The Power of the Fixed Index Annuity for Retirement: Key Benefits and Market Growth Explained

Are annuities a good investment?

The Fixed Index Annuity is often overlooked as a valuable retirement tool, offering benefits like principal protection, guaranteed income, tax deferral, and market participation. Join Troy Sharpe® as he interviews industry experts Laurence Black and Branislav Nikolic of The Index Standard® about the expanding realm of fixed indexed annuities (FIAs) within retirement planning, unpacking their nuanced benefits, market trends, and evolving complexities.

You’ll walk away with a comprehensive understanding of FIAs, including their role as stable components in retirement portfolios, the significance of volatility-controlled indices, and the crucial need for clear guidance amidst misconceptions. With expert analysis and a focus on real-world applications, this interview equips viewers with the knowledge to navigate the intricacies of FIAs confidently, empowering them to make informed financial decisions for their retirement futures.

Jump right in:

Troy Sharpe: In 2023, the fixed index annuity market experienced a significant surge, reaching $95.6 billion in annual sales, representing a remarkable 20% growth from the preceding year. In today’s interview, we are pleased to introduce two esteemed and impartial industry experts poised to delve deep into essential insights about fixed index annuities and the factors driving their escalating popularity within retirement portfolios.

Whether you currently own a fixed index annuity, are contemplating its purchase, or are approaching retirement and seeking to learn about safeguarding a portion of your savings from market uncertainties while also securing stable and predictable retirement income, this video is a must-watch for you. Upon the conclusion of this interview, you will gain a comprehensive understanding of the product, its advantages and constraints, and its suitability for your retirement planning needs.

Acknowledging the inadequacy of annuity education to rival the substantial industry innovation, this video aims to dispel outdated misconceptions and present an insightful perspective on the design and intended utilization of these financial instruments to astute and curious investors. Our distinguished guests for today’s interview are Laurence Black and Branislav Nikolic from The Index Standard.

Laurence Black, the founder of The Index Standard, is an esteemed index advisor to Professor Robert J. Shiller, Sterling Professor Emeritus of Economics at Yale University. Prior to establishing The Index Standard, Laurence held the role of Managing Director and Head of Quantitative Indices and Strategies at Barclays, overseeing the development of the Barclays index family and championing innovations in smart beta and factor indices.

Branislav Nikolic, an esteemed thought leader in annuities and retirement income planning, brings a decade of experience from CANNEX Financial Exchanges, where as Vice President of Research, he significantly enhanced CANNEX’s influence in the retirement income domain. Branislav’s academic background includes a master’s degree in probability and financial engineering and a PhD in applied mathematics from New York University, Toronto, where he also serves as a lecturer in finance and mathematics. Without further delay, let us embark on this enlightening exchange of ideas and knowledge.


Okay. Really excited about today’s interview. Guys, why don’t you go ahead and introduce yourselves? Tell us a little bit about who you are, what you do, The Index Standard. We’ll go from there.

Laurence Black: Fantastic. Thanks, Troy. It’s great to be with you here today. My name is Laurence Black, and I’m the founder of The Index Standard. I founded The Index Standard about 3 years ago on the back of a 20-plus year in investment banking. Started off my career actually as a risk manager and a bond trader, then I moved into developing indices. I like to tell people I’ve almost become a– I was a poacher, and now I’m a gamekeeper. Rather than developing indices, now at The Index Standard, we’re analyzing and evaluating indices.

At The Index Standard, you can think about us today as a mini Morningstar. What we do is we rate and evaluate indices, we provide forecasts, and we provide model allocations.

Troy: When you and I first had a conversation, it was interesting because you told me that you were thinking about actually leaving your current position and going to start your own index essentially. Then if I remember correctly, you said, “You know what, Troy, one of the last things I think the world needs is another index, so I decided to start analyzing them or ranking them and helping people have more visibility into the mechanics of the indices so they can make better decisions for their retirement and investment portfolio.”

Laurence: Just a quick comment. I’m so impressed that you remember that. Actually, there’s more than three million indices. Does the world need another three millionth and oneth indice? I don’t think so. I think perhaps the world needs someone to help decode and demystify them. That’s what we do. Over to you, Branislav.

Branislav Nikolic: Thank you, Laurence. Thank you, Troy, for the opportunity. It’s an absolute pleasure to be here to have this chat with you, gentlemen. My name is Branislav Nikolic. I’m Head of Insurance at Index Standard. I’ve known Laurence for a few years now. My question for Laurence was, okay, we have now information about indices, we have ratings, we have forecasts, but where rubber really hits the road is when you put this into an insurance wrapper.

One conversation after another, Laurence asked me to join him in this mission to help people derive actionable insights when it comes to indices, but from my lens, more importantly, actionable insights for insurance products that are linked to the indices themselves.

