What Is Variable Annuity

Tony

February 08, 2022

You may have heard about Annuity plans or Fixed Annuity plans. But what is a Variable Annuity plan? What does it differ from Fixed Annuity plans? What type of investors is suitable for Variable Annuity plans? I have an introduction for you in this article.


Photo by Josh Appel on Unsplash

Demand in the Low Interest Rate Environment

In my article Upcoming Major Changes on Participating Policies posted last year, I mentioned that due to the low interest rate environment since the global financial crisis in 2008, the Illustrated Investment Rate of Return for Participating Policies in Singapore has been reduced and reduced. Quite a few Participating Products were taken off the shelf in 2021. Participating Products are an important type of low-risk investment vehicle. Most of them have capital-guarantee feature. Under such situation, for investors who prefer capital-guarantee feature, what are the alternatives? Variable Annuities which also have capital-guarantee feature can be considered.

How Variable Annuities Work

Fixed Annuities are a type of Participating Policies. The investor invests a lump sum or certain amount over a few years. From a designated year onwards, the insurance company pays out money to the investor for a number of years. The pay-out amount is related to the investment return by the insurance company. But the total pay-out amount will not be lower than the total investment amount by the investor, so the plan is capital guaranteed.

Variable Annuities are a type of Investment-linked Policies. The investor invests a lump sum to a third-party fund. From a designated year onwards, the insurance company pays out money to the investor for a number of years. The pay-out amount is related to the investment performance of the third-party fund. But the total pay-out amount will not be lower than the total investment amount by the investor, so the plan is also capital guaranteed. Moreover, the pay-out amount is locked in with the best investment performance of the third-party fund during the investment horizon, which will not be affected by the fluctuation of the fund. The insurance company takes a fraction of the profit of the third-party fund to offer the capital-guarantee and best performance locked-in features.

Because the investment is no longer handled by the insurance company, the investment asset allocation of Variable Annuities (i.e. the investment asset allocation of the third-party fund) is not restricted by the investment asset allocation rules imposed on Participating Policies. It gives the third-party fund the flexibility to increase the allocation to equities, to respond to different interest rate environments. Under such mechanism, while maintaining the capital-guarantee feature, Variable Annuities provides investors upside potential in the investment compared with Fixed Annuities.

Suitable Investors

Suitable investors for Variable Annuities are similar with those for Fixed Annuities. They intend to invest now and receive passive income in the future. Their risk profile is moderately conservative or balanced. If you prefer taking a bit higher risk to achieve higher return, mutual funds may be more suitable for you.

Above is my introduction on Variable Annuities. You are welcome to contact me for a discussion on relevant topics.

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