Equity-indexed Annuity

Delia is comparing a FIXED annuity with a VARIABLE annuity from the same insurer. Payments into the variable contract go into the insurer separate account, and payments into the fixed contract go into its general account. What does this mean for Delia?

1. A.Both contracts guarantee her payout, because both are ultimately backed by the insurer claims-paying ability.Claims-paying ability supports general account guarantees. It does not convert separate account performance into a guarantee.
2. B.Both contracts leave her bearing the investment risk, and only the tax treatment differs.The fixed contract shifts investment risk to the insurer. Tax deferral is similar for both, but the risk allocation is not.
3. C.In the variable contract she bears the investment risk and her payout rises and falls with separate account performance; in the fixed contract the insurer bears that risk and guarantees the payout.Correct. Where the money sits determines who is exposed, and that difference is why one contract is a security and the other generally is not.
4. D.In the variable contract the insurer bears the investment risk and guarantees a minimum payout.This reverses the two. Separate account performance passes through to the contract owner, which is what makes the payout variable.

Why: The account determines who carries the investment risk. General account assets support guaranteed obligations, so the insurer promises a fixed payout and absorbs any shortfall in investment performance. Separate account assets are held apart and their performance flows directly to the contract owner, so Delia payout rises and falls with results. Review annuity structure in the packaged products topic.

Callowfield Life offers a registered index-linked annuity whose crediting formula absorbs a stated amount of index loss and passes any further loss to the owner. Compared with a traditional fixed indexed annuity, this contract

1. A.is not a security, because the insurer continues to absorb a stated portion of any index loss.Wrong. Absorbing part of a loss leaves the residual with the owner, and the residual is what matters.
2. B.is a security, because the owner can lose principal as a result of index performance.Correct. Exposure of principal to market results is the line that separates a registered contract from an insurance one.
3. C.is a security only where the supporting assets are held in the general account of the insurer.Wrong. General account funding is a hallmark of unregistered insurance products, not a trigger for registration.
4. D.is not a security, since the crediting formula tracks an index rather than a managed portfolio.Wrong. A traditional indexed annuity tracks an index too and is not a security, so the reference decides nothing.

Why: Classification turns on whether the owner can lose money to market performance, not on whether an index is referenced or how much protection the insurer offers. A traditional fixed indexed annuity floors the credit at zero, so the owner never loses principal to the index and the contract stays outside the definition of a security. An index-linked contract that passes losses beyond a buffer hands genuine investment risk to the owner, so it is registered and sold with a prospectus. Partial protection reduces the magnitude of that risk without changing who ultimately carries it.

Thaddeus Ruiz is offered an EQUITY-INDEXED ANNUITY that credits interest tied to a broad stock index, subject to a stated participation rate and an annual cap, and that guarantees a minimum rate of interest on his premium so that the account value cannot decline because of index losses. He asks whether he will receive a prospectus and whether a market decline can reduce his account. Which response is correct?

1. A.It is a fixed insurance product rather than a security, so no securities prospectus is delivered; the guaranteed minimum protects the account from index losses while the participation rate and cap limit the upside.Correct. The insurer bears the investment risk, which keeps the contract outside the definition of a security.
2. B.It is a variable annuity, so it must be sold with a prospectus and index declines reduce the separate account value.Wrong. A variable annuity puts investment risk on the owner through separate account subaccounts; this contract guarantees a minimum instead.
3. C.It is a security registered on Form S-1 and must be sold by a representative holding both securities and insurance licenses.Wrong. A traditional equity-indexed annuity with a guaranteed floor is not registered as a security at all.
4. D.No prospectus is required, but index declines pass directly through and can reduce his principal.Half right and half wrong. No prospectus is correct, but the guaranteed minimum is precisely what prevents index declines from reducing the account.

Why: A traditional equity-indexed annuity with a guaranteed minimum credited rate is a fixed insurance product, not a security. The insurer bears the investment risk: the guaranteed floor protects the contract from index declines, and in exchange the participation rate and the annual cap limit how much of an index gain is credited. Because it is not a security, no securities prospectus is delivered and the sale is regulated by the state insurance authority. This is what distinguishes it from a registered index-linked annuity, which exposes the owner to some downside and therefore is registered as a security.

An investment adviser representative recommends a fixed indexed annuity, which is not a security, to an existing advisory client and will be paid an insurance commission on the sale. Which statement best describes the obligations of the representative?

1. A.None arise under advisory law, since the recommendation does not concern a security.Wrong. The duty follows the advisory relationship and does not turn on classifying each product discussed.
2. B.Only the obligations of an insurance producer apply, the advisory agreement being suspended.Wrong. An advisory contract does not switch off when the adviser puts on a second hat.
3. C.The fiduciary duty continues to govern the recommendation and the disclosure of the commission.Correct. Both halves of the duty survive intact, since neither depends on the product being a security.
4. D.The representative must first register the contract with the state securities administrator.Wrong. A product outside the definition of a security has nothing to register in that capacity.

Why: The fiduciary duty an adviser owes arises from the advisory relationship, not from the classification of each product discussed, so it does not switch off when the recommendation happens to concern an insurance contract. The representative must therefore have a reasonable basis for the recommendation given the goals and circumstances of this client, and must disclose the commission as material compensation flowing from the advice. Wearing a second hat as an insurance producer adds obligations rather than substituting for the advisory ones. Registration is irrelevant, since a product outside the definition of a security is not registered as one.