Risk Control Indexes Are Multiplying, and So Are Their Critics
Critics of volatility-control indexes for life and annuity products argue that they’re complex, opaque and, in recent years, poor performers.
By Warren S. Hersch| April 10, 2024
Insurers are adding a growing number of multi-asset risk control indexes to products, including fixed-indexed annuities, index-linked variable annuities, and indexed universal life products.
Because they control volatility — fluctuating less than conventional benchmarks like the S&P 500 — the indexes let insurers reduce hedging costs, boosting their products’ profitability. With less volatility to hedge, the carriers can offer higher upside potential through more generous participation rates and caps. And they appeal to risk-adverse buyers wanting to limit the stomach-churning effects of market gyrations on their nest eggs.
Yet the new indexes have become a focus of lawsuits — including complaints against Lincoln National and Security Benefit Life — filed by buyers alleging they were misled by overly rosy illustrated rates of return. Industry watchers expect litigation to proliferate along with the number of indexes.
Nearly 35 have debuted just since the start of 2023 (see table). Many of them have exotic, hard-to-understand mechanics, and critics worry that agents and advisors are playing fast and loose with them in marketing to boost sales.
Secured Financial Solutions CEO Anil Vazirani
For Secured Financial Solutions CEO Anil Vazirani, a bone of contention is the frequent lack of a real-world track record for these bespoke indexes to support the yields promoted in policy illustrations. Fixed-indexed annuities are problematic, he claims, because the products are often being presented as if they were securities. And volatility-controlled indexes are designed to give the FIAs that use them features that resemble investment products more than typical fixed annuities.
“If it looks like a duck, and walks like a duck, it is a duck,” he said of fixed-indexed annuities, adding that he thinks the Securities and Exchange Commission should regulate them.
What many buyers don’t realize — and what insurers and distributors often fail to educate them about — is the limited duration of initially high ceilings on product returns, he said. The insurer may, for example, offer a guaranteed 10% cap rate in the first contract year, then reduce it to 2% in the second.
Vazirani likens the strategy to deceptive “bait-and-switch” sales techniques.
An Unknowable FutureWhile proprietary indexes have enabled carriers to market attractive, hypothetical, back-tested returns that get magnified through high cap and participation rates — a key reason for their rapid emergence — no one knows what to expect for future cap and participation rates on the indexes. And that, says Jerry Vanderzanden, secretary of the Life Insurance Consumer Advocacy, is concerning.
Jerry Vanderzanden, an insurance fiduciary
“All we know is that most of the volatility-controlled indices have performed poorly in the last four years,” he said in an email. “Popular ‘uncapped’ indices rely on high nonguaranteed participation rates that fuel illustrations but carry tiny minimum rate guarantees, meaning reductions in the future are possible and will lead to disappointment.”
Vanderzanden added that most of the 170 proprietary indexes for fixed annuities and indexed universal life products have been in existence for just a few years. So, he questions whether anyone really knows what is “reasonable” or “sustainable” with respect to the indexes’ crediting parameters.
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He cited the lack of transparency into the workings of the indexes as a particular concern, given their complexity. Most of the proprietary indexes found in fixed-indexed universal life products feature excess return indexes with a 5% target volatility with an embedded fee of 0.5%, he noted, but most of the illustrations don’t disclose these features or their importance. And marketing materials tend not to describe the rules that govern how the indexes and their multiple asset components work.
“Searching the name of the index online might lead you to a fact sheet at the investment firm that created the strategy for the insurer, but very few agents get that far,” he said. “And most lack the investment experience or licensing to explain how these indices work.”
Diving into the MechanicsIn tandem with the proliferation of risk control indexes, financial institutions are increasingly turning to third parties like The Index Standard to vet the products, according to Laurence Black, the company’s founder. The due diligence may entail examining the robustness of an index’s design, decoding the weighting process, reviewing risk management processes, and checking fees and expenses.
Laurence Black, founder of The Index Standard
“People are asking hard questions about how these indices will perform in the future,” he said in an interview. “They’ve become more skeptical.”
Using a historical period to back-test returns isn’t enough to evaluate an index — one must also consider the future performance or the forecast, Black said. For example, where an index has a strong bias to a popular theme, say the “Magnificent Seven” stocks that have performed very well over the last decade, it is reasonable to question whether the positive trend can be sustained, he said.
An analysis of risk-controlled indexes’ performance over the last decade by Black’s firm shows that about 44% outperformed the S&P 500 Index. In comparison, just 12% of mutual funds outperformed the S&P 500 Index.
In 2022, though, many of the indexes underperformed the benchmark index because, in contrast to normal years, that year bonds and equities didn’t move in opposite directions to balance each other out. Bonds can provide stability and income during market downturns, while equities offer the potential for higher long-term growth. The two asset classes are now beginning to “yin and yang” again — i.e., move in opposite directions, Black said, and as a result, the risk control indexes are performing much better this year.
Also trending: the creation of simpler indexes. These may, for example, apply an intraday volatility control to a benchmark index like the S&P 500. So, if the benchmark index dips in value, the risk control index will decline a bit less, and similarly increase in value if the benchmark should rise.
These indexes are “much easier to explain, much simpler to track,” Black said. “And then the volatility control provides much more certainty around the pricing parameters.”
The Rise of Risk Control Indexes
| Multi-asset risk control indexes that have debuted since the start of 2023 Index Name | Type |
| Barclays Transitions 12% VC Index | Multi Asset/Rates |
| Barclays Transitions 6% VC Index | Multi Asset/Rates |
| BlackRock Adaptive US Equity 5% Index | Benchmark/Bonds/Rates |
| BlackRock Adaptive US Equity 7% Index | Benchmark/Bonds/Rates |
| BlackRock Market Advantage Index | Multi Asset/Rates |
| BofA U.S. Agility Index | Equity/Bonds/Rates |
| BofA Global MegaTrends Index | Equities/ Bonds |
| Dimensional US Small Cap Value Systematic Index | Equity |