Quick Answer
Every insurance question comes down to one test: who bears the investment risk? If the contract owner picks subaccounts and takes the risk, the product is a security (registered with the Securities and Exchange Commission (SEC), sold with a prospectus). If the insurance company guarantees the return, it is insurance only, regulated by state insurance departments.
The whole unit on one sheet: fixed versus variable annuities, equity-indexed annuities, the life insurance ladder, and the "variable equals security" trigger the exam loves.
The One-Liners That Win Points
- The word "variable" is the trigger. Variable means subaccounts; subaccounts mean the owner bears the risk; owner risk means it is a security (SEC registration plus prospectus).
- Fixed annuities are NOT securities. The insurance company bears the investment risk and guarantees the return; regulated by state insurance departments, not the SEC or the Financial Industry Regulatory Authority (FINRA).
- Variable annuities ARE securities. The contract owner bears the investment risk through subaccounts; registered with the SEC, sold with a prospectus.
- Equity-indexed annuities (fixed indexed annuities) are NOT securities. They link to a market index but the guaranteed floor means the insurer absorbs the downside, so the owner does not bear the full risk.
- Among annuity types, mortality and expense (M&E) charges are unique to variable annuities. Fixed annuities do not carry them (variable life insurance can also have M&E charges).
- Sellers of variable products need BOTH a securities license AND an insurance license.
- On the life insurance side: term, whole, and universal life are NOT securities; variable life and variable universal life (VUL) ARE.
- Among the life-contingent payout options, life only pays the highest periodic amount. Every added guarantee (period certain, joint and survivor) shrinks the payment because the insurer takes on more risk.
Numbers to Lock In
| Item | Value |
|---|---|
| Mortality and expense (M&E) risk charge | typically 1.25% to 1.50% per year |
| Surrender charge schedule | typically declining over 5 to 7 years (for example 7% year 1 down to 0%) |
| Early-withdrawal IRS tax | generally 10% on the taxable portion of withdrawals before age 59 1/2, on top of ordinary income tax (absent an exception) |
| Example participation rate | 80% (index gains 10%, contract credited 8%) |
| Example cap rate | 7% (index gains 12%, contract credited only 7%) |
| Example floor | 0% to 3% (index loses 15%: a 0% floor credits 0%, a 3% floor credits 3%) |
| Term life periods | 10, 20, or 30 years |
| Joint and survivor continuation | 100%, 75%, or 50% to the survivor |
Annuities
- Fixed: guaranteed rate for a set period; insurance company bears the risk; predictable income; not a security; state-regulated.
- Variable: return depends on subaccount performance (like mutual funds; the insurer's separate account is generally registered under the Investment Company Act of 1940); owner bears the risk; a security.
- Equity-indexed: return linked to a stock index with a guaranteed minimum; insurer bears the downside via the floor; owner does not select subaccounts; not a security.
- Tax treatment (variable, nonqualified, pre-annuitization): tax-deferred growth in the accumulation phase; the taxable portion of withdrawals is taxed as ordinary income (not capital gains); last in, first out (LIFO) means earnings come out first, so early withdrawals are taxable until earnings are exhausted.
- Death benefit: typically guarantees beneficiaries at least the amount invested (minus withdrawals) if the annuitant dies during accumulation, though the exact guarantee is contract-specific; applies only in the accumulation phase.
- Two phases: accumulation (purchase payments grow tax-deferred, death benefit guarantee applies), then annuitization/payout (converts to an income stream, amount depends on the payout option).
- Payout options among the life-contingent choices, biggest payment first: life only (highest, nothing to beneficiaries), life with period certain, joint and survivor (lowest). Fixed period pays for a set number of years regardless of survival, so its payment size depends on the chosen period rather than fitting this ranking.
Life Insurance
- Term: pure death benefit for a set period; no cash value; least expensive; not a security.
- Whole life (ordinary life): permanent, level fixed premiums; guaranteed fixed-rate cash value; can borrow against it; not a security.
- Universal life: permanent with flexible premiums and adjustable death benefit; interest rate set by the insurer with a guaranteed minimum; not a security.
- Variable life: subaccount cash value; policyholder bears the risk; a security (prospectus required); guaranteed minimum death benefit but NO guaranteed cash value (premiums fixed).
- Variable universal life (VUL): flexible premiums plus subaccount investing; adjustable death benefit; most flexible and most complex; a security (prospectus required); policyholder bears the risk.
Top Gotchas
- The 10% early-withdrawal tax is IN ADDITION to ordinary income tax, generally. A pre-59 1/2 withdrawal gets hit twice absent an exception.
- LIFO means earnings come out first, so early withdrawals from a nonqualified variable annuity are taxable until the earnings are exhausted.
- The variable-annuity death benefit guarantee applies only during accumulation. Once annuitized, the death benefit depends on the payout option chosen.
- Among the life-contingent options, joint and survivor pays the LEAST per period, not the most; students assume covering two people pays more, but the insurer's obligation lasts longer.
- Equity-indexed annuities are NOT securities despite tracking a market index; the guaranteed floor keeps the downside risk with the insurer.
- Variable life has a guaranteed minimum death benefit but no guaranteed cash value; the cash value can decline to zero.
- Only products with "variable" in the name are securities. Fixed annuities, equity-indexed annuities, term, whole, and universal life are not.
One-Breath Recap
Every insurance-based product on this exam turns on one question: who bears the investment risk? Fixed annuities, equity-indexed annuities, term, whole, and universal life all leave the risk with the insurance company (or carry no cash value at all), so they are insurance products regulated by state insurance departments, not securities.
The moment the word "variable" appears (variable annuities, variable life, variable universal life), the owner is choosing subaccounts and bearing the risk, which makes it a security registered with the SEC, sold with a prospectus, and sold only by someone holding both securities and insurance licenses.
Lock in the variable-annuity details (mortality and expense charges, LIFO ordinary-income taxation, the 10% pre-59 1/2 tax, the accumulation-only death benefit) and the payout ladder among the life-contingent options (life only pays most, joint and survivor pays least; fixed period depends on the chosen term instead), and this unit answers itself.
Need more than the recap? This is a condensed summary. If it is not enough, read the full Insurance-Based Products unit for the complete lesson.