Variable Contracts of an Insurance Company

The two requirements work in parallel: the variable-contracts framework sets the compensation and distribution rules for all variable contracts; the deferred variable annuity rule layers a deferred-VA-specific supervisory regime on top.

What a Variable Contract Is

A variable contract is an insurance product (variable annuity or variable life insurance) whose values vary with the performance of a separate account invested in securities (typically mutual fund subaccounts).

• Variable contracts are securities under the Securities Exchange Act of 1934 (SEA) and insurance products under state insurance law (dual SEC and state-insurance regulation)
• The separate account itself registers as an investment company under the Investment Company Act of 1940 (ICA) and the underlying subaccounts mirror mutual fund structures
• Distinguish from a fixed annuity (insurance contract with guaranteed return; not a security; not subject to FINRA rules)

Variable Contracts: Sale and Compensation

The FINRA variable-contracts requirement sets the compensation and distribution framework for all variable contracts.

Compensation Channeling

An AP may only receive compensation in connection with variable-contract sales from the member with which the person is associated.

• The insurance carrier may not pay the AP directly
• All compensation flows: carrier → member firm → AP through the firm's payroll
• This rule prevents the insurance carrier from creating off-the-books incentives outside the firm's supervision

Cash and Non-Cash Compensation

Cash and non-cash compensation restrictions parallel the requirements covering direct participation programs (DPPs), investment company securities, and corporate financing covered in Unit 5. The four permitted non-cash compensation categories (gifts, occasional meals / entertainment, offeror-funded training, internal non-cash arrangements) all apply to variable-contract sales.

Recordkeeping

The member must maintain records of all compensation received from offerors in connection with variable-contract sales: offeror name, AP name, cash amount, and nature and value of any non-cash compensation. These records feed the broader per-rep transaction record kept under the books-and-records framework.

Exam Tip: Gotchas

• Variable contracts are simultaneously securities and insurance products. A variable annuity sold by a rep without a securities license is not just an insurance violation; it is a securities violation under the statutory definition of "security." A rep must hold both the appropriate FINRA registration (Series 6 or 7) and the state insurance license.
• Compensation must flow through the member firm. A bonus check or sales prize sent by the insurance carrier directly to the AP, even with the firm's knowledge, violates the variable-contracts compensation framework because it bypasses the firm's compensation records and supervisory chain.

The Deferred Variable Annuity Rule

The deferred variable annuity rule applies to recommended purchases and exchanges of deferred variable annuities. It sets a heightened supervisory regime distinct from standard suitability.

Required Customer Disclosure Before Recommendation

Before recommending a deferred-VA purchase or exchange, the rep must inform the customer of the various features:

• Surrender period and surrender charges (including the schedule of declining charges over the surrender period)
• Potential tax penalty (10% federal penalty on pre-59½ withdrawals, in addition to ordinary income tax on the gain portion)
• Mortality and expense (M&E) fees, investment advisory fees, and any additional rider charges (e.g., guaranteed minimum income benefit (GMIB) rider, guaranteed minimum withdrawal benefit (GMWB) rider)
• Death benefits, including any step-up provisions
• The existence of any market-value adjustment (MVA) that affects surrender value if rates rise

Principal Review and Approval: 7 Business Days

A registered principal (Series 24, Series 26, or Series 9 / 10) must review and approve or reject the recommendation in writing.

The principal's review must occur before the application is transmitted to the issuing insurance company.

Exam Tip: Gotchas

• The 7-business-day clock starts when the OSJ receives a complete and correct application package, not when the rep takes the customer's order. A missing signature or missing form restarts the clock once corrected. The 7 business days run from the complete package, not from any earlier point.
• The principal review must be completed before the application is transmitted to the insurance carrier. A firm that transmits to the carrier first and reviews later has violated the deferred-VA rule even if the principal's eventual decision was approval. The order of operations is the rule.

Exchange Supervision

Replacing one variable annuity with another (a "1035 exchange") triggers heightened scrutiny. The principal must evaluate whether the customer would benefit from the new product's enhancements considering:

• New surrender charges (the new VA typically resets the surrender schedule, locking the customer in for another 5-10 years)
• Loss of existing benefits (death-benefit step-ups, locked-in withdrawal rates, vintage GMIB / GMWB rider terms that may not be available on the new product)
• Surrender charges on the existing product (selling out of an existing product before the schedule expires consumes principal)
• Customer's frequency of recent exchanges (a customer who has done multiple exchanges in recent years is presumptively being churned)

The frequency of recent exchanges is a key factor. A customer who exchanged once five years ago is in a different posture than a customer who has exchanged twice in the past three years.

Required Training

The member must train associated persons on:

• The deferred variable annuity supervisory framework
• The product features (surrender period, M&E fees, riders, MVA)
• The suitability factors that apply to deferred-VA recommendations

Training must occur before any rep recommends a deferred VA. A firm that distributes deferred VAs without documented rep training has a supervisory failure regardless of whether the individual sales appear suitable.

Exam Tip: Gotchas

• The deferred variable annuity rule covers deferred variable annuities specifically. Variable life insurance and immediate variable annuities are governed by the variable-contracts framework and general suitability, not by the heightened deferred-VA framework. Do not apply the 7-business-day principal-review clock to all variable products.
• A 1035 exchange resets the surrender schedule. A customer 6 years into an existing 7-year surrender schedule who exchanges into a new VA enters a fresh 7-year schedule on the new contract. The principal must verify that the customer benefit (better rider, lower fees, step-up basis) outweighs the loss of being one year from no-charge access on the existing contract.