Understanding Accumulation Units in Variable Annuities

12.4.1 Accumulation Units

Accumulation units are a fundamental concept in the realm of variable annuities, representing the contract owner’s interest in the separate account during the accumulation phase. Understanding how these units work is crucial for anyone preparing for the Series 6 Exam, as well as for professionals managing variable annuity contracts. This section will delve into the mechanics of accumulation units, their valuation, and their impact on the contract value.

What Are Accumulation Units?

Accumulation units serve as a measure of the contract owner’s investment in a variable annuity during the accumulation phase. Unlike fixed annuities, where the interest rate is predetermined, variable annuities allow the contract owner to invest in a variety of subaccounts, which can include stocks, bonds, and money market instruments. Each payment made into the annuity buys a certain number of accumulation units, the value of which fluctuates based on the performance of the underlying investments.

Definition

• Accumulation Units: Accounting units representing the contract owner’s investment during the accumulation phase of a variable annuity. They are used to track the value of the investment in the separate account.

• Separate Account: An investment account maintained by an insurance company, segregated from its general account assets, which holds the investments for variable annuities.

Purchasing Accumulation Units

When a contract owner makes a payment into a variable annuity, that payment is used to purchase accumulation units. The number of units purchased depends on the unit price at the time of the payment. The unit price is determined by the net asset value (NAV) of the underlying investments in the separate account.

Calculation of Accumulation Units

The number of accumulation units purchased is calculated using the formula:

For example, if a contract owner makes a $1,000 payment and the unit price is $10, they would purchase 100 accumulation units.

Fluctuation in Value of Accumulation Units

The value of accumulation units is not fixed; it fluctuates based on the performance of the underlying investments in the separate account. As the value of these investments rises and falls, so does the value of the accumulation units. This fluctuation is a key feature of variable annuities, offering the potential for higher returns compared to fixed annuities, but also introducing investment risk.

Example of Value Fluctuation

Consider a scenario where the initial unit price is $10, and a contract owner purchases 100 units with a $1,000 payment. If the value of the underlying investments increases by 10%, the new unit price would be $11. The total value of the contract owner’s accumulation units would then be:

Conversely, if the investments decrease in value by 10%, the unit price would drop to $9, and the total value would be:

Role of Accumulation Units in Contract Value

During the accumulation phase, the total value of a variable annuity contract is determined by the number of accumulation units owned and their current unit price. This value is crucial for the contract owner, as it affects the potential income they can receive during the annuitization phase.

Determining Contract Value

The contract value during the accumulation phase can be calculated as:

This formula highlights the importance of both the number of units and the performance of the underlying investments in determining the contract’s value.

Practical Examples and Scenarios

To further illustrate the concept of accumulation units, let’s consider a few practical scenarios:

Scenario 1: Regular Contributions

A contract owner decides to make regular monthly contributions of $500 into their variable annuity. Assuming the unit price is $10 at the time of each contribution, they would purchase 50 units each month. Over a year, they would accumulate 600 units. If the unit price increases to $12 by the end of the year, the contract value would be:

Scenario 2: Market Volatility

Suppose a contract owner makes an initial lump sum payment of $10,000 when the unit price is $10, purchasing 1,000 units. Over the next year, the market experiences volatility, causing the unit price to fluctuate between $8 and $12. The contract value would vary accordingly, demonstrating the impact of market conditions on the annuity’s value.

Importance of Accumulation Units in Financial Planning

Understanding accumulation units is essential for financial planners and investors. These units provide a transparent way to track the performance of a variable annuity and make informed decisions about future contributions and investment strategies. They also play a critical role in determining the income potential during the annuitization phase.

Regulatory Considerations

The Securities and Exchange Commission (SEC) provides guidelines and educational materials on variable annuities, including the role of accumulation units. For further reading, you can refer to the SEC’s Variable Annuities guide.

Conclusion

Accumulation units are a vital component of variable annuities, offering a way to measure and track the contract owner’s investment during the accumulation phase. By understanding how these units are purchased, how their value fluctuates, and their impact on the contract value, investors and financial professionals can better manage variable annuity contracts and make informed financial decisions.

Series 6 Exam Practice Questions: Accumulation Units

This comprehensive guide on accumulation units in variable annuities provides the foundational knowledge needed for the Series 6 Exam, emphasizing practical understanding and application in real-world scenarios.