Valuation Period

What Is a Valuation Period?

The valuation period is the interval at the end of a given period of time during which value is determined for variable investment options. Valuation is the calculation of a product’s value and is typically done by appraisers at the end of each business day.

Key Takeaways

  • The valuation period is the time at the end of a given period when the value is determined for variable investment options.
  • The valuation period applies to certain types of life insurance policies and annuities.
  • An annuity is a financial product that can offer investors a source of steady income during retirement.
  • There are two value formulas (future and present) when it comes to annuities and valuation.
  • Calculating the future value of the annuity requires calculating the future value of each cash flow in an annuity over a period of time.

Understanding the Valuation Period

The valuation period applies to investment products like variable annuities and certain life insurance policies.

Annuities are financial products that offer investors a source of income during retirement. Variable annuities are annuity products that provide payouts and are variable dependent on the value of the annuity's investments. The owner of the annuity can choose their investment products and designate percentages or whole dollar amounts toward the various investment vehicles.

The contract value of a variable annuity will depend on the performance of its investments.

A variable annuity offers the potential for greater earnings and larger payouts, but because of the day-to-day valuation, variable annuities involve more risk than other kinds of annuities, such as fixed deferred annuities.

Calculating Present and Future Values 

In thinking about valuation, it’s helpful to understand the process. When it comes to valuation and annuities, there are present and future value formulas.

Present Value

The present value of an annuity is today’s value of future payments from an annuity when factoring in a specified rate of return or discount rate. The annuity's future cash flows are cut at the discount rate. The higher the discount rate, the lower the present value of the annuity. 

This calculation relies on the concept of the time value of money, which says that a dollar now is worth more than a dollar earned later. This concept means that receiving money today is worth more than receiving the same amount of money in the future because the money today can be invested at a given rate of return.

For example, receiving a lump sum of $10,000 today is worth more than getting $1,000 per year for ten years. The lump sum, if invested today, is going to be worth more at the end of the decade than incremental investments of $1,000 each. This is true even if invested at the same rate of interest.

Future Value

Knowing the future value (FV) of an ordinary annuity formula is useful when an investor knows how much they can invest per period for a certain time period and wants to find out how much they will have in the future. FV is also useful knowledge when making payments on a loan as it helps to calculate the total cost of the loan.

Calculating the future value of the annuity requires calculating the future value of each cash flow over a period of time. Annuities have a number of cash flows. The future value calculation requires taking the value of each cash flow, factoring in the original investment and interest rate, and adding these values together to determine the accumulated future value.

Example of a Valuation Period

When an annuity is valued, the present and future values are calculated. It is important to remember that interest rates and inflation are factored into the calculations.

What is Annuity Due?

An annuity due is when the payment is required at the beginning of the period. The most common example is when a landlord requires rent to be paid at the beginning of the rental cycle. A different, more complicated example would be a whole life annuity due, where an insurance company requires payments at the beginning of each period, just like the landlord example.

What Is the Difference Between an Annuity Due and an Ordinary Annuity?

The main difference between an annuity due and an ordinary annuity is when the payments are required. Annuity due payments are required at the beginning of the period, whereas an ordinary annuity requires the payment at the end. Annuity due payments tend to favor the recipient, as it provides them access to capital at the beginning of the period, which they can then use to invest.

What Is the Valuation of a Corporation?

The valuation of a corporation is different from an annuity valuation. There are many more facets that must be considered when valuing a corporation such as assets, debts, revenues, the potential for expansion, and others. A corporation can be valued to determine a fair stock price, when paying out equity to shareholders, or when entering or considering a liquidity event.

What Is an Annuity Period?

An annuity period is when the annuity starts making payments to the investor. This is different from the accumulation period of an annuity, which is when the investor is making payments on the annuity.

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