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

    Is it Time to “Buy” Inflation?

    Based on recent data from the Treasury-Inflation Protected Securities (TIPS) market, it would seem that most investors aren’t worried about inflation.
  2. Investing

    How To Build a Currency Hedged Strategy?

    We are still unsure of how to implement a currency hedge strategy based on the dollar's movement. So let’s focus on what’s easier to measure: time horizon.
  3. Mutual Funds & ETFs

    The Top Vanguard Emerging Market ETF

    Learn why growth investors should consider investing in VWO's portfolio of emerging market stocks.
  4. Professionals

    How to Ace the CFA Level I Exam

    Prepare to ace the CFA Level 1 exam by studying systematically.
  5. Investing

    Which Economy Is Larger - The United States or China?

    China's economy may be larger than the U.S. economy, but it all depends on which exchange rate method you use to make the GDP comparisons.
  6. Investing

    An Overview of Companies and Brands Owned by Yahoo

    Yahoo is much more than a web portal. Here are four companies owned by the multibillion-dollar conglomerate.
  7. Investing

    How Trust Funds Can Safeguard Your Children

    Certain types of trust funds can help to protect your assets from bankruptcies and civil actions, and can be established to safeguard your children and designated beneficiaries.
  8. Investing Basics

    How to Pick the Best Muni Bonds and Muni Bond ETFs

    Municipal bonds are a good addition to a diversified portfolio as long as you choose correctly based on population and local economic trends.
  9. Stock Analysis

    8 Solid Utility Stocks for a Bear Market

    If you're seeking modest appreciation, generous dividend payments and resiliency, consider these eight utility stocks.
  10. Professionals

    RIAs: Why Discounting Your Fees Is a Big Mistake

    For RIAs, lowering your set price is a short-term fix. Here are a few other ways to reach out and appeal to a wider array of potential clients.
  1. Unicorn

    In the world of business, a unicorn is a company, usually a start-up ...
  2. Private Equity Real Estate

    A Definition of "Private Equity Real Estate" and how it applies ...
  3. Put-Call Parity

    A principle that defines the relationship between the price of ...
  4. Encumbrance

    A claim against a property by a party that is not the owner. ...
  5. EBITA

    Earnings before interest, taxes and amortization. To calculate ...
  6. Qualitative Analysis

    Securities analysis that uses subjective judgment based on nonquantifiable ...
  1. What is the annual contribution limit for a 529A account?

    Contributions to a 529A plan are limited up to the annual gift tax exclusion limit, currently $14,000 a year in after-tax ... Read Full Answer >>
  2. What happens to a 529A account when the beneficiary dies?

    According to the Achieving a Better Life Experience Act of 2014 (ABLE Act), when the designated beneficiary of a 529A account ... Read Full Answer >>
  3. Can you have more than one 529A account?

    According to the Achieving a Better Life Experience Act of 2014 (ABLE Act), a disabled person can generally set up only one ... Read Full Answer >>
  4. What is the size of the average retirement nest egg?

    According to a 2015 Government Accountability Office (GAO) study, people between the ages of 55 and 64 with any retirement ... Read Full Answer >>
  5. How often are mutual fund prices updated?

    A mutual fund's price, or its net asset value (NAV), is determined once a day after the markets close at 4 p.m. Eastern time ... Read Full Answer >>
  6. Can minors invest in mutual funds?

    A mutual fund can be opened under the name of a minor through a custodial account overseen by a guardian. The custodian holds ... Read Full Answer >>
Hot Definitions
  1. Ex Works (EXW)

    An international trade term requiring the seller to make goods ready for pickup at his or her own place of business. All ...
  2. Letter of Intent - LOI

    A document outlining the terms of an agreement before it is finalized. LOIs are usually not legally binding in their entirety. ...
  3. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  4. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  5. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  6. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
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!