Troy: Where did you guys meet?

Laurence: That’s a great question. Branislav actually used to work at a company called CANNEX, one of the premier data providers. We met him there because we were looking for some data. Branislav, he obviously knows everything about the insurance industry, he’s just got his PhD in math, so super smart. That’s how we met and we just connected very well.

Troy: It seems like when, Laurence, you’re starting this venture, obviously you need somebody with that skill set to come in and help analyze, decipher, and then be able to organize and communicate that information in a way that people can understand and actually apply to their decision making.

Laurence: Yes, I think you’re right. I’ve got to say I’m very proud of our management team because we’ve got another guy called Jay Watson who spent 20 years developing indices. He’s also deeply quantitative, so he understands every aspect of designing an index, but also the process around building a data business, storing, all the legals around that. With myself and Branislav and then our COO, we’ve got a great management team actually.

Troy: Just starting from the beginning here, when we talk about an index, we’re talking about a bucket of stocks or bonds or a combination of stocks or bonds. The Index Standard, you guys rate ETFs, which are actually market-based investments, where you’re invested in the market. You have a bucket of stocks or bonds and that can go up and down in value. Indices also go into fixed annuities. This is where we’re going to focus the conversation today because there are hundreds of indices available out there inside these fixed insurance products and the marketplace is somewhat convoluted.

It’s very hard for the consumer to understand what is this index-linked strategy and why do I have 6, 7, 8, 9, 10 of them inside my fixed annuity. How do I know which one to allocate to? I’ll tell you this, financial professionals, this is how I found you guys. We as financial professionals, because so many of these indices are new and they have so many machinations inside, they’re very complicated for us to understand as well.

I guess I should point out that’s how I found you all because we started out on this venture to say who out there can help us make better decisions for our clients. Thank you very much for starting The Index Standard because it’s gone a long ways towards helping us make better decisions, we feel, that put clients in an opportunity to have consistent returns over time, potentially.

Okay. Focusing on fixed annuities, they seem to be one of the most, well, not really seem to be, they are, I think, probably the most or definitely one of the most misunderstood financial products in the entire marketplace for retirement. It seems they all get lumped together. At a high level, guys, can you explain what the value proposition is with annuities? What differs from fixed or variable? What should consumers know?

Branislav: Absolutely. That’s something that I was studying with a great passion over the last 10 years because annuity in a business world, especially in a financial advice world, is still considered a bad word, right? There is nothing further from the truth that you can think of. Originally, what annuities were, and if you go what classic annuities are, is you give the insurance company or a group of people a bag of money and you get installment payments for the rest of your life.

That was the original back-and-forth. Then, obviously, with the tax code changes, variable annuities and what was known then as equity-indexed annuities gained the popularity where we actually had your market investment that was tax sheltered because it’s an annuity that had some lifetime provisions on them. Then the enhancements, you had smart people interested in this field and they wanted to come up with what’s the greatest value they can provide to a client, so they started adding all these bells and whistles in terms of lifetime income benefits, guaranteed debt benefits.

Something that was intrinsically very simple, basically a bag of money for installments for life became a very complicated structure product with options that were struck on not only market events but also longevity events. Again, the key driver was what I believe is the tax implications, the fact that this allowed for tax-sheltered growth and then ability to move from one annuity to the other to the exchanges without incurring tax penalty.

Now, if you look into the categories, I would always start with a single premium immediate or deferred annuities, those that pay income for life, then I would move on to the variables, which is basically an insurance wrapper around something like a mutual fund that would have different lifetime or LTC or debt benefit provisions on it, then the fixed index annuity, which is really born out of a fixed annuity, where you actually get a fixed credit for a year, for many years, usually guaranteed, but in a low-interest rate environment, insurance companies wanted to offer more. Indexing and relating those interest credits to index really allowed them to do so over the last decade of low interest rates.

Troy: Your basic immediate annuity, which is the traditional concept of annuity, and one of the parts still that is misunderstood because a lot of people still believe, I hear it all the time, “Troy, if I give my money to the insurance company, they’re just going to give it back to me. If I pass away, I’ve lost out. There’s no money left to go to my beneficiaries.” That belief stems from that original bag of cash, installment payments. That’s how it was for a long time with annuities. Really, over the past 20 years or so, 25 years, the industry has evolved, but those myths, many of them still hang around.

Branislav: You’re absolutely right. One thing that shakes me up to my core when I hear is when people borrow concepts from one annuity group to the other annuity group, and they would say, “Oh, annuities have high fees.” They’re saying, “Oh, I don’t think SPIA or DIA has high fees or fixed index annuity doesn’t have any explicit fees. Where are you coming from?” “Oh, yes, but VAs, they’re charging you 3.5%, 4% for everything included.”

