How to Get the Most Knowledge from This Course!

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1 How to Get the Most Knowledge from This Course! To enhance the learning and knowledge process, this course uses learning strategies designed to increase your comprehension and retention. The format includes traditional headings and subheadings, as well as highlighting and text borders to bring attention to critical concepts and facts that will help you pass the exam. 1. Highlighting: Pay particular attention to areas highlighted in yellow. Understanding concepts and facts contained within these areas are critical to successful completion of the final examination. 2. Text Borders: In order to reinforce certain material in the text it will be set apart through the use of text borders such as the one surrounding this paragraph. When you encounter text surrounded by a text border, pay particular attention to the point being made. Material within the text border will be reinforced later in the course through the use of review questions. 3. Case Studies: Some of the more variable concepts will be illustrated using case studies. These case studies are designed to reinforce the concept being discussed and it is recommended that you take the necessary time to digest the points made within the case studies. 4. For Insurance Licensees in Non-Monitored States, our exclusive web-based search feature allows quick retrieval of important data for maximizing the learning process. Simply execute Ctrl + F (the Ctrl and F keys at the same time) and enter keyword(s) or key phrase(s) to locate those items electronically in the course material. Understanding all of the material in this text is necessary to achieve the overall learning strategies that have been incorporated to Success Continuing Education copyrighted courses to increase exposure to portions of the text that are fundamental to the learning process and help you pass the test. *Not all courses currently have review questions or case studies.

2 HOW FIXED, VARIABLE, AND INDEX ANNUITY CONTRACT PROVISIONS AFFECT CONSUMERS 4-HOUR COURSE COPYRIGHT 2013 SUCCESS CONTINUING EDUCATION, INC. 2 Corporate Plaza Drive, Suite 100 Newport Beach, CA (949) (A member of the Success CE family of Companies) 1

3 Copyright 2013 Success Continuing Education, Inc. All Rights Reserved. No part of this publication may be used or reproduced in any form or by any means, transmitted in any form or by any means, electronic or mechanical, for any purpose, without the express written permission of Success Continuing Education, Inc. This publication is designed to provide general information on the topic presented. It is sold with the understanding that the publisher is not engaged in rendering any legal or professional services. Although professionals prepared this material, it should not be used as a substitute for professional services. If legal or other professional advice is required, the services of a professional should be sought. 2

4 TABLE OF CONTENTS BACKGROUND AND INTRODUCTION... 1 COURSE LEARNING OBJECTIVES... 2 COURSE FORMAT... 2 CHAPTER SUITABILITY... 3 SUITABILITY OF ANNUITY SALES... 3 AGENT TRAINING REQUIRED... 3 CHECKLIST REQUIRED BY CIC (E)... 5 INSURER RESPONSIBILITIES UNDER CIC CHAPTER 1 -- REVIEW QUESTION... 7 CHAPTER CONTRACT PROVISIONS AND INCOME DISTRIBUTIONS... 8 TYPICAL ANNUITY CONTRACT PROVISIONS... 8 ISSUE AGE... 8 MAXIMUM AGE FOR BENEFITS TO BEGIN... 9 ANNUITY PREMIUM PAYMENTS SINGLE-PREMIUM ANNUITIES SINGLE-PREMIUM DEFERRED ANNUITY SINGLE-PREMIUM IMMEDIATE ANNUITY PERIODIC PREMIUMS FLEXIBLE PREMIUMS SURRENDER CHARGES AFFECT OF SURRENDER CHARGE ON PRINCIPAL MARKET VALUE ADJUSTMENT HOW THE MVA IS DIFFERENT MVA RISK FACTOR SURRENDER CHARGE WAIVERS NURSING HOME WAIVER TERMINAL ILLNESS WAIVER UNEMPLOYMENT DISABILITY DEATH CHARGES AND FEES BAILOUT WAIVER WITHDRAWAL PRIVILEGE

5 POLICY ADMINISTRATION CHARGES AND FEES REQUIRED NOTICE AND PRINTING REQUIREMENTS REQUIRED NOTICE FIXED ANNUITIES REQUIRED NOTICE VARIABLE ANNUITIES EXCEPTIONS TO REQUIRED NOTICE DISCLOSURE OF CASH SURRENDER VALUE ON ANNUAL STATEMENT REQUIRED NOTICE OF SURRENDER CHARGE AND PRINTING REQUIREMENTS ANNUITY INCOME DISTRIBUTIONS SPLIT ANNUITY ANNUITY SETTLEMENT OPTIONS LIFE ONLY OR STRAIGHT LIFE SETTLEMENT OPTION ADVANTAGES OF THE LIFE ONLY SETTLEMENT OPTION DISADVANTAGES OF THE LIFE ONLY SETTLEMENT OPTION LIFE ONLY WITH GUARANTEED MINIMUM OPTION OR CASH REFUND LIFE WITH PERIOD CERTAIN JOINT LIFE ADVANTAGES OF THE JOINT LIFE SETTLEMENT OPTION DISADVANTAGES OF THE JOINT LIFE SETTLEMENT OPTION JOINT AND CONTINGENT SURVIVOR SETTLEMENT OPTION PERIOD CERTAIN ADVANTAGES OF THE PERIOD CERTAIN SETTLEMENT OPTION DISADVANTAGES OF THE PERIOD CERTAIN SETTLEMENT OPTION AMOUNT CERTAIN ADVANTAGES OF THE AMOUNT CERTAIN SETTLEMENT OPTION DISADVANTAGES OF THE AMOUNT CERTAIN SETTLEMENT OPTION INVESTMENT INCOME SETTLEMENT OPTION ADVANTAGES OF THE INVESTMENT INCOME ONLY SETTLEMENT OPTION DISADVANTAGES OF THE INVESTMENT INCOME ONLY SETTLEMENT OPTION INFLATION DURING INCOME DISTRIBUTION CHAPTER 2 -- REVIEW QUESTIONS CHAPTER VARIABLE ANNUITIES LICENSING REQUIREMENTS TO SELL VARIABLE ANNUITIES PROSPECTUS FINRA SEPARATE ACCOUNTS GENERAL ACCOUNT VARIABLE SUB-ACCOUNT OPTIONS VARIABLE ANNUITY CHARGES AND FEES MORTALITY AND EXPENSE CHARGES ADMINISTRATIVE EXPENSE SEPARATE ACCOUNT EXPENSES OTHER CHARGES OR FEES

