Mastering Variable Contracts for the Series 6 Exam

15.1.3 Variable Contracts

Variable contracts, including variable annuities and variable life insurance, are crucial components of the Series 6 Exam. These investment products offer unique benefits and risks, making them suitable for specific client profiles. This section will guide you through the intricacies of these products, focusing on their features, regulatory requirements, and suitability considerations.

Understanding Variable Annuities

Variable annuities are insurance products that provide a combination of investment and insurance benefits. They are designed to offer a stream of income, typically for retirement, and are characterized by their investment flexibility and potential for growth.

Key Features of Variable Annuities

1. Accumulation Units and Annuity Units:

   • During the accumulation phase, contributions purchase accumulation units. The value of these units fluctuates based on the performance of the underlying investments.
   • Upon annuitization, accumulation units are converted into annuity units, which determine the payout amount during the annuity phase.

2. Payout Options:

   • Variable annuities offer various payout options, including life-only, period certain, and joint-and-survivor options. Each option affects the payout amount and duration.

3. Tax Treatment:

   • Contributions to variable annuities are made with after-tax dollars, and the earnings grow tax-deferred. Withdrawals are taxed as ordinary income, with potential penalties for early withdrawals before age 59½.

4. Expenses and Fees:

   • Variable annuities often come with higher fees than other investment products, including mortality and expense risk charges, administrative fees, and investment management fees.

Suitability and Sales Practices

When recommending variable annuities, it is essential to assess the client’s financial situation, investment objectives, and risk tolerance. Variable annuities are suitable for clients seeking long-term growth potential and income in retirement, but they may not be ideal for those with short-term liquidity needs.

Regulatory Requirements:

• Disclosure Obligations: Advisors must provide clients with a prospectus detailing the annuity’s features, fees, and risks.
• Replacement Rules: When replacing an existing annuity, advisors must ensure the new product offers a clear benefit to the client.

Exploring Variable Life Insurance

Variable life insurance combines life insurance protection with investment options. Policyholders can allocate a portion of their premium to a variety of investment subaccounts, potentially increasing the policy’s cash value.

Key Features of Variable Life Insurance

1. Policy Structure:

   • Variable life insurance policies offer a death benefit and a cash value component. The cash value can be invested in subaccounts, similar to mutual funds.

2. Death Benefit Options:

   • Policies typically offer a fixed death benefit or a variable death benefit that fluctuates with the policy’s cash value.

3. Policy Loans and Cash Surrender:

   • Policyholders can borrow against the cash value or surrender the policy for its cash value, subject to fees and penalties.

Suitability and Sales Practices

Variable life insurance is suitable for clients who need life insurance coverage and are comfortable with investment risk. Advisors must ensure clients understand the product’s complexity and the potential for cash value fluctuation.

Regulatory Requirements:

• Disclosure Requirements: Advisors must provide a prospectus and ensure clients understand the policy’s features and risks.
• Replacement Rules: When replacing a policy, advisors must document the reasons and benefits for the client.

Regulatory Compliance and Best Practices

Compliance with regulatory requirements is critical when dealing with variable contracts. Advisors must adhere to FINRA rules and state insurance regulations to ensure ethical and professional conduct.

Key Compliance Considerations

1. Sales Practice Standards:

   • Ensure all recommendations are suitable for the client’s financial situation and objectives.
   • Provide clear and comprehensive disclosures to clients.

2. Replacement Guidelines:

   • Document the rationale for any replacement transactions and ensure they are in the client’s best interest.

3. Continuing Education:

   • Stay informed about changes in regulations and industry best practices through ongoing education and training.

Practical Examples and Case Studies

To illustrate the application of these concepts, consider the following scenarios:

Scenario 1: Variable Annuity Suitability:

• A 55-year-old client with a moderate risk tolerance is planning for retirement. They have a diversified portfolio but lack a guaranteed income stream. A variable annuity with a lifetime income rider may be suitable, providing growth potential and income security.

Scenario 2: Variable Life Insurance Replacement:

• A client with an existing whole life policy is considering a variable life policy for its investment options. The advisor must evaluate the client’s risk tolerance, investment knowledge, and the benefits of the new policy over the existing one.

Conclusion

Mastering variable contracts is essential for passing the Series 6 Exam and serving clients effectively. By understanding the features, risks, and regulatory requirements of variable annuities and variable life insurance, you can make informed recommendations and ensure compliance with industry standards.

Series 6 Exam Practice Questions: Variable Contracts

By mastering the concepts and regulatory requirements of variable contracts, you will be well-prepared for the Series 6 Exam and able to provide valuable guidance to clients seeking these investment products.