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Fixed vs. Variable Annuity Risk Practice Questions

Updated 12 min read
Key takeaway

A fixed annuity generally credits interest or pays benefits under contract guarantees backed by the issuing insurer, while a variable annuity exposes separate-account value to investment performance.

  • An indexed annuity uses a contractual index-credit formula and is not direct index ownership.
  • Guarantees, fees, market exposure, and access restrictions depend on the actual form and rider.
On this page16 sections
  1. Question 1: fixed interest guarantee
  2. Question 2: variable subaccount loss
  3. Question 3: indexed formula and direct investment
  4. Question 4: market gain exceeds index cap
  5. Question 5: variable payout rider guarantee
  6. Question 6: zero floor and charges
  7. Question 7: guaranteed minimum versus current illustration
  8. Question 8: insurer financial strength
  9. Question 9: fixed payment and inflation
  10. Question 10: risk comparison for two contracts
  11. How to analyze annuity-risk cases
  12. Assign each risk to the right party
  13. Work a simple market-loss example
  14. Compare liquidity and contract tradeoffs
  15. Evaluate a guarantee by its trigger
  16. Ask what a surrender quote actually guarantees

These original cases ask who bears which risk. A fixed annuity’s stated minimums are contractual obligations of the insurer, subject to policy terms and its ability to perform. Variable annuity subaccounts fluctuate with their investments, so the owner bears market risk for that value, except to the extent a specific guarantee or rider applies. An indexed annuity uses a formula tied to an index; the owner generally does not invest directly in index securities. Product names alone do not reveal all guarantees, fees, or access limits. Use the facts provided and read the policy for an actual recommendation.

Fixed annuity
Insurer contract governs interest or payment guarantees
Variable annuity
Separate-account value changes with underlying investment performance
Indexed annuity
Formula references an index; caps, participation, spreads, and floors can apply
Guarantee rider
Only what the contract expressly guarantees, with stated conditions
Insurer risk
Applies to contractual obligations; ratings are not guarantees
Practice status
Original scenarios, not actual Pearson items

Question 1: fixed interest guarantee

Identify the insurer-backed promise

A contract guarantees a minimum interest credit for a stated period and the owner does not select separate-account investments. Which risk is most directly associated with the promised minimum?

  1. The issuing insurer’s obligation under the contract
  2. The owner’s direct ownership of common stocks
  3. An index’s daily return with no policy formula
  4. A beneficiary’s life expectancy
Answer: A. A is correct: the stated fixed minimum is a contractual obligation of the insurer, subject to the actual policy and insurer’s ability to perform. B describes direct investment not stated here. C describes neither a fixed credit nor a formula-limited indexed credit. D can matter to a life-contingent payout but not the guaranteed interest credit. Fixed does not remove inflation, liquidity, or credit risk; it identifies the contractual mechanism.

Question 2: variable subaccount loss

Identify who bears market risk

An annuity owner allocates value to equity subaccounts. The market declines, and no rider guarantees the account value. Who bears the investment loss under these facts?

  1. The contract owner bears the market risk in the separate-account value.
  2. The insurer must restore every market decline under all variable annuities.
  3. TDI pays the loss through its guaranty association.
  4. The beneficiary is responsible for replenishing the account.
Answer: A. A is correct because variable subaccounts fluctuate with underlying investments, and the owner bears that market risk unless a specific guarantee applies. B invents a universal principal guarantee. C confuses regulation or limited insolvency protection with market-loss insurance. D assigns an unrelated obligation to a beneficiary. A variable annuity can contain optional guarantees, but their conditions, fees, and limitations must be stated in the contract.

Question 3: indexed formula and direct investment

Do not equate an index reference with securities ownership

An insurer calculates interest using an external index, applies a cap and participation rate, and does not place the owner directly in the index. Which product is described?

  1. Indexed annuity
  2. Variable annuity directly invested in the index
  3. Fixed-period life settlement
  4. Mutual life policy
Answer: A. A is correct. An indexed annuity uses an index-linked contractual formula; the owner generally does not own the index’s securities. B ignores the stem’s express formula and no-direct-investment facts. C and D describe unrelated products. The index change is not the credited rate, and caps, participation rates, floors, spreads, and renewal terms matter. A floor on interest does not necessarily protect the account from charges or withdrawals.

Question 4: market gain exceeds index cap

Recognize formula-limited credit

An index rises 15%, but the indexed annuity’s contract cap is 7% for that term. Assume 100% participation and no spread. What is the maximum index-linked credit before other adjustments?

