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ALFS Module - III

ALFS Module - III. Module Objectives . Review of Mutual Funds Variable Products Prepare for Module IV. Variable Products. Separate Accounts Definition of Variable Contracts

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ALFS Module - III

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  1. ALFS Module - III

  2. Module Objectives • Review of Mutual Funds • Variable Products • Prepare for Module IV

  3. Variable Products • Separate Accounts • Definition of Variable Contracts • Traditional fixed life and annuity products have the investment performance risks taken by the insurance company, not the contract holder. • With Variable life and annuity products, the investment risk is borne by the contract holder. The investor gets the gains, but the losses as well. Because the contract holder bears the risk, the SEC considers variable contracts to be securities. • Regulation as Securities- Variable contracts must be registered with the SEC. The issuing company must register under the Securities Exchange Act, 1934. The variable contract must be registered under the Securities Act, 1933.

  4. Variable Products • Registration As Securities • The people who sell variable contracts must be dually licensed • Separate Accounts- A separate account is defined by the Investment Company Act of 1940 as an account established and maintained by an insurance company..under which income, gains, and losses, whether or not realized from assets allocated to such account are..credited to or charged against such account without regard to other income, gains, or losses of the insurance company.

  5. Variable Products • Separate Account Investments- State laws require most of an insurance company’s general assets to be invested in bonds and mortgages, because they are lower risk. • The company can have a separate account that is not subject to state laws. This fund can concentrate its investments in common stocks, bonds, or even money market securities. • Direct or Indirect Investment • The separate account can invest the funds paid into it either directly or indirectly. • In direct method, the separate account functions like a mutual fund. • Indirect method is organized much like a unit investment trust.

  6. Variable Products • Separate accounts as Investment Companies-similar regulations as mutual funds companies apply • Professional Management • Diversification- seek to diversify interests • Investment Return- the overall gain or loss in separate account is determined by 4 factors: • Dividend Income • Interest Income • Realized capital gains and losses-when a security is sold for more or less than what it cost • Unrealized appreciation or depreciation

  7. Variable Products • Investment Policies of Separate Accounts • Classification by Investment Objective • Growth • Income • Growth and Income • Specialized • Classification by Underlying Investment • Money Market-short term, highly liquid • Bond & Preferred Stock-steady interest income at long-term rates • Common Stock-dividend income and potential capital appreciation • Government Securities-interest income at long-term rates, guaranteed by the federal government • Ginnie Mae-type of gov’t security providing interest income at mortgage rates

  8. Variable Products • Classification by Underlying Investment • Option/Income- derives gain from buying options and then exercising or selling them when the price of the underlying security moves sufficiently. • Global or international- • Precious Metals- • Asset Allocation- • Sub-Accounts, into which contract funds may be allocated.An asset allocation portfolio consists of a mixture of stocks, bonds, or money-market instruments. Also called “managed” accounts.

  9. Variable Products • Variable Life Insurance • Features- • Whole Life • Universal Life • Variable Life • Fixed premium variable life • Flexible premium variable life • Death Benefits-Vary by type of policy • Cash Values-Handled differently based on product • Loans-Available with most insurance contracts with cash values

  10. Variable Products • Features of the Contract • Separate Account-with variable life products, policyowners can choose from a variety of investment options. • Premium Payments-Variable life and whole life policies are structured on a fixed, level payment schedule. Universal and flexible premium life have a flexible premium payment schedule. • Risk- Variable and Flexible premium variable life policyowners bear the risk of unfavorable investment results. Universal life policyowners bear no risk to principal and are given a minimum interest guarantee.

  11. Variable Products • Policyowners Objectives • Main objective for insured should be the protection the life insurance policy provides, with additional need of growth of the cash value. Variable life policyowners should also have desire to make choices about the kind of investments that support the benefits of their policies. Favorable tax treatment is ideal as well. • Voting Rights of Policyowners- They are given these just as if they were in a mutual fund, with one exception: the insurance company uses its right to deny the ability to vote.

  12. Variable Products • Settlement Options- Death benefits may be paid in lump or payments. The fixed payment options are as follows: • Interest Only-Proceeds are held for some period, paying only interest to beneficiary. • Life Income- A monthly payment is based on the life expectancy of the beneficiary and continue as long as they are alive. The Life income certain and refund life income options were designed to avoid the disadvantage of true life income, which will not pay out many proceeds if the beneficiary dies early. • Fixed Period and Fixed Amount Options-Principal and interest are paid out in equal installments over a chosen period.