6 SURRENDER CHARGE DISCLOSURE OF FEES AND CHARGES IN PROSPECTUS DOLLAR COST AVERAGING VARIABLE ANNUITY DEATH BENEFIT GUARANTEES ENHANCED DEATH BENEFIT GUARANTEES PRINCIPAL COMPOUNDED AT A FIXED RATE ANNIVERSARY RATCHET DEATH BENEFIT GUARANTEE ANNUITY DEATH BENEFIT GUARANTEE (CIC ) VARIABLE ANNUITY LIVING BENEFITS GUARANTEED MINIMUM ACCUMULATION BENEFIT GUARANTEED MINIMUM INCOME BENEFIT GUARANTEED MINIMUM WITHDRAWAL BENEFIT VARIABLE ANNUITY SUMMARY ACCUMULATION PERIOD DISTRIBUTION PERIOD WITHDRAWALS SYSTEMATIC WITHDRAWAL PLAN ANNUITIZATION FIXED ACCOUNT SEPARATE ACCOUNT CHAPTER 3 -- REVIEW QUESTIONS CHAPTER FIXED ANNUITIES SAFETY OF PRINCIPAL CHARACTERISTICS OF FIXED ANNUITIES FIXED ANNUITY DEATH BENEFITS DEATH BENEFIT PROVISION TAX CONSIDERATIONS RELATED TO THE DEATH OF THE ANNUITY OWNER LUMP SUM VS. ANNUITIZATION IF DEATH OCCURS AFTER ANNUITY STARTING DATE IF DEATH OCCURS BEFORE ANNUITY STARTING DATE IF SPOUSE IS BENEFICIARY FIXED ANNUITY DEATH BENEFITS AFTER ANNUITIZATION FIXED ANNUITY CHARGES AND FEES INTEREST RATE STRATEGIES ANNUAL INTEREST RATE STRATEGIES MULTI-YEAR GUARANTEED INTEREST ANNUITY (MYGIA) INTEREST RATE CREDITING NEW MONEY RATE INTEREST CREDITING PORTFOLIO-BASED INTEREST CREDITING INTEREST RATES - GUARANTEED VS. CURRENT BONUS ANNUITIES FIRST YEAR BONUS

7 ANNUALIZED BONUS RATE CALCULATION PREMIUM BONUS ANNUITIZATION BONUS VESTING OF BONUS AMOUNTS SUMMARY OF BONUS DISCUSSION RENEWAL INTEREST RATES MINIMUM GUARANTEED RATES IMPACT OF LOW INTEREST RATE ENVIRONMENT ON FIXED ANNUITY INTEREST RATES ON THE POSITIVE SIDE OF A LOW INTEREST RATE ENVIRONMENT CHAPTER 4 -- REVIEW QUESTIONS CHAPTER INDEX ANNUITIES FIXED INDEX ANNUITIES DIFFERENCES BETWEEN INDEX AND TRADITIONAL FIXED ANNUITIES INDEX ANNUITY TERMINOLOGY PARTICIPATION RATE CAP RATE OR CAP ON INDEX LINKED INTEREST FLOOR RATE SPREAD, MARGIN, OR ASSET FEE RATCHET OR ANNUAL RESET INDEXING METHODS SPECIFIC TERM POLICY YEAR INDEXING METHODS USED TO CALCULATE INDEX CHANGE FIXED INTEREST MONTHLY AVERAGING DAILY AVERAGING POINT-TO-POINT INDEXING ANNUAL POINT-TO-POINT INDEXING EXAMPLE MONTHLY POINT-TO-POINT INDEXING EXAMPLE LONG TERM POINT-TO-POINT INDEXING HIGH WATER MARK INDEXING COMBINING INDEXING METHODS CHOICE TO ALLOCATE AMONGST INDEXING METHODS IMPACT OF PREMATURE SURRENDER CHARGES WITHDRAWALS FROM INDEX ANNUITY DURING INDEX TERM FIXED INDEX ANNUITY DEATH BENEFIT TWO-TIERED ANNUITIES INDEX ANNUITY CHARGES AND FEES FLUCTUATION OF CAP AND PARTICIPATION RATES

