Mortality And Expense Risk Charge

Delia Marchetti reads her deferred variable annuity prospectus and finds an annual MORTALITY AND EXPENSE RISK charge assessed against the separate account. She asks her representative what that charge buys her. What is the accurate answer?

1. A.The cost of selecting and managing the securities held inside each subaccount.Portfolio management is paid for through the subaccounts' own investment advisory fees, disclosed separately.
2. B.The insurer's guarantee that annuity payments will continue for the annuitant's entire life, and its promise not to raise the contract's stated expense charges.Correct. Those two guarantees, longevity and capped expenses, are exactly what the charge compensates the insurer for bearing.
3. C.The state premium taxes the insurer must remit on the contract.Premium taxes, where imposed, are a separate deduction and are not what this charge covers.
4. D.The surrender charge the owner would pay on an early withdrawal.A surrender charge is a contingent deferred sales charge paid only on early withdrawal, not an ongoing separate account charge.

Why: The mortality and expense risk charge compensates the insurer for two guarantees it makes to the contract owner. The mortality piece covers the insurer's promise to pay annuity income for as long as the annuitant lives, however long that proves to be, and in the accumulation phase it also supports the death benefit guarantee. The expense piece covers the insurer's promise that the administrative and expense charges stated in the contract will not be increased over the life of the contract. Both are risks shifted from the owner to the insurer.

In a variable annuity, which charge is assessed inside the subaccount rather than against the contract value?

1. A.The mortality and expense risk charge collected by the issuing insurance company.Wrong. That charge buys the guarantees of the insurer and is deducted at the contract level.
2. B.The contingent deferred sales charge stated in the surrender schedule of the contract.Wrong. It is taken from the contract value and only when an early excess withdrawal occurs.
3. C.The investment management fee charged by the underlying portfolio adviser.Correct. It is netted inside the portfolio, which is why it shows up as a lower unit value instead of a deduction.
4. D.The annual contract administration fee covering recordkeeping and statements.Wrong. Recordkeeping is an insurer function, so the fee is assessed against the contract rather than the portfolio.

Why: A variable annuity carries two layers of cost, and candidates must be able to say which layer a given charge belongs to. Contract-level charges, including the mortality and expense risk charge, the administration fee and any contingent deferred sales charge, are deducted by the insurer from the contract value. The investment management fee of each underlying portfolio is taken inside the portfolio itself and is reflected in the accumulation unit value rather than appearing as a separate deduction. That is why comparing only the contract-level charges of two contracts understates the total cost. If the owner allocated to a different subaccount, the contract-level charges would be unchanged but the management layer would differ.

Delia Marchetti purchases a deferred variable annuity and pays an additional annual charge for a GUARANTEED MINIMUM WITHDRAWAL BENEFIT rider. What does that rider give her?

1. A.A waiver of the contract's surrender charges in any year in which the separate account declines in value.Wrong. Surrender charge waivers are a different contract feature and are typically tied to events such as death, disability or nursing home confinement.
2. B.A contractual floor on the amount she may withdraw each year for a stated period, regardless of separate account performance, in exchange for an additional charge.Correct. A guaranteed minimum withdrawal benefit protects the withdrawal stream, backed by the insurer's general account.
3. C.A guarantee that the subaccounts within the separate account will earn at least the contract's assumed interest rate.Wrong. No rider guarantees separate account investment performance, and the assumed interest rate is a payout-phase benchmark, not a floor on returns.
4. D.An increase in the death benefit equal to the cumulative withdrawals she has taken.Wrong. Withdrawals generally REDUCE the death benefit. This describes no rider that exists.

Why: A guaranteed minimum withdrawal benefit is a living benefit rider. For an extra annual charge, the insurer contractually guarantees that the owner may withdraw at least a specified amount each year for a stated number of years, or in some designs for life, even if poor separate account performance would otherwise have exhausted the contract value. The guarantee is an obligation of the insurer's general account, so it depends on the insurer's claims-paying ability. Two practical points: the rider charge reduces net return, and withdrawing more than the guaranteed amount in a year can reduce or forfeit the guarantee.

During the payout phase of a variable annuity, which element is an obligation of the general account of the insurer rather than a function of separate account performance?

1. A.The dollar amount of each monthly payment made to the annuitant.Wrong. That figure moves with the annuity unit value and is never promised in a variable payout.
2. B.The annuity factor and the expense charge, neither of which the insurer may increase once payout begins.Correct. The guarantee is structural, covering duration and cost, which is exactly what the mortality and expense charge buys.
3. C.The rate of return that will be credited to the subaccounts over the payout period.Wrong. Subaccounts credit whatever the underlying portfolios earn, with the insurer promising nothing.
4. D.The assumed interest rate, which the insurer promises the separate account will earn.Wrong. That rate is a pricing benchmark the payout is measured against, not a return the insurer undertakes to deliver.

Why: A variable payout leaves the investment result entirely with the owner, so nothing about the size of any given payment is promised. What the insurer does promise, and funds from its general account, is the annuity factor and the expense structure: once payout begins it must continue paying for the life of the annuitant however long that turns out to be, and it may not raise the expense charge it built into the factor. That promise is what the mortality and expense risk charge pays for. The assumed interest rate is not a promise of return but the benchmark used to set the first payment and adjust later ones.