  13. Variable Products • Other Contractual Provisions • Policy Loan Interest Rate- • Supplementary Benefits- riders are available • Premium Payment Modes- • Expense Guaranty • Transfers between Investment Options • Conversion to a Fixed Policy • Policy Surrender • Nonforfeiture Options

  14. Variable Products • Charges & Expenses- • Limitation on Charges- no defined limit • Other charges possible: • admin charges • Mortality Costs • Investment management fees

  15. Variable Products • Valuation of the Policy • Death Benefit- Depends on the policy • Variable Life- AIR is structured in • Flexible Premium-death benefit stays at face value until which point the cash value surpasses the point when it has to increase to keep the corridor. • Cash Value- • No value is guaranteed. • Tax Treatment-receive same tax benefits as other life policies

  16. Variable Products • Tax Treatment • Cash Value-increases are not taxed as current income.Loans are not considered income, either. • Death Proceeds-not taxable to beneficiary.Proceeds are generally included in policyowner’s estate for estate tax purposes. • Full Surrender-when surrendered, any gain is taxable as income. The gain is the value minus the cost basis(premiums paid). Losses cannot be reported. • Partial Surrender-Tax free unless the amounts exceed cost basis

  17. Variable Products • Variable Annuities • Like variable life, variable annuities make use of a separate account. • Methods of purchasing annuities- • Immediate or deferred • Fixed and variable annuity features • Payments to the annuitant-fixed annuity provides the annuitant a guaranteed, fixed number of dollars each period. A variable annuity generally provides a payment that varies with th investment performance of the separate account. • Rate of Return- A fixed annuity guarantees a fixed rate of return during the accumulation phase. A variable annuity has no guarantee of return or principal.

  18. Variable Products • Variable Annuities • Risk- Fixed has lower risk, obviously. • No surrender During Payout- With fixed, holders generally have no control over the principal once the payout phase begins. The variable annuity works the same way. • Contract holder Objectives • People buy them to insure monthly payments throughout their retirement years. Downside of fixed is the payments may not keep up with inflation. Variable’s provides a potential hedge against inflation.

  19. Variable Products • Settlement Options- • Fixed- Pays a fixed dollar amount • Variable- Pays in units, rather than dollars • Other Contractual Provisions • Mortality Guarantee • Expense Guarantee • Death Benefits • Nonforfeiture Provisions • Conversion to Fixed Period • Loans

  20. Variable Products • Sales Charges and Expenses- found in prospectus • Level Sales Charge- % charge • Deferred Sales Charge- • Valuation of the contract • During the accumulation phase of a variable annuity, the value is expressed in units, known as accumulation units. • Accumulation Unit-an accounting measure to determine a contract owner’s interest in the separate account during that phase. Sales charges must be deducted before the payments count as units. • Annuity Unit-These units determine the amount of each payment to the annuitant during the payout period.

  21. Variable Products • Valuation • Assumed Interest Rate-The Assumed Interest Rate (AIR) concept is the same as life policies.However, with annuities it is applied in determining the amount of annuity payments. • Taxation • Accumulation Period-Tax liability is deferred until the annuity period begins or until the contract is surrendered. IF annuity is surrendered during the accumulation period, and the value is more than the cost, the difference is taxable. • Withdrawals and Loans- • Amounts withdrawn before the annuity starting date are treated as earnings, until all earnings are used. • An additional 10% tax is applied if withdrawn before age 59 1/2.

  22. Variable Products • Taxation • Annuity Period • Part of an annuity payment(the gain) is considered current income when received. • 403B Plans • Also known as Tax-deferred annuities (TDA’s). These are available to certain not for profit organizations and schools as a retirement plan. Under a 403B plan, the employee agrees to let employer withhold a part of his or her salary. The employer then uses this deferred salary to purchase an annuity.The employee’s current taxable income doesn’t include the amount withheld. • Limit for contribution- $9,500 per year • Rollovers- now allowed from 403’s to IRA’s.

  23. Variable Products • Market Value Adjusted (MVA) Annuities • Set up similar to bank CD’s in that the person decides on an annuity period for a set number of years. If the annuity is withdrawn before the end of the term, an MVA is made. Depending on whether the interest rates in effect at the time of the withdrawal, the adjustment could penalize or benefit the annuitant. • MUTUAL FUNDS OR VARIABLE ANNUITIES? • Annuity Benefits • Lifetime income guarantee • Tax-shelter advantages • Financial stability of the issuing company • Annuity Disadvantages • May be large deductions for charges beyond the sales charges. • Premium taxes may be levied • Portfolio managers may be more conservative • Investors are tied to investment policy of 1 company

  24. Variable Products • ON TO PART 4

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