6.2 Variable Annuities

Series 7 General Securities Representative

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1 Introduction

About the Series 7 How to Use This Guide

2 Chapter 1: Equity Securities

1.1 Common Stock Basics 1.2 Dividends and Stock Splits 1.3 Preferred Stock 1.4 Rights and Warrants 1.5 ADRs and Foreign Securities

3 Chapter 2: Debt Securities

2.1 Bond Fundamentals 2.2 Bond Yields and Pricing 2.3 Corporate Bonds 2.4 Bond Features and Risks

4 Chapter 3: U.S. Government & Agency Securities

3.1 Treasury Securities 3.2 Agency Securities 3.3 Mortgage-Backed Securities 3.4 Money Market Instruments

5 Chapter 4: Municipal Securities

4.1 Municipal Bond Basics 4.2 General Obligation Bonds 4.3 Revenue Bonds 4.4 Municipal Bond Analysis 4.5 Municipal Securities Rules

6 Chapter 5: Investment Companies

5.1 Investment Company Basics 5.2 Mutual Funds (Open-End Funds) 5.3 Mutual Fund Pricing and Fees 5.4 Closed-End Funds and ETFs 5.5 Investment Company Taxation

7 Chapter 6: Variable Products & Annuities

6.1 Annuity Basics 6.2 Variable Annuities 6.3 Annuity Taxation 6.4 Variable Life Insurance

8 Chapter 7: Alternative Investments & DPPs

7.1 Direct Participation Program Basics 7.2 Types of DPPs 7.3 DPP Suitability and Risks 7.4 Real Estate Investment Trusts (REITs) 7.5 Hedge Funds and Other Alternatives

9 Chapter 8: Options

8.1 Options Basics 8.2 Long and Short Option Positions 8.3 Hedging Strategies 8.4 Spreads and Combinations 8.5 Index and Non-Equity Options 8.6 Options Account Requirements

10 Chapter 9: Customer Accounts

9.1 Account Types 9.2 Cash Accounts 9.3 Margin Accounts 9.4 Margin Calculations 9.5 Fiduciary and Institutional Accounts

11 Chapter 10: Retirement & Education Plans

10.1 ERISA and Qualified Plans 10.2 Defined Benefit vs. Defined Contribution 10.3 Individual Retirement Accounts 10.4 Education Savings Plans 10.5 Plan Distributions and Taxation

12 Chapter 11: Securities Markets & Trading

11.1 The Primary Market 11.2 The Secondary Market 11.3 Order Types and Execution 11.4 Trade Settlement and Reporting 11.5 Market Participants

13 Chapter 12: Rules, Regulations & Ethics

12.1 Regulatory Framework 12.2 Suitability Requirements 12.3 Communications with the Public 12.4 Prohibited Activities 12.5 Customer Protection Rules 12.6 Ethics and Professional Conduct

6.2 Variable Annuities

Key Takeaways Explain This Topic AI

Premiums buy accumulation units in a separate account; Accumulation Unit Value (AUV) = total separate-account value divided by units outstanding.

At annuitization the NUMBER of annuity units is fixed forever; only the unit VALUE varies with subaccount performance.

The Assumed Interest Rate (AIR) is the benchmark: performance above AIR raises the check, equal keeps it flat, below lowers it.

A higher AIR gives a higher first check but is harder to beat; a lower AIR gives a smaller first check that is easier to grow.

Variable annuity costs include mortality & expense (M&E) risk fees, admin fees, subaccount expenses, contract fees, and a declining surrender charge (CDSC).

Last updated: June 2026

The Separate Account

Variable annuity premiums flow into a separate account , legally walled off from the insurer's general account so the assets are not exposed to the insurer's creditors. The separate account holds a menu of subaccounts (equity, bond, balanced, money market) that behave like mutual funds; the owner allocates among them and bears all investment risk . The separate account is registered as a security and, when managed actively, also registers under the Investment Company Act of 1940.

Accumulation Units

During accumulation the investor buys accumulation units — analogous to mutual fund shares. AUV = Total Separate Account Value Number of Accumulation Units \text{AUV} = \frac{\text{Total Separate Account Value}}{\text{Number of Accumulation Units}} AUV = Number of Accumulation Units Total Separate Account Value

Worked example: A client invests $10,000 when the AUV is $25, buying 400 units. If subaccounts rally and AUV climbs to $30, the position is 400 × $30 = $12,000 . Notice the number of accumulation units grows every time the owner contributes, while the value per unit floats. Dividends and capital gains are automatically reinvested, and nothing is taxed during accumulation.

