Justificación Técnica

Variable annuities represent a sizable asset base as well as a primary momentum for the life insurance industry. The variable annuity industry is booming and 1999 was a record year, with estimated sales of $109 billion.

Variable annuities represent a way to satisfy the consumer’s preference for equity investments. The tax-deferred status of variable annuities, guaranteed living benefits and payout methods make variable annuities very important and

attractive features for consumers with the tax deferred status a key component for sales. Guaranteed living benefits make variable annuities not only accumulation vehicles, but also payout vehicles after retirement. Variable annuities have become a part of the retirement and investment plans of many Americans.

According to Moody’s Investors Service “the VAst portion of variable annuities continue to be sold through commissioned brokers and agents.” That is why it is so important for brokers and agents to understand all the intricacies involved in variable annuities.

Definitions

Accumulation Unit is a measure of ownership interest in a subaccount prior to the Annuity Date or surrender of the contract. The value of the unit reflects the investment experience similar to that of a share owned in a mutual fund.

Accumulation Period is the interval of time usually from the contract date of issue to the annuity date or surrender of the contract.

Annuity Date is the date elected by the annuity holder when annuity payments are to begin.

Annuity Unit is the measurement used in determining the amount of any variable annuity payment. The value of an annuity unit for each subaccount usually

depends upon the assumed investment rate and the investment experience of that subaccount and will vary in dollar amount.

Contingent Annuitant is the person named to become the annuitant on the annuitant’s death prior to the annuity date.

Current Rate is the interest rate, which is credited to the fixed or guaranteed account. The current rate is established by the insurance company and may change with interest rates in general.

Guaranteed Account or Fixed Account is a subaccount, which is not a part of the separate account and is a part of the general account of the issuing company.

This account is segregated from other assets of the company and earns a guaranteed interest rate payable by the company.

Guaranteed Interest Rate is the interest rate, which is stated by the company to be paid on funds in the guaranteed account.

Guarantee Period is a period of time during which the company will credit a stated rate of interest. Typically, a guarantee period is one year.

Premium Tax – is a tax charged by the state or any other governmental authority on either the premium payment or value of the separate account. Some states impose a “State Premium Tax” against either the Accumulated Value of the variable annuity or the Purchase Payments. Typically, insurance companies deduct these taxes as incurred according to state regulations. State tax laws change and it is important to check for the most current status.

Taxes as of December 1, 1997

State Qualified

Funds

Non-Qualified Funds

South Dakota 0% 1.25%

Assesses a Premium Tax against the initial Premium Payment and all Additional Premium Payments

California .50% 2.35%

District of Columbia 2.25% 2.35%

Kansas 0% 2.0%

Kentucky 2.00% 2.00%

Nevada 0% 3.50%

(Source: Annuities Online)

Separate Account with the assets, which are segregated by the issuing insurance company from all other assets of the company. These assets are invested and managed by professional portfolio managers similar to that of a mutual fund.

Variable Annuity Option is an annuity option, under which the company will make to the annuitant, or any other payee designated by the owner of the contract, payments. These payments vary in amount according to the net investment

experience of the subaccounts selected by the owner.

What is a Variable Annuity?

A variable annuity is a contract between an individual and an insurance company, under which the insurer agrees to make periodic payments to the annuity holder

(an annuitant), beginning either immediately, or at some future date, which depends on the stipulations of the contract and the manner of purchase.

A variable annuity can be purchased with a single purchase payment or a series of payments. The product is designed to be a long-term investment, and is good to meet retirement and other long-range goals. Variable annuities are not suitable for meeting short-term goals because of substantial taxes and insurance company charges may apply if an annuity holder decides to withdraw the money early.

A variable annuity offers a wide range of investment options. The value of the investment varies in accordance with the value of the total investment

performance. If fixed annuities guarantee fixed monthly amounts, annuity monthly payments vary and will depend on the performance of the investment options an annuity holder chooses. The fluctuation of the cash value and monthly income is the main difference between variable and fixed annuities.

