Registered index-linked annuities (RILAs) have surged in popularity in recent years with sales steadily growing. The RILA crediting strategy that provides downside protection and upside potential results in a risk/return trade-off profile between that of traditional variable annuities (VA) and fixed index annuities (FIA) and makes the RILA an attractive investment option for retirement planning. Additional living benefits, namely the Guaranteed Lifetime Withdrawal Benefit (GLWB) option, have been added to the RILA to make them more similar to the FIA and VA product suites, and RILAs with GLWBs have grown quickly since 2019. They now represent around 10% of the total RILA sales. The volume of GLWBs on RILAs is expected to rise as the RILA market continues to grow. With the sales volume of RILAs with GLWBs reaching a critical level, it is now more important for companies to finalize hedging strategies for the riders on the portfolio.
The majority of FIA writers typically hedge the index crediting strategy only and not the GLWB riders, due to the lower volatility of the net amount at risk associated with the GLWB. Although the index design of the RILA is more analogous to that of the FIA, the risk profiles and capital implications of attached GLWBs are actually more similar to that of traditional VAs. Our analysis has shown that hedging GLWBs on RILAs provides material benefits to RILA writers. As with hedging VA GLWBs, there are strong rationales for hedging the capital market risks associated with RILA GLWBs.
This paper dives into the hedging and capital management for RILAs with GLWBs, with comparison against VAs and FIAs with GLWBs.
Figure 1: Annuity sales ($ billions)
Source: LIMRA
Note: The 2023 VA sales split between those with and without a guaranteed living benefit (GLB) is approximated based on the average split in 2022.
Product design and valuation framework
In order to analyze the hedging and capital management implications of the products, it is important to understand the key product futures and valuation frameworks. The table in Figure 2 shows the high-level product and valuation approach for the three annuity products:
Figure 2: Product and valuation comparison of annuity products
| VA | RILA | FIA | |
|---|---|---|---|
| Underlying fund return profile | Full equity participation opportunity without downside protection Typical investment mix is 60% equity (EQ)/40% fixed income (FI) |
Vanilla design: 10% buffer Less than 100% equity participation on the upside |
Full downside protection Less than 100% equity participation on the upside |
| GLWB rider designs | Return of premium, ratchet, roll-up | ||
| GLWB rider cost | Buffer design in RILA segments contributes to generally lower GLWB rider cost compared to the GLWB rider cost associated with traditional VAs with 60/40 EQ/FI fund allocation. Most RILA writers increase the guaranteed withdrawal rates on RILA GLWBs to align the rider cost with traditional VA GLWBs.
Rider cost for FIA GLWBs is between those of VA and RILA. |
||
| Valuation approach | VM-21 | VM-21, i.e., can be aggregated with VA valuation | AG 33/35 CARVM with prescribed assumptions. Overall a conservative approach that reduces market risks. |
| Statutory capital | Subject to C1 on general account assets only
C3 for market/interest rate risk based on 25% of CTE98 – CTE70 |
All deposits are subject to C1
C3 for market/interest rate risk based on 25% of CTE98 – CTE70 |
All deposits are subject to C1.
C3 for market/interest rate risk based on prescribed factors. |
GLWB riders on RILAs have a very similar risk profile to GLWB riders on traditional VA products, and both are subject to the same valuation framework (VM-21). As such, the benefits of well-defined future hedging strategies under VM-21 are just as applicable to GLWBs on RILAs as for the more traditional products.
FIA on the other hand follows the Actuarial Guideline (AG) 33/35 valuation and a factor-based capital approach, and hence the consideration is very different. Hedging benefits of the crediting strategy is implied in the valuation approach. There is no reserve or capital relief due to hedging directly either for GLWBs or for the crediting strategy.
The rest of this paper focuses on analyzing VAs and GLWBs attached to VAs because the provision for future hedging strategies are considered in a similar manner.
Considerations for hedging
Companies are still formulating hedging strategies for the GLWB riders attached to RILAs, because the product is still relatively new (affecting materiality as a percentage of total RILA sales) and because the cash surrender value (CSV) floor on reserves or capital under VM-21 can provide some near-term insulation from capital consequences until hedge programs are in place.
However, it is in the interest of RILA with GLWB writers to develop a well-defined future hedging strategy that determines when and how hedge positions change for two key considerations:
- The fair value profiles of RILA GLWBs look similar to traditional VA GLWBs so lessons from traditional VA GLWBs hedging can be used to further our understanding of these risks. In fact, RILA GLWBs exhibit slightly more convexity than VA GLWB. There are two key drivers for the higher convexity in RILA GLWBs: 1) the higher equity allocation in a RILA, and 2) more generous withdrawal rates offered in RILAs. This is shown in Figure 3, comparing VA and RILA GLWB option values under various shocks. They gray dotted line captures VA GLWBs with a RILA underlying rider design, mainly aligning withdrawal rates and shows a risk profile that’s between the VAs with GLWBs and RILAs with GLWBs.
Figure 3: Comparison of VA and RILA GLWB option values by equity shock – starting account value of $100,000
- For new business valuation on a statutory basis, the minimal capital on a RILA with GLWB, due to the CSV floor, can be a temporary situation just like for a traditional VA (i.e., it changes quickly with market conditions and as the block ages).
To further examine the implication of hedging the GLWB rider attached to a RILA, capital at-risk analysis on a hypothetical new business issue block of a RILA with GLWBs was performed. The new issue block consists of RILA with 1-year, 3-year, and 6-year point-to-point crediting strategies linked to the S&P index, with 10% buffer and 21%/125%/uncapped for the three segments, respectively.
There were three key takeways that demonstrated clear benefits in hedging the GLWB attached to the RILA:
- Unfloored conditional tail expectation (CTE) 98 requirement is reduced significantly when the GLWB is hedged. This is similar to the VA valuation results, where there is a hedge benefit when reflecting a future hedging strategy for the GLWB in the valuation.
- Hedging the GLWB rider helps reduce market sensitivities in the required capital, just like the observations for VA.
- Hedging helps minimize the likelihood of capital requirements going above the CSV floor when the market falls. This reduces the gamma costs associated with macro hedge programs that deal with the capital requirement oscillating around the CSV floor.
Milliman Hedge Cost Index (MHCI) for RILA GLWB
Given the increasing popularity of GLWBs with RILAs and the risk management considerations discussed above, Milliman has expanded the hedge cost index to include a new chassis for GLWBs on RILAs. The new index provides the expected hedge cost for a hypothetical RILA GLWB block. The MHCI for GLWBs on RILAs is available starting the end of March 2024.
Based on the current designs, the RILA index and updated VA index closely track each other over the past two-year period. Please note that the VA index reflects the recent design update by Milliman.
Figure 4: MHCI (basis points)
The MHCI methodology document can be found at: https://www.milliman.com/mhci-methodology/.