Group Life Insurance and Annuities 

 January 21, 2022


Group Life Insurance & Annuities

  1. Basic Principles of Life, Health Insurance and Annuities
  2. Nature of Insurance; Risk, Perils and Hazards
  3. Legal Concepts of the Insurance Contract
  4. Life Insurance Policies, Provisions, Options and Riders
  5. Life Insurance Premiums, Proceeds and Beneficiaries
  6. Life Insurance Underwriting and Policy Issue
  7. Group Life Insurance
  8. Annuities
  9. Social Security
  10. Retirement Plans
  11. Uses of Life Insurance
  12. Health and Accident Insurance
  13. Health Insurance Providers
  14. Disability Income Insurance
  15. Medical Expense Insurance
  16. Private Insurance Plans for Seniors
  17. Health Insurance Policy Provisions
  18. Health Insurance Underwriting
  19. Michigan Laws and Rules Pertinent to Insurance

Master The Following:

  • Principals & Characteristics of Group Life Insurance
  • Underwriting Requirements for Group Life Insurance
  • Taxation of Group Life Insurance Plans
  • Other Forms of Group Life Insurance
  • Purpose & Function of Annuities
  • Basic Structure and Design of Annuities
  • Investment Configuration
  • Date Annuity Period
  • Annuities and Taxation
  • Uses of Annuities
  • Annuity Investment and Senior Citizens

focused on:

  • Individual & Group Insurance Contracts.
  • Understanding the Underwriting Process of Group Life. 
  • Eligibility under a Group Life Insurance Contract.
  • Features of Group Insurance contracts.
  • Difference between contributory & noncontributory group plans.
  • Eligibility of employee group members.
  • Concepts of adverse selection & the law of large numbers.
  • Conversion Privilege under group life policies.
  • Rate Classification System used in life insurance contracts.
  • The Types of risks.
  • Determine which risks are insurable or declined.
  • Understand Taxation of Group Life Insurance plans.
  • Identify other types & features of group life insurance plans.
  • Understanding the concept and structure of an annuity.
  • Differentiate between an annuity contract and a life insurance contract
  • Differentiate between Fixed annuity and a Variable Annuity.
  • Understand how an annuity is Funded.
  • Understand how annuities are Taxed.
  • Differentiate between the different types of annuities based on their payment options.
  • Be familiar with the many uses of annuities.
  • Be familiar with the standards and procedures for recommendations made to senior consumers to annuities.

Group Life Insurance

Group life insurance is a type of term in life insurance that covers a group of people under a single policy contract. Typically, it is offered by a large association or entity for its workers.

Depending on the type of policy, the workers may contribute to the cost of the policy through weekly or monthly paycheck deductions (premium payments).

Group Life Insurance Policies contain many features and conditions that are different from those covered in an individual life insurance policy. These notes will introduce the basic concept of group life insurance, terms, conditions of group life insurance, eligibility, types, and features. Understanding the process of underwriting group insurance and the many advantages of group life insurance.

Principals & Characteristics of Group Life Insurance

Group insurance is a way to provide life insurance, health insurance, or both kinds of coverage for a number of people under one contract. Typically, group insurance is provided by an employer for its employees; however, it is available to other kinds of groups as well, as we will see. Different form of individual life insurance, which is written on a single life, group life insurance is written on more than one life. Group life insurance is usually written for employee-employer groups and is most often written as an annually renewable term policy.

Group life insurance differs from individual life insurance contracts in several ways. One of the difference between the two is that group insurance is most often comprised of annual renewable term life insurance. In contrast, individual insurance contracts may be term life or whole life insurance. Underwriting is handled differently, and varying types of policy provisions appear in a group life policy. Group life insurance coverage is characterized by the underwriting of numerous individuals rather than one. Group term life insurance, like all insurance contracts previously mentioned, is a two-party contract between the policyholder and the insurer (just like an individual contract). However, unlike an individual insurance policy, the insured is almost never the policy owner of group life insurance. The employer generally plays the role of the policy owner.

The employer or group providing the group life coverage pays all or a portion of the premium and is the policyholder. The employer or plan sponsor receives the master policy. 

In contrast, the covered employees or plan participants receive a certificate of coverage or a booklet that describes the benefits, the coverage provided, and how long the insurance coverage will last. The covered employee or plan participant is also known as the certificate holder. Types of groups that are eligible include employees of a single employer, credit groups, labor unions, and multiple employer groups.

Employer Responsibilities

The employer is responsible for the selection of group coverage, record keeping, and employee enrollment. The employer is not permitted to discriminate, especially when the plan is noncontributory.

Group Insurance  Vs  Individual Insurance

Features that separate group insurance from individual insurance include:

  1. Underwriting : a) In an Individual policy, the insured must prove they are insurable. b) In a Group Insurance, the group must meet various criteria, but the insureds are not individually underwritten.
  2. Policy Ownership : Traditionally with Individual Insurance, the insured is also the policy owner. While there may be instances of third-party ownership, this is not common. With Group Insurance, the insured is rarely the policy owner. There is one master policy owned by the employer or plan sponsor. Employers or Plan Sponsors receive the Master Policy, and as such, are the policy owner of the contract holder. Employees or Plan Participants receive the certificates of insurance (not individual policies), and as such, are certificate holders.
  3. Policy Type : Group life insurance is always considered temporary insurance. Typically, annually, renewable term is used, which provides a fixed amount of coverage throughout the contract. Individual insurance can be any of the previously discussed temporary or permanent insurance products. Whenever a person converts their group insurance to individual insurance, they are always converting temporary protection to permanent protection.
  4. Cost : Individual Insurance Policies are considerably more expensive for the insurer to issue (underwrite, commission, billing, maintenance, etc.). As we've learned, these administrative costs are passed on to the customer, making individual policies more expensive to purchase. Group Insurance Policies are substantially less expensive for the insurer to underwrite, issue and maintain. Group Insurance is much more cheaper for the customer to purchase. In some cases, the employer or sponsor may pay a substantial portion or all the premium cost for the group insurance policy. With individual insurance, the customer (policy owner) is always responsible for all the premium cost.

