Assumed interest rate (AIR)
Also known as: AIR, assumed investment return
The assumed interest rate (AIR) is the benchmark rate of return used to set the initial payment on a variable annuity and to adjust each payment thereafter. Separate account performance above the AIR raises the next payment, while performance below it lowers the payment.
The assumed interest rate is a performance hurdle written into a variable annuity contract at annuitization. The insurance company uses the AIR, along with the annuitant's age, gender, and payout option, to calculate the first annuity payment. From that point on, the AIR becomes the yardstick every future payment is measured against.
The mechanics are straightforward once you see the comparison. Each period, the insurer compares the actual performance of the separate account to the AIR. If a contract carries a 4% AIR and the separate account returns 6%, the next payment rises. If the account returns exactly 4%, the payment stays flat. If it returns 2% — still a gain — the payment falls, because 2% underperformed the assumption. This is the single most misread point about variable annuities: a positive return can still shrink your check.
Two further details matter. First, each payment is compared to the immediately preceding payment, not to the original first payment, so a string of below-AIR periods produces a string of declines. Second, the AIR affects only the annuity (payout) phase — during the accumulation phase, the contract owner holds accumulation units whose value simply tracks the separate account with no AIR involved. A conservative AIR produces a smaller first payment that is easier to grow; an aggressive AIR produces a larger first payment that is harder to sustain.
The AIR is heavily tested. Life and health insurance licensing exams and the combined life and health exam expect you to explain how the AIR governs payment fluctuation, and the Series 65 covers annuities as an investment vehicle with the same emphasis. Expect questions that give you an AIR and an actual return and ask whether the next payment rises, falls, or stays level.
Key takeaways
- The AIR is the benchmark return assumed when calculating a variable annuity's first payment.
- Separate account performance above the AIR increases the next payment; performance below it decreases the payment, even if the return was positive.
- Performance exactly equal to the AIR leaves the payment unchanged.
- The AIR applies only during the payout phase, not during accumulation.
- Each payment is compared to the previous payment, so consecutive below-AIR periods compound the decline.