Typically, variable annuities are invested in mutual funds, but mutual funds and variable annuities are different in several important ways:

 Variable annuities provide an option to receive periodic payments for life (or for the life of the spouse, or any other person, designated in the annuity

contract). This feature offers protection against the possibility for the annuity holder to outlive his or her assets.

 Variable annuities have a death benefit. If the annuitant dies before the insurer has started making payments, the beneficiary is guaranteed to receive a specified amount, typically at least the amount of the purchase payment. The beneficiary is entitled to this benefit, even if at the time of annuitant’s death the account value is less than the guaranteed amount. Usually, in case of an annuity holder death the beneficiary will receive the greater of:

1. All the money in the account

2. Or some guaranteed minimum (for example all purchase payments minus prior withdrawals)

Example: John owns a variable annuity that offers a death benefit equal to the greater of account value or total purchase payments minus

withdrawals. He has made purchase payments totaling $60,000. He has withdrawn $5,000 from his account. Due to withdrawals and investment losses, his account value is $50,000. If he dies at that moment, his

designated beneficiary will receive $55,000, the total amount in purchase payments minus $5,000 in withdrawals.

Some variable annuities offer a “stepped-up” death benefit. ”, That provides an additional return on the payments if the VA is held for a long period of time.

Under this feature the guaranteed minimum death benefit may be based on a

greater amount than purchase payments minus withdrawals. The guaranteed minimum specified in the annuity may be the account value as of specified date.

The purpose of a stepped-up death benefit is to “lock-in” the investment

performance and prevent a later decline in the value of the account from eroding the amount an annuity holder expects to leave to his or her heirs. However, this feature carries a charge, which reduces the account value. Besides that a step-up benefit has some other advantages and disadvantages.

Advantages

A beneficiary may receive all the money in the account, that may be a much higher than the initial sum. But even with a not very good performance of the cash value, the beneficiaries will still be taken care of by getting the guaranteed

minimum.

Disadvantages

The fees for such an option are very high and can be up to 1.4 percent on annual investment. Some analysts say that if VA holder with this option holds the annuity for a long time, the guaranteed death benefit may substantially cut into the gain made. This feature can be advantageous if the VA with this option is held for a short period of time.

(Source: insure.com. Mark Cybulski)

 Variable annuities are tax-deferred. No taxes are to be paid on the income and investment gains from the annuity, until money is withdrawn. This option also allows transferring money from one investment option to another within the variable annuity without paying tax at the time of transfer. Section 1035 of the U.S. tax code, commonly known as 1035 exchanges, can be useful if another annuity has features that the annuity holder may prefer, such as a larger death benefit, different annuity payout options, and/or a wider selection of investment choices. However, this may trigger surrender charges on the old annuity. Once the money is taken out of variable annuity, it will be taxed on the earnings at ordinary income tax rates rather than lower capital gains rates.

In general, the benefits of tax deferral can outweigh the costs of a variable annuity only if the annuity is a long-term investment to meet retirement or other long-range goals.

However, it should be noted here that IRAs and employer-sponsored 401(k) plans also have a feature of tax-deferred growth and some other tax advantages.

Moreover, if an individual invests in a variable annuity through a tax-advantaged retirement plan, such as 401(k) plan or IRA, there will not be additional tax advantage from the variable annuity. Nevertheless, such variable annuity features as lifetime income payments and death benefit protection still make variable annuities very attractive for retirement purposes.

The common feature between variable annuities and mutual funds is that they both involve investment risk.

Besides lifelong payments and guaranteed death benefits, variable annuities offer other attractive features:

 Long Term Care Riders

 Living Income Benefits

 Extra Credit Sign-Up Bonuses

 Waivers

But while Variable annuities offer some very attractive features, they also have some pitfalls. The US Securities and Exchange Commission (SEC) on June 5, 2000 issued an “investor alert” to help investors understand the benefits, costs and risks of variable annuities.

