The appeal of an indexed annuity is that it is a savings vehicle which credits interest based on an index, such as that of a stock market.
At the end of a contract year, if the index has increased, some or all of the increase is credited to the annuity. If, on the other hand, the index has decreased, the annuity’s value is protected from the decline.
That has been a winning value proposition for years for consumers and the companies that offer these annuities.
(Related: Why Do Pundits Hate Indexed Annuities?)
As for the index itself, the most popular option has always been the S&P 500.
But over the last four years, another very popular choice has arisen: the volatility-controlled index.
Unique Assets Provide Protection
The enduring appeal of the S&P 500 index is that it is well understood. Agents and consumers know what it is and how it works. Not only that, the performance of the S&P 500 index is widely reported in the financial press, so clients may generally know what’s going on with their annuity value just from following the business news.
Volatility-controlled indices are different. They tend to carry the brand name of a prestigious investment bank. If your favorite carrier has an annuity using an index branded by an investment bank — such as JP Morgan, Barclays, Deutsche Bank, Goldman Sachs or BNP Paribas, for example — chances are it is a volatility-controlled index.
A volatility-controlled index tracks a basket of assets that changes regularly with the goal of making the index fluctuate up or down less than the S&P 500 index. While these indices have that characteristic in common, each insurance company tends to offer its own unique volatility-controlled index. Since each index is different, agents and consumers need to make more of an effort to understand how each particular index works.
The benefits of volatility-controlled indices for insurance companies, agents and consumers are:
The index can be uncapped, so there is theoretically no limit on potential upside interest crediting for the consumer
The index can include multiple asset classes, not just stocks
The performance of the index can include dividends on any stocks in the index
The index can be unique, making the product different from any other product in the marketplace
And yet, the cost of the option contracts that the insurance company must buy to back the annuity are cheaper and more stable over time on volatility-controlled indices than on the S&P 500 index
How is it possible for an index to do all of this? The key is understanding how the volatility control works.