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
Related Articles
  1. Investing

    Five Things to Consider Now for Your 401(k)

    If you can’t stand still, when it comes to checking your 401 (k) balance, focus on these 5 steps to help channel your worries in a more productive manner.
  2. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
  3. Economics

    The Problem With Today’s Headline Economic Data

    Headwinds have kept the U.S. growth more moderate than in the past–including leverage levels and an aging population—and the latest GDP revisions prove it.
  4. Forex Education

    China's Devaluation of the Yuan

    Just over one week ago the People’s Bank of China (PBOC) surprised markets with three consecutive devaluations of the yuan, knocking over 3% off its value.
  5. Fundamental Analysis

    Calculating Return on Net Assets

    Return on net assets measures a company’s financial performance.
  6. Investing Basics

    Explaining Rehypothecation

    Rehypothecation occurs when an asset used as collateral for one party is reused in another transaction.
  7. Investing Basics

    What's a Price-Taker?

    Price-taker is an economic term describing a market participant who has no effect on overall market activity.
  8. Economics

    Explaining the Participation Rate

    The participation rate is the percentage of civilians who are either employed or unemployed and looking for a job.
  9. Economics

    Understanding Organic Growth

    Organic growth is the increase in a company’s revenue and value due to internal operations.
  10. Investing Basics

    Explaining Options Contracts

    Options contracts grant the owner the right to buy or sell shares of a security in the future at a given price.
RELATED TERMS
  1. Yield To Maturity (YTM)

    The total return anticipated on a bond if the bond is held until ...
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the ...
  3. Interest Coverage Ratio

    A debt ratio and profitability ratio used to determine how easily ...
  4. Monetary Policy

    The actions of a central bank, currency board or other regulatory ...
  5. Receivables Turnover Ratio

    An accounting measure used to quantify a firm's effectiveness ...
  6. Remittance

    The term most commonly refers to money being sent via mail or ...
RELATED FAQS
  1. Are spousal Social Security benefits taxable?

    Your spousal Social Security benefits may be taxable, depending on your total household income for the year. About one-third ... Read Full Answer >>
  2. What are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>
  3. How are non-qualified variable annuities taxed?

    Non-qualified variable annuities are tax-deferred investment vehicles with a unique tax structure. After-tax money is deposited ... Read Full Answer >>
  4. Why would someone change their Social Security number?

    In general, the Social Security Administration, or SSA, does not encourage citizens to change their Social Security numbers, ... Read Full Answer >>
  5. Are spousal Social Security benefits retroactive?

    Spousal Social Security benefits are retroactive. These benefits are quite complicated, and anyone in this type of situation ... Read Full Answer >>
  6. Is Argentina a developed country?

    Argentina is not a developed country. It has one of the strongest economies in South America or Central America and ranks ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!