8 INSURER INVESTMENT USED TO HEDGE INDEXING STRATEGIES FACTORS AFFECTING INDEX OPTIONS USED BY INSURERS MARKET VOLATILITY RISK FREE RATE OF RETURN MINIMUM NONFORFEITURE RATE VS. MINIMUM ANNUAL CREDITED RATE MINIMUM NONFORFEITURE RATE MINIMUM ANNUAL CREDITED RATE HYPOTHETICAL MODELS VS. ACTUAL RETURN DIFFERENCES IN CAPS NEW MONEY VS. RENEWALS COMMON INDEXES USED IN INDEX ANNUITIES STANDARD & POORS S VARYING VIEWS COMPARISON TO THE DOW JONES INDUSTRIAL AVERAGE CHAPTER 5 -- REVIEW QUESTIONS CHAPTER ANNUITY RIDERS LIFE INSURANCE RIDERS LONG TERM CARE RIDERS HOW LONG TERM CARE RIDERS WORK ANNUITY ACCOUNT BALANCE FIRST LTC APPROACH ANNUITY ACCOUNT BALANCE LAST LTC APPROACH COINSURANCE LTC APPROACH WITHDRAWALS CAN AFFECT LTC BENEFITS LIFETIME MAXIMUM BENEFIT DAILY MAXIMUM BENEFIT LONG TERM CARE SERVICE LEVELS COVERED CRISIS BENEFIT VS. LTC RIDERS RIDER TERMS AND CONDITIONS MINIMUM PREMIUMS MEDICAL UNDERWRITING FOR LTC RIDERS WAIVER OF SURRENDER CHARGE VS. LTC RIDER ANNUITY LOAN PROVISIONS ANNUITY LOAN PROVISIONS LOANS PRIOR TO AGE 59 ½ CHAPTER 6 -- REVIEW QUESTIONS CHAPTER PENALTIES PURPOSE OF CIC CIC 782: VIOLATION OF PROVISIONS OF CIC 780 OR CIC ADMINISTRATIVE PENALTY, AMOUNTS, RESCISSION OF CONTRACTS

9 CIC ALLEGATIONS OF MISCONDUCT AGAINST A PERSON 65 YEARS OR OLDER CIC ADMINISTRATIVE PENALTIES CHAPTER 7 -- REVIEW QUESTIONS ANSWERS TO CHAPTER -- REVIEW QUESTIONS REQUIRED ATTACHMENT

10 Background and Introduction During the last roughly 10 years, insurance regulators have been monitoring complaints from consumers concerning annuity sales. According to Kansas Insurance Commissioner, Sandy Praeger, who addressed the U.S. Senate Select Committee on Aging in September 2007, the total number of annuity complaints remains low when compared to other lines of insurance. The number of complaints is still significant, however, and indicates a troubling trend. In the states that reported data on annuity sales to the National Association of Insurance Commissioners (NAIC), the period from 2004 through 2007 experienced a marked increase in the number of total complaints in the categories of suitability, agent handling, and misrepresentation. The total number of complaints reported in these categories rose from approximately 1400 in 2004 to more than 2300 in The proportion of these complaints attributed to suitability issues also increased each year--from just over 10% in 2005 to more than 18% in Each complaint is reviewed and investigated by the respective state Department of Insurance and, since 2004, more than 75% of the annuity complaints reported to the NAIC by state regulatory agencies have been resolved in favor of the consumer. In light of the rising number of complaints about annuity sales, the NAIC adopted a white paper in 2006 that called for the development of suitability standards for non-registered annuity products similar to those that existed under the Securities and Exchange Commission (SEC) regulations for registered products. The white paper resulted in the creation of a working group under the NAIC Life Insurance and Annuities Committee; that group drafted a model regulation establishing suitability standards for all life insurance and annuity products. The committee decided to focus first on the area identified as subject to the greatest abuse: the inappropriate sales of annuities to persons over the age of 65. The latest version of their efforts is the NAIC Suitability in Annuity Transactions Model Regulation (2010). This model regulation is a guide that individual states can use to address relevant issues at a local, state, level. It is important to note that California regulatory actions related to the area of annuity suitability predate the actions taken by most other states. 1

11 Course Learning Objectives This course is designed to comply with the four hour annuity training requirement of California Insurance Code Section At the conclusion of this four-hour course, the student shall: Understand the producer s legal and ethical obligations toward the consumer (and to the insurer and to regulatory authorities) with regard to the suitability of annuity product recommendations; Be able to define suitability; Be able to define the types of information that must be obtained from the consumer in order to make suitable annuity product purchase recommendations; Be able to identify the product features and circumstances where an annuity product would be suitable and it would be unsuitable for a consumer; Understand the processes in place to audit and supervise producer activities; Identify the regulatory requirements that have been enacted to protect the senior consumer during the purchase and exchange of annuity products; Identify how violations of suitability standards may be identified; and, Know and understand the penalties provided for violations of applicable laws. COURSE FORMAT Within the text of this course, sections of and excerpts from California Insurance Code will be incorporated for clarity. Whenever such information is included it will always be in italics and clearly labeled as such so the reader is aware of the source. Each time we display excerpts for the California Insurance Code the text of the code will be preceded by the abbreviation for California Insurance Code (CIC) following by the code section and or subsection referenced. Occasionally we will bold a term or phrase within the CIC. This is only done to draw particular attention to the word or phrase and does not infer that any portion of the law is more important than another. Chapter review questions will follow each chapter to reinforce material covered. 2

