The usual advice for managing investment portfolios is to take a holistic approach and consider a client’s holdings as an integrated whole. But that approach wasn’t always optimal when evaluating equity allocations in variable annuities (VAs) with generous guaranteed benefits. In those cases it often made sense to override the full-portfolio target allocation and increase the equity exposure to take advantage of the VA’s contractual guarantees.
That approach can backfire on two levels, however. While VA owners doubtless appreciate the increased equity exposure during bull markets, the reduced diversification could rattle them and cause them to switch out of equities when stocks’ volatility increases, particularly in a bear market. High equity exposure, combined with historically low interest rates, has strained VA issuers in recent years, as well. They can raise contract fees and reduce benefits to an extent, but a competitive market limits just how far they can go.
A better method?
A possible solution that’s been gaining momentum is to manage investment portfolio volatility, which could benefit both investors and insurers. According to research firm Strategic Insights, assets in managed volatility accounts rose from “$35.3 billion at the end of 2006 to $305.8 billion at the end of 2013, an annualized growth rate of 36.1 percent.” Assets reached $360.9 billion by the end of 2014’s second quarter; VA assets comprised 72 percent of that amount.
A sub-account or fund can choose from several methods to control portfolio volatility. It can target a level of volatility and dynamically adjust equity weightings in response to market conditions. Another approach is to cap volatility and a third is to focus on principal protection. Additionally, there is a range of strategies used within each category.