- A variable annuity is a tax-deferred retirement vehicle with account values linked to the performance of underlying investment options, typically mutual funds.
- A variable annuity with risk control framework has the added feature of providing caps and floors to the investment performance, which in turn is linked to the performance of the underlying investment options, typically a price index.
- We construct hypothetical portfolios that allocate between a variable annuity with a risk control mechanism and a blended portfolio of stocks and bonds. Historical performance for the hypothetical portfolios with allocation to products with a risk control feature showed better downside protection than a stock portfolio or a traditional 60/40 stock/bond portfolio in some scenarios.
INTRODUCTION OF VARIABLE ANNUITIES WITH RISK CONTROL
A variable annuity is a tax-deferred retirement vehicle with account values linked to the performance of the investment options chosen by the market participant. The investment options for a variable annuity are typically mutual funds that invest in stocks, bonds, money market instruments, or some combination of the three.
A variable annuity that uses a risk control framework has the added feature of providing caps and floors to investment performance that are linked to the performance of the underlying investment options. If the underlying index delivers returns greater than the cap level or lower than the floor level, market participants will receive guaranteed payments at the cap or floor level, respectively. Therefore, variable annuities with risk control offer downside protection to investors at the expense of forgoing a degree of upside return. They offer market participants better visibility and predictability on future cash flows from annuities by effectively incorporating risk management tools in investment products.
A variable annuity with risk control features shares the same concept as and similar structure to those of risk control indices. Risk control indices are designed to measure the performance of underlying equity or futuresbased indices at specified volatility levels. As a benchmark provider of risk control indices, S&P Dow Jones Indices finds it relevant and meaningful to investigate the impact of incorporating a risk control framework into investment products, such as variable annuities, in a portfolio context.