Annuity Units

At annuitization , accumulation units are exchanged for a fixed number of annuity units .

Feature Accumulation Units Annuity Units
Phase Accumulation Payout
Number Variable (rises with each deposit) Fixed at annuitization
Value Variable Variable

Every month: payment = fixed number of annuity units × current annuity unit value . Because the unit count is frozen, the only thing that moves the check is the unit value — which is driven by the AIR comparison below.

Assumed Interest Rate (AIR)

The AIR is a conservative benchmark the insurer sets to size the first annuity payment. After that, each period's actual subaccount return is compared to the AIR to decide whether the next check goes up, stays flat, or drops. The AIR touches annuity units only — never accumulation units — and it is not a guaranteed return.

Subaccount performance vs. AIR Effect on next payment
Exceeds AIR Payment increases
Equals AIR Payment unchanged
Below AIR Payment decreases

Worked example — the subtle trap: AIR is 5%. Month 1 the account earns 7% → check rises. Month 2 it earns 6%. Six percent is below the prior 7% but still above the 5% AIR , so the check rises again (just by less). The check only falls when the actual return drops below the AIR itself , not when it merely slows. Many test-takers wrongly say a falling return always cuts the check.

High vs. low AIR: A higher AIR front-loads a bigger first payment but the account must keep beating that higher hurdle to grow — harder to maintain. A lower AIR starts smaller but is easier to exceed, so checks rise more readily.

Layered Fees

Fee What it covers Typical level
Mortality & Expense (M&E) risk charge Death-benefit and lifetime-income guarantees ~1.0%–1.5%/yr
Administrative fee Recordkeeping/servicing small annual %
Subaccount (investment) expenses Fund management, like an expense ratio varies
Contract/maintenance fee Flat annual charge ~$25–$50/yr
Surrender charge (CDSC) Penalizes early surrender, declines yearly e.g., 7%→0 over ~7 yrs
Licensing to Sell

A representative selling variable annuities must hold a securities license (Series 6 or Series 7) , a state insurance license , and typically a state securities (Series 63 or 66) registration — because the product is simultaneously a security and insurance. A pure insurance license alone is never enough. Trap: bonus/L-share contracts with longer surrender schedules raise suitability concerns; never recommend exchanging one VA for another solely to earn a new commission (a 1035 churning red flag, covered in 6.3).

Prospectus and Disclosure Duties

Because a variable annuity is a registered security, the customer must receive a current prospectus at or before solicitation, and any sales literature must be accompanied or preceded by it. The prospectus discloses subaccount objectives, all layered fees, surrender schedules, and the fact that values fluctuate and are not guaranteed. Reps may not describe the separate account as "safe," "guaranteed," or "FDIC-insured" — only the death benefit and certain optional riders carry insurer guarantees, and even those depend on the insurer's claims-paying ability.

FINRA Rule 2330 imposes heightened review on deferred variable annuity transactions, including principal review within seven business days.

Optional Living-Benefit Riders

Modern variable annuities sell on living-benefit riders the exam expects you to recognize at a high level. A Guaranteed Minimum Income Benefit (GMIB) guarantees a minimum annuitization income regardless of subaccount performance. A Guaranteed Minimum Withdrawal Benefit (GMWB) guarantees the return of premium through periodic withdrawals even if the account drops. A Guaranteed Minimum Accumulation Benefit (GMAB) guarantees a floor on contract value after a set period. Each rider adds an extra annual fee on top of M&E, which compounds the fee drag — a recurring suitability theme.

The key teaching point: riders convert investment risk back toward the insurer in exchange for cost, so the client trades upside/liquidity for a guarantee.

Death Benefit During Accumulation

If the owner dies before annuitizing, the contract pays a death benefit to the beneficiary. The standard guarantee returns at least total premiums paid (less withdrawals) even if the account has fallen below that. Enhanced stepped-up death benefits lock in the highest anniversary value reached. This is the insurance feature that distinguishes a variable annuity from a plain mutual fund and justifies the M&E charge — a frequently tested rationale.