12 Chapter 1 Suitability SUITABILITY OF ANNUITY SALES Annuities are complex financial contracts that do not meet the needs of all consumers. Annuity agents are required by both ethical and legal constraints to confirm, before the sale, that the purchase of an annuity is in the best interests of our client and that the agent can show reasonable grounds for the appropriateness, or suitability, of recommendations to their clients. Annuities are intangible products that cannot be evaluated using the same methods utilized to assess tangible products. The value of an annuity is often difficult for a client to grasp especially a senior. The annuity contract is, by necessity, filled with legal terms, exceptions, and contingencies and the average consumer is not equipped to understand them, so they place their trust in the agent recommending and selling the product. This trust is usually well deserved; however, the opportunity for agents to mislead or deceive consumers exists. Suitability requirements were established for the protection of consumers and, specifically, to prevent individuals from entering into contracts that are not appropriate for their particular situations and needs. California requires agents to have reasonable grounds for recommending an annuity to a consumer. To paraphrase from California Insurance Code Section (a) In recommending that individual consumers, including consumers over the age of 65, purchase or exchange an annuity, the insurance producer (or insurer where no producer is involved), must have reasonable grounds for believing that the recommendation is suitable for the individual consumer on the basis of the facts disclosed by the individual consumer as to his or her investments and other insurance products and as to his or her financial situation, needs, and objective. AGENT TRAINING REQUIRED Because of the complicated nature of annuities, California Insurance Code (CIC) requires producers to complete eight hours of continuing education on the subject of annuities before being able to sell them. In addition, CIC requires producers selling annuities to complete four hours of annuity specific continuing education every license renewal period. 3

13 These required annuity training courses (such as this one) must follow content outlines developed by the California Department of Insurance. A producer who is familiar with an insurance product is far more likely to make appropriate recommendations to the consumer than is a producer with little or no knowledge of the same product. Below is the section of the California Insurance Code that covers these agent annuity training requirements. CIC (a) Every life agent who sells annuities shall satisfactorily complete eight hours of training prior to soliciting individual consumers in order to sell annuities. (b) Every life agent who sells annuities shall satisfactorily complete four hours of training prior to each license renewal. Completion of the eight-hour annuity training required by subdivision (a) does not satisfy the four-hour annuity training required by this subdivision. For resident licensees, this requirement shall count toward the licensee s continuing education requirement, but may still result in completing more than the minimum number of continuing education hours set forth in this section. (c) The training required by this section shall be approved by the commissioner and shall consist of topics related to annuities, and California law, regulations, and requirements related to annuities, prohibited sales practices, the recognition of indicators that a prospective insured may lack the short-term memory or judgment to knowingly purchase an insurance product, and fraudulent and unfair trade practices. Subject matter determined by the commissioner to be primarily intended to promote the sale or marketing of annuities shall not qualify for credit toward the training requirement. Any course or seminar that is disapproved under the provisions of this section shall be presumed invalid for credit toward the training requirement of this section unless it is approved in writing by the commissioner. (d) The training requirements set forth in this section shall not apply to nonresident agents representing an insurer that is a direct response provider. For the purposes of this section, direct response provider means an insurer that meets each of the following criteria: (1) The insurer does not initiate telephone contact with insureds or prospective insureds. (2) Agents of the insurer speak with insureds and prospective insureds only by telephone, and at the request of the insureds or prospective insureds. (3) Agents of the insurer are assigned to speak with insureds or prospective insureds on a random basis, when contacted. (4) Agents of the insurer are salaried and do not receive commissions for sales or referrals. End of CIC

14 CHECKLIST REQUIRED BY CIC (E) California requires the insurance producer or insurer representative to make a record of the recommendation (see paraphrase of CIC (a) on the first page of this chapter) or obtain a signed statement from the customer stating they refuse to provide suitability information or obtain a signed statement from the consumer acknowledging that an annuity sale is not recommended but they still want to enter into an annuity transaction not based on a recommendation. Immediately below is the section of California Insurance Code that details this requirement. CIC (e) (e) An insurance producer or, where no insurance producer is involved, the responsible insurer representative, shall at the time of sale do all of the following: (1) Make a record of any recommendation subject to subdivision (a). (2) Obtain a customer-signed statement documenting the customer s refusal to provide suitability information, if any. (3) Obtain a customer-signed statement acknowledging that an annuity transaction is not recommended if the customer decides to enter into an annuity transaction that is not based on the insurance producer s or insurer s recommendation. End of CIC (e) INSURER RESPONSIBILITIES UNDER CIC In addition to providing and verifiying of agent training and making a record of the recommendation (or lack of recommendation), the insurer must establish a system to supervise compliance with the suitability requirements. Specifically the supervision system must, among other things, maintain a system to review each recommendation (screening is allowed) and maintain procedures to detect recommendations that are not suitable. Below is the section of California Insurance Code that provides the full details on this issue. CIC (f) (D & E) (f) 5

15 (1) An insurer shall establish a supervision system that is reasonably designed to achieve the insurer s and its insurance producers compliance with this article, including, but not limited to, all of the following: Subsections A, B, and C omitted Per California Department of Insurance required outline. (D) The insurer shall maintain procedures for review of each recommendation prior to issuance of an annuity that are designed to ensure that there is a reasonable basis to determine that a recommendation is suitable. The review procedures may apply a screening system for the purpose of identifying selected transactions for additional review and may be accomplished electronically or through other means, including, but not limited to, physical review. An electronic or other system may be designed to require additional review only of those transactions identified for additional review by the selection criteria. (E) The insurer shall maintain reasonable procedures to detect recommendations that are not suitable. This may include, but is not limited to, confirmation of consumer suitability information, systematic customer surveys, interviews, confirmation letters, and programs of internal monitoring. Nothing in this subparagraph prevents an insurer from complying with this subparagraph by applying sampling procedures or by confirming suitability information after issuance or delivery of the annuity. End of CIC (f) (D & E) 6

16 CHAPTER 1 -- REVIEW QUESTION Answers are in the back of the text 1. An insurer selling annuities must establish procedures designed to detect annuity recommendations that are not suitable. [a] True [b] False 7