Contributory & Noncontributory Plans

Noncontributory Plan - The employer pays the entire cost of the plan. The insurance company requires that 100% of all eligible employees participate. The most significant benefit of all noncontributory insurance plan is that it helps the insurer avoid adverse selection.

With a noncontributory group insurance plan, the employees or plan participants do NOT contribute to the premium payments.

Contributary Plan - An employee group insurance plan in which employees share the cost. The insurance company requires at least 75% of all eligible employees participate.

With a contributory group insurance plan, the employees or plan participants contribute to the premium payments.

Eligible Groups

People may not form a group just to secure group insurance coverage. The securing of such coverage must be incidental to the group's formation. In other words, a group of people cannot form an organization whose primary purpose is to secure insurance coverage for the group.

Businesses are operated in order to produce product or provide service and earn a profit, and therefore, are eligible to purchase group insurance. A group of persons who are engaged in occupations of a common industry may form an association (i.e., all hat manufacturers) and later purchase group coverage.

Remember, the primary requirement for groups to offer group insurance is that the group is formed for a purpose other than acquiring insurance. Offering group insurance products should be a benefit of the group, not the purpose of the group to have existed for more than two years or has a minimum of two members.

While there is generally an employment or professional relationship present in order for group coverage to be secured, this is not always the case. Examples of some of the groups eligible to participate in group insurance exam include but are not limited to:

  • Single Employee Groups (employer)
  • Multiple Employee Groups (employment-related)
  • Labor Unions
  • Trade Associations
  • Cred/Debit Groups
  • Fraternal Organizations
  • Customer Groups (such as credit union members)
  • Trustee Groups (established by two or more employers or union)

Eligibility of Group Members - (employees)

  • Employee must be full time and actively working.
  • If Contributory, employees must approve of automatic payroll deduction.
  • New employee probationary period is usually 1 to 6 months.
  • The employee has 31 days during the enrollment period to sign up. Otherwise, they may need to provide evidence of insurability.

Underwriting Requirements for Group Life Insurance

Sound group underwiring can prove profitable to an insurer, mainly since it reduces adverse selection. Adverse selection or anti-selection is the tendency or danger of an insurer to write (i.e., approve) more bad risks than acceptable risks. People with more significant risk tend to seek insurance coverage more than those with little risk. Since more individuals are covered under group policies, there is higher probability that a "bad" risk will be included. The insurer may continue to earn a profit, however, if the acceptable risks far outweigh the bad. The offset of high versus low risk is what an insurer is depending on when the write group life coverage. Writing large groups of individuals also helps to reduce adverse selection based on the law of large numbers. Other group life characteristics include:

Proof of insurability may not be required of larger numbers. Insurers may require some type of insurability for smaller groups. As we learned, the smaller the group, the greater the potential for adverse selection (law of large numbers).

For example, if an insurer writes  a group life insurance policy for five hundred employees, the law of large numbers says that some of these employees will be of high risk, and some will be low risk, but the majority should be of standard risk. The insurance company will hardly notice if, throughout the year, they need to pay out one or two death claims out of the group of five hundred insureds. However, if the insurer writes a group life insurance policy for ten insureds, the law of large numbers no longer applies. The risk is far less predictable. Paying out one or two death claims out of the group of ten insureds could have a significant impact.

Group life plans will not exclude employees with a physical impairment (i.e., paralysis) from the group life plan. 

Several people may not form a group just to secure group insurance coverage. The securing of such coverage must be incidental to the group's formation. In other words, a group of people cannot form an organization whose primary purpose is to secure life insurance coverage. Businesses are founded in order to produce a product and earn a profit, and therefore are eligible to purchase group insurance. A group of persons who are engaged in occupations of a common industry may form an association (i.e., all hat manufacturers) and later purchase group coverage. There generally must be an employment relationship present in order for group coverage to be secured.

Underwriters take policy persistency into account as well. As it pertains to insurance, persistency is the percentage of active policies in force, without lapsing or being replaced by policies of other insurer. Insurers may measure policy persistency in various periods. For example, one year, three years, or five years from policy issue. Due to the expenses involved with acquiring and issuing a new policy, persistency and be a vital factor in the stability and success of an insurer. The insurer may shy away from groups that change insurers regularly. Therefore, the insurer feels that writing such groups does not represent an acceptable risk.

Classification of Risk

Insurers require that a minimum number of group members/employees participate in a group insurance plan in order to minimize adverse selection. Adverse selection means that the people most likely to need life insurance will purchase life insurance in greater numbers than those in good health.

After all necessary information is collected on an applicant, the underwriter will classify the applicant based on the degree of risk assumed. The following rating classification system is used to categorize the favorability of a given risk:

  • Preferred - Low Risk - Lower Premiums
  • Standard - Average Risk - No extra Ratings or Restrictions
  • Substandard - High Risk - Related Up - Higher Premiums
  • Decline - Not Insurable -Potential of Loss to Insurance Company Too High


A Conversion is when an insured individual changes his or her group insurance to an individual policy with the same insurer at the termination of employment

When Converting from GROUP to PERMANENT LIFE Insurance, the conversion being applied for within 31 days of termination
Group Life Insurance Plans are characterized by Group Underwriting, not individual.
A person whose life is insured under a group insured policy has the right to designate a beneficiary and the right to have an individual policy issued in the case of termination of employment.

The Insurer will issue an Individual Certificate to the policyowner for delivery to each person insured under a group of life policy.

The Certificate of Coverage & Benefits describes the coverage, conditions, and limitations found in the Master Policy of a Group Contract.

An insurer would consider the AVERAGE AGE when determining whether to accept a group life plan or not.

Associations and labor groups have a constitution and bylaws. They are organized and maintained in good faith to obtain insurance.

