Separate Accounts
Now that you understand the dual nature of variable annuities, let's examine the structure that makes the "variable" part work: the separate account.
Purpose and Structure
- A separate account holds the assets backing variable annuity and variable life insurance contracts
- It is legally separated from the insurance company's general account; creditors of the insurance company cannot reach separate account assets
- The separate account is registered as an investment company under the Investment Company Act of 1940
- Each subaccount within the separate account operates like a mutual fund, with its own:
- Investment objective
- Portfolio manager
- Expense ratio
General Account vs. Separate Account
| Feature | General Account | Separate Account |
|---|---|---|
| Holds assets for | Fixed annuities, whole life, universal life | Variable annuities, variable life |
| Investment risk borne by | Insurance company | Contract owner |
| Creditor protection | Creditors CAN reach assets | Creditors CANNOT reach assets |
| Registered as | Not a security | Investment company (1940 Act) |
| Returns | Guaranteed minimum rate | No guarantee - fluctuates with market |
| Backs guarantees? | Yes (death benefits, living benefits) | No |
Subaccount Options and Management
- Subaccount options typically include:
- Equity funds
- Bond funds
- Money market funds
- Balanced funds
- International funds
- Index funds
- The contract owner selects how to allocate purchase payments among available subaccounts
- The owner may reallocate among subaccounts at any time
- The insurance company's investment adviser manages the subaccounts according to stated investment policies
- A prospectus must be delivered to the purchaser before or at the time of sale, disclosing subaccount objectives, risks, fees, and performance
Exam Tip: Gotchas
- Subaccount transfers within a variable annuity are NOT taxable events. However, a withdrawal or surrender from the contract IS a taxable event. The exam may present a scenario where a client reallocates from an equity subaccount to a bond subaccount and ask whether this triggers taxation; it does not.
How Performance Works
- Separate account performance determines:
- The accumulation value during the pay-in phase
- The variable payout amount during annuitization
- Unlike a fixed annuity (where the insurance company bears investment risk in the general account), the contract owner bears the investment risk in a variable annuity
- The separate account does NOT guarantee any rate of return
Key distinction: The separate account is where investments live and risk resides. The general account is where guarantees live and insurance company solvency matters.
Exam Tip: Gotchas
- The separate account provides NO guarantees. Guarantees (death benefits, living benefits) come from the general account.
- The separate account IS a security. It is registered as an investment company under the 1940 Act, while the general account is not.