On March 19 at the 30th Annual CBOE Risk Management Conference, three experts discussed “Design and Management of Low Volatility Products by Insurance Companies”:
- Alan Grissom, Global Head of Insurance, S&P Dow Jones Indices
- Chris Quallan, Vice President, Derivative Trading, 40/86 Advisors
- Barry S. Seeman, Global Head of Derivatives Structuring, AEGON
Topics discussed included —
– New product designs including volatility control products, low volatility by stock selection and VIX-linked structures
– Managing risk of low volatility products
– Special considerations for insurance companies
– Hedging challenges presented by exotic optionality within Fixed Indexed Annuities
Alan Grissom referred to the White Paper “VIX® for Variable Annuities (Part II) – A Study Considering the Advantages of Tying a Variable Annuity fee to VIX.” One of the indexes discussed by Alan was the S&P 500 Dynamic VEQTOR Index (SPVQDTR), an index that is designed to provide broad equity market exposure with an implied volatility hedge by dynamically allocating between equity, volatility (with VIX futures) and cash. The index allows investors to receive exposure to the equity and volatility of the S&P 500 Index in a dynamic framework, and the index had positive returns in 2008 and in subsequent calendar years.
Barry Seeman discussed Volatility Controlled Funds in Variable Annuity (VA) Product Design.
He noted that:
1. Low interest rate environments present greater challenges in hedging long-term guarantees in the VA product space.
2. Insurance companies, such as Aegon/Transamerica, have used vol-controlled funds to better manage the vega impact of the long dated put exposure of the VA liability.
3. Volatility controls attempt to increase risk adjusted returns by dampening volatility, and limiting downside in high volatility, declining equity markets, and as a result, insurance companies can offer specific living benefits as they are better able to manage volatility levels of the underlying products.
Chris Quallan discussed Fixed Indexed Annuities (FIAs) and noted that:
1. FIAs are insurance contracts with a tax-deferred interest component.
2. Insurers promise to protect buyers against market losses but cap the upside gain they pay.
3. A typical FIA may guarantee a return equal to the greater of 0% or 50% of the return of the S&P 500 index over the last year.
4. FIA writers typically invest deposits in Fixed Income markets and hedge the equity exposure with derivatives.
5. Estimated 2013 sales were around $36.1 billion, and the top FIA sellers were Allianz Life, Security Benefit Life, American Equity, GAFRI and Aviva.
and 6. Static hedging strategies by FIAs can isolate embedded options in the liabilities and buy offsetting options.
Attendees seemed to find the panelists knowledgeable and insightful.