Variable Annuities

Accumulation Units Defined (Understand this! A Review)

MR. WATSON: A variable annuity (VA), just like a fixed or conventional annuity, may be purchased on either a deferred or immediate basis. Here our discussion centers around the deferred type.

A company's VA funds are assigned to a special "Variable Annuity Account" and invested separately, usually in common stocks. The total value of the "Variable Annuity Account" is the total value of all securities held in the separate fund.

MR. WATSON: In a deferred VA, the period of time during which funds accumulate - that is, from the contract's issue date to the start of payments - is called the accumulation period. During the accumulation period, the value of each individual account rises or falls depending on the company's investment results for the Variable Annuity Account. Premiums paid into the company, less a deduction for expenses, are converted to accumulation units and credited to the individual's account. For example, if that person's net premium contribution is $125 and the cost of one accumulation unit is $125, the net contribution buys one accumulation unit. If the net contribution to an individual account is $200 and the cost of one accumulation unit is $100, two accumulation units are assigned to the individual's account. Fractional units also may be assigned as necessary.

MR. WATSON: The company cannot guarantee an interest yield from investments, because investment results are usually geared to a portfolio of common stocks. So the value of the accumulation unit fluctuates accordingly. Over a period of time, the number of accumulation units credited to an individual's account keeps growing, even as the unit value rises or falls. To find the dollar value of a person's VA, the company multiplies the current value of one accumulation unit times the number of accumulation units in the individual account. Thus, if a person owns 3,200 accumulation units and each unit is valued at $4, the dollar value of the individual VA is $12,800.

MR. WATSON: Remember, state law says that at least every year the company must provide to the contract holder a report on an approved form that states the number of units credited and the dollar value of each unit as of a date not more than two months prior to the report.

Annuity Units Defined

MR. WATSON: Before VA benefits can be paid out, the accumulation units in the participant's individual account must be converted into annuity units. At the time of retirement, the annuity unit calculation is made and, from then on, the number of annuity units remains the same for that annuitant. The value of one annuity unit, however, can and does vary from month to month depending on investment results.

An annuity unit is defined as a statistical symbol used to calculate the amount of each payment made to an annuitant after retirement. To convert a lump sum in an individual's VA account into annuity units, the company's annuity tables are used to determine the amount that applies to every $1,000 in the annuitant's account. Suppose an individual beginning retirement is entitled to a $7.10 monthly income per thousand dollars of VA funds, based on the company's annuity tables. If that person had accumulated $60,000 in VA funds, the first monthly income payment would be $426 (60 $7.10).

MR. WATSON: As we've talked about, while the number of annuity units figured at the start of retirement stays the same, the value of the annuity unit may vary from month to month, based on the investment results of the company's VA fund. Consequently, the dollar amount of each payment to the annuitant depends on the dollar value of the annuity unit when the payment is made.

The theory is that the payout from a VA over a period of years will keep pace with the cost of living and thus maintain the annuitant's purchasing power at or above a constant level. As with fixed annuities, the VA owner has various payout options from which to choose. These options usually include the life annuity, life annuity with period certain, unit refund annuity (similar to a cash refund annuity), and a joint and survivor annuity.

Assumed Interest Rate

MR. WATSON: Earlier we talked about how variable life and variable annuities accounts would rise or fall depending on the market. I told you that if the accounts earned above a certain interest rate stated in the contract the account would go up, if it earned below this amount it would fall. Remember?

Student: I can't even remember my name.

MR. WATSON: Whatever. This is called an assumed interest rate (AIR). It is set by the insurance company at the time of the contract issue date. Let's say it is 2 1/2 %. This helps offset the insurance company's expenses. Anything above this amount would be applied. If the company's separate account earned 5 1/2% then the variable product would increase by 3%.

MR. WATSON: But be careful here, this A.I.R. applies to the Variable life death benefit, not the cash value. So any investment earned above this A.I.R. would apply to the face amount of the policy, any investment earned above zero would be applied to the cash value. With a variable annuity, the A.I.R. applies to the annuity unit, not the accumulation unit.

• Variable Life - A.I.R. applies to the face amount, not the cash value
• Variable Annuity - A.I.R. applies to the annuity unit, not the accumulation unit

Annuity guarantees

Accumulation Death benefit

MR. WATSON: All annuities have some type of death benefit. It is the total of all premiums (deposits) made or the account balance, whichever is greater. Just like your savings account at the bank.