The swiss army knife for conservative investors
by Jeff Cusack
Mr. Cusack is Chief Distribution Officer of RetireOne, an independent platform for fee-based insurance solutions.The Great Recession of 2008 was the culmination of an extended period of expansion in U.S. home construction and prices, including housing credit, or mortgages. The economic slump began when the housing market went from boom to bust because of questionable sub-prime lending practices, which caused mortgage-backed securities (MBS) and derivatives to plummet in value.
Banks and other investors holding these assets failed or needed to be bailed out to retain trust in the U.S. banking system and the economy as a whole.
While criticized by some, the Emergency Economic Stabilization Act of 2008 and the Troubled Asset Relief Program (TARP) resulted in roughly $700 billion in government spending to remove these toxic assets from bank ledgers, in exchange for partial ownership as a way to recoup some of the bailout funds. This controversial legislation paved the way for the bull market run that lasted from 2009 to 2020, when the COVID-19 pandemic shuttered or stalled large parts of the global economy.
What’s followed has been a seemingly never-ending drumbeat of negative events that have acted as a drag on markets, including supply chain disruption, inflation, the Russian invasion of Ukraine and most recently, the sudden failure of a pair of banks (as of this writing) which have caused flashbacks to 2008.
For investors who have a long runway until they need to access their retirement savings, this period will likely be a hiccup along that journey, as was the Great Recession for people with a similar long-term time horizon back before the bull market run began in 2009.
Not everyone is so lucky, though. Investors in their “fragile decade,” the period spanning their last five working years through their first five years in retirement, are watching as a poor sequence of returns eats away at their portfolios just as they are nearing or at the end of the of the accumulation phase of their investing lives. For investors in their fragile decade who need to shelter a portion of their portfolio from market volatility, these losses could be devastating. Protecting a portion of assets from market losses during this life stage can be critical to protecting their spending in retirement and helping them enjoy a high quality of life.
A relatively recent innovation, the Registered Index-Linked Annuity, or RILA, can act as a multifaceted and versatile Swiss Army knife for conservative investors (and those in the fragile decade), offering them customization, personalization and the potential for some market upside, while protecting their principal.
RILA’s Sales Have Surged, Setting An All Time High
Total RILA sales reached $40.9 billion in 2022, six percent higher than the previous year. This set an all-time high for the product line, according to LIMRA’s U.S. Individual Annuity Sales Survey. To put this into perspective, RILA sales were $1.4 billion in 2012. (Source: Morningstar/MARC, LIMRA, Beacon, Wink & Allianz Life Insurance Company of North America.)
A rising interest rate environment is helping to spur growth in RILAs, multi-year guaranteed annuities (MYGAs) and fixed index annuities, as investors flock to higher rates across the range of annuity options.
Customization and Personalization are Driving Growth
For risk-averse investors, RILAs have become an increasingly popular solution that allow for participation in potential stock market gains tied to an index of their choosing, such as the S&P 500 or the Russell 2000, while protecting their principal against steep market downturns. Investors can customize allocations to the indices to be invested in (also called crediting strategies) and then dial up or down protections via buffers – all of which can impact how much downside is protected and how much upside may be captured. Additional protections may also be available to provide lifetime income or return of premium in the event of an investor’s untimely passing.
Upside via the crediting strategy may be capped, and this cap may correlate to the amount of risk the investor is willing to take on via the buffer. The buffer, meanwhile, protects against a set percentage of losses. Generally speaking, the greater the buffer protection, the lower the cap on performance.
A typical RILA may offer a 10 percent buffer and/or 20 percent buffer which limit losses through those percentages. For example, if an investor chooses a 10 percent buffer and their crediting strategy loses 9 percent, they have been protected against any losses for that period. If the index selected for their chosen crediting strategy loses 12 percent, then their portfolio only loses 2 percent.
Let’s look at an example, focusing on an investor who is currently entering their fragile decade. They choose to place an initial investment of $500,000 into a RILA with a 10 percent buffer and 15 percent cap. Performance will be credited to them each year on the contract anniversary via a one-year point-to-point crediting strategy following the S&P 500 index.
First year: The S&P 500 Index gains 20 percent, so the investor participates in those gains up to the 15 percent cap.
- The RILA grows to $575,000.
Second Year: The index drops 5 percent; however, with the 10 percent buffer in place, the investor loses nothing.
- The RILA account value remains $575,000.
Third year: The index gains 10 percent, which is within the 15 percent cap, so the investor realizes the full gain.
- The RILA grows to $632,500 in value.
Fourth year: The index drops 12 percent but, with a 10 percent buffer, the investor only experiences a decline of 2 percent.
- The RILA account value declines to $618,950.
The above hypothetical example does not reflect RILA annual contract fees or charges. It simply aims to show conceptually how a RILA with a cap of 15 percent and a 10 percent Buffer would perform in varying market conditions. It assumes no change in the cap. Caps are subject to change at the discretion of the issuing carrier. Although an external market index or indices will affect a client’s values, it is important to note that RILAs do not directly participate in any stock or equity investments. Values credited via the external market index do not include dividends paid on the stocks underlying a stock index, and protection of principal is subject to the claims paying ability of the insurance company.
Personalization has been a growing trend within the financial services industry, whether its investors seeking a portfolio that’s reflective of their values or prioritizing the quality and timeliness of advice over performance of their investments. RILAs are flexible financial instruments that can be personalized to help mitigate a host of common market risks, the most common of which is market volatility.
RILAs can also be deployed to fight inflation, by diversifying a traditional retirement asset allocation to include an increasing income opportunity, through an income rider for an additional fee. This could be used to supplement Social Security income or pension payments.
Investor sentiment also can play a role when deciding to select a RILA, by shifting a portion of cash, or cash equivalent, to gain an entry point to the market. The product can even be structured to participate in more market upside potential, tying to an index like the Russell 2000 or even an international selection.
Fasten Your Seatbelt, More Market Turbulence Lies Ahead
If history has taught us one economic lesson, it’s that markets are unpredictable. The current economic environment, with the Fed expected to continue raising interest rates to temper inflation, presents an excellent opportunity to use RILAs as a diversifying instrument to provide portfolio protections and retirement income. Interest rates haven’t been this high since the mid-2000s.
For investors entering their fragile decade, or for those who are in cash and hesitant to re-enter the market, RILAs present an opportunity to limit downside risk with buffers while still allowing for potential market participation. The product even offers the added benefit of tax-deferred growth.
RILAs can be customized and personalized based on an investor’s changing goals as they approach or proceed through retirement and even provide retirement income in the form of an optional guaranteed living withdrawal benefit. They can be utilized to combat a host of common market risks, including volatility and inflation.
From the Great Recession to the havoc wrought by COVID-19, market volatility is top of mind for many investors. Little wonder, then, that RILAs have been surging in popularity; clearly investors are waking up to the fact that they can provide much-needed protection as they approach or enter retirement.
