RILAs: One way to keep the ‘risk on’ in retirement

These are difficult times for investors. So far in 2022, stocks and bonds are down, and inflation is up. While this may scare many investors away from investing in risky assets such as stocks, maintaining an exposure to the stock market can be essential for retirees who need to fund income for 30 years or more.

Registered index-linked annuities are one product that has gained an increasing amount of interest — and assets — among investors. Here is an introduction to RILAs, as well as an exploration of some of the differences in individuals who purchase RILAs both 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 aren’t technically all that new, as they’ve been available for about a decade, they are relatively new as annuities go. RILAs go by a variety of names such as structured annuities, indexed variable annuities or buffered annuities. Although these sound like very different things, the underlying strategy is generally very similar in that an insurance company uses financial options to gain a unique exposure to some type of market/investment, typically using a “buffer” or a “floor” approach. Buffers are the most common option, where the first amount of loss is absorbed by the product, based on the buffer level, and the investor would suffer any loss beyond that point.

RILAs can be thought of as a riskier or next-generation version of fixed indexed annuities. With an FIA, the annuitant has virtually no downside risk — apart from the insurer’s default or inability to honor its claims-paying commitments, which applies to pretty much any annuity — and relatively limited upside (called the “cap rate”). However, the upside potential of FIAs has declined significantly in recent years as interest rates have fallen, making FIAs less attractive to investors that want more upside potential.

Investors show interest in products with protected income

There is relatively little empirical research on individuals who purchase RILAs and how the RILAs are used. I was recently given access to historical sales data for Prudential’s FlexGuard RILA products, both the accumulation-focused version (called FlexGuard), which I simply refer to as a RILA, and one that has a protected lifetime income benefit (called FlexGuard Income), which I refer to as a RILA+PLIB. For this analysis, I focus only on the products sold since June 18, 2021, which is when FlexGuard Income (i.e., the RILA+PLIB) was first available. After applying various filters, the data set consists of over 15,000 policies.

Interestingly, the demographics for those in the RILA and RILA+PLIB contracts are relatively similar across dimensions such as annuitant gender, age, marital status, household income and total wealth.

The most notable difference was in premium size, where the RILA+PLIB annuitants tended be significantly higher (approximately $150,000 versus $100,000). Additionally, the RILA+PLIB was more commonly purchased in qualified accounts (77% versus 64%).

The fact that wealth levels are similar for individuals who purchase RILAs, but the premiums are larger for the RILA+PLIB version, suggests that investors may be more willing to allocate higher portions of savings to products that offer protected lifetime income.

The equity-like risk of RILAs

One thing I was especially interested in exploring in the data set was how the allocation decisions varied across the two products (i.e., those with and without a PLIB).
Estimating the risk of RILAs is tricky, though, given how they are constructed. In order to estimate the equity-like risk, I used a substitution analysis where I ran a simulation to determine the equity risk equivalent of adding that particular RILA strategy to a portfolio considering four different risk metrics (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 those annuities that only use the available buffer strategies (i.e., aren’t also invested in other non-RILA options within the same contract). What I found is the equity allocations between the RILA and RILA+PLIB were quite similar, but the RILA+PLIB contracts tend to be allocated slightly more conservative, with allocations that are about 5% lower, on average. Note, this effect persists even if controlled for demographic attributes in an ordinary least squares regression.

What is perhaps more interesting, though, is not how the risk levels differ from each other, but how they differ when compared to other professionally managed portfolios, such as target-date mutual funds. The exhibit on the previous page includes information about the average equity allocation for different age groups for the two different RILA products and the average equity allocation for U.S. target-date mutual funds, based on data obtained from Morningstar Direct.

Investors in the RILA tend to have the most aggressive portfolios, followed by the RILA+PLIB, followed by the target-date fund industry average. The risk differences at older ages are relatively startling. The 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 approximately 70% equities, versus 60% equities for the RILA+PILB, versus 37% for the average target-date fund.

RILAs allow more risk

While the optimal risk level varies based on each client situation, this analysis suggests RILAs may be an attractive way for investors to keep the “risk on” during retirement, to the extent they may not be willing to do in a more traditional portfolio.

Additionally, RILAs (or annuities in general) that offer protected lifetime income may be more attractive to retirees given the larger premium for those that provide the PLIB versus those that don’t, especially considering how similar the other demographic attributes were.

David Blanchett is research fellow, Alliance for Lifetime Income, and managing director and head of retirement research, PGIM DC Solutions. David may be contacted at [email protected].