ADVERSE SELECTION is the tendency of less favorable insurance risks to seek or continue insurance to a greater extent than others.
Because all eligibility employees are usually covered, noncontributory plans are desirable from an underwriting standpoint because ADVERSE SELECTION is minimized.


Purpose & Function

An annuity is a product only sold by a life insurance company that protects an individual against outliving their income. It is a savings vehicle that is primarily used to set aside funds for the future. 

An annuity can be defined as the liquidation of an estate.

This definition is the opposite of life insurance, which involves the immediate creation of an estate. Policy insurance and pricing of whole life or term life is based, in part, upon a mortality risk (i.e., mortality factor).

An annuity is primarily an investment product and does not require proof of insurability. There is, however, a payment made to a beneficiary if the contract owner dies before income commences. This payment is limited to the amount paid into the contract plus any contract interest credited.

An annuity has its primary function the systematic approach to liquidating an estate (i.e., savings). for a specified period of life. Therefore, an annuity is a systematic approach to liquidating an estate (i.e., funds).

It is an insurance company vehicle for liquidating a sum of money. An individual is also known as the policy or contract owner. 

  • The policy holder possesses contractual rights in the annuity contract when the contract is purchased.

When the contract owner decides to receive income in the future, as soon as the insurer makes the first periodic payment, the contract owner is known as the annuitant. The annuity phase begins. Therefore, the annuitant is the person who receives a monthly income from the annuity contract. A beneficiary who will have access to the accumulated funds if the contract owner dies must be designated by the owner.

This amount is really not a death benefit in the whole life or term insurance sense since it only includes the amount contributed and accumulated due to interest credited. This indicates that an annuity possesses an insurance aspect.

During the accumulation phase, the principal grows at interest. "The interest earned" as the principal grows is tax-deferred. When a periodic payment is received at some point in the future, it is considered to represent a combination of principal plus interest. Therefore, an annuity contract provides peace of mind to those who are concerned with receiving income for life.

With tax purposes, annuities are classified as "Non-Qualified". A non-qualified annuity is one that is not tax-qualified. The contract owner receives tax deferral of interest earned, but there is no tax deduction of premiums (or yearly tax savings through a salary reduction). Annuities purchased outside qualified pension plans do not receive tax-favored treatment of premium payments. 

Premiums are not tax deductible. 

Non-qualified annuities may be purchased by an individual or entity, the premium payments are not tax-deductible.

A Qualified annuity is one that is purchased as part of a tax-qualified retirement plan. If the premium paid for a qualified annuity is in the form of a contribution by an employer to a qualified retirement plan, the premium is tax deductible.

Some qualified annuities permit employees to fund the plan through salary reduction (i.e., TSA). In this case, the plan is funded with pretax dollars, which lowers the employee's yearly taxable income. The interest earned is tax-deferred. Whether the annuity is qualified or non-qualified.

Most individuals purchase an annuity contract in order to receive income in the future (i.e., retirement). It is attractive to investors since insurers generally pay higher interest rates than other traditional savings vehicles (i.e., certificates of deposit or money market funds).

However, if the contract owner dies or becomes disabled, funds can be withdrawn without penalty. The parties involved in an annuity contract include the insurer, the contract owner, the annuitant, and the beneficiary. The contract owner has the right to name a beneficiary who will have access to the funds in the event of the owner's death prior to annuitization (i.e., the annuity or payout phase). 

An annuity possesses some insurance aspects in that mortality factor is used to determine periodic payments. However, it is not the same mortality factor as used in whole life or term life insurance.

In addition, as mentioned previously, a beneficiary must be named in the event that contract owner dies prior to the annuity phase.. If no beneficiary is listed on an annuity contract and the owner dies before the "annuitization", the proceeds are paid to the owner's estate.

An annuity may be described as a systematic liquidation or reimbursement of an estate. Annuities may be classified in several categories including:

  1.  According to the Premium Paid.
  2.  According to when Benefits Commence.
  3.  According to the Units Expressed.
  4.  According to the Disposition of Proceeds.
  5.  According to the Number of Lives Covered.

Classification According to: Premiums


Annuities posses their own morality tables, which are different from those used for life insurance. Items taken into consideration include the interest rate paid, the amount of total contributions or accumulations, and the settlement option selected. An annuitant's occupation or hobbies do not influence an annuity since these things will not affect the liquidation of funds.

Annuities may be funded with a single or periodic premium. There are two classifications of periodic premium plans.

  1. SINGLE PREMIUM ANNUITIES; this class of annuity is characterized by a lump sum or single payment. The annuity is entirely funded by a single premium. Monthly Income Payments made to the annuitant may begin immediately (i.e., 30 days following the single premium) or beginning at some time in the future (i.e., Deferred). When an annuity is funded with a single lump sum payment, the principal is created immediately. Generally, this type of annuity does not permit the contract holder to make any additional deposits into the contract. This means that the contract is fully funded with one lump sum payment.
  2. PERIODIC PREMIUM ANNUITIES; This class is made up of two types. The level premium annuity is characterized by level or constant payments each year, which funds the annuity.  For Example, Jhon, age 35, purchases a level premium annuity with an annual premium of $1,200. John will pay that level sum each year until retirement (i.e., Age 65). At that time, he will begin to receive monthly income payments. This type is also known as an annual premium annuity.
  3.  A FLEXIBLE PREMIUM is characterized by periodic premiums that may be variable amounts each year. In this case, the contract owner wishes to begin receiving income at retirement time. As long as a minimum payment is made, the contract owner may contribute whatever he or she can afford each year. The future income benefit will be based upon the total amount of funds saved when the plan annuitizes (i.e., when income begins). 

  The Accumulation Period is that time during which funds are being paid into the annuity. The payout or annuity period refers to the point at which the annuity ceases to be an accumulation vehicle and begins to generate payments on a regular basis.

