Which risk is specifically related to guarantees within a variable annuity contract?

• A. Market risk
• B. Liquidity risk
• C. Credit risk of guarantees
• D. Currency risk

Answer: (C)

Guarantees inside a variable annuity are promises made by the insurer to pay certain benefits regardless of how markets perform. The risk that matters here is the insurer’s ability to honor those promises—credit risk of guarantees. If the insurer runs into financial trouble or becomes insolvent, the guarantee may not be fully paid or could be compromised, even if the underlying investments perform well or poorly.

This is different from market risk, which deals with the value of the investment options themselves due to price movements; it’s also different from liquidity risk, which concerns how easily you can access funds, and currency risk, which involves exchange rate effects. When assessing guarantees, you focus on the insurer’s financial strength, credit ratings, and capitalization because the guarantee’s reliability rests on the guarantor’s solvency.