I was like, “Yes, but that’s for VAs. Let’s focus there. There is a value that they provide for the fees that they are charging. They’re explicit. On the other hand, on fixed index annuities, your fees will not be explicit. Someone has to pay for your organization to run. That’s showing up differently in the product. The same goes for the immediate annuities.” I think sticking with the annuity category, demystifying one category one by one is where I think we’ll have a lot of work to do.

Laurence: I think people tend to look at fees on mutual funds and ETFs and see that there’s a bit of a difference when it comes to an annuity. They also tend to forget that with the annuity, you’re getting that longevity protection. You live to be 95, you’re going to get your fees. We all tend to forget that. We’re all living longer, right? In a way, annuity is the only place where you can get that longevity guarantee, which is what I think people should really be thinking about nowadays as well.

Troy: The decision comes to the value proposition. Just like anything in life, if I’m paying a fee, whether explicit or implicit, what is the value proposition that I’m receiving? When we talk about fixed index annuities, what is the value proposition for someone in retirement, approaching retirement?

Branislav: For me, I think it’s the unique ability to put several benefits that you can arguably get elsewhere efficiently in one spot. The first one is principal protection. That’s something that you can achieve elsewhere, but that’s just one of the benefits in the FIA. Another one is guaranteed income provisions, basically ability to now combine your principal protection and now add guaranteed income for life. You get certain form of market participation. You’re not invested in a market, but you can benefit from indices that trades the market and get some of these translated into your annual credits.

You get debt benefit provisions similar to what, let’s say, life insurance would do. You have the basic ones that would give you your money back if you get hit by the bus. Also, you have enhanced provisions that really are looking more like an insurance policy. You have, in all that, ability to access your money. You’re not giving the bag of cash not to see it ever again. Usually, you have 10 or so percent a year that you can take back penalty-free from that annuity, so you preserve access. Then capturing all that, it’s tax deferral.

Now, each of these benefits individually, you can get a good tax advisor or a tax lawyer who will help you optimize your taxes. You’ll be able to find a good insurance policy. You can find a structured note. They will give you the principal protection. You can buy immediate annuity for guaranteed income. We are talking three to five products, three to five people, and hoping that all of them are really in sync when doing this for you. This is why I think FIA is very unique in the sense that product providers, insurance companies and their product development people and actuaries are actually looking to cover as many needs as possible within one umbrella.

Troy: Just to add to that, the potential for reasonable rates of return over time on top of your deposit. The evolution of the fixed index annuity marketplace over the past 10 to 15 years especially, but really just the past 20, 25 years since they were invented, what has that been like? What should consumers understand and how has that played out?

Laurence: Troy, I think on that one, from my point of view, what we’ve seen is a tremendous choice in the indices that you can link your credits to. It just used to be the S&P and then we’ve seen this really explosion of, let’s call them custom risk control indices. Now, we’ve seen this explosion for a number of reasons. One is I think all the carriers wanted to differentiate themselves. They didn’t necessarily just want to have the S&P, I want to be able to show you something interesting, maybe something that adds some diversification. You’ve seen that’s been a huge driver of growth.

I think the other thing, what we saw was– The S&P, it’s a wonderful index, but we all know it can be wildly volatile at times. A risk control index has a feature to stabilize it. It’s much smoother and it’s buffered. You get much more stable performance. As a result, the par rates and the product parameters are much more stable, and people like that. You might have your par rates or participation rates as they’re known on the S&P move around a lot. On the risk control indices, they are very stable, very consistent, you can get great value for them.

Then finally, again, the US benchmark indices are wonderful indices. They weren’t designed for annuity. Also, if you buy one of them, you’ve got exposure risk. You might just really have, these days, a large exposure to large-cap tech. You really want to be diversified. That’s the number one thing in investing or portfolio management, diversification. By adding some of these risk control indices, you can blend in other things to the portfolio and provide great diversification.

Troy: A couple key points to make sure that people understand, and that’s with your fixed indexed annuity, typically, you’re going to track the market on a point-to-point basis over a 12-month period, or maybe over a 2-year period, but the gains that you make are locked in at that point. What you see with the S&P 500, if you’re tracking the S&P 500, it’s a more volatile index. Maybe in the days or weeks leading up to your lock-in date, where your earnings are determined, you could have some volatility that could wildly fluctuate that.

Then at the end of what we call the reset period, that 12-month or 24-month period, the insurance carrier reserves the right to adjust your cap rate or your participation rate if they’re uncapped. They do that based on the volatility in the market, which has a direct correlation to the price of options, and also the interest rate environment, probably profitability, some other metrics.