17 Chapter 2 Contract Provisions and Income Distributions TYPICAL ANNUITY CONTRACT PROVISIONS ISSUE AGE Many insurance companies allow annuities to be purchased by individuals (both contract owner and annuitant) until they are age 80 or 85. Minimum issue age is often set at age 0. Some annuities will have shorter surrender charge periods for issues ages over a certain age (usually age 65 or 70). Some annuity companies will offer multiple annuity products with some products not available for clients over a certain age. This is often done to comply with various state laws relating to maximum surrender charge percentages and durations for consumers over certain ages. The minimum and maximum issue ages are usually expressed as the age of the annuitant, but some insurers will specify the minimum or maximum issue age applies to the owner or annuitant. California addresses issues related to issuing an annuity to an individual under the age of 19 ( a minor) in California Insurance Code Section which is reproduced below. In reading the code section below you will notice that it begins by stating this section is subject to several sections of the California Probate Code. The section of the California Probate Code referenced total about 10 pages of probate code. In summary, the sections of California Probate Code referenced deal with different scenarios where a minor has a claim or benefit (disputed or not) to property. These various scenarios include (but are not limited to): There is no parent to act as guardian There are parents but only one has custody There is no guardian of a minor s estate interests The court appoints a guardian The court directs a trust to be written and appoints a trustee As long as one of the above scenarios doesn t exist then CIC (below) applies to when an individual under the age of 18 is an annuity owner or annuitant. To sell an annuity to or upon the life of an individual under the age of 18 you need the written consent of a parent. CIC

18 Subject to Section 2459 of the Probate Code, in respect to life or disability insurance, or annuity contracts (except as provided in Sections 2500 to 2507, inclusive, of the Probate Code and Section 3500 of the Probate Code and Chapter 4 (commencing with Section 3600) of Part 8 of Division 4 of the Probate Code), heretofore or hereafter issued to or upon the life of any person not of the full age of 18 years for the benefit of such minor or for the benefit of the father, mother, husband, wife, child, brother, or sister, of such minor, or issued to such minor, subject to written consent of a parent or guardian, upon the life of any person in whom such minor has an insurable interest for the benefit of himself or such minor s father, mother, husband, wife, child, brother or sister, such minor shall not, by reason only of such minority, be deemed incompetent to contract for such insurance or annuity, or for the surrender thereof, or to exercise all contractual rights thereunder, or, subject to approval of a parent or guardian, to give a valid discharge for any benefit accruing or for any money payable thereunder; provided, that all such contracts made by a minor under the age of 16 years, as determined by the nearest birthday, shall have the written consent of a parent or guardian, and that the exercise of all contractual rights under such contracts, or the surrender thereof, or the giving of a valid discharge for any benefit accruing or money payable thereunder, in the case of a minor under the age of 16 years, as determined by the nearest birthday, shall have the written consent of a parent or guardian. All such contracts made by a minor not of the full age of 18 years which may result in any personal liability for assessment shall have the written assumption of any such liability by a parent or guardian in consideration of the issuance of the contract. Such assumption shall be in a form approved by the commissioner, reasonably designed to inform the parent or guardian of the liability thus assumed. Such assumption of liability may be made a part of and included with any written consent of such parent or guardian required under other provisions of this section and it may be provided therein that such assumption shall cover only up to the anniversary date of the policy nearest to the member s birthday at which he or she attains age 18. End of: CIC MAXIMUM AGE FOR BENEFITS TO BEGIN The annuity date or income date is the date at which the annuitant begins to receive annuity payments. This date is the earlier of the optional date elected by the annuitant or the maturity date. The maturity date is the latest date the annuitant may defer annuity payout options and is stated in the contract. Many contracts stipulate that the annuitant may change the maturity date; however, the new maturity date may be the last day of the term but may be no later than the maximum age stated in the contract. The maturity date is often misunderstood. It is typically the last date by which the annuitant must take receipt of the proceeds -and not the first date on which proceeds may be withdrawn without surrender penalties. 9

19 The IRS does not require age limits when benefits are paid but most insurance companies establish annuitization limits at age 80 to 90; others establish the maximum age at 100. It is important for an agent to know what age maximums apply to both contract owners and annuitants, since differing age limits will affect a variety of features of an annuity. If the annuity is a qualified annuity withdrawals must begin by April 1 st of the year following the owner turning age 70 ½ in order to avoid a tax penalty for underdistribution of a qualified retirement plan. ANNUITY PREMIUM PAYMENTS SINGLE-PREMIUM ANNUITIES Single-premium annuities are purchased with a lump sum and payouts begin either immediately or at some point in the future. This is the most common type of immediate annuity. Single-premium annuities involve the payment of a single premium, and the insurance company promises to pay the annuitant an amount over a certain period (monthly, quarterly, semi-annually, or annually). SINGLE-PREMIUM DEFERRED ANNUITY A single-premium deferred annuity (SPDA) is an annuity that is purchased with only one premium payment. Usually, that single premium is relatively large--but it does not have to be. Insurance companies require minimum premiums for this type of contract and they may range from a few thousand dollars to much larger amounts. The money placed in an SPDA is left to accumulate for the future. When the annuitant desires to have a stream of income, he or she can elect an annuity settlement option. SINGLE-PREMIUM IMMEDIATE ANNUITY A single-premium immediate annuity (SPIA) is an annuity that is also purchased with only one premium payment. Like the SPDA s premium, it is also relatively large and subject to certain minimum amounts. An SPIA differs from an SPDA because the annuitant chooses to receive an income stream immediately after (or as part of) making the annuity purchase. PERIODIC PREMIUMS Another type of premium payment is periodic. In these annuities, the premiums are paid in periodic payments over a number of years prior to the date on which the annuity payout begins. The premiums can usually be paid monthly, quarterly, semi-annually, or annually. These annuities are often called multiple premium or installment premium contracts. FLEXIBLE PREMIUMS The final type of premium payment is a flexible-premium annuity. In these annuities, the annuity owner has the option to vary the amount of each premium payment, so long as 10

