Valuation of Variable Annuities for Exam LTAM

Variable Annuity Basics

Variable annuities (VAs) invest policyholder premiums in separate account funds (equity, bond, or mixed). The account value fluctuates with investment returns. Annuity unit values determine payout amounts during the annuitization phase. The assumed investment return (AIR) is the rate used to set the initial payment. If actual returns exceed the AIR, payments increase; if returns fall below the AIR, payments decrease. Fees include mortality and expense risk charges, fund management fees, and charges for optional guarantees.

Guaranteed Minimum Benefits

VAs often include guaranteed minimum benefits: GMDB (death benefit), GMAB (accumulation), GMIB (income), and GMWB (withdrawal). These guarantees create contingent liabilities for the insurer. Valuation requires stochastic modeling of investment returns, often using risk-neutral pricing. The cost depends on the guarantee level, volatility of the underlying funds, policyholder behavior assumptions, and mortality rates. Exam LTAM covers the basic mechanics of variable annuities, the impact of investment performance on benefits, and the conceptual framework for valuing embedded guarantees.