New options that have recently hit the market give new twists to an already complex investment decision. Let us have a look at four new features on VAs and their advantages and disadvantages.

Long-Term Care Riders

Long Term Care Rider provides long term care insurance in addition to a steady stream of income. If a VA holder suffers an illness or injury that requires a home health aide or nursing home care, this feature will cover costs without cutting into the monthly payments

Advantages

A very expensive need is covered. According to the U.S. General Accounting Office, in 1995 private insurance covered less than 1 percent of long term care.

Since the number of people over age 65 will be doubled by 2030, according to the U.S. Census Bureau, the need for long term care will rise with the coming years.

If the average annual cost of nursing home care is $40,000, the costs are expected to triple in the next 20 years.

Disadvantages

This option in VA is very expensive. Nationwide’s InvestCare generally costs between $30,000 and $50,000 up-front (the average annuity lump sum payment is

$30,000). Besides, in some VAs, this feature is activated only when the annuitant suffers a serious accident or is diagnosed with a severe medical condition. Some companies sell VA riders that specify a certain period of time before the VA holder can activate this rider.

Living Income Benefits

Living Income Benefits is a “safety net” feature, which guarantees a minimum monthly payment if the investment drops in value due to the stock market conditions. If a regular monthly payment, for example, is $800, the lowest monthly payment may drop to 80 percent and be $640.

Advantages.

With the Living Income benefit there is a chance to gain a great amount from a good stock market performance, while the safety net feature covers any losses if the value of the investment portfolio suddenly drops. Analysts say that this feature appeals to baby boomers, who are willing to take on some risk but still want security.

Disadvantages.

The greatest disadvantage is that this benefit charges very high fees. Percentage charged on the investments varies. Keven Maloney, vice president at Moody’s Investors Service, warns about the insurance companies selling this benefit, as these companies must be very strong financially. According to Maloney, some reinsurance companies which provide cash reserves to insurance companies to back up customer claims have declined to back up VAs with this feature fearing that the market may crumble.

Extra Credit Sign-Up Bonuses/Bonus Credits

These bonuses are designed to attract customers by adding extra cash in the initial annuity investment. The bonuses generally fall between 1 and 5 percent of the investment. For example, if an applicant signs up for a variable annuity and pays a lump sum payment of $30,000 and the extra credit sign up bonus is, for example, 3%, the account value will be $30,900. Bonus Credit feature may offer a bonus credit in the range from 1% to 5% of purchase payments. Some insurers use

“credit bonus” term in both cases, when a bonus applies to the initial premium payment, or to premium payments made within the first year of the annuity contract. Under some annuity contracts the insurer will take back all bonus

payments made to the annuity holder within the prior year or some other specified period, if the annuity holder makes a withdrawal, if a death benefit is paid to the annuity holder’s beneficiaries upon the annuitant’s death, or in other

circumstances.

Advantages

This feature with a few percentage points can add up to a nice sum of cash, provided that the initial payment is a large amount of money.

Disadvantages

Though the feature is attractive, there might be some hidden pits. Some companies charge extra fees and/or extend surrender periods. There might be higher surrender charges as compared to a variable annuity with no bonus credit feature. Higher mortality and expense risk charges and other charges may be deducted for a variable annuity that pays a bonus credit. Some contracts may impose a separate fee specifically to pay for the bonus credit feature. With the extension of surrender period the insurer locks into the annuity to have a chance to return the money through further investment.

Waivers

Besides the riders mentioned above, some annuities may contain waivers that trigger payments that are not subject to the usual surrender fees. The Variable Annuity Research and Data Service (VARDS) reports that 161 variable annuity contracts offer some type of waiver. Considering the hundreds of annuity products on the market today, it is not very many.