  1. 15%
  2. 7%
  3. 22%
  4. 0%
Answer: B. The cap limits the calculated credit to 7%, so B is correct. A applies the raw index gain without the contractual limit. C adds the index gain and cap. D incorrectly assumes no credit despite a positive result. A cap is a maximum, not necessarily the rate credited every year. Renewal caps may change if the contract permits; the current term’s cap and guarantee govern this question.

Question 5: variable payout rider guarantee

Read a guarantee’s specific scope

A variable annuity has a rider guaranteeing a minimum lifetime withdrawal amount if the owner meets age and withdrawal conditions. Separate-account value can still fluctuate. Which statement is best?

  1. The rider guarantees only the stated benefit under its conditions; it does not necessarily guarantee the entire account value.
  2. The rider converts all subaccounts into fixed investments.
  3. The owner can ignore withdrawal conditions because the rider is attached.
  4. The guarantee means the insurer cannot fail.
Answer: A. A is accurate because a rider promises only the benefit and scope written in the contract. The account value may still rise or fall. B changes the investment allocation without basis. C ignores eligibility and excess-withdrawal rules. D overstates an insurer guarantee and ignores credit risk. Review rider fees, benefit base, age requirements, permitted withdrawal schedule, and how withdrawals affect any future amount.

Question 6: zero floor and charges

Understand the limit of a floor

An indexed annuity credits 0% interest on a negative index year. The owner also takes a withdrawal subject to a surrender charge. Which result is possible?

  1. Index interest is floored at zero, but account or surrender value can still fall from the withdrawal and charge.
  2. The floor guarantees the account can never decline for any reason.
  3. The withdrawal must be paid without charge because the index fell.
  4. The insurer must credit the negative index change as interest.
Answer: A. A distinguishes the index-credit floor from every other value change. The contract may credit zero for the index calculation while a withdrawal reduces value and a surrender charge applies. B expands a limited floor into an unlimited principal guarantee. C invents a charge waiver. D contradicts the floor. Read what the floor applies to and check surrender value, fees, and access provisions separately.

Question 7: guaranteed minimum versus current illustration

Separate contractual floor from assumed performance

A variable annuity illustration shows an assumed 6% return, while the policy has a distinct guaranteed minimum death benefit under specified conditions. What is the owner entitled to treat as guaranteed?

  1. Only the policy’s stated guarantee under its conditions; the assumed investment return is not guaranteed.
  2. The 6% assumed return and the death benefit are both guaranteed.
  3. Neither value can ever be guaranteed by an insurer.
  4. The assumed return becomes guaranteed after one year.
Answer: A. A is correct. An illustrated assumed return is not a promise; a separately stated minimum death benefit can be guaranteed if the owner satisfies policy conditions. B conflates projection with guarantee. C denies the possibility of contractual guarantees. D invents a time-based conversion. Check the rider definition, required holding period, withdrawals, premium rules, and charge. Do not describe an assumed rate as a likely or guaranteed outcome.

Question 8: insurer financial strength

Ratings inform but do not guarantee performance

An insurer has a favorable rating from an independent rating organization. What does the rating most appropriately indicate?

  1. An opinion about financial strength or claims-paying ability, not a guarantee of future solvency or return.
  2. A binding promise that every annuity investment will earn a fixed rate.
  3. A guarantee of FDIC insurance for all annuity balances.
  4. Proof that variable subaccounts cannot lose value.
Answer: A. A correctly describes a rating as an independent opinion, not a guarantee. B turns an assessment into a contract crediting promise. C confuses insurer obligations with bank deposit insurance. D ignores market risk. Ratings can change and use different methodologies. Review the issuing legal entity, contract, and current information; a rating does not replace understanding surrender charges or risk allocation.

Question 9: fixed payment and inflation

A stable nominal check may lose purchasing power

A fixed annuity pays $1,000 monthly under a level-payment option. Consumer prices rise over time. Which statement is true?

  1. The nominal check may remain level while its purchasing power declines.
  2. The payment automatically rises with the CPI in every fixed annuity.
  3. The insurer must double the payment when prices rise.
  4. The fixed payment becomes variable when inflation occurs.
Answer: A. A is correct. A level contractual amount can remain the same in dollars while buying less if prices rise. B assumes an inflation rider not stated. C invents an adjustment. D confuses general price changes with the annuity’s payment formula. If inflation protection is a goal, inspect a contract’s actual step-up or index-linked payout feature and compare its starting amount and later formula.

Question 10: risk comparison for two contracts

Compare guarantees and market exposure separately

Contract F offers a guaranteed minimum rate from the insurer. Contract V invests through separate accounts and has no principal guarantee, but may earn more when markets rise. Which comparison is most accurate?

