Why Guaranteed German Pension Products Just Aren’t Worth It

How they tell you guaranteed pension products work

Investors in this product can choose to have a guaranteed annual minimum return or an index option with participation in either the Euro Stoxx 50 or the S&P 500 index. The latter has your uptick capped at about 2 % for each month, and, in return, your nominal investment is guaranteed never to drop. Note that you won't get any dividends if you select index participation, as dividends are not reflected in the index. Note also that the guarantees are before cost, so after cost, your investment may decline. Allianz does guarantee that your total loss after cost is not more than 10 %, but this guarantee only applies at the start of your pension. 

How guaranteed pension products really work

You may be surprised to hear this, but fundamentally, index participation is an options arbitrage strategy. Here is a precise, though necessarily somewhat complex, explanation — that you can skip if you like and continue reading about the cost in the next section:

The product involves the annual purchasing of a so-called 'put option' on your chosen stock index, with a one-year maturity period. This option gives Allianz the right to sell the investment in the index at the prevailing price for a duration of one year. This protects the investment but will cost you a sizable part of your assets, currently about 8 %. 

To offset this, Allianz sells monthly call options, which are valid for one month and can be exercised when about 2 % above the prevailing price. For example, Allianz gives away the right to benefit from a gain of over 2 %. This is what they call the cap, and Allianz, in turn, caps the maximum monthly gain you can get from their investment. These call options can be sold for, say, 0,67 % each. Over 12 months, that yields 8 %. On balance, this strategy is, therefore, about cost neutral: the cost of the put is offset by the gains of the calls.² As long as the calls can be sold “out of the money” (i.e., with a strike price above the prevailing stock price), there is some gain to be made from this strategy.

In addition, Allianz offers as an option an annual minimum guaranteed return, currently about 1,9 % (before cost). How they finance this is unclear, possibly from the profits made by clients implementing the Index participation option. 

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The cost and how it eats up your returns

The extent of the cost of a product like this is not regulated. Examining a recent offer, we see Allianz charges an effective cost of 1,29 % if the product is kept for 30 years but about a percent higher if the contract is only held for 15 years.

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Assessing the returns of guaranteed pension products

The strategy earns a nice return if the index grows very gradually. But in volatile years, losses are high and can easily outweigh gains, as these gains are capped. For example, a stable growth year with 8 months of 1,5 % gains and 4 months of 1 % loss yields you a net gain of 8 %. In a volatile year, 4 months of 4 % gains, 4 months of 2 % losses, and 4 months with zero gain earn you 0 %, while the index increases by 8 %, as the gain of 4 × 4 % is capped to 4 × 2 %.

To examine the reality of this further, we ran this strategy over the longest-time data set available for the two indices offered by Allianz. 

 Over 40 years, this strategy (with a cap of 2 %) for the Euro Stoxx 50 index would have earned a gross return of about 1,75 %. After cost, this would be about a 0,4 % return for you. 

Over a period of 150 years, this strategy using the S&P 500 instead of Euro Stoxx would have yielded considerably better results. After cost, a return of just over 2 % remains, just about equal to that of inflation. And this is before dollar hedging costs. Holding stocks outright over this period would have yielded 9,3 % annually! You don't have to be a math wizard to realize that's many times more!

Our view on guaranteed pension products

We are rather skeptical about using such a strategy for a long-term pension portfolio, given the zero or negative real return. 

Fundamentally, additional risks are involved if this strategy by Allianz is deployed over a longer period: there is no guarantee that the option’s prices will stay where they are. Hence, these returns are not guaranteed to hold up. In fact, this arbitrage strategy is unlikely to remain attractive and provide significant yields. If the strategy is used more widely, the returns will drop and make it even less attractive.

There is clear evidence of this. When Allianz introduced this strategy, the returns were much higher than they have been in recent years. I.e., the cap was much higher and hence the expected returns. 

Therefore, we would strongly advise clients not to invest in Allianz Index Select or any other product with such a strategy for the long term. Especially as the product involves significant upfront costs (upfront fees are levied over the lifetime contribution), and the minimal return before the cost is not even secure. 

What warrants even further concern is that there seem to be no articles available from advisors or Altersvorsorge websites that explain how the real strategy works, as we do above. Or run tests with long-term historical data to check the benefits of these products in Germany. In other words, it appears that this product is too complex for advisors as well.³

In Sum

The Index Select product from Allianz is not really an index participation strategy as it is being billed, but an options arbitrage strategy. It is not suitable for long-run investors, given the high cost and low returns and the uncertainty of whether even the modest returns will hold up over the medium to long run.

Long-term investors should go for good stock indices. Over the long-term, 6% returns are attainable even in the worst-case scenario.⁴

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¹ This principle does not only apply to Allianz Index Select. Similar products offered by various other companies display these same drawbacks.

² This strategy uses the fact that monthly call options are normally more costly than annual put options.

³ One exception is a publication from the Institute für Vorsorge und Finanzplanung, which has a study from 2014 that is available for a whopping 1.166,20 €. Their conclusion, that the Index policy outperforms the index (based on data from 1987-2013), could not be replicated by us, and would also not be supported by option arbitrage as a permanent outcome, as an arbitrage strategy is cost neutral. Their result implies both more safety AND higher returns. This should have been flagged as inconsistent with financial theory and, hence, not a basis for predicting the future. In the figure above, we use the longest time series available from the owner of the index Boerse.de, namely February 1991. The results presented in Figure 1 contradict the conclusion of the IVFP study, as you can see that the Index clearly outperforms the Index Select product for an average assumed cap of 2,2 %. The IVFP study may be due to very favorable results for the index in two years, 1987 and 1989, and an unrealistic cap in the early period, assuming that the product was not even available.  

⁴ In the long term, protecting your portfolio from a decline through options is as costly and unnecessary as stocks. Eventually, do not fall in price, as you buy part of the real economy, and the real economy, in the end, always grows. The longer you hold stocks, the safer they are – provided you spread them well, e.g., by participating in a broad index.