Volatility Management of Equity-Based Insurance Guarantees was the final session of the 29th CBOE Risk Management Conference. Hark Hadley of Numerix and Stephen Stone from AIG Life and Retirement were the presenters.
This session introduces equity based insurance guarantees, discusses new product designs including volatility control products, and the volatility profile of equity based insurance guarantees, and how insurance companies manage risk.
Stone started out describing how there is an embedded put option in variable annuities. He demonstrated an example of how a guaranteed payout works. He also noted that by their nature they have a short put embedded in them. This put option is a function of the guaranteed payments that go along with the annuity.
An interesting part of the presentation discusses how to implement a volatility control formula using VIX to determine equity exposure. Another structure presented involves tying fees to the level of VIX. Higher VIX would result in higher fees. He noted the majority of Vega exposure occurs in the early part of the life of an annuity which is why much of the risk management function focuses on this time frame.
Hadley took the stage and ran though different methods of hedging based on target volatility. He says that target volatility is predictable within a range and that strategies based on target volatility can be successful. He mentions there are a wide variety of ways to approach targeting volatility and that they do succeed in reducing Vega risk but not completely eliminating this risk.
The final conclusion is that target volatility strategies can insulate the claims leg from equity volatility risk. Fee indexing can offset equity volatility risk in an orthogonal way to target volatility. Combined these can result in a positive Vega product.