While a death waiver is most common in the fixed annuities survey, VARDS shows the most popular waiver found in variable is the nursing home waiver, with 103 variable annuity contracts containing that provision, 83 provide death

waivers, 69 have terminal illness waivers, and 42 carry disability waivers.

Situations that trigger the waiver and allow an annuity holder to make early annuity withdrawals vary. For example, a 90-day nursing home confinement may be required before the benefits of the annuity are activated. Some insurers may require a 60-day nursing home confinement. Lincoln Benefit National Life imposes a 180-day confinement to a “licensed nursing facility”. Some insurers consider an annuity holder disabled if he or she is unable to work in any

occupation, while some insurers stipulate that the annuity holder is unable to work in his or her current occupation. For example, an insurer may consider a surgeon to be disabled because he or she cannot operate any longer due to arthritis in the hands, while another insurer might decide that the surgeon can still se patients in the office without performing surgery).

(Source: Lisa Karam Middleton insure.com) Death Benefit Waiver

This waiver passes on the annuity to the beneficiary, if the annuity holder dies before the he or she starts receiving payments from the annuity. For example, Prudential’s Discovery Select Variable Annuity will pay the greater of the following: the fund value as of the date proof of death is received; the total of all payments made into the annuity minus withdrawals, if any, and related

withdrawals charges; or the highest contract fund value, as calculated every third year on the annuity contract anniversary date, when withdrawals the annuitant

made are adjusted. The annuity contributions remain unchanged even if the annuity’s subaccounts have lost value. The beneficiary is responsible for taxes on the gain in the account.

Nursing Home waiver

With the nursing home waiver option, an annuity holder won’t be charged surrender fees and he or she will be allowed access to some or all of the annuity, in case the annuitant is confined to a nursing facility. The preliminary

confinement period in the nursing home, before an annuity holder’s waiver will trigger benefits, vary. It is typical that the doctor will be asked to submit an attending physician’s statement together with the completed claim form. Besides, the insurer is entitled to have the insurer’s independent doctor have the annuity holder examined to be certain of the incapacitation.

Terminal Illness Waiver

An annuity might also contain a provision that waives surrender charges if the annuity holder becomes terminally ill. In this case the annuitant is allowed access to his or her money when it is needed most. The definition of “terminally ill” may vary, but generally it is a condition that will result in the annuity’s holder’s death within six months to a year. Security Benefit Life’s Variflex annuity, for example, defines a terminal illness as “an incurable condition that, with medical certainty, will result in death within one year.”

Prudential’s Discovery Select Critical Care Access provides annuity income for either terminal illness or nursing home confinement. Prudential’s waivers are triggered when an annuity holder is diagnosed with a life expectancy of six months or less, or after a three-month nursing home stay. Similar to the nursing home waiver, an insurer will want certification from the attending physician and might also require an independent doctor’s examination for confirming that the annuity holder’s life expectancy is actually a matter of months.

Disability Waiver

A relatively few insurance companies offer disability waiver, as the risk of

disability is greater than the risk of death at all ages between 20 and 65. Delaware Medallion III offers a disability waiver, defining “disability” condition by

inability to work and earn a living by the annuity holder with a medical certification of attending physician. In this case the annuity holder is allowed access to the money in the annuity without being charged surrender charges.

However, this example is sooner an exception than the rule, as most other insurers with the disability waiver impose a more stringent definition of disability.

Actuaries determine insurer’s costs for providing waivers, and due to this fact an annuity might contain some provision for charging for a waiver. Besides, the age

and health status will be taken into consideration for adding waivers. In most cases, however, there are no extra charges for waivers, as they are built into the annuity contract when an individual purchases it with all costs and fees included.

But certain tax consequences might be applies to such withdrawals.

Variable Annuity Charges

Variable annuity charges include load and management charges. These charges will reduce the value of an annuity account and the return on the investment.

Variable annuity charges include load and management charges. These charges will reduce the value of an annuity account and the return on the investment.