20 they fall between minimum and maximum amounts. The California Insurance Code Section (immediately below) addresses the maximum annuity premiums that can be collected in advanced. CIC An incorporated life insurer issuing life insurance policies on the reserve basis may collect premiums in advance. Such insurers may also accept moneys for the payment of future premiums related to any policies issued by it. No such insurer may accept such moneys in an amount to exceed (1) the sum of future unpaid premiums on any such policy or (2) the sum of 10 such future unpaid annual premiums on any such policy if such sum is less than the sum of future unpaid premiums on any such policy. This section shall not limit the right of such insurers to accept funds under an agreement which provides for an accumulation of such funds for the purpose of purchasing annuities at future dates. End of: CIC SURRENDER CHARGES While insurance companies independently determine how surrender charges and penalties are structured (subject to state DOI approval), most utilize a charge that decreases over a specified number of years. The charge is usually a percentage of the contract values and is also referred to as a contingent deferred sales charge (in the case of a variable annuity). Most insurers apply a surrender charge when either funds are withdrawn (a partial surrender) or the annuity is surrendered (a full surrender) in the early years of the contract. Although not common, some insurance companies apply the surrender charge to each deposit made into the annuity. This type of surrender charge typically applies to flexiblepremium annuities. For example, each deposit is tracked by the company, and if withdrawals are made or the contract is surrendered, the surrender charge is calculated based on the amount of the withdrawal/surrender with respect to the size and date of the deposits. For purposes of calculating the surrender charge, if the annuity owner makes a withdrawal, then the funds are considered to be drawn first from the first premiums contributed. An example of a surrender charge schedule might look like the following table: Contract Year Surrender Charge or Penalty 1 8% 2 7% 11

21 3 6% 4 5% 5 4% 6 3% 7 2% 8 1% Note: These surrender charges do not reflect the 10% penalty imposed by IRS if withdrawals and surrenders are made prior to age 59 ½. AFFECT OF SURRENDER CHARGE ON PRINCIPAL A surrender charge has the potential to reduce the cash surrender value of the annuity to an amount less that the principal deposited by the annuity owner. For this reason liquidity and the portion of an individual s assets that might be placed in an annuity is a big part of the suitability equation. A big issue with annuity sales is overselling an annuity. Overselling is taking a situation where an annuity purchase is appropriate for the consumer but the agent recommends that too much of their assets be put into the annuity. When an annuity is oversold the consumer often finds themselves needing cash for some reason and the only place they can turn (short of borrowing) is the annuity which may still be within the surrender charge period. A good rule of thumb to prevent overselling annuities is, for an individual over the age of 65 to never place more than 50% of their net worth into an annuity. In addition they need a clear plan to provide for their liquidity needs. Each insurance carrier will have their own limits that may be greater or less that described here. The current and future liquid resources and needs of the consumer should be a major consideration in determining annuity suitability. MARKET VALUE ADJUSTMENT Some fixed annuities impose a market value adjustment (MVA) on surrenders and withdrawals prior to the end of the surrender charge period. MVAs adjust the amount surrendered or withdrawn to reflect the effect of current economic conditions on the value of the insurance company s invested assets (generally bonds), supporting the guaranteed crediting rate of fixed annuities. The MVA adjustment can be positive--in which case the withdrawal or surrender proceeds will be reduced--or negative--in which case these proceeds will be increased to reflect asset gains. In every case, however, an MVA adjustment will not be allowed to reduce product values below the minimum guaranteed values required by state insurance law. This provision maintains the insurance status of the product by limiting the degree of investment risk transferred to the owner by insurance company. Generally, if a surrender charge does not apply during the surrender charge period, as in 12

22 the case of a free withdrawal, death or other surrender charge waiver, the market value adjustment does not apply. An MVA can be attached to a deferred annuity that features fixed interest-rate guarantees combined with an interest rate adjustment factor. The MVA may cause the actual crediting rates to increase or decrease in response to market conditions. HOW THE MVA IS DIFFERENT If a contract owner wants to surrender the annuity prior to the end of the surrender charge period, a market value adjustment will be made. The actual contract value received has the potential to be positively or negatively affected by current market conditions. Because the issuing insurance company has invested the premium to ensure it can pay the rate guaranteed in their contract, it could lose money if it had to sell those investments at a discount to refund premiums paid plus their earnings. The reverse can also be true. MVA RISK FACTOR One of the most common ways for a MVA to take place is based on the difference between the fixed account credited rate at issue and the fixed account credited rate available on new accounts, the amount withdrawn or surrendered is adjusted either up or down. The formulas used to determine the amount of the market value adjustment vary from one insurer to another. If an agent recommends an annuity with a market value adjustment they should understand how the MVA is calculated. The MVA serves to protect the insurance company against investment losses incurred by early withdrawals. When having a more predictable pattern of withdrawals, MVA annuities offer a greater potential to credit higher interest rates than the traditional fixed annuity does. Due to the bond-like mechanics of the MVA feature, the market-adjusted value of the product actually increases as interest rates decline. In this environment, the credited rate should be better than new money alternatives, which show a decline after the annuity is issued. On the other hand, in an increasing rate environment, the market-adjusted value of the contract may decrease, as with a bond. SURRENDER CHARGE WAIVERS Most annuities allow several waivers to their surrender terms and charges; requirements vary by state. These surrender charge waivers are designed to allow withdrawal or surrender of the annuity without a surrender charge during the surrender charge period. When reviewing the surrender charge waivers described below keep in mind that these are meant to lessen the impact of surrender charges when unforeseen or unplanned events 13

