One way to keep ‘risk’ in retirement – InsuranceNewsNet
These are tough times for investors. So far in 2022, stocks and bonds are down and inflation is up. While this may deter many investors from investing in risky assets such as stocks, maintaining exposure to the stock market can be essential for retirees who need to fund income for 30 years or more.
Registered indexed annuities are a product that is attracting more and more interest — and assets — among investors. Here’s an introduction to RILAs, as well as an exploration of some of the differences between people who buy RILAs with and without a Protected Lifetime Income Benefit, or PLIB. This information is based on actual sales data from Prudential Financial, based on their FlexGuard and FlexGuard Income products.
Although RILAs are technically not that new, having been available for about a decade, they are relatively new when it comes to annuities. RILAs go by a variety of names such as structured annuities, indexed variable annuities or buffered annuities. Although it looks very different, the underlying strategy is usually very similar in that an insurance company uses financial options to gain unique exposure to a certain type of market/investment, typically using a “buffer” or “floor” approach. Buffers are the most common option, where the first amount of loss is absorbed by the product, depending on the buffer level, and the investor would suffer any loss beyond that point.
RILAs can be considered a riskier or next-generation version of fixed indexed annuities. With an AIF, the annuitant has virtually no downside risk – apart from the insurer’s default or inability to meet its claims payment commitments, which applies to almost all annuities – and a potential relatively limited upside (referred to as the “cap rate”). However, the upside potential of AIFs has declined significantly in recent years due to falling interest rates, making AIFs less attractive to investors who want more upside potential.
Investors are interested in income-protected products
There is relatively little empirical research on who buys RILAs and how RILAs are used. I recently had access to historical sales data for Prudential’s FlexGuard RILA products, both the accumulation-focused version (called FlexGuard), which I simply refer to as RILA, and the one that has an income benefit at protected life (called FlexGuard Income), which I call an RILA + PLIB. For this analysis, I am only focusing on products sold since June 18, 2021, when FlexGuard Income (i.e. RILA+PLIB) first became available. After applying various filters, the dataset consists of over 15,000 policies.
Interestingly, the demographics of RILA and RILA+PLIB participants are relatively similar in dimensions such as annuitant gender, age, marital status, household income, and total wealth.
The most notable difference was in the amount of premiums, where RILA + PLIB annuitants tended to be significantly higher (about $150,000 versus $100,000). Additionally, RILA+PLIB was more frequently purchased in qualified accounts (77% vs. 64%).
The fact that wealth levels are similar for people who buy RILAs, but premiums are higher for the RILA + PLIB version, suggests that investors may be more willing to allocate higher shares of their savings to products offering protected lifetime income.
RILA equity risk
One thing I was particularly interested in exploring in the dataset was how allocation decisions varied between the two products (i.e. those with and without PLIB).
Estimating the risk of RILAs is tricky, however, given the way they are constructed. In order to estimate equity risk, I used substitution analysis in which I ran a simulation to determine the equity risk equivalent of adding this particular RILA strategy to a portfolio considering four measures of risk (standard deviation, downside risk, value-at-risk and conditional value-at-risk) for each strategy. In other words, the risk of adding the respective RILA to the portfolio had the equivalent risk of adding a simple equity allocation, as estimated.
For the analysis, I focused entirely on annuities that only use available buffer strategies (i.e. are not also invested in other non-RILA options within the same contract) . What I found was that the equity allocations between RILA and RILA+PLIB were quite similar, but RILA+PLIB contracts tend to be allocated slightly more conservatively, with allocations lower by approximately 5% on average. Note that this effect persists even when controlling for demographic attributes in an ordinary least squares regression.
What is perhaps more interesting, however, is not how the risk levels differ from each other, but how they differ from other professionally managed portfolios, such as mutual funds. maturity investment. The table on the previous page includes information on the average stock allocation for different age groups for the two different RILA products and the average stock allocation for US maturity mutual funds, based on data obtained from Morningstar Direct.
RILA investors tend to have the most aggressive portfolios, followed by RILA + PLIB, followed by the target date fund industry average. The differences in risk at advanced ages are quite surprising. Average equity allocations are relatively similar for the youngest cohort and relatively aggressive, but increasingly diverge at older ages. For example, at age 80, the average RILA allocation is around 70% equity, versus 60% equity for RILA+PILB, versus 37% for the average target date fund.
RILAs allow more risk
Although the optimal level of risk will vary depending on each client’s situation, this analysis suggests that RILAs may be an attractive way for investors to retain “risk” during retirement, as they may not be be unwilling to do so in a more traditional portfolio.
Additionally, RILAs (or annuities in general) that provide protected lifetime income may be more attractive to retirees given the larger premium for those who provide the PLIB compared to those who do not, especially considering the similarity of other demographic attributes.