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Difficulty: MediumAnnuities and Insurance-Based Products

An investor purchases a non-qualified variable annuity contract and allocates contributions across several subaccounts within the separate account. Which of the following statements regarding the investment risks and unit mechanics during the accumulation phase are correct?

  1. The investor assumes all investment risk associated with the performance of the chosen subaccounts.Answer
  2. Net contributions purchase accumulation units whose values fluctuate daily based on subaccount performance.Answer
  3. C
    Contract surrender charges levied by the insurance company for early contract surrender represent a direct tax penalty remitted to the IRS.
  4. D
    The insurance company guarantees a fixed minimum rate of return for assets held in separate account subaccounts.

Answer

The correct statements are that the investor assumes all investment risk associated with the chosen subaccounts, and net contributions purchase accumulation units whose values fluctuate daily.
In a variable annuity, contributions are placed into subaccounts within a separate account. The investor bears all investment risk based on market performance, and payments purchase accumulation units that fluctuate in value daily.

Step-by-Step Solution

1
Analyze the risk profile of variable annuity separate accounts.
Unlike fixed annuities backed by the insurer's general account, variable annuity separate account performance is determined by market securities, so the investor bears all market risk.
Variable annuities pass investment gains and losses directly through to the contract owner.
2
Examine the accounting unit structure during the accumulation phase.
Investor premiums buy accumulation units, which function similarly to mutual fund shares with daily fluctuating values.
Accumulation units measure the contract owner's proportional interest in the separate account subaccount.
3
Distinguish insurer contract charges from tax penalties and fixed return guarantees.
Surrender charges are contractual fees set by the insurer, not IRS tax penalties, and separate accounts provide no guaranteed minimum return.
Equating issuer surrender fees with IRS penalties or expecting fixed guarantees in separate accounts confuses contract terms with tax code rules and fixed annuity features.

Key Concept

Variable annuity separate account risk and accumulation unit valuation mechanics
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Topics

Annuities and Insurance-Based Products

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