23 occur in the life of the annuity owner/annuitant or sometimes their spouse. The more waivers provided by an annuity contract, and the more generously worded they appear, the less restrictive the surrender terms and charges are viewed. However, if the consumer needs access to annuity funds during the surrender charge period and their withdrawal does not comply with the requirements of one or more of the waivers, they can experience shrinkage of annuity values due to surrender charges. NURSING HOME WAIVER Some insurance companies include a waiver to provide withdrawals without surrender charges. Their annuity contracts offer a waiver of the contract s surrender charges or withdrawal penalties in the event the annuitant is either hospitalized or confined to a nursing home for a certain period of time, such as 30 days or longer. This provision allows the contract owner to withdraw funds from the annuity to pay expenses or replace lost income associated with the hospitalization or confinement. Other annuity contracts allow medically-related surrenders that are not subject to surrender charges. Generally, there is a requirement that the annuitant be confined in a medical care facility for a certain period of time or be diagnosed with a terminal illness. Some insurers also permit the confinement of a spouse of the annuitant in a nursing home to trigger the waiver. Note: The nursing home waiver of surrender charges should never be described or relied upon as a long term care policy or benefit. TERMINAL ILLNESS WAIVER Some annuities will waive all or part of a surrender charge if the annuitant is terminally ill. Terminal illness usually requires a life expectancy of 6 month or less. Some insurers also permit the terminal illness of a spouse of the annuitant to trigger the waiver. UNEMPLOYMENT A small portion of annuities offer an unemployment surrender charge waiver. When this waiver is available, it always specifies that the annuitant be under age 65 at time of issue and/or unemployment. Some unemployment waivers require that you have been employed fulltime for a certain number of years (usually 2 or more) prior to issue date in order to benefit from the waiver. In addition, the unemployment waiver will specify a minimum period of unemployment such as 30 or 60 consecutive days before you can make a withdrawal free of the surrender charge. DISABILITY Many insurance companies will waive surrender charges if the annuitant becomes disabled. The definition of disability used in the waiver trigger can differ from one annuity to another so the agent needs to understand how disability is defined if they recommend an annuity with a disability waiver for the surrender charge. Note: The IRS applies a 10% penalty (premature distribution penalty) to withdrawals from annuities that are made before annuitants reach age 59 ½. This 14

24 penalty does not apply if the annuity owner qualifies as being disabled, disability here being defined by the Internal Revenue Code (IRC). The IRC definition may differ from the definition used in the annuity contract. For purposes of waiver of the 10% premature distribution penalty tax, IRC defines disabled as follows: being unable to engage in any substantially gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. DEATH Many insurance companies will waive surrender charges if the annuitant dies. It should be noted that a number of annuities will waive the surrender charge upon death only if the beneficiary draws the funds out over at least a five year period. CHARGES AND FEES Some of these surrender charge waivers are available for an additional premium charge or may charge a nominal fee to process the withdrawal. BAILOUT WAIVER Some fixed annuities may have a bail-out provision (sometimes called an escape clause). This feature allows the contract owner to cash in the contract without surrender charges if the interest rate credited to the annuity falls below a certain predetermined level. An example involves a provision with the bail-out rate specified to be 1.5% below the current credited rate at time of annuity issue. In this instance, if a future declared interest rate is more than 1.5% below the current interest rate at time of annuity issue, the contract owner could surrender the annuity and not pay any surrender charges. This provision provides flexibility for the contract owner who wants to reposition money in times that experience dramatically falling interest rates but would not otherwise be able to do so. WITHDRAWAL PRIVILEGE In addition to the partial and full surrender waivers previously discussed, annuitants frequently need to access funds for a variety of reasons. Many annuities allow annuitants to withdraw up to 10% of their account value each year without applying surrender charges. Similarly, other contracts allow for withdrawals of the interest in the account, or 10% of the contract value, whichever is greater. Still other contracts allow the 10% withdrawal amounts to accumulate each year to allow for accumulated withdrawals of 20%, 30%, 40%, etc. as time goes by. POLICY ADMINISTRATION CHARGES AND FEES Annuities can have various charges and fees designed to recover the costs of the insured to administer the annuity contract. The charges and fees can be called policy fees, administrative fees, or may be described as fees to exercise certain options or riders within the contract. In the case of a policy fee the mount is usually nominal ($25 to $30) 15

25 and accessed annually. Other potential fees are triggered by the exercise of an option or rider. Variable annuities, which are securities products, are required to disclose their fees in more detail. For example, insurers are required to pay premium taxes on both fixed and variable annuities, but the fixed annuity will include the costs of premium taxes in their overall premium computations; whereas, the variable annuity is required to show it in detail. All fees and charges should be disclosed and explained to the annuity consumer so they can make an informed purchasing decision. California requires that insurers offer a 30 day right to return on all annuity contracts. This is often called a 30 day free-look period. We have reproduced required sections of the California Insurance Code below that deal with the right of a policyowner to return an annuity contract within 30 days of issue for a refund without surrender charges being imposed. If the annuity in question is a variable annuity it is possible that the annuitant will receive more or less than the amount contributed if the annuity premium was invested in an equity based separate account. REQUIRED NOTICE AND PRINTING REQUIREMENTS CIC a) Every policy of individual life insurance and every individual annuity contract that is initially delivered or issued for delivery to a senior citizen in this state on and after July 1, 2004, shall have printed thereon or attached thereto a notice stating that, after receipt of the policy by the owner, the policy may be returned by the owner for cancellation by delivering it or mailing it to the insurer or agent from whom it was purchased. The period of time set forth by the insurer for return of the policy by the owner shall be clearly stated on the notice and this period shall be not less than 30 days. The owner may return the policy to the insurer by mail or otherwise at any time during the period specified in the notice. During the 30-day cancellation period, the premium for a variable annuity may be invested only in fixed-income investments and money-market funds, unless the investor specifically directs that the premium be invested in the mutual funds underlying the variable annuity contract. Return of the policy within the 30-day cancellation period shall have one of the following effects: (1) In the case of individual life insurance policies and variable annuity contracts for which the owner has not directed that the premium be invested in the mutual funds underlying the contract during the cancellation period, return of the policy during the cancellation period shall have the effect of voiding the policy from the beginning, and the parties shall be in the same position as if no policy had been issued. All premiums paid and any policy fee paid for the policy shall be refunded by the insurer 16

