In a previous blog entry I described the basic mechanics of structured note variable annuities (SNVAs). The products’ partial or complete downside protection plus potential to participate in investment index-linked returns are proving popular with investors and sales continue to grow.
The presence of structured notes adds complexity to VAs, which can already be quite complicated. Investors must consider index selection (if multiple indexes are available), segment and segment duration, performance caps and buffers in addition to the usual VA-features and benefits.
SNVAs have attracted criticism, as well. Advisors considering the products for clients should review a recent Journal of Retirement article from Fairfax, Virginia-based Securities Litigation and Consulting Group (SLCG), a financial economics-consulting firm. (You can download the article, Structured Product-Based Variable Annuities, and view a video discussing the research.)
Here’s a high level summary of the paper’s approach and key findings. The authors demonstrate how capped and buffered structured notes can be decomposed into a portfolio of four financial assets:
1) a zero-coupon bond;
2) a short European put option with a strike price equal to the buffer level;
3) a long European at-the-money call option, and