Equity protection swaps: investment insurance for superannuation accounts

A novel type of an investment insurance product for holders of superannuation accounts in Australia, tentatively named an Equity Protection Swap (EPS), is proposed and examined. An EPS shares some features with the variable annuity known as the registered index-linked annuity (RILA) but it is a standalone financial derivative, which makes it appropriate as a protection tool against downside risk for holders of superannuation accounts. Its basic forms, dubbed buffer and floor EPSs, offer a partial protection against losses on a reference portfolio below a predetermined threshold in exchange for a share of portfolio's gains if the realised return on a reference portfolio is above a predetermined level. Model-free explicit pricing formula for a generic EPS is obtained by considering its static hedging by a portfolio of European options. As opposed to classical insurance products, the structure of an EPS allows for the fair initial premium to be null through a judicious selection of the provider's participation rate in portfolio's gains. A theoretical study of forward performance of EPSs based on the cross-currency market model and an empirical cost/benefit analysis based on market data for S&P 500 and S&P/ASX 200 indices demonstrate tangible benefits of EPSs as an efficient investment insurance tool for superannuation accounts.