Classification According to:  The Date Income

Annuities may be described according to when the payout or Distribution Phase commences


This class of annuity is designed to generate an income stream to the annuitant soon after it is purchased. It provides for the first installment payment to an annuitant thirty (30) days after the annuity is funded or purchased. An insurer will accept only lump sum premiums for the type of plan. This means that there is no accumulation period since only a single payment is made. No income is paid to the annuitant until the lump sum has been provided to the insurer. The income payments made to the annuitant consist of principal and interest.

In addition the first payment from a single premium immediate annuity must be made within twelve months of the contract date.

As it is in any annuity, how long the annuity generates income to the annuitant will depend upon a couple of factors, including:

  1. The Total Account Amount
  2. The Settlement of Distribution Option Selected.

The longer the period of income payments to the annuitant and the more guarantees provided (i.e., period certain, etc.), the lower the amount of each installment. The income from the annuity may either be fixed dollar amount of each or a variable sum. 

An Immediate Annuity may either be a fixed dollar amount each month or a variable sum. An immediate annuity is best suited for a person who needs "immediate" income (i.e., someone who is totally disabled or someone who is ready to retire).


This class of annuity may be funded with any type of premium pan. This classification of an annuity is deferent from the immediate annuity since it does not include an accumulation period. This means that there is a lengthy period between the time the contract is purchased and when the income or annuity phase commences. A deferred annuity is useful for those who wish to defer income until the future (i.e., retirement).

Contributions may accumulate over time, and every year the insurer credits the funds with a specific rate of interest, which is tax-deferred. When the owner wishes to receive cash from the fund in the future (i.e., retirement), he or she has three options, including a lump sum distribution, of which the interest credited is taxable: systematic or periodic withdrawals; or convert the fund to the annuity phase and begin to receive an income stream per month.

For example, if a new physician is just beginning his or her practice and wants to set aside funds for the future, but his or her current expenses are high, one method available in order to achieve this objective is to purchase a flexible premium deferred annuity. A deferred annuity emphasizes the Safety of Principal, Asset Accumulation and Tax Deferral of Interest

Structure & Design of Annuities


Annuities can be funded with a single lump-sum premium, in which case the principal sum is created immediately. For example, individuals nearing retirement whose financial priority is retirement income could surrender their whole life policies and use the cash value as a lump sum premium to fund an annuity.


Annuities can also be funded through a series of periodic premiums that will eventually create the annuity principal fund. At one time, it was common for insurers to require that periodic annuity premiums be fixed and level, much like insurance premiums. The purpose of this type of funding is to create a certain amount of periodic annuity income. In other words, the contract defines what premium is required to generate specified amount for a specified period of time upon contract maturity.

Today, it is more common to allow annuity owners to make flexible premium payments. A certain minimum premium may be required to purchase the annuity. After that, the owner can make premium deposits as often as is desired. With flexible premium annuities, the benefit is expressed in terms of accumulated value. For instance, a contract might specify that it will provide for guaranteed lifetime monthly payments of $5.06 per $1,000 at the annuitant's aged 65. This means that a contract that has grown to $100,000 upon the annuitant's aged 65 would generate $506 a month for life.


Annuities can be classified by the date in which the income payments to the annuitant begin. Depending on the contract, annuity payments can begin immediately, or they can be deferred to a future date.

Classification According to: Investment Source


A variable annuity is a contract issued by an insurer that provides the contract owner with the option of having premiums invested and managed differently. This type of annuity generally consists of two investment accounts, including a general account and a separate account. A guaranteed return is provided when funds are invested in the "general account".

When funds are invested in a "separate account", they are being invested in equity products such as common and preferred stocks, bonds, and other such vehicles.

There is a more significant potential for Higher Returns in a variable annuity, but there is no guarantee present as there is no guarantee present as there is in the general account. The separate account holds all of the variable account options of the insurer. 

The variable annuity allows the contract holder to control the investment of his or her premiums. This means that the contract holder assumes the investment risk when funds are directed to a separate account. However, more flexibility is provided since the contract owner can determine how much risk he or she is willing to assume. The benefits ultimately paid by the contract will be determined by the performance of the separate account (i.e., stock market performance). 
If an equity fund (i.e., mutual fund) performs well, the monthly income amount paid to the annuitant will increase. If the fund does poorly, the monthly installment payment will decrease. In other words, just like the cash value in a variable whole life insurance policy, the cash in a separate account of a variable annuity contract is not guaranteed.

A FINRA (formerly NASD) Series 6 securities license and life insurance license are needed in order to sell this product. This product allows the owner to keep pace with economic conditions and create a bit of a hedge against inflation. A variable annuity is characterized by variable or flexible premiums, variable rates of return, and its performance advances or declines with economic and market conditions. This product also provides the contract owner with flexibility and control over the investment portion of the contract. In a variable annuity, during the accumulation period, contributions made by the contract owner (minus expenses) are converted to accumulation units.

The value of each unit will vary daily based upon the performance of the underlying investment. The value of each unit is determined by dividing the net value of the separate account by the total number of outstanding accumulation units. When payout commences, the accumulation units are converted into annuity units. The number of annuity units remains the same, although the value of each (annuity) unit will vary based on investment performance.

Classification According to: Settlement Option

Classification According to Disposition of Proceeds (Annuity Payment/Settlement Options)

An annuity is not a life insurance contract that pays a guaranteed death benefit like a whole life or term life policy. When determining the income to be paid to the annuitant, the insurer utilizes a mortality table with an extra factor known as a survivorship factor. An annuity may also be described according to the life payout period or life contingency settlement options available including: Annuity Certain

An annuity certain, is a description of income or installments for a fixed period of time if that is what the owner decides. This means that the monthly income will be paid for a specified period only (i.e., not for life).  If the annuitant dies prior to the end of that period, payments continue to the designated beneficiary for the remainder of the specified period. An annuity certain may also be paid for life but with a guaranteed (i.e., certain) income period. This means that if the annuitant lives for thirty years, he or she will receive the monthly payments during that time. However, if the annuitant dies within the guaranteed period, an installment of lump sum refund will be paid to the beneficiary.

