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Difficulty: MediumAnnuities and Insurance-Based Products

An investor annuitizes a variable annuity contract and selects a monthly payout option based on an Assumed Interest Rate (AIR) of 4%4\%. During the previous month, the separate account earned an annualized return of 4%4\%, resulting in a payment of $600\$600. If the separate account earns an annualized return of 6%6\% in the current month, how will the current month's payout compare to the previous month's payout?

  1. The payment will increase above $600\$600 because separate account performance exceeded the AIR.Answer
  2. B
    The payment will remain unchanged at $600\$600 because payout amounts are permanently fixed once annuitization begins.
  3. C
    The payment will decrease because performance above the 4%4\% benchmark triggers contract surrender penalties.
  4. D
    The payment will increase to exactly $900\$900 because monthly payouts increase strictly in proportion to cumulative equity value.

Answer

The monthly payment will increase above $600\$600 because separate account performance (6%6\%) exceeded the contract's Assumed Interest Rate (4%4\%).
During the payout phase of a variable annuity, monthly check amounts fluctuate based on subaccount performance compared to the contract's Assumed Interest Rate (AIR). When separate account performance (6%6\%) is greater than the AIR (4%4\%), the payout increases relative to the previous month's payment.

Step-by-Step Solution

1
Identify the relationship between separate account return and the Assumed Interest Rate (AIR).
Separate account return (6%6\%) > AIR (4%4\%).
Variable annuity payout adjustments are determined by comparing actual separate account performance against the AIR benchmark.
2
Apply the rule governing variable annuity payout adjustments.
Because performance exceeded the AIR, the next monthly payment increases compared to the prior month's payment.
If performance equals AIR, payouts stay the same; if performance exceeds AIR, payouts increase; if performance falls short of AIR, payouts decrease.

Key Concept

Assumed Interest Rate (AIR) Payout Mechanics in Variable Annuities
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Topics

Annuities and Insurance-Based Products

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