Packaged Securities - Valuing a Variable Annuity Contract
To determine the value of a variable annuity contract, compute the present value of the payments. You will probably not have to do this for the Series 7 exam, but you will need to know how to come by the payment amount and the discount rate.
The payment amount is usually quoted as a dollar figure per $1,000 invested at the beginning of the payout period. The discount rate of a variable annuity is called the assumed interest rate (AIR). The AIR is a projection, nothing more. It is certainly not a guarantee.
Exam Tips and Tricks
You cannot bring a calculator into the exam room, and you will not be expected to do present value calculations on scratch paper. But let\'s walk through the mechanics so you understand the process conceptually.
Say that, at the beginning of the payout phase, an investor has amassed $1,000,000 and the payment amount is given at $90 per $1,000 invested, so her payment from the insurance company would be $90,000.
Let\'s further assume that the AIR set by the company and agreed to by the investor is 7%. Lastly, let\'s assume she has selected the option of receiving one payment per year for life, which an actuary for the company estimates at 25 more years.
So the payment is $90,000, the interest rate is 7% and the number of payments is 25. Punch all that into a financial calculator and you come up with a present value of $1,048,822, which would be the value of the variable annuity contract.