What you’re saying there, Laurence, is that with the volatility control indices, and we’re going to define those in just a few minutes and give some examples, they’re more stable from a pricing perspective, once the consumer hits their anniversary and the insurance company says, “Okay, here’s what’s going on in the marketplace, interest rates, volatility,” I can spend this much of the budget to go buy options and that the consumer can expect a more stable, what we call a renewal rate with those indices.

Laurence: Yes, you’re exactly right. I think you’ve explained that very clearly. Let me just add two things. Firstly, I think with the S&P, as I said, it’s wildly volatile, so you’ve got a lot more timing risk. If anyone who bought the S&P towards the end of ’22, when markets were very high, could not even have seen maybe any positive credits, because markets went down, and they’ve sort of recovered now. You’ve got a lot of timing risk.

Secondly, with the S&P, often you’ll get a par rate or participation or how much exposure or how much of the S&P can you buy. A lot of the times that might vary between 35 to 50% of the S&P. Effectively, because the S&P is so volatile, you’re only getting half exposure to it, whereas on these risk control indices, you can get higher exposure to them as well in exchange for their additional stability.

Branislav: For me, when we talk about the evolution, index evolution is definitely one thing. If you look back 10, 15 years ago, you had benchmarks, a handful of innovative at that time risk control indices, but over the last 5 or 7 years, you just had an explosion. That also drove the variety of crediting strategies. What you mentioned, Troy, was S&P participation with cap. What Laurence mentioned was S&P or custom index for just participation. You’ve seen a lot of strategies that are trying to capture different market events. You had strategies that were averaging monthly returns, adding up monthly returns. You had strategies that would just give you what’s called a digital exposure.

If the index just breaches into positive territory, you get certain fixed amount credited. You had inverse of that. If index is a bit negative, if you are thinking that index will not do well, that you can actually capitalize from that. A lot more trading strategies and something that, again, we don’t necessarily see in the retirement portfolios or retirement products was added into these fixed annuities, making them more complicated to evaluate.

Obviously, the fact that there are no explicit fees, there is always that question of where is this coming from. Why are they providing this great benefit to me? How do I see that in either annuity rates or guaranteed income provisions? Again, ability to put all these benefits together, I think it was the key evolution. Again, it started from being investment vehicle only, then there was a proliferation of lifetime benefits, then towards the end of the bull run and very low interest rates, this really started to be a real contender for investment-only vehicles. People stopped thinking about guaranteed income provisions altogether, which then added even more value for those who actually were choosing it.

That was the evolution that I’ve observed from where I was sitting in the last 10 years.

Troy: That last part there, you’re talking about because interest rates, the economic environment is so favorable today for these types of products where consumers can still find value and be attracted to the fixed indexed annuity because there is the opportunity for consistent returns because the caps are 10%, 12%, 13% on the S&P 500, or these volatility controlled indices you’re mentioning, 150, 200%, 300% participation. The more favorable economic environment now that we’ve got past the zero interest rate policy, hopefully until the next recession brings us back, some of the rates are more favorable.

You don’t have to look at them as just income pools, whether immediate or deferred, they have accumulation qualities that can, for the most part, be relied upon to provide reasonable rates of return over time.

Laurence: Yes. That’s a great point. One thing that we do at The Index Standard, we forecast expected returns, and then we’ll put a product parameter on that. To give someone a pretty simple example, if I’m expecting that I might get 3% expected return and I’ve got 200% participation, 3 times 2 means I’m going to get maybe 6%. If we survey all the credits that we analyze, we expect that you might get anywhere from 4 to 7, 7.5% as some reasonable expected rate of return, but clearly, your expected credit is dependent on the index you choose and how that performs.

Branislav: Laurence, what I think you bring in is an important point, and that goes back to one of the first questions, where did these FIAs came out as a concept? I think it’s really important to reiterate these are fixed annuities, that we should not expect returns that are much higher or much lower than on a typical MYGA or a fixed-rate annuity. That’s what we are seeing in a broad market, that you get returns even when we forecast them, that they are anywhere really 2, 3% potentially higher than a MYGA rate or on the low end.

Basically, you are choosing to take some variability in your credit while still having the same principal protection for the perspective of a slightly higher credit than you may get every other year while you hold the policy.

Troy: For the person who’s never learned about fixed index annuities or maybe the person watching this that is getting introduced, it’s a good time to point out where your company, The Index Standard, really provides value to firms like ours and the industry as a whole because you guys have mentioned what we call multiple different crediting strategies, annual point-to-point, monthly point-to-point, averaging, annual lock-in, inverse trigger, performance trigger. These are what we call crediting strategies, and there’s a lot of them out there.

