The Basics of Annuity – Part Four: Variable and Market Value Adjusted Annuities

Varible Annuity : A variable annuity is a type of annuity under which

1. Investment risk is owned by contract owner 

2. Contract owner determines how to invest his premiums 

3. Value of annuity depends on performance of investment accounts in variable subaccounts. 

Premiums from a fixed account is kept in a general account and from a variable account is kept in a separate account. The separate account provides a means of keeping the premium funded by traditional insurance products from variable insurance products. A sub account is the means by which variable annuity contract owners invest their premiums within the separate account. 

When someone buys a variable annuity they need to put money in at least one or more subaccount. Rest can be allocated to fixed account. The contract owner can transfer money between subaccounts or change percentage allocation of money in subaccounts or add/subtract list of accounts.

Accumulation Units: The contact owner invests premiums in a variable annuity subaccounts by purchasing shares of subaccount’s holdings. These ownership shares are called accumulation units.
Capital Appreciation: Increase in the market value of invested assets.
Asset Classes: A group of similar investment instruments linked by related risk and return features. They are classified under the following classes:

1. Money Market Subaccount: An asset class where money is invested in short term low risk money instrument or cash equivalents like United States Treasury Bills. They are low risk and low return subaccounts.

2. Bond Subaccount: It is an asset class in which shares are typically invested in a variety of short term and long-term government and corporate bonds. A bond is a type of debt which reflects the money insurer has borrowed and must replay to bond holder. Money market and bonds both generate income in the form of interest – fees that bond issuers, banks, etc pay for the use of the borrowed money. Bonds give a better return and thus are less safer than money market.

3. Stock: It is an asset class where shares are typically invested in array of domestic and foreign stocks. A stock is an ownership share in a company. Stocks generate income in the form of dividend. A dividend is a stockowner’s share of a company’s profit. This provides the highest return and is thus the most unsafe investment also.

Asset allocation: The process of investing in money markets , bonds and stocks in predetermined proportions is known as asset allocation.

Portfolio: A diversified collection of financial instruments that aligns specific investment strategies with the financial goals of an investor.

While deciding an asset mix investors must consider:

a. Risk Tolerance

b. Target Return

c. Investment Time frame

Risk – return trade off : The interplay between risk and return – higher the risk higher the return and lower the risk lower the return is known as risk – return trade off.

Asset allocation model: A tool that uses an investor’s personal and financial data to generate options for strategically distributing assets among different type & classes of investments.
Special Service Provisions:

Automatic Dollar Cost Averaging:

Investing a fixed dollar amount in one or more financial instruments on a regular, periodic basis is known as dollar cost averaging. Variable annuity contract owners generally deposit their premiums directly into a variable annuity’s fixed account or money market subaccount which is then used to periodically purchase accumulation units in one or more of the annuity’s subaccounts.

Over time, this provision enables contract owner to systematically purchase more accumulation units when unit prices are low and few units when prices are high. This strategy reduces the average prices of accumulation units purchased, thereby reducing costs to contract owner and increasing the amount of the contract owner’s investment available to earn returns.

Transfers between Subaccounts:

Transfers allow contract owners to move assets between subaccounts during the accumulation and payout phase. The ability to transfer helps investors to respond to changing market condition and adjust asset allocation. There may be a limit on max number of transfers and minimum amount per transfer. Some insurer might charge a fee when these limits are exceeded. Once the payout period has begun, most variable annuity contracts do not allow transfers in and out of fixed account.

Automatic Rebalancing:

This allows for an automatic transfer of assets between subaccounts in order to maintain the asset allocation balance contract owner has specified.
4. Death Benefit: Variable annuity contracts often do include a minimum death benefit guarantee. The death benefit guarantee protects the contract owner against the loss of principal invested in a variable annuity and in some cases even protects the contract owner against loss of investment earnings. 

Payout Period: Unlike fixed annuity, variable annuity contract owner has additional choices regarding how money will be paid out. The choices are: 

1. He can choose to receive fixed payments through out the payout period2. He can choose to receive variable payments through out the payout period3. He can choose to receive partly fixed payments and partly variable payments

Fixed Payout Option: Under this option, insurer makes a series of payments to the payee that are of fixed amount. The accumulated value of the annuity is transferred from the separate to the fixed account. The value of annuity depends on the number and value of accumulation units across all subaccounts. The accumulation units are thus “cashed in” and the money is distributed in equal payments. The payment amount varies on accumulated value of annuity, payout period selected, interest rates.

Variable Payout Option: Under this option, contract owner chooses to receive variable payments. The accumulated value of the annuity remains in the separate account. On the income date, the accumulated values are converted to annuity units. The insurer establishes the annuity units as per the rate on income date before making the first payment. The payments are then made based on the price of the annuity units. Annuity units can be allocated to subaccounts just like the premiums in accumulation phase.

Fixed and Variable Payout Option: This is a combination of the previous two options where the total accumulated value of the annuity is split in any proportion between fixed and variable payout option and payments are made according to the rules of each option on their portion of m money.
Assumed Investment Return: The total return that the subaccount investments must earn in order for annuity payments to remain the same throughout the payout period. The AIR is used to calculate the initial annuity payments under the annuity. If the return on the underlying subaccount investments is less than the AIR, the annuity payments will decrease. If the return on the underlying subaccount investments is more than the AIR, the annuity payments will increase.
Market Value Adjusted Annuities: Type of annuity that features fixed interest rate guarantees combined with an interest rate adjustment factor that can cause the actual rate credited to fluctuate in response to market conditions. In addition, insurers include a market value adjustment feature in other types of annuity products. For example, an insurer might link a market value adjustment to one or more of the guarantee periods offered under a fixed annuity or to one or more of the guarantee periods associated with a variable annuity’s fixed account.

A market adjustment works by allowing the contract owner to place money in an account earning a fixed rate of interest. The insurer holds contracts owner’s money in this account for a designated period of time – the guarantee period. The insurer specifies a basis on which market value adjustments will be based like performance of a market index. As long as the contract owner leaves all the money in the account till the end of guarantee period, the value of invested will rise at a fixed rate. If contract owner decides to remove all or part of investment before end of guarantee period then a market value adjustment will apply and account value will increase or decrease depending on prevailing market rates. Mostly insurers allow partial withdrawals to a specified percent of total value with no adjustments. Usually, if the withdrawal is made within a specified period of time preceding the end of guarantee period – usually 30 days then no adjustment is done.

The Basics of Annuity Articles

The Basics of Annuity Part I : Different Types & Differences with Insurance

The Basics of Annuity Part II : The Annuity Contract

The Basics of Annuity Part Three : Fixed and Equity Indexed Annuities

The Basics of Annuity – Part Four: Variable and Market Value Adjusted Annuities