26 to the owner within 30 days from the date that the insurer is notified that the owner has canceled the policy. The premium and policy fee shall be refunded by the insurer to the owner within 30 days from the date that the insurer is notified that the owner has canceled the policy. (2) In the case of a variable annuity for which the owner has directed that the premium be invested in the mutual funds underlying the contract during the 30-day cancellation period, cancellation shall entitle the owner to a refund of the account value. The account value shall be refunded by the insurer to the owner within 30 days from the date that the insurer is notified that the owner has canceled the contract. (b) This section applies to all individual policies issued or delivered to senior citizens in this state on or after January 1, All policies subject to this section which are in effect on January 1, 2003, shall be construed to be in compliance with this section, and any provision in any policy which is in conflict with this section shall be of no force or effect. REQUIRED NOTICE FIXED ANNUITIES The subsection of code immediately below describes the wording required in the notice of right to return as well as the minimum font size, location on document, and blank space surrounding the notice that must accompany every fixed annuity delivered. (c) Every individual life insurance policy and every individual annuity contract, other than variable contracts and modified guaranteed contracts, subject to this section, that is delivered or issued for delivery in this state shall have the following notice either printed on the cover page or policy jacket in 12-point bold print with one inch of space on all sides or printed on a sticker that is affixed to the cover page or policy jacket: IMPORTANT YOU HAVE PURCHASED A LIFE INSURANCE POLICY OR ANNUITY CONTRACT. CAREFULLY REVIEW IT FOR LIMITATIONS. THIS POLICY MAY BE RETURNED WITHIN 30 DAYS FROM THE DATE YOU RECEIVED IT FOR A FULL REFUND BY RETURNING IT TO THE INSURANCE COMPANY OR AGENT WHO SOLD YOU THIS POLICY. AFTER 30 DAYS, CANCELLATION MAY RESULT IN A SUBSTANTIAL PENALTY, KNOWN AS A SURRENDER CHARGE. The phrase after 30 days, cancellation may result in a substantial penalty, known as a surrender charge may be deleted if the policy does not contain those charges or penalties. 17

27 REQUIRED NOTICE VARIABLE ANNUITIES The subsection of code immediately below describes the wording required in the notice of right to return as well as the minimum font size, location on document, and blank space surrounding the notice that must accompany every variable annuity delivered. (d) Every individual variable annuity contract, variable life insurance contract, or modified guaranteed contract subject to this section, that is delivered or issued for delivery in this state, shall have the following notice either printed on the cover page or policy jacket in 12-point bold print with one inch of space on all sides or printed on a sticker that is affixed to the cover page or policy jacket: IMPORTANT YOU HAVE PURCHASED A VARIABLE ANNUITY CONTRACT (VARIABLE LIFE INSURANCE CONTRACT, OR MODIFIED GUARANTEED CONTRACT). CAREFULLY REVIEW IT FOR LIMITATIONS. THIS POLICY MAY BE RETURNED WITHIN 30 DAYS FROM THE DATE YOU RECEIVED IT. DURING THAT 30-DAY PERIOD, YOUR MONEY WILL BE PLACED IN A FIXED ACCOUNT OR MONEY-MARKET FUND, UNLESS YOU DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO UNDERLYING THE CONTRACT DURING THE 30-DAY PERIOD. IF YOU DO NOT DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO, AND IF YOU RETURN THE POLICY WITHIN THE 30-DAY PERIOD, YOU WILL BE ENTITLED TO A REFUND OF THE PREMIUM AND POLICY FEES. IF YOU DIRECT THAT THE PREMIUM BE INVESTED IN A STOCK OR BOND PORTFOLIO DURING THE 30-DAY PERIOD, AND IF YOU RETURN THE POLICY DURING THAT PERIOD, YOU WILL BE ENTITLED TO A REFUND OF THE POLICY S ACCOUNT VALUE ON THE DAY THE POLICY IS RECEIVED BY THE INSURANCE COMPANY OR AGENT WHO SOLD YOU THIS POLICY, WHICH COULD BE LESS THAN THE PREMIUM YOU PAID FOR THE POLICY. A RETURN OF THE POLICY AFTER 30 DAYS MAY RESULT IN A SUBSTANTIAL PENALTY, KNOWN AS A SURRENDER CHARGE. The words known as a surrender charge may be deleted if the contract does not contain those charges. EXCEPTIONS TO REQUIRED NOTICE (e) This section does not apply to life insurance policies issued in connection with a credit transaction or issued under a contractual policy-change or conversion privilege provision contained in a policy. Additionally, this section shall not apply to contributory and noncontributory employer group life insurance, contributory and noncontributory 18