Return potential of IVAs

Based on the 2013 Allianz Investor Market Perceptions study, respondents identified a return of 10% as an acceptable rate of growth. Accordingly, for purposes of this discussion, let us define "growth potential" as the potential for returns of 10% or greater. Consider three benchmarks and two IVAs with allocation choices:

  1. Bond benchmark: 100% in the Barclays Capital U.S. Aggregate Bond Index (formerly the Lehman Aggregate Bond Index)
  2. Equity benchmark: 100% in the S&P 500® Index
  3. Balanced benchmark: A 65% S&P 500® Index/35% Barclays Capital U.S. Aggregate Bond Index (Barclays Index) allocation strategy
  4. An IVA crediting on the index return of the S&P 500® Index with an annual cap greater than 10% and a 10% loss buffer
  5. An IVA crediting on the index return of the S&P 500® Index with an annual cap less than 10% and a 10% loss buffer

Looking at the calendar-year returns over the last 37 years (the longest common period among the indexes), we see that the bond benchmark showed nine years (24%) that had an annual return of at least 10%. The equity benchmark had 20 years (54%) with an annual return of 10% or greater, demonstrating the higher growth potential of equities over bonds. As expected, the 65/35 balanced benchmark lies between the bond and equity benchmarks, with 19 years (51%) that had returns of 10% or greater. The notable aspect of this analysis is the performance of the IVA with a cap greater than 10% – it would have provided the same growth potential as the equity benchmark with 20 years (54%) with returns of 10% or greater.


Sources: Bloomberg, Yahoo! Finance

An IVA with a cap of less than 10% would make a 10% credited return unattainable, so an IVA with a cap less than 10% would have provided 0 years with credited returns of 10% or greater.

Given a high enough cap, IVAs can have significant growth potential from exposure to equity indexes. Caps on in-force contracts are subject to change annually and may fluctuate significantly. While the IVA cap does mean that the investor gives up some of the upside of the index, the investor in this example would still have received the acceptable rate of return of 10% with a high frequency, with the IVA providing similar upside to both the 65/35 equity/bond mix and the equity benchmark itself.

Crediting methods of IVAs

For positive index returns, IVAs are credited with the return of the selected index over the investment period up to a specified cap. The difference in market protection between IVA and FIA crediting is that IVA investors are exposed to downside risk through negative returns in order to have higher growth potential. One method of downside participation that can be used to realize this trade-off is a loss buffer, where the insurer absorbs a stated level of negative performance before the investor experiences losses.

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