Valuation of a Variable Annuity Contract
With an understanding of how the separate account works, you can now see how variable annuity contracts are valued: through accumulation units during the pay-in phase and annuity units during the payout phase.
Accumulation Units (Pay-In Phase)
During the accumulation phase, each purchase payment buys accumulation units - similar to buying shares of a mutual fund.
- Number of accumulation units purchased = payment amount / accumulation unit value (AUV) on that date
- The AUV fluctuates daily based on the net asset value of the underlying subaccounts
- Contract value = total accumulation units owned x current AUV
- Accumulation units can:
- Increase in number through additional payments
- Change in value through investment performance
Example: If the AUV is $10 and you invest $5,000, you purchase 500 accumulation units. If the AUV rises to $12, your contract value is 500 x $12 = $6,000.
Exam Tip: Gotchas
- Accumulation units work like mutual fund shares. Both the number and the value can change. The number increases with new payments; the value changes with investment performance.
Surrender Value
- Surrender value = current contract value minus any applicable surrender charges and outstanding policy loans
- Contingent deferred sales charges (CDSC) typically apply during the early years of the contract
- The surrender value is what the owner would receive upon full withdrawal or contract cancellation
Exam Tip: Gotchas
- Surrender value is NOT the same as contract value. Surrender value is reduced by any CDSC and outstanding policy loans.
Annuity Units (Payout Phase)
When the contract owner annuitizes, accumulation units are converted into a fixed number of annuity units:
- The number of annuity units remains constant for the life of the annuity
- The value per unit fluctuates based on separate account performance relative to the assumed interest rate (AIR)
- Monthly payout = fixed number of annuity units x current annuity unit value
- Once annuitized, the contract owner cannot surrender the contract or make additional changes (annuitization is irrevocable)
| Feature | Accumulation Units | Annuity Units |
|---|---|---|
| Phase | Pay-in (accumulation) | Payout (annuitization) |
| Number of units | Changes with each payment | Fixed at annuitization |
| Value per unit | Fluctuates daily | Fluctuates based on performance vs. AIR |
| Can add more? | Yes (additional payments) | No (number is locked) |
| Can surrender? | Yes (subject to charges) | No (irrevocable) |
Exam Tip: Gotchas
- During annuitization, the NUMBER of annuity units is fixed but the VALUE per unit changes. This means payments vary from month to month. This is often confused with fixed annuities, where payments are level.
- Annuitization is irrevocable. Once the contract is annuitized, the owner cannot surrender it or make changes.