Variable Annuity 

A contract issued by an insurance company that has no minimum guaranteed interest rate, where crediting of any excess interest is determined by the performance of underlying investment choices that the annuity purchaser selects. A Variable Annuity is considered a high risk/high return annuity product.

In your evaluation of annuities, it helps to understand the “300 foot view” of the annuity transaction. The sale of an annuity has to benefit the three parties to the annuity transaction:
The annuity purchaser- via fair interest rate crediting/gains
The annuity salesperson- via fair compensation
The annuity issuer (insurance company)- via a fair profit, i.e. a spread

We refer to this as the “three-legged stool” of the annuity transaction. To fully understand, it also helps to consider how the insurance company makes money by selling annuities. Simplistically, the insurance company invests the annuity purchaser’s premium payment(s) in different investment vehicles, in order to make a return that is high enough to pay administrative costs (such as the salesperson’s compensation), credit interest to the annuity purchaser, and still retain a profit.

The Variable Annuity purchaser chooses to directly invest in an array of available stocks, bonds, mutual funds, and underlying subaccounts on their annuity; any gain or loss is passed directly to the annuity purchaser in whole (less fees and charges). Let’s review:

There is a potential for the annuity purchaser to experience a loss of principal and gains with a Variable Annuity, in the event of poor market performance;

The variable sub-accounts have no minimum guaranteed interest, but the upside potential of a Variable Annuity is greater than that of Fixed and Indexed Annuities;

An annuity purchaser acquires a Variable Annuity with a minimum guarantee of 1.00% only on the fixed subaccount, and no minimum guarantee on the variable subaccounts;

Assuming 100% of the premiums are allocated to variable sub-accounts, if the market “tanks,” the insurance company bears no risk, but passes it directly to the annuity purchaser through a loss in their annuity’s value;

So, the annuity purchaser holds the risk with a Variable Annuity. The insurer has no minimum guarantees to honor in the contract (they collect their fees and charges regardless of performance), and any negative performance on the underlying investments is fully-realized by the annuity purchaser.