulation phase, beneficiary receives…

the greater of:

 

• Total annuity value at death

• Amount of original investment

 

*59.5 rule does NOT apply to death during accumulation phase payout 

Which of the following annuities includes augmentation of the premium payments by the insurance company?

A)

Equity index annuity

B)

Combination annuity

C)

Bonus annuity

D)

Fixed annuity

C - "augmentation" = increasing or improving

An insurance company offering a variable annuity makes payments to annuitants on the 15th of each month. The contract has an AIR of 3%. In July of this year, the contract earned 4%. In August, the account earned 6%. If the contract earns 3% in September, the payments to annuitants in October will be

A)

less than the payments in September.

B)

less than the payments in August.

C)

greater than the payments in September.

D)

the same as the payments in September.

D

6.2 - Suitability and Taxation of Variable Annuities

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(5) suitability rules for recommending variable annuities:

1. Funded with cash only - no borrowing, cashing out of existing life insurance, refinancing home

2. Not for short-term needs

3. Not for tax-favored accounts - VAs already grow tax deferred. No need to place in an IRA

4. Market risk involved - are they risk tolerant?

5. Best used as a supplement - max out 401ks first

Taxes: always assume a variable annuity is…

nonqualified (not held in an IRA)

how is a lump-sum annuity withdrawal taxed?

growth is taxed as income that year

How is annuitization taxed?

part of each payment is income (taxable) and other part is non-taxed return of principal (exclusion ratio)

How are random annuity withdrawals taxed?

taxed as income until the "growth" portion is all gone

A change in VA investment objectives or investment manager could be made by….

vote of the VAs owners

6.3 - Characteristics of Variable Life Insurance

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"Life insurance provides benefit for X, Annuities provide benefit for Y"

dying too soon, living too long

Variable life insurance premiums are split into (2) parts

1. General account - insurance company's general assets

2. Separate Account - insured person's choice of growth, income, balanced, index, or MM

which account provides funding for the minimum death benefit?

General Account

How does the death benefit decrease/increase?

doesn’t drop below a gtd minimum, but can increase if separate account performs well

How are life insurance death benefits taxed for the beneficiary?

tax-free

Variable life prospectus must be delivered…

at/before solicitation

how often is the variable death benefit adjusted?

annually

relationship between Assumed Interest Rate (AIR) and Death benefit/Cash Value:

• Returns > AIR: death benefit and cash value increase

• Returns = AIR: death benefit stays the same

• Returns < AIR: death benefit decreases (never below gtd minimum)

"Cash Value" =

the investments in the separate account

If a rep is trying to sell variable life to customer and uses projection (illustration) to show what it would look like with 12% maximum investment returns, they must also….

show them an illustration based on a 0% return

for policies with schedued premiums, cash value can be accessed in (2) ways:

1. surrendering the policy (canceling it for its cash value)

2. taking a loan against cash value

AIR affects the X, but not the Y

death benefit, cash value

what % can the insured person borrow against their cash value, and how long do they have to own the policy to do that?

75%, 3 years

no required repayment schedule

(2) risks of taking loan against cash value

1. if loan is outstanding at death, death benefit decreased by outstanding amount

2. if unpaid loan causes cash value to go negative, insured has 31 days to fix by depositing money. Or else the contract is canceled

Contract Exchange

Within the first few years of own a variable life policy, the insured can exchange it for a traditional whole life policy

contract exchange must be made available for at least….

24 months

the new whole life policy will have the exact same….

contract date and death benefit

is medical evidence (proof of insurability) required for a contract exchange?

no

max sales charge of variable life =

9% of total payments

Free-Look period

full refund if canceled within 45 days of signing application OR within 10 days of receiving the policy

If you cancel within 2 years, you'll receive…

your cash value + a portion of sales charges

If you cancel outside of 2 years, you'll receive…

your cash value but no sales charges

(4) suitability requirements for variable life:

1. Must have a need for life insurance

2. Must be comfortable with separate acct and no guarantee of the cash value

3. Must understand variable death benefit

4. Prospectus delivered at/before solicitation