Definition
A life annuity is an annuity, or series of payments at fixed intervals, paid while the purchaser is alive. A life annuity is an insurance product typically sold or issued by life insurance companies. Life annuities may be sold in exchange for the immediate payment of a lump sum or a series of regular payments, prior to the onset of the annuity.
Variable Annuity
What is a ‘Variable Annuity’
A variable annuity is a type of annuity contract that allows for the accumulation of capital on a tax-deferred basis. As opposed to a fixed annuity that offers a guaranteed interest rate and a minimum payment at annuitization, variable annuities offer investors the opportunity to generate higher rates of returns by investing in equity and bond subaccounts. If a variable annuity is annuitized for income, the income payments can vary based on the performance of the subaccounts.
Explaining ‘Variable Annuity’
Variable annuities were introduced in the 1950s as an alternative to fixed annuities, which offer a guaranteed rate of interest. Variable annuities allow investors to invest in a dozen or more professionally managed subaccounts consisting of various asset classes, including stocks, bonds and money market funds. This gives investors the opportunity to earn higher rates of return, which can increase the amount of capital they can accumulate and provide a variable income stream to potentially outpace inflation. However, investors assume the risk of their subaccounts not outperforming the guaranteed return of a fixed annuity, which can result in less capital accumulation and a smaller income stream.
Variable Annuity Pros and Cons
One advantage variable annuities have over mutual funds is the guaranteed death benefit feature. Regardless of how the subaccounts perform, a variable annuity death benefit ensures the annuity owner’s beneficiaries receive no less than the initial investment. Variable annuity investors pay for the cost of that protection through a mortality charge. For an added charge, some variable annuities offer a minimum rate guarantee that pays a minimum rate of return even if the subaccounts experience a loss for the year. A similar rider is offered for income payments at the time of annuitization that guarantees a minimum payout rate regardless of the performance of the subaccounts.
Further Reading
- Regression modeling for the valuation of large variable annuity portfolios – www.tandfonline.com [PDF]
- Household ownership of variable annuities – www.journals.uchicago.edu [PDF]
- Application of data clustering and machine learning in variable annuity valuation – www.sciencedirect.com [PDF]
- Pricing and hedging variable annuity guarantees with multiasset stochastic investment models – www.tandfonline.com [PDF]
- Efficient greek calculation of variable annuity portfolios for dynamic hedging: A two-level metamodeling approach – www.tandfonline.com [PDF]
- Financial valuation of guaranteed minimum withdrawal benefits – www.sciencedirect.com [PDF]
- A multi-asset Monte Carlo simulation model for the valuation of variable annuities – ieeexplore.ieee.org [PDF]
- Variable payout annuities and dynamic portfolio choice in retirement – www.cambridge.org [PDF]
- Valuing variable annuity guarantees on multiple assets – www.tandfonline.com [PDF]
- Statutory financial reporting for variable annuity guaranteed death benefits: Market practice, mathematical modeling and computation – www.sciencedirect.com [PDF]