Then you add on top of that different indices that people can track and choose how we’re going to participate in the market. Then you overlay that with being able to allocate inside one product, maybe I want to go 20% to this index, 20% to this index. Maybe you can track the same index with two different crediting strategies even. It becomes very complex from a decision-making standpoint, but what you guys have done at The Index Standard is, I don’t want to call it a roadmap necessarily, but provided very clear visibility into– I would say, you guys talk about forecasts with the equity markets being reliable up to an extent.

You can talk about that. I wanted to say 50, 60% was the research over a 10-year period as far as the accuracy when we look at how they have performed. The fixed-income markets are pretty accurate when we’re looking at 10-year forecasts. You guys have done a couple of things. It’s great transparency inside the indices themselves as far as the mechanisms, the levers, which ones are most transparent, which ones have some opaqueness to them, which makes it very difficult to ascertain how they may perform in different economic environments. Then you’ve rated them from platinum down to, I believe, bronze.

You’ve done that. You’ve created a system that provides us visibility into what we can expect as far as the quality of the index that’s created, but then also the forecasting, what can we expect this index to possibly do? Then you’ve wrapped that up and put it into a nice, pretty deliverable that helps us understand, “Okay, we don’t have to hire 24 analysts to go through and understand all this. We can rely on you guys to do the work because you’ve done this for so long and really come up with an interesting way and easy-to-understand way of looking at the value proposition so we can help our clients make better decisions.”

Laurence: Yes. Maybe I’ll make a couple observations because I think you’ve actually articulated what we do so well. When I founded this company, where I was coming from, we wanted to really help people retire better. Our standard of care is we like to think about our grandmothers. Is this good for her? That’s actually where we’re coming from because we want to help people retire better.

I think, Troy, as you said, it’s become so complicated, “All these new indices, I don’t know how to understand them.” We have a rating system to help people decode them and understand them. We put a platinum, gold, or silver on the indices, and so on. I think the other thing that has been really challenging in this industry is some of these products have gotten pretty complex. I think we’ve analyzed, we see one fixed index annuity that has 33 choices that you have to make. It’s very tough when you have to choose 135% of the S&P, 175% of XYZ index, 200% of XYZ index with a 1% fee. It’s just hard.

I was speaking to someone last week and he summarized it in a way that I liked. He said to me, “It used to be guesswork, but with The Index Standard, it’s evidence-based.” That’s exactly what we want to do. We want to provide you, Troy, our client with all the evidence to make a good choice to help your clients so people can retire better.

Troy: Yes. That’s what you guys have done because it allows us to more reliably and confidently make a recommendation into a certain index or crediting strategy that we feel comfortable saying this is the reason for doing it, here’s the methodology behind it. It may not work out still, right? No one can predict the future, but the goal is to put ourselves in the best position to make 4, 5, 6, 7% without the downside risk. That’s the type of consumer that typically is looking for something like this. That’s really what helps us make better decisions for clients is the work that you guys have done there.

Laurence: Yes. I appreciate that.

Troy: Okay. We’ve talked a lot about the benefits here of fixed index annuities for a retirement portfolio and how you guys have really simplified what otherwise could be a complex process for consumers and advisors. What are some of the drawbacks? What are some of the maybe downsides to the fixed index annuity product itself?

Branislav: Let me start on that one. When we think about drawbacks, there is rarely ever a proposition whether or not. For me, the chief complaint about fixed index annuities, again, this can hold true for, let’s say fixed annuities or variable annuities as well, is the fact that they come with this period when you’re locked in, that there is this surrender charge period or the length of time when you can’t take your decision back.

You can do this in portions, you can do 10, 15% every year. You cannot take your money off the table, so to speak. Why is that? Because the insurance company has invested that money for long term, paid all the parties involved in allowing you to have this wonderful opportunity. Now to unwind that, someone has to cover that cost. The surrender charges are reasonably high. Now, going back to the history of it, it all started with equity index annuities where you had 15 year of a surrender period and then starting of 12, 15% of a surrender charge in year one going all the way down to zero over that period of time.

That was something that no one liked and it was really, really a lot of fees if you run into a situation that you need the liquidity. I think those days are gone. Now you have products that are like 3, 5, 7, 10 years in duration of the surrender charge period. You do have basically a trade-off between how much upside you get in one or the other. If you’re saying what’s a key disadvantage, is that money is locked away for a certain period of time.

I think the other drawback, and I don’t think this is necessarily a product deficiency but really lack of understanding and for lack of a better word misrepresentation, is basically two things. One is selling this on an illustration basis, basically looking into the illustration, printing that out and saying, “This is what this annuity will deliver,” which is with certainty a thing that’s not going to happen. Then the other one is this misconception that you’re participating in the market, that when you say, “Oh, I’m invested in a crediting strategy that’s linked to the S&P,” try various math formulae and different parameters, I think the easy answer to a client is, “Yes, this is like buying an S&P ETF.”