  1. F shifts specified rate risk to the insurer under the contract; V leaves investment performance risk with the owner for its separate-account value.
  2. Both have identical risk because they are annuities.
  3. V’s possible gain proves the insurer guarantees the principal.
  4. F has no risk of any kind, including inflation or insurer credit risk.
Answer: A. A distinguishes the primary risk allocation while retaining the scope of the guarantee. F’s stated minimum is an insurer obligation; V’s account fluctuates with investments unless a rider says otherwise. B ignores product differences. C confuses potential returns with guarantee. D overstates fixed annuity security; inflation, liquidity, and issuer risk remain. The right comparison lists the actual guarantee, market exposure, fees, surrender terms, and who bears each risk.

How to analyze annuity-risk cases

First classify fixed, variable, or indexed mechanics; next identify the exact guarantee; then determine whether money is in a general account or separate account; finally review fees, withdrawals, surrender limits, and insurer strength. A guarantee can be conditional and does not necessarily extend to every contract value. An index floor may protect only the interest-credit calculation, while a variable rider may guarantee a withdrawal amount but not account principal.

TDI’s annuity guide explains product differences and directs consumers to review fees, terms, and company information. The Pearson outline covers annuity types, investment risk, and guarantees. These original questions simplify terms for study; the issued contract and prospectus control real outcomes. Neither a regulator nor a rating organization promises investment performance.

Assign each risk to the right party

A fixed annuity generally promises values or income under contract guarantees, making the insurer responsible for those contractual obligations and exposing the owner to insurer credit risk and inflation risk. A variable annuity allocates value to investment options whose performance affects account value; the owner bears investment risk, while guarantees may be available only through optional riders with conditions and costs. The phrase “annuity” alone does not indicate a return guarantee. In the stem, look for who absorbs investment losses and whether the benefit is a contract guarantee or an account projection.

Work a simple market-loss example

If a variable account is $100,000 and the selected investments fall 12% before charges, the market value becomes $88,000. A rider might promise a separate lifetime withdrawal base, but that base is not the same as cash surrender value and does not necessarily prevent loss on full surrender. A fixed contract might instead credit a guaranteed or declared rate subject to its terms, but the insurer’s financial strength matters. Calculate the named account or benefit base only; do not apply a rider guarantee to every value in the contract.

Compare liquidity and contract tradeoffs

Both fixed and variable annuities can have surrender charges, market value adjustments, free-withdrawal provisions, tax consequences, and limitations on changing payout elections. Variable contracts also have investment expenses and may have mortality, administration, and rider charges. Fixed products may have renewal-rate risk after an initial period. A candidate should not infer that “fixed” means immediate access or that “variable” means the owner can withdraw at market value without penalty. Determine the contract year, withdrawal amount, charge schedule, and any applicable exception.

Evaluate a guarantee by its trigger

A guaranteed minimum withdrawal benefit may require an annuitization-like schedule or only allow withdrawals within a stated percentage. An income rider’s benefit base may be a calculation for future withdrawals, not money available as a lump sum. Guarantees are subject to insurer claims-paying ability and rider conditions. For a real comparison, ask for a personalized illustration with fees and guaranteed/non-guaranteed values. For an exam case, underline the word “guaranteed,” identify what is guaranteed, and check whether the scenario meets the trigger rather than assuming every advertised benefit applies immediately.

Ask what a surrender quote actually guarantees

A current account value is not always the amount available on surrender. Ask whether the quote includes market movement through the transaction date, surrender charges, taxes withheld, loan balance, or rider termination. An income guarantee may apply only if the owner follows the rider’s withdrawal rules and keeps the contract in force. A comparison should state the date and value type: accumulation value, cash surrender value, benefit base, or guaranteed payment. These labels prevent a sales illustration from being mistaken for cash the owner can take immediately.

Common questions

Who bears investment risk in a variable annuity?

Generally, the owner bears investment risk for separate-account subaccounts, subject to any specific guarantee or rider. The contract states the guarantee’s scope, fees, eligibility, and withdrawal conditions. In a test case, apply the facts given and the specific contract provision; do not assume another insurer uses the same design.

Does an indexed annuity directly invest in an index?

Generally no. The insurer uses an index-based formula to calculate crediting, subject to policy terms such as caps, participation rates, spreads, and floors. In a test case, apply the facts given and the specific contract provision; do not assume another insurer uses the same design.

Does a fixed annuity have no risk?

No. A fixed contract may guarantee specified values, but inflation, liquidity restrictions, surrender charges, and the insurer’s ability to perform remain relevant risks. In a test case, apply the facts given and the specific contract provision; do not assume another insurer uses the same design.

Are these actual Pearson VUE items?

No. These are original scenarios based on annuity topics in the official Texas Life Agent outline. They are not recalled questions or recommendations for a particular contract. In a test case, apply the facts given and the specific contract provision; do not assume another insurer uses the same design.

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