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Difficulty: MediumAnnuities and Insurance-Based Products

A registered representative is conducting an educational workshop regarding variable annuity contracts and insurance-based financial products. Which of the following statements regarding the structural characteristics, regulatory framework, and risk profile of variable annuities are correct?

  1. The contract owner bears the investment risk associated with the performance of the subaccounts held in the separate account.Answer
  2. The separate account of a variable annuity is generally registered and regulated as an investment company under the Investment Company Act of 1940.Answer
  3. C
    Surrender charges levied by an insurer during the early years of a contract constitute a federal tax penalty assessed by the Internal Revenue Service.
  4. D
    Fixed annuity assets are held in the separate account to protect contract holders against systemic inflation risk.

Answer

The correct statements are that the contract owner bears the investment risk associated with the separate account subaccounts, and that the separate account is regulated as an investment company under the Investment Company Act of 1940.
Variable annuities pass investment risk directly to the contract owner because account values fluctuate based on the market performance of subaccount securities. Additionally, because the separate account functions as a pool of securities, it is regulated as an investment company under the Investment Company Act of 1940.

Step-by-Step Solution

1
Analyze separate account risk allocation.
Confirm that variable annuity owners bear the investment risk of subaccount choices.
Because payments fluctuate based on market performance of the underlying securities, investment risk is borne by the owner rather than the insurer.
2
Identify regulatory jurisdiction of variable annuity separate accounts.
Confirm separate accounts are regulated under the Investment Company Act of 1940.
Variable annuity separate accounts invest in portfolios of securities and are classified as investment companies under federal securities law.
3
Evaluate insurer surrender fees versus IRS tax penalties.
Distinguish between contract surrender charges and IRS penalties.
Surrender charges are contract fees levied by the insurance carrier, whereas the 10% early withdrawal penalty is an IRS tax code provision on earnings withdrawn prior to age 59frac1259 frac{1}{2}.

Key Concept

Structural and Regulatory Framework of Variable Annuities
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Topics

Annuities and Insurance-Based Products

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