A lot of people say, “Yes, but S&P went up 15% and I get only 7%.” “Oh, but there was this cap.” “Okay, next year.” What happened next year? Again, it went up 20%. I got seven again. I think it’s that misrepresentation and ability to misrepresent something that was really meant to work as a fixed annuity as a market-participating vehicle like an ETF or a mutual fund. Those will be two things that I would focus on as conflicted, the chief concerns in this environment.

Laurence: I think, Branislav, you hit the nail on the head. I would just maybe add, I did refer to say they can be a little bit complex, but some of these indices that they’re putting into some of these fixed index annuities are a little new and they can experience variable performance. Other than that, I think they’ve got a lot of great features too.

Troy: When we talk about the complexity what we’re getting into is the amount of choices that someone has as far as how they earn interest inside that fixed index annuity. At the core, it’s you make a deposit, you have a principal-protected financial tool for part of the overall portfolio. If you make good choices, let’s say, because you have the methodology and you have the research and you have the forecast or you have quality indexes and quality crediting strategies, it’s a safe financial tool for part of an overall retirement plan that you can reasonably expect to make somewhere between 4 to 7% and lock in those gains.

Then the benefits you mentioned, Branislav, of possible long-term care benefits, enhanced death benefits, lifetime income benefits. For the consumer though, it’s really identifying which product may be best for my portfolio, which crediting strategies. That’s where a good advisor really comes in, someone that they trust because annuity products pay commissions. Most commissions on annuity products these days are 6%, 7%. You have people out there who maybe don’t understand some of the nuances that we’re discussing today, and they’re focused on generating revenue for themselves or their firm, and they may misrepresent, to your point, Branislav, that this is an equity replacement for your retirement portfolio, and it’s not. It’s a replacement, in my opinion, for the fixed income portion or the CD portion of someone’s retirement portfolio. I’m glad you brought that up because one of the marketing tools that people who don’t use fixed index annuities for their clients that they use, we often see is, well, these are marketed as equity replacements when they’re not.

Equities still play a very critical role in a retirement portfolio. Our job as planners to help determine, based on someone’s income need, their longevity, their growth goals, what portion, their willingness to accept risk and withstand market volatility, what portion goes to equities, what portion goes to fixed income and where does the fixed-indexed annuity fit because of the benefits that we’ve talked about before, and then like ingredients in a recipe, how do we tie that all together?

Laurence: Yes, that’s a great point. I think everyone’s recipe is going to be unique, but I think what people have started to realize was after a 40-year bond bull market, people thought, “Oh, I’m always going to get money from my bonds,” yet you look in 2022, the ag was down 13%. I think that the fixed index annuity can really act as a portfolio anchor or stabilizer that you know you’re going to never lose money, and that’s really important.

Troy: Laurence, you wrote a paper for Athene, which is a large insurance carrier, the number one seller of fixed indexed annuities currently in the marketplace, and Athene’s just having an amazing year. The research really focused on what is a volatility-controlled index. We’ve talked about, and I think most people are familiar with, tracking the S&P 500.

You have a floor of 0, maybe a cap of 12, gains lock in every 12 months, let’s say, but your participation rate there may be 100, but they capped, so that’s the implicit cost. What is a volatility-controlled index? What are the costs associated with a volatility-controlled index, and how do they have participation rates of 200%, 300%, and what can consumers expect?

Laurence: Sure. Let me break that down in two ways. I’ll describe what a vol-control index is, and secondly, I’ll talk a little bit about the power rates and why they’re much more efficient. Firstly, a volatility-controlled index is an index that smooths and cushions. You can think about it as providing a buffer. They are stabilized, they’re not as wildly volatile as the S&P. That’s what they do. Now, how do they do this? Very simply, what a volatility-controlled index will do is the following.

It’ll look at something called volatility, or some of you may have heard of the VIX, which is known as the fear index, and often what happens is, when the VIX goes up, risky asset prices go down. What a volatility-controlled index simply does is, it monitors the volatility, and if it sees volatility rising, it’ll take some money away from, let’s say if it’s invested in a bunch of stocks, it’ll put some of it into cash. The way a volatility-controlled index provides the stable and cushioned performance is, it toggles between some risky assets and cash. That’s all it does.

That’s how it provides you this much more stabilized performance. That’s what they do. Now, to keep it quite simple, if you think about the S&P, it’s got a wide range of outcomes, and some of those outcomes could be very high outcomes. If I’m hedging that, and if I have a high outcome that I may have to pay you, I’m going to charge you for that. That means my option is going to be more expensive. Now, a risk-controlled index, because it’s cushioned and smooth, it has a much lower, more constrained range of outcomes. If that range of outcomes is lower, it means the option cost is lower.

