A Comparison of Index-Linked Annuities

In recent years, index-linked annuities (ILAs) have gained considerable popularity in the U.S. retirement savings market, reflected by rapidly increasing sales and new product developments. These products offer investors some equity exposure while also providing financial protection against downside risk. The products differ primarily based on how much the investor could potentially lose (and gain) year over year. A second (and related) differential is that some products are considered “fixed annuities” (due to their principal protection) and, as such, they face fewer regulations, among other benefits, compared to “variable annuities.” We describe the most common types of ILAs, discuss their differences, and compare them from the perspective of a typical investor by numerically solving dynamic optimization problems. When calibrating the model to current market conditions, we find that the newly introduced fixed index-linked annuity is the preferred product for investors with moderate to high levels of risk aversion, particularly if carriers can convert the lighter regulatory framework into moderately higher cap rates. On the other hand, investors who are only mildly risk averse or even risk-loving would generally prefer a traditional mutual fund investment or a registered index-linked annuity with a buffer feature. Our insights should prove useful for actuaries working on product development as well as for insurance agents and retirement planners.