Life with Refund 

A life with refund annuity is a classification of annuity plans where the contract owner makes premium payments to the insurer throughout his or her life. The contract also assures the return of the original amount paid into the annuity contract. If the annuitant dies before the original amount is distributed, the beneficiary receives the remaining amount. Due to this guarantee, the premium for a refund annuity plan is generally higher than other annuity plans. Again, the purpose of any "Life Annuity" is to make sure that the annuitant will not outlive his or her income.


This contingency option also referred to as a pure life annuity or "life" annuity, is classified according to the length of time for which the annuitant will receive income. It provides income to the recipient, once it commences, for life with no refund paid to the annuitant's family upon his or her death. This settlement option possesses the most significant amount of risk to the annuitant as well since there is no survivorship (i.e., no refund). This purpose of straight life annuity is to protect against outliving one's income. This means that a straight life annuity protects against using up income due to longevity. 

Insurers paying out under life annuities may suffer adversely may suffer adversely if there is a sudden decrease in the mortality rate. This means that more people are living longer, and therefore, insurers are paying life incomes longer as well. In addition, since woman have a longer life expectancy than men, monthly payments would be smaller to a female, all things being equal.

For example: Joe and Joan are twins and inherit an equal amount of money from their favorite aunt. If they both purchase an annuity with the funds and each contract includes the same life income option, Joe's monthly income payments from the annuity contract will be higher since his life expectancy is shorter than that of Joan.


A life annuity with a period certain (i.e., a guaranteed minimum) pays a benefit (i.e., income) for life. However, it pays a survivor benefit if the annuitant dies before the end of the period certain (i.e., 10 years). In other words, the annuitant or survivors are entitled to a guaranteed income of at least a specified number of years (i.e., period certain), or a refund if the annuitant dies before the end of the guaranteed refund period (i.e., refund life annuity). This refund availability indicates that there will be a guaranteed minimum returned to a beneficiary if the annuitant dies.

For example: if an annuitant is to receive $2,000 per month for five years certain, and she dies after the second year, her beneficiary possesses two options to choose from that will provide a refund or return of annuity (income) proceeds. Remember that a refund annuity or annuity certain classification guarantees a definite number of income payments.


The installment refund option will pay the beneficiary the same monthly income benefit that the annuitant was receiving until the end of the period certain. In our previous example this would be $2,000 per month for three (3) years.


The cash refund option is available where the beneficiary of the annuitant chooses to receive the refund in a lump sum. In our previous example, the cash refund amount would be $72,000 ($2,000 per month for three years). The beneficiary does not receive a future refund equal to the beginning annuity funds plus interest. He or she receives a "refund" of the remaining guaranteed amount.

Classification According to: The Number Of lives

Annuities may be classified according to the number of lives covered, whether single or multiple life types. There are three basic types, including:


An individual or single life annuity is the most common form of an annuity. This type of annuity covers one life only. Generally, there is no survivorship with this type of annuity.


A joint life annuity is a type of multiple life contract designed to pay benefits to two or more annuitants at the same time. All benefits, however, will end once the first annuitant dies. In this manner, it is similar to a joint life insurance policy.


A joint and survivor annuity is a form of a multiple life contract. The benefits under this type of annuity are paid throughout the lifetime of one or more annuitants. Therefore, payments continue until the last annuitant dies. In other words, join and survivor annuities guarantee income payments for the duration of two lives.

Additional Annuity Characteristics


During the pay-in phase, the insurer is obligated to return all (or potion) of the annuity's value if the contract owner dies. This value will be equal to the amount of any contributions (minus withdrawals or other expenses), plus interest. Although the contract does not identify the proceeds available at death as a death benefit per se, the owner must name a beneficiary who is entitled to proceeds if the owner dies during the accumulation period.

The interest earned during the accumulation phase is tax-deferred. Surrender Charges may also be assessed at withdrawal. The accumulation period will cease when any of the following occur:

  1.  The Contract Owner Dies
  2.  The Annuity or "Payout" Phase Begins
  3.  The Policy is Surrendered
This period will not cease if a premium payment has not been made.


This is the Income Phase. Sometimes referred to as "annuitization", this is the period of time beginning when the contract owner gives up the right to the funds in the contract, in return for a promise of monthly income.

Additional Annuity Structure


The charges assessed when the contract owner cancels an annuity are called surrender charges. These are sometimes referred to as back-end loads. A surrender charge (i.e., penalty) is assessed whenever a cash withdrawal is made in excess of a specified percentage (i.e., 10%), in any policy year. If the total annuity is surrendered, the surrender charges are subtracted from the annuity value. For any withdrawals of less than the specified percentage, no surrender charge is assessed. This surrender charge generally decreases each year. For instance, an insurer may assess a surrender charge of 8% if any withdrawals in excess of 10% of the account balance are affected in the first year. This penalty will decrease by 1% per year for the next eight years. In year nine, there will be no surrender charge for excess withdrawals. In other words, after this time period expires, the insurer effects a waiver of surrender charges.


Annuity contracts also identify the nonforfeiture values, which will be the value of the funds less any surrender charges if funds are being withdrawn. As in certain types of qualified retirement plans available today, funds may be withdrawn with no surrender charges if the owner dies or becomes disabled or requires specific types of extended medical care in a skilled nursing or other types of extended care facility. Surrender charges assessed by an insurer differ from the 10% federal tax penalty for a premature withdrawal. Therefore, a withdrawal from an annuity can be subject to both a surrender charge and a tax penalty.

The nonforfeiture value of an annuity before annuitization is all premiums paid, plus interest, minus any withdrawals, and surrender charges. If the annuitant dies before the annuity period start date, the beneficiary receives the premiums paid plus interest earned.