Now, the way a participation rate works is, you can think about it like going to fill up your gas tank. Let’s say I got $50, or let’s say my gas tank takes $50, and my budget is $50. That means I can fill up my gas tank 100%. Now, the S&P, because it’s a Mustang, it might have a very big gas tank, so to actually fill up my gas tank might cost me $100, but let’s say I’ve only got a budget of $50. That means I can only fill up my Mustang 50%. Same as the S&P. It’s expensive.

Now, let’s look at a risk-control index. Let’s say the gas capacity to fill up that tank is about $50. However, if I have got $50 in my back pocket, I can fill it up 100%. Now, in actual fact, some of these risk control indices, their gas tank capacity might be 25. If I’ve got $50 in my pocket, and it costs me $25 to fill up, I can fill it up twice. That’s 200% power rate. That’s how you get these higher power rates. Because these volatility control indices are, they’re very cheap options. They’ve got very constrained outcomes. They’re actually much cheaper. Then the insurance carrier can offer you more exposure to them.

Troy: Because there’s not a person in there going from stocks to bonds or stocks to cash. At least to my understanding, most of these, if not all of them, there’s a rules-based methodology that the index follows. That’s part of what contributes to the constrained range of outcomes, which makes the index able to essentially buy more options or the budget has room to purchase more options because they cost less because of the constrained outcome possibility. Is that correct?

Laurence: Yes, that’s correct. I’m so glad you brought that point up because I think one thing we see in the industry is that some people get confused, and they think there is a portfolio manager when there’s an index. Let me clarify, there is none. Even if you see an index that has been branded with an asset manager’s name, there is no portfolio managers. That’s such a great point. It’s very important to clear that up.

These are rules-based and algorithmic. The index will always say, for example, buy 100 cheap stocks. Then it might say, buy 100 cheap stocks. If volatility goes up, instead of buying $100 of the cheap stocks, put 50 into the cheap stocks and 50 into cash. It’s always rules-based, algorithmic and preset.

Troy: Just to bring this back down to the basics for the person watching who may be new to fixed-indexed annuities. You transfer, let’s say, 200,000 to a fixed indexed annuity. You have your contract. On that application, you get to choose how you want to earn interest. One of these methods that you can choose is a volatility-controlled index. If you allocate to that, again, you have downside protection. You won’t lose money if the index goes down, but you may get 200% or 300% participation in the upside. If it makes 3%, you may make 6 or 9 for that 12-month period.

Everything that we’re talking about here ties back into the choices that a consumer can make with their fixed-indexed annuity product. Then you have 25, 30 carriers, probably more. You have hundreds of products. You have thousands of indices. Bringing it back home, that’s where you guys come in because you rate the indices with respect to their transparency and methodology but as well as how they credit interest and provide forecasts.

There’s a ranking system, and that helps firms like ours have more visibility into what can we expect from a consistent return standpoint from all the products out there in the marketplace. We can help people make better decisions. I just wanted to bring that back home. Why would a consumer choose a volatility-controlled index to allocate to inside their fixed indexed annuity versus just going with the S&P 500? If they can get a 12% or 13% cap with no risk, the principle of the market goes down, why would a consumer go in that direction?

Branislav: Troy, let me just say something based on what you just mentioned. I think that that’s a key, going back to why we exist, how you are helping others, is to have a good experience in pre and in retirement. Part of the index choice, strategy choice, even product creation is what we call a good in-force experience. What’s a good in-force experience for a fixed annuity is that you have a consistent credit coming every year so that you can plan around it. This is not a Bitcoin portion of your portfolio. This is not your Apple or Google or AI bet.

This is probably something that will fund your core expenses, your the baseline of the portfolio. You’re looking to get as consistent amounts of credit on a go-forward basis so you can plan around it. Again, that’s something that I credit to Laurence, but if you think about choice for volatility-controlled index inside the FIA, it’s like in baseball. You can win a game with three home runs in three separate innings, or you can get bunch of singles across all of the innings.

When added together, the outcome will be the same. You won the game, the score sheet at the end, [unintelligible 00:45:00] looks the same, how you got there is really what can make a difference. For those who are sensitive to that sequence, to getting a credit each and every year, A, selecting one index may not be the best option. I think selecting multiple is the way to go. Then importantly, choosing something that can be that bedrock, that constant force of bringing the credit in and then building on top of that in addition.

Laurence: Yes, I’d love to add a couple comments there. I think these benchmark indices are fantastic. They’ve been around for a long time. If you go back 100 years, what you’ll see is the returns oscillate. They go up, and they go down. Now, if I look at the last 10 years, we’ve had a fantastic last 10 years. S&Ps averaged almost 10%, double-digit returns. That’s amazing. I think we’ve really all forgotten that. We’ve been so spoiled. Everyone expects that the S&P is going to carry on doing this. If you look at historical returns, they go up and down.

