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By Investopedia AAA

Variable Contracts - Types and Valuation of Variable Annuities

Types of Variable Annuities
Variable annuities fall into two broad categories: immediate and deferred annuities, which differ depending on when the annuity payout period begins. That is, each annuity is distinguished by how premiums are paid and when the benefits begin.

Immediate Annuity
With an immediate annuity, the investor deposits a lump sum. Within 60 days, the insurance company will begin to pay the annuity benefits.

Deferred Annuity
Types of deferred variable annuities include single-premium deferred and periodic-payment deferred.

  • Single-Premium Deferred Annuities: When an investor deposits a single lump sum and the annuity benefits are deferred until a later date, the annuity is called a single-premium deferred annuity.

  • Periodic-Payment Deferred Annuities: An annuity contract can allow an investor to make periodic payments on a scheduled basis, either monthly, quarterly or annually. The annuity pays out its benefits at a later date and is referred to as a periodic-payment deferred annuity.
Exam Tips and Tricks

You may need to know the types of variable annuities and what makes each one different. Remember that there are two general types of annuities: immediate and deferred. From there, ou can distinguish between the various types of each one.

Valuation of Variable Annuities

Accumulation Phase
The accumulation phase is the period during which the investor is putting money into the annuity contract. During this time, the money in the securities is generating dividends, interest and capital gains that are reinvested on a tax-deferred basis. The money will purchase accumulation units in the separate account. Accumulation units are accounting measures that represent the investor's share of separate account ownership, similar to the NAV of mutual funds. The accumulation unit value will change with the value of the securities held in the separate account and the total number of accumulation units outstanding.

There is no penalty if the investor misses a payment during the accumulation phase. In fact, the client can terminate the contract at any time during this period. Some insurance companies allow investors to borrow from the annuity during the accumulation phase to discourage cancellations.

Annuitization Phase
The annuitization phase is the period during which the investor draws income from the annuity; it is the payout stage of the annuity. When the contract is annuitized, the accumulation units become annuity units. The rate of exchange from accumulation units to annuity units is determined by an actuarial formula that takes into consideration several factors, including the annuitant's age, sex, payout option chosen and a baseline measure called the assumed interest rate (AIR). (The AIR is a rate used to evaluate the returns on the separate accounts in order to determine future payments.) The annuity units in turn will define the amount of monthly payments to the annuitant.

Once the number of annuity units is determined, the insurance company will decide the payout amount per unit. The number of annuity units remains fixed throughout the payout period; however, the value of the annuity units will fluctuate in relation to the performance of the separate account. The periodic payments may be more, less or equal to each other, depending on the value of the separate account in relation to the AIR.

Exam Tips and Tricks
The exam may test your understanding of accumulation and annuity units.

Types of Annuity Payouts

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