Additional Annuity Characteristics


This is the most popular annuity product sold today. It provides flexibility regarding payments and allows for the supply of income to an annuitant in the future. Interest earned is tax-deferred. This type of annuity has virtually replaced the annual premium retirement annuity contract. This older contract provided a fixed schedule or annual premiums and possessed a high load (i.e., Expanses). It also included bundled premiums. 

Today's FPDAs have no (or tittle) front-end loads due to the tremendous competition between insurers. Many FPDAs do have back-end or surrender charges.


Single Premium Annuity types may provide immediate income (SPIA) or deferred income (SPDA). Single premium immediate income annuities require a lump sum payment, and income begins thirty (30) days later. Single premium deferred annuities are paid for with a lump sum, but income will be paid in the future. SPDAs sometimes include a bailout provision that allows owner to withdraw funds without a penalty if the interest rate falls below a specified rate.


A fixed annuity pays a guaranteed, predetermined, or level benefit payment amount during the annuity phase. Premiums are placed in the insurer's general premium asset account with other non-variable product premiums. These premiums are invested in fixed-rate vehicles (i.e., CDs, money market, etc.) to provide a "fixed" return based upon interest rate guarantees.

These contracts include minimum interest rates guarantees and may pay higher rates based on current economic market conditions. Premiums paid on variable annuities are placed in a separate account. These funds are invested in securities or equities such as common stock, preferred stock, or bonds. This type of annuity provides the potential for increasing income if the securities perform well. A life insurance and NASD securities license are needed in order to solicit this product.


Annual premium retirement annuities are a vehicle that provides tax-deferred income to the owner. The income earned on the annual premium paid into the contract will not be taxed until it is removed from the account. Amounts deposited into the account are not tax-deductible. However, again, the interest of earnings paid on the principal is tax-deferred. These older types of contracts were characterized by "HIGH LOADS". 


Long-Term care riders may be attached to an annuity or a life insurance policy and allow for the payment of a percentage of the death benefit if an individual is not terminally ill but requires long-term care.


A Guaranteed Minimum Withdrawal Benefit is a rider in an annuity insurance policy. It guarantees the policyholder a steady stream of retirement income regardless of market volatility. During market downturns, the annuitant can withdraw a maximum percentage of their entire investments in the annuity. Annual maximum percentages available for withdrawal vary with contracts but are usually between 5 and 10 percent of the initial investment amount until reaching the depletion of the Total Initial Investment amount, the annuitant may continue to receive income during the withdrawal period.

New Types of Annuities


Insurers also offer equity-indexed annuities as well as market value adjusted annuities. A non-variable annuity product whose renewal interest rate is linked to (but the funds re not directly invested in) a stock market-related index (i.e., Standard & Poor's 500 Index) is referred to as an equity-indexed annuity.

This form of annuity is also referred to as an indexed annuity. Index annuities provide the contract owner with the safety of principal (since the principal is guaranteed), and a guaranteed minimum return (i.e., 3%) since a high percentage of the contract owner's premium is invested in high-grade government bonds.

This provides a downside guarantee if the market performs poorly. This type of contract allows the owner to participate in market gains without assuming the risk of a market decline. It also provides the opportunity for appreciation (i.e., upside potential) in the stock market. Generally, the contract owner is obligated to remain in the contract for a minimum period of time, such as three years, and then return a percentage of the application (i.e., 10%) in the selected equity index over that time. This "percentage of the appreciation" may also be referred to as the participation rate.

A market value-adjusted annuity (MVA), is also called a modified guaranteed annuity, shifts some but not all of the investment risk from the insurer to the contract owner since the annuity account value will fluctuate as market interest rates fluctuate. In other words, it is a type of single premium-deferred annuity that allows contract owners to lock in a guaranteed interest rate over a specified maturity period (i.e., usually two to ten years).

They function similarly to that of bonds with regard to bond value fluctuations (i.e., when interest rates fall, bond prices rise, etc.) MVAs generally provide higher interest rates than traditional annuities. They also possess lower reserving requirements and pass on more risk to the contract owner. When surrendered, there will generally be both a market value adjustment and a surrender penalty assessed to the owner.

Uses Of Annuity

This type of insurance contract may be used for any reason in which to accumulate cash but is primarily used to provide income at retirement. By definition, annuities provide a structured and systematic way to liquidate principle. Where life insurance intends to create an estate, annuities intend to liquidate an estate. In this section, we will look at some of the common uses of annuities.


Again, an annuity is a vehicle with tax deferral or tax-deferred growth. Contract owners may elect to receive a lump sum payout (i.e., settlement) when the annuity phase begins. Receiving a lump sum settlement can lead to significant tax liability on the part of the recipient.

An annuity is designed to liquidate principal, but in a structured, systematic way that guarantees it will last a lifetime. They may be used to fund Individual Retirement Accounts (IRAs) and thus are known as Individual Retirement Annuities. Annuities may also fund non-qualified retirement plans, but such plans do not receive the same tax-advantaged treatment as a qualified plan. Some annuities are used to provide funds for a child's education or to pay out lottery winnings as well. The primary use of an annuity, for most individuals, is to set aside funds for retirement while receiving tax-deferred growth.


Annuities may also be used to fund qualified retirement plans, on an individual or group basis, which receive tax deferral and tax deductions in some cases. For example, vehicles such as Keogh Plans, Simplified Employee Pensions (SEPs), 401(k) Plans, pension plans, and profit-sharing plans. These latter two plans may be of the defined contribution type, which specifies the amount that each employee will contribute to the plan; or of the defined benefit type, which specifies the benefit amount the (retired) employee will receive in the future. However, annuities may be used for employees in a group or, as previously reviewed, on an individual basis.

A qualified deferred annuity in the accumulation phase may be used to fund an IRA and permit continued contributions within the maximum limits set by the IRS. IRA funds that have been annuitized no longer permit contributions.

