Annuity Benefit Payment Options: Fixed or Variable

Fixed-benefit annuities guarantee a minimum annuity benefit payment per dollar of accumulated value, similar to settlement options under life insurance policies.

Variable-benefit annuities make no guarantees. Variable benefit payments depend on the market value of the assets in the separate accounts.

About 90 percent of all outstanding annuity contracts fall into the fixed-rate category, but variable annuities are becoming increasingly popular (variable annuities are also fairly new compared to the long history of fixed annuities). The investment account in a fixed-rate contract operates much like the cash value account of a universal life policy. The annuity investment earns a fixed rate, which the insurer often guarantees for the first one to five (occasionally as many as ten) years of the contract. After that time, the rate depends on the investment success of the insurer’s general portfolio (subject to a guaranteed floor, typically 3 to 4.5 percent). The fixed-rate contract gives the contract owner no choice or say in the underlying investments.

Some fixed-rate contracts have a bailout provision. If the contract return falls below the bailout rate, the contract owner can terminate the contract without cost (i.e., without surrender charges).

In the past two decades variable annuities have become quite popular because, in return for the assumption of greater risk, the contract owner may obtain both greater investment flexibility and a (potentially) higher return. (However, since the bear market of 2007-2009, not surprisingly, variable annuities have been less popular.) The contract owner can select from among a number of separate accounts that are similar to mutual fund investments. The investment options typically include diversified stock, bond, and money market funds. Most insurers also now offer a broad array of alternative funds such as specialized stock funds (sector funds, small capitalization stock funds, index funds), foreign stock and bond funds, junk bond funds, real estate equity and mortgage funds, GNMA-type funds, and asset allocation funds (where the company’s investment manager selects portfolio weights allocating investments among the other funds). It is important to note that although there is a great deal of latitude in investment selection, the investor is limited exclusively to the selection of investment choices that are offered within the annuity contract.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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