The Basics

Introduction | Regulation | NTM 05-50 | IA Rates | Crediting Methods | History | Glossary

Glossary of Terms

1035 Exhange—a tax-free method of exchanging an existing life insurance or annuity policy for a new policy with a different company. This procedure is often exercised when it is beneficial for the policy owner to move to a more favorable contract that offers rates or features they don’t currently have (1035 refers to the tax code number).

A

Annuitize—to change all or a portion of the annuity contract from a cash accumulation period to the periodic distribution of funds.

Annuity—An annuity is a contract in which an individual agrees to pay premiums to an insurance company and receives, in exchange, a regular stream of income payments from the issuer either now or at some time in the future.

B

Bailout Provision—an annuity contract provision that enables the contract owner to surrender the annuity contract, usually without a surrender charge applying, if renewal interest rates on a fixed annuity fall below a pre-established level.

Beneficiary—the person or legal entity that receives the annuity death benefit upon death of the contract owner or annuitant.

Broker/Dealer—as defined by the SEC Act of 1934, a broker is “any person engaged in the business of effecting transactions in securities for the account of another.” A dealer means “any person engaged in the business of buying or selling securities for his own account.” Accordingly, a broker/dealer trades for his or her own account and for the accounts of others.

C

Cap Rate—the maximum interest rate that will be used in the crediting calculation on an indexed annuity. Note that indexed crediting methods may also use a participation rate or a spread rate.

Cash Surrender Value—the amount that an insurance policyholder is entitled to receive should he or she discontinue the coverage.

Certificate of Deposit (CD)—a receipt issued by a bank for a cash deposit for a specified period of time at a fixed rate of interest. Upon maturity the bank pays the depositor the principal plus all accumulated interest.

Consumer Price Index (CPI)—the government’s method of measuring the price of goods and services bought by urban wage earners and clerical workers.

Contract Owner—the individual or entity that applies for and purchases an annuity contract and is responsible for funding the annuity.

D

Death Benefit—the annuity benefits that are paid to the beneficiary upon the death of the contract owner or annuitant.

Dow Jones Euro Stoxx 50—a market capitalization-weighted index of 50 blue-chip stocks from the countries that participate in the European Monetary Union.

Dow Jones Industrial Average (DJIA)—a stock indicator calculated each trading day that tracks the market value of 30 leading industrial stocks.

Due Diligence—research conducted by insurance agents and other financial advisors on the legal and economic soundness of an investment or product.

E

Exclusion Ratio—regarding payments from an immediate annuity or annuitization, part of each payment the annuitant receives is considered to be a return of principal, which is not taxed. The remaining portion of the payment consists of interest earnings and is taxable. The exclusion ratio determines the taxable and nontaxable portions of each payment.

Executor—the person named in a will to carry out the decedent’s wishes for the distribution of his or her assets; the executor fulfills his or her duties under court supervision.

F

FIFO to LIFO—in 1982 the tax treatment of annuity distributions changed from first in, first out (“FIFO”), meaning your principal came out first, then interest, to last in, first out (“LIFO”) meaning interest is distributed before principal.

Free Look Period—an annuity contract provision that varies by state, and dictates that the contract owner has approximately 10 to 20 days to examine the annuity contract immediately after purchase, with the option of returning it to the insurer for a full refund.

Free Withdrawal Provision—an annuity contract provision that grants the owner the right to withdraw a portion of the annuity’s contract value (usually 10%) during the accumulation period without incurring a withdrawal charge.

FTSE 100—A market-weighted index of the 100 leading companies traded in Great Britain on the London Stock Exchange. The full name is Financial Times-Stock Exchange 100 Share Index.

G

Hang-Seng—a market-weighted index of 33 stocks making up approximately 70% of the market value of all stocks traded on the Stock Exchange of Hong Kong.

I

Independent Marketing Organization (IMO)—an establishment that serves as a distributor of many carrier’s insurance products, and may perform many of the functions traditionally provided by an insurance carrier (recruiting/ licensing of agents, marketing, and sales support). Typically these services are provided to independently contracted agents, in exchange for a percentage of their commission.

Individual Retirement Account (IRA)—An arrangement that allows people with earned income to deposit a portion of that income in a tax-deferred savings plan. An IRA can be established and funded at any time between January 1st of the current year, up to and including the date an individual’s income tax return is due (generally, April 15 of the following year), not including extensions.

J

Joint Annuitant—an individual who is named in the contract with the annuitant, whose age and life expectancy are also used in the calculations to determine what the annuity payments will be.

Joint Owner—a person who shares ownership of an annuity contract and would have the same right as the contract owner to approve any decisions made about the contract.

L

Lehman Brothers Aggregate Bond Index—An index of U.S. Treasury bonds and notes, and government-agency bonds (excluding mortgage-backed securities).

M

Market Value Adjustment (MVA)—feature that is often attached to deferred annuities, which could increase or decrease the accumulation value of an annuity only if more than the penalty-free amount is withdrawn or the contract is surrendered during the surrender charge period. In general, if interest rates are lower at the time of withdrawal than at the time the contract was issued, the accumulation value will be increased (market value adjusted). If interest rates are higher at the time of withdrawal than at the time of issue, the accumulation value will be reduced.

Maturity Date—the latest date at which an annuity must be converted to income payments (or annuitization).