Secondly, the S&P, the NASDAQ, Russell are fantastic indices. The U.S. stock market, again, if you look back over 100 years, it doesn’t always perform the best. You can never be sure. What I like to say is a little bit along the lines of Brian’s lab, you really want to blend in some risk control indices to your main benchmarks and build a diversified portfolio. It’s nothing wrong with adding a multi-asset index or some international exposure to your favorite U.S. index that you may like. Just build a diversified portfolio to ensure consistent credits. That’s what I would think about.

Troy: The unique quality, of course, with the fixed index annuity, if you’re going to add diversification to the retirement portfolio with multi-asset indices or international indices, is the inherent protection of principle if everything goes down or if those particular indices go down. Most clients that we work with, they care more about the return of their money as opposed to hitting the home run and getting the highest return possible on their money.

Again, that’s where we talk about planning in the context of trying to achieve someone’s objectives but using the different tools like ingredients in a recipe. You’re baking a cake, and you don’t put enough flour or not enough sugar, it may not come out tasting the way you want it to. If you have the appropriate ingredients, and they’re measured or allocated how they should be based on probability and a good methodology, you can expect to have a more consistent experience over time.

That’s what we really want once we’ve begun that distribution phase, because having 3%, 4%, 5%, 6%, 7% positive returns in the distribution phase consistently really eliminates a lot of very bad things that can happen during that time of life.

Laurence: I couldn’t agree more.

Troy: Branislav, why are there so many indices out there and the role that carriers play in this whole space other than underwriting them? Can you talk to us a little bit about that?

Branislav: Absolutely. Yes, Troy, that’s very thoughtful and deep question. When you look on a surface, someone like us who monitor the entire market, we can say there is many indices to monitor, many indices to rate or to forecast. You really slice and dice the distribution environment. You see that in every distribution channel, whether it’s a bank, a broker, dealer or IMO channel, you then start cutting that index space, especially on insurance products, into meaningful chunks. Then you do that by distribution firms. Advisors will have dozen or two dozen choices.

Something that on a surface looks like 200, 300 indices to sift through, they would have dozen or two dozen choices based on the carriers that they cover or distribute or sell. Now, one important thing is to always go back to the source of all this, and that’s carriers, because I believe that they’re not credited enough with the thought process that goes into creating the comprehensive product set. For them, I think they’re also thinking high level of what we just discussed.

They wanted to ensure the best in-force experience, meaning not just one good index, not something they will be getting home runs occasionally, but offer a diverse set of indices that if you allocate to properly, you will get that saying that X and Y carriers annuity now as a total package had that good experience of constant credits that allowed you to have it as a bedrock of your retirement portfolio.

Again, product managers, actuaries, are actually doing their due diligence, some of them hiring us as well to help them with that, in selecting the high-quality indices, indices their value adds to their existing product set, removing the indices when they’re doubling up exposure or something that does not prove to operate as expected within the insurance wrapper. There’s a lot of thought that goes into it. I would argue that in some cases, there is not enough choice to provide the diversification that everyone is looking at at the individual annuity level.

Troy: One of the things that I really appreciate is what I’ve seen over the past 15 years or so in the marketplace is one, the transparency, but also there’s an inherent system of checks and balances, which the marketplace of course provides, if you think that invisible hand.

When we come across a carrier that, maybe over the past six, seven years, we’ve seen from afar, we’ve spoke to friends in the industry or maybe wholesalers or people at other insurance companies at the executive level, when we’re doing our research and understanding the product marketplace, there really is a system of checks and balances inherently out there, where things are much more transparent today than they were possibly 20 years ago or so. What I mean is carriers are competing for the business from firms like ours and many of the people I know in this industry because consumers can’t go direct to insurance companies and buy these products.

You have to go through a licensed agent who is contracted with that particular carrier. If we see a carrier not doing or providing a sound quality product and choices within that product for the marketplace, we’re going to go in a different direction and start to work with other carriers. That’s one thing that I do appreciate is it seems that the marketplace itself is providing a really good check and balance for these carriers. The products are becoming more transparent and also a higher quality from my experience. Would you guys agree with that?

Branislav: I would say absolutely. I think that was absolutely necessary given how many new entrants you have in a space, both on the index side, as well as on a carrier side. I think it’s super important to have certain level of transparency, checks and balances. Gatekeepers like our firm and few other, they’re actually adding a level of due diligence and helping you in the process of making sure that you’re making the best recommendation or best decisions for your clients. I think it’s necessary. I think it’s getting better and better over the years. I sure hope that doesn’t become counterproductive in the near future, but I think we are on a good trajectory.

Laurence: Yes, and I agree. I think you see a lot more thought around the choice of the indices. You’