Tax-Sheltered Annuity 403(b) or 501(c)(3)Plans

A tax-sheltered annuity, or TSA, is a special type of annuity plan reserved for nonprofit organizations and their employees. It also is known as 403(b) plan or a 501(c)(3) plan because it was made possible by those sections of the Tax Code. For many years, the federal government, through tax laws, has encouraged specified nonprofit charitable, educational, and religious organizations to set aside funds for their employee's retirement. Regardless of whether the money is set aside by the employer of such organizations or the funds are contributed by the employees through a reduction in salary, such funds may be placed in TSAs and can be excluded from the employees current taxable income.

Upon retirement, payments received by employees from the accumulated savings in tax-sheltered annuities are treated as ordinary income. However, as the total annual income of the employees is likely to be less after retirement, the tax to be paid by such retirees is likely to be less than while they were working. Furthermore, the benefits can be spread out over a specified period of time or over the remaining lifetime of the employee. This allows the amount of tax owed on the benefits in any one year to be generally small. In addition to TSAs and IRAs, annuities are an acceptable funding mechanism for other qualified plans, including pension and 401(k) plans.


Annuities are also used to distribute funds from the settlement of lawsuits or the winnings of lotteries and other contests. Such arrangements are called structured settlements. Court settlements of lawsuits often require the payment of large sums of money throughout the rest of the life of the injured party. Annuities are perfect vehicles for the settlements because they can be tailored to meet the needs of the claimant. Annuities are also suited for distributing the large awards people win in state lotteries. These awards are usually paid out over a period of several years, usually 10 or 20 years. Because of the extended payout period, the state can advertise large awards and then provide for the distribution of the award by purchasing a structured settlement from an insurance company at a discount. The state can get the discounted price because a one-million-dollar award distributed over 20 years is not worth one-million-dollars today. Trends indicate that significant growth can be expected from both these markets fir annuities.


An annuity provides a steady stream of income, typically used for retirement, but can also be used to fund education for children or family members.

Suitability In Annuity Investments

Insurers and insurance producers must have reasonable standards for determining whether an agent's recommended transactions meet the consumer's insurance needs and financial objectives. A producer may not recommend any person the purchase, sale, or exchange of any annuity contract unless the producer has reasonable grounds to believe that the transaction or recommendation is not unsuitable for the person. Suitability is based upon the producer conducting a reasonable inquiry regarding the applicant's insurance objectives, current financial situation, and insurance needs.

Suitability information means information needed that is reasonably appropriate to determine the suitability of a recommendation and includes;

  • The Age of Applicant and spouse.
  • The Annual Household Income.
  • The Financial Situation and needs, including the financial resources used for the funding of the annuity.
  • Financial experience of the person.
  • Financial objectives of the prospective purchaser.
  • The Intended Use of the annuity.
  • Financial Time Horizon.
  • Existing assets, including investment and life insurance holdings of the prospective buyer.

The producer should also take into consideration the liquidity needs of the consumer, his or her liquid net worth, the risk tolerance of the individual, and tax status information such as the tax bracket of the consumer.

State legislatures have established standards and procedures for recommendations made to senior consumers relating to annuities. A senior consumer is any person aged 65 or older. In cases of a joint purchase by more than one party, a purchaser is a senior consumer if any one party is aged 65 or older.

Agents are required to make reasonable efforts to obtain information concerning the senior's financial status, tx status, and risk tolerance, among the specified information relevant to determining suitability.

Annuities & Taxation

Annuity benefit payments are a combination of principal and interest. Accordingly, they are taxed in a manner consistent with other types of income. The portion of the benefit payment that represent a return of principal (i.e., the contributions made by the annuitant) are not taxed. However, the interest earned on the declining principal is taxed as ordinary income. The result is a tax-free return of the annuitant's investment and the taxing of the balance.

Though a detailed discussion on how to compute the taxable portion of an annuity payment is beyond the scope of this text, the basics are not difficult to understand. A simple formula called the exclusion ratio is used to determine annual annuity income exempt from federal income taxes. The formula is the investment in the contract divided by the expected return.

The owner's investment (cost basis) in the contract is the amount of money paid into the annuity (the premium). The expected return is the annual guaranteed benefit the annuitant receives multiplied by the number of years the annuitant's life expectancy. The resulting ratio is applied to the benefit payments, allowing the annuitant to exclude from income a like-percentage from income tax.

Deferred annuities accumulate interest earnings on a tax-deferred basis. While no taxes are imposed on the annuity during the accumulation phase, taxes are imposed when the contract begins to pay its benefits. To discourage the use of deferred annuities as short-term investments, the Internal Revenue Code imposes a penalty (as well as taxes) on early withdrawals and loans from annuities. Partial withdrawals are treated first as earned income and are thus taxable as ordinary income. Only after all earnings have been taxed are withdrawals considered a return of principal.

Furthermore, a 10% penalty tax is imposed on withdrawals from a differed annuity before age 59 1/2. Withdrawals after age 59 1/2 are not subject to the 10% penalty tax, but they are still taxable as ordinary income.


Section 1035 of the Internal Revenue Code allows tax-free exchanges of certain kinds of financial products, including annuity contracts. Recall that no gain will be recognized (meaning no gain will be taxed) if an annuity contract is exchanged for another annuity contract. The same applies when a life insurance or endowment policy is exchanged for an annuity contract. An annuity contract cannot be exchanged tax-free for a life insurance contract. This is not an acceptable exchange under Section 1035.


Current tax law states that if a corporation owns an annuity, it must name a natural person as an annuitant. If a non-natural entity is named an annuitatn, such as the company itself, then the interest earned is taxable as ordinary income in the year credited. If a natural person is named as the annuitant, the interest credited to the annuity each year may be tax-deferred in some cases. Sometimes this natural person is referred to as a measurable life.