Mortality and Expense (M&E) Risks Charge—this fee only applies to variable annuities. In most cases, the “M&E” pays for the guaranteed death benefit, ensures that the expense risks charged on the contract won’t increase, covers a guaranteed interest rate paid on one type of variable annuity subaccount, and may cover the overhead expenses the insurer incurs with the annuity contract.

N

NASDAQ—National Association of Securities Dealers Automated Quotation. The automated quotation system for the Over-the-Counter (OTC) market, showing current bid-ask prices for thousands of stocks.

National Association of Securities Dealers (NASD)—nonprofit self-regulatory organization of brokers and dealers in the over-the-counter securities business, under supervision of the SEC.

Nikkei 225—a stock market index for the Tokyo Stock Exchange.

Non-qualified Annuity—a type of annuity that has no contribution limit and no required minimum distributions at age 70^1/2 (unlike qualified). It can be funded with after-tax dollars from any source and is available to any investor.

Non-rolling Surrender Charge—in a flexible premium deferred annuity, the stated length of the surrender charge term will start the day the initial premium deposit is received. Future deposits will not change the point at which all of the funds are penalty free.

O

Options—calls (puts) that give the holder the right to buy (sell) 100 shares of stock within a specified period at a specified price.

P

Participation Rate—the percentage of positive index movement that will be used in the crediting calculation on an index annuity. Note that indexed crediting methods may also use a cap rate or a spread rate.

Period Certain—an income option offered by an immediate annuity where the contract owner can select to receive periodic payments for a specified period of time. The payout amount is determined by the contract value and the length of the period selected.

Premature Withdrawal—taking cash out of an annuity before contract owner reaches the age of 59 ^1/2. Subject to a 10% federal tax penalty in addition to any income taxes that may be due, and possible policy surrender charge from the insurance company.
Premium Bonus- additional money credited to the annuity by the company as a percentage of the amount deposited.

Principal—the total amount the contract owner has invested in an annuity, not including interest earned.

Prospectus—a written document federal regulations require be given to any prospective variable annuity buyer before the sale. It describes the investment objectives of any separate accounts, past performance of subaccounts, as well as any fees or expenses.

Q

Qualified Annuity—an annuity that is purchased to either fund or distribute funds from a tax-qualified plan. In most instances, premiums paid can reduce current income taxes and the accumulations are tax-deferred.

R

Required Minimum Distribution (RMD)—IRA’s and qualified plans both have certain “required” distributions. For IRA’s, you must begin to withdraw funds by April 1st of the year following the calendar year you attain age 70^1/2. For qualified plans, withdrawals must begin by April 1st of the year following the later of, (a) the year you reach age 70^1/2, or (b) the year you retire.

Risk Averse—a client or investor who will not assume a given level of risk unless there is an expectation of adequate compensation for having done so.

Rolling Surrender Charge—in a flexible premium deferred annuity, each deposit will have it’s own independent surrender charge schedule. (i.e. with a 5 year surrender charge, each deposit will start the 5-year period the day the money is received by the company). Therefore, different amounts of the annuity will be free of surrender charge at different times.

Rollover—funds from an IRA or qualified retirement plan that are moved to another of the same type, or to an IRA, preserving its tax-deferred status.

Rule of 72—a simple method for approximation the number of years it takes an investment to double at a given compound interest rate; divide the interest rate into 72.

S

S&P 500 Composite Index (S&P 500)—market value index of stock market activity covering 500 leading stocks.

Savings Bond—a non-transferable U.S. government bond issued in denominations from $50 to $10,000. They are sold at discount with their effective interest pegged to Treasury securities. Income from savings bonds is exempt from state and local income taxes and federal income tax is deferred until redemption.

Securities and Exchange Commission (SEC)—federal regulatory and enforcement agency that oversees public investment trading activities.

Separate Account—insurance company's investment portfolio that supports a Variable Annuity; kept separate from the insurance company's regular investment accounts.

Spread Rate (a.k.a. Asset Fee, Margin)—a deduction that comes off of the positive index growth at the end of the index term in the crediting calculation on an indexed annuity. Note that indexed crediting methods may also use a cap rate or a participation rate.

State Guaranty Funds—each of the 50 states has enacted legislation to protect the contract owners of that state should an insurance company be faced with insolvency. Most state guaranty funds assess their admitted insurers an extra charge to cover any carrier insolvencies within the state. Different states have different limits of protection. All guaranty associations are funded by insurance companies and administered by the states.

Subaccount—the investment portfolios offered in variable annuity contracts where premiums may be allocated.

Surrender Charge—a penalty imposed by the insurance company for withdrawing funds from an annuity prematurely. Usually applies during the first 7 -10 years.

T

Tax-deferral—when taxes on earnings are postponed until any earnings are withdrawn from the annuity.

Tax-sheltered Annuity (TSA)—a retirement annuity sold only to public school teachers and employees of hospitals, colleges, and other organizations offering qualified retirement plans under section 403(b) of the US Internal Revenue Code.

Two-tiered—an annuity where the interest rate credited to the annuity during the accumulation phase is competitive against comparable products that are not two-tiered, and benefits are contingent upon annuitization. If the owner does not stay, their contract will be assessed an applicable surrender charge and be retroactively credited with lower interest rates back to the inception of the contract (i.e. the contract owner gets one tier of interest rates by staying with the contract through annuitization and another, lower tier of rates if he or she does not). Comparing the annuitization rates as well as the rates while in the accumulation phase is advisable on two-tiered annuities.

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