United States
Hong KongFixed, variable and indexed annuities
A fixed annuity credits a guaranteed rate from the insurer's general account, so the insurer carries the risk. A variable annuity uses separate accounts the owner directs, so the owner does and a securities registration is needed to sell it. An indexed annuity credits a rate tied to an index, with a floor and a cap.
The same three-way split you learned for life products applies here, and it applies for the same reason: what changes is where the money sits. Learn it once and it pays twice on this paper.
The three, by who carries the risk
| Fixed | Indexed | Variable | |
|---|---|---|---|
| Where the money sits | General account | General account | Separate account |
| Who carries investment risk | Insurer | Insurer, within the formula | Owner |
| Growth | Guaranteed rate | Index-linked, floor and cap | Sub-account performance |
| Can the value fall? | No | Not from index movement | Yes |
| Securities registration to sell | No | No | Yes |
| Purchasing power risk | Highest | Middling | Lowest |
The last row is the one people skip and the exam likes. A fixed annuity has no investment risk and the most inflation risk, because a guaranteed dollar amount buys less every year. That inversion is a favorite stem: the safest product on the list carries the risk the client was actually worried about.
Fixed annuities and the two rates
A fixed annuity contract carries a guaranteed minimum rate and a current rate. The insurer must credit at least the minimum and normally credits more. Where a stem contrasts what an illustration showed with what the contract promises, the promise is the minimum. Every time.
Variable annuities and the two phases
During accumulation, contributions buy accumulation units whose value moves with the sub-accounts. At annuitization those are converted into annuity units, and the number of annuity units is then fixed while their value continues to move. So the payment amount varies month to month even though the unit count does not.
That is the most technical thing in the annuity heading and it is worth learning as two sentences rather than as a diagram. Units vary in number during accumulation. Units vary in value during payout.
Indexed annuities and the order of operations
- The participation rate credits a stated share of the index movement.
- A spread or margin is deducted from the credited amount.
- A cap limits the credit for the period.
- A floor, commonly zero, limits the loss from index movement.
Apply them in that order. A stem that gives you a participation rate and a cap is asking whether you know the cap binds after the participation rate has been applied, not before.
An indexed annuity is a general account product and is not a security. The owner is not invested in the index. This is the single most reliable mistake on the annuity heading and it costs the same mark twice, because the licensing consequence is asked separately from the product definition.
A client aged sixty wants retirement income that cannot fall below what she starts with, and says she is worried her income will not keep pace with prices. Which product is the least suitable match for her stated concern?
- A fixed annuity
- An indexed annuity
- A variable annuity
- A deferred annuity
Where this lands on the paper
- Section
- I, types of policies (life), 15 questions
- Listed as
- Annuities, sub-item 3 (fixed and variable) and sub-item 4 (indexed)
- Our estimate for annuities overall
- About 4 of the 15, ours and not published
- Overlaps with
- Indexed life crediting, and section IV tax treatment
The opinion, and the concession
Study the three annuity growth types on the same afternoon as the three life crediting types, because the underlying distinction is identical and studying them a week apart doubles the work for no gain. General account or separate account. Insurer risk or owner risk. Security or not a security. Six products, one idea.
The concession: what makes a variable annuity a genuinely difficult sale in practice, the fee stack and the rider pricing, is nowhere in this outline. The exam wants the mechanics and the risk allocation. We are not going to pretend the paper covers the part of the product that gets agents into trouble, because it does not.
Common questions
Is an indexed annuity a security?
No. The premium sits in the insurer's general account and the owner is not invested in the index, so a Texas general lines life, accident and health license is sufficient to sell one. Variable annuities are securities because their value sits in separate accounts the owner directs.
What is the difference between an accumulation unit and an annuity unit?
During the accumulation period of a variable annuity, contributions buy accumulation units and the number you hold grows. At annuitization these convert to a fixed number of annuity units whose value continues to fluctuate, so the payment varies while the unit count does not.
Which annuity has the most inflation risk?
The fixed annuity. It guarantees a dollar amount, and a guaranteed dollar buys less each year. Exam stems often pair a client who wants safety with a client who fears inflation, because the two concerns pull toward different products and only one of them can be the stated priority.
Do fixed annuities guarantee only one rate?
Two. There is a guaranteed minimum rate written into the contract and a current rate the insurer declares, usually higher. The insurer is obliged to credit at least the minimum. Where a stem contrasts an illustrated value with a guaranteed one, the guarantee is the minimum rate.