There is an exception to this non-natural person rule. If the annuity is held by a trust, corporation, or another non-natural person, as an agent for a natural person being, interest earned continues to be tax-deferred. Other exceptions to this rule includes but are not limited to:

  • An annuity contract that is acquired by a person's estate following the death of that person.
  • An annuity contract that is held under a qualified retirement plan, a TSA or an IRA.
  • A contract which is an immediate annuity purchased with a single premium, with periodic payments to commence withing a year.

Corporate-owned life insurance is generally treated as a deductible business expense. The proceeds are paid tax-free up to a certain level ($50,00). If more than this amount is provided to an employee, the excess premium used to purchase must be reported by the employee as taxable income. An annuity could also be owned by a nonliving entity such as a trust, and the tax considerations will be based upon whether it is qualified or non-qualified.


  •  A life annuity certain provides a guaranteed minimum of benefit payments, whether the annuitant lives or dies.
  • A Straight Life Annuity will have the HIGHEST MONTHLY PAYOUT.
  • An annuity where the policyowner chooses a pre-determined number of benefit payments is called Period Certain.
  • A deferred annuity is an annuity contract in which periodic income payments are not scheduled to begin for at least 12 months.
  • Annuities are not intended to create an estate.
  • The Policyowner is the only one who can surrender an Annuity during the accumulation period.
  • A Guaranteed Lifetime Withdrawal Benefit (GLWB) is a rider on a variable annuity that allows minimum withdrawals from the invested amount without having to annuitize the investment. This rider guarantees that a certain percentage (often based on age) of the amount invested can be withdrawn each year for as long as the contract holder lives.
  • The Exclusion Ratio is used to determine the taxable portion of each annuity payment.
  • It is the insurance company that bears the investment risk of a fixed annuity. The insurance company guarantees the annuitant's principal as well as a guaranteed minimum rate of return, even if the underlying assets underperform the guaranteed rate.
  • The taxable and non-taxable portions of annuity payments are determined by the exclusion ratio. 
  • The annuitant dies before the payout start date, the interest earned is taxable.
  • If an annuitant dies during the accumulation period, his or her beneficiary will receive the greater of the accumulated Cash Value or the Total Premium Paid.
  • The Nonforfeiture value of an annuity prior to annuitization is all premiums paid, plus interest, minus any withdrawals and surrender charges.
  • An Annuity that returns the difference between the Annuity Value and Income Payments made to a beneficiary when the annuitant dies during the distribution period is a refund annuity.
  • The Period when the annuitant starts to receive payments from the annuity is the Annuitization Phase. The accumulated value in an annuity is paid out.
  • A life certain provides a guaranteed minimum number of benefit payments, whether the annuitant lives or dies.
  • TAX-DEFERRED GROWTH until retirement is called "Accumulation Period".
  • The Type of Annuity in which All Payments Cease Upon the Death of an Annuitant is referred to as a Life Annuity.
  • The settlement option that pays a specified amount to an annuitant, but pays NO RESIDUAL VALUE to a beneficiary is known as LIFE INCOME.

* 1868 Paul v. Virginia : This case, which the U.S. Supreme Court decided, involved one state's attempt to regulate an insurance company domiciled in another state.

* 1944 U. States v. SEUA : In the Southeastern Underwriters Association case, the Supreme Court ruled that the insurance industry is subject to a series of Federal Laws, many of which conflicted with existing state laws. As such, insurance is a form of interstate commerce to be regulated by the federal government.

* 1945 McCarran-Ferguson Act : This law made it clear that the states continued regulation of insurance was in the publics best interest. However, it also made possible the application of federal antitrust laws to the extent that [The insurance business] is not regulated by state law.

* 1958 Intervention by the FTC : In 1958 the Supreme Court held that the McCarran Ferguson Act disallowed such supervision by the FTC, a federal agency. Additional attempts have been made by the FTC to force further Federal Control, but none have been successful.

* 1959 Intervention by the SEC : The Supreme Court ruled that Federal securities laws applied to insurers that issued variable annuities and, thus, required these insurers to conform to both SEC and state regulations. The SEC regulated variable life insurance.

* 1970 Fair Credit Reporting Act : Requires fair and accurate reporting of information about consumers, including applications for insurance. Insurers must inform applicants about Any Investigations that are being made upon completion of the application.

* 1994 U. States Code (USC) Section 1033 & 1034.
According to 18 U.S.C. 1033 & 1034 : It is a criminal offense for an individual who has been convicted of a felony involving dishonesty or breach of trust to willfully engage or participate (in any capacity) in the business of insurance without first obtaining a "Letter of Written Consent to Engage in the Business of Insurance" from the regulating insurance department of the individual's state of resistance.

* 1999 Financial Services Modernization Act. :  In 1999 Congress passed the Financial Services Modernization Act, which repealed the Glass Steagall Act. Under this new legislation, commercial banks, investment banks, retail brokerages and insurance companies can now enter each other's lines of business.

* 2001 Uniting & Strengthening America by Providing Appropriate Tools Required to Intercept & Obstruct Terrorism Act. : The Patriot Act, which amends the Bank Secrecy Act (BSA), was adopted in response to the September 11, 2001, terrorist attacks. The Patriot Act is intended to strengthen U.S. measures to prevent, detect, and deter terrorists and their funding. The act also aims to prosecute international money laundering and the financing of terrorism. These efforts include anti-money laundering (AML) tools that impact the banking, financial, and investment communities.

* 2003 Do Not Call Implementation Act. : The Do Not Call Registry allows consumers to include their phone numbers on the list to which telemarketers cannot make solicitation calls.

* 2010 Patient Protection & Affordable Care Act (PPACA) : Often shortened to the Affordable Care Act (ACA), it represents one of the most significant regulatory overhauls and expansions of health insurance coverage in U.S. history.

Personal Notes From: Michigan Pre-licensing Education - Life, Accident and Health Insurance course has been approved by the Michigan Department of Financial Services as meeting the mandatory 20-hour requirement for Life and 20-hour Requirement for Health | XCEL Solutions LLC. Provider ID#: 0950 Course ID#: 60731/60732

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