By Wade D. Pfau


Annuities are contracts that can be arranged to provide various protections to their owners. Often, we think of these protections in terms of the ability to provide lifetime income that can help retirees to manage the risk of outliving their assets. But the emergence of structured annuities provides a new direction for protection by changing the relationship between downside market risks and upside growth potential when investing. In either context, it now is possible to frame an annuity, or the protections it provides, as an asset class for households to help manage market risks and the risk of outliving assets. These two complementary frames distinguish protection as an asset class, which we will examine further.

First, we start within an investing framework. We consider how adding a structured annuity, whose returns are linked to a stock market index, as an asset class choice can improve the efficient frontier for investors by providing a better risk-adjusted return. Downside risks are present in both stocks and bonds, as evidenced in 2022 when stock and bond markets both experienced double-digit losses. Near-retirees who are depending on bond funds to maintain the value of their assets may be vulnerable to a rise in interest rates. We will illustrate how structured returns impact the efficient frontier for household portfolios, enhancing the risk-adjusted returns for the overall portfolio relative to holding just stocks and bonds.

Then, we will add a lifetime income benefit to the annuity and consider its role in developing an efficient frontier for retirement income that expands beyond the simple investing environment to look at how different asset allocation strategies impact the ability to meet lifetime spending goals while also preserving assets for liquidity and legacy.

We accomplish this with a simple example for a structured annuity: a fixed index annuity that protects principal and caps market upside. Still, there are many different structured annuity designs that provide different tradeoffs between downside risk and upside potential that could also have been included to expand
this analysis.

Protection as an asset class is affirmed: structured annuities can impact both the underlying portfolio returns as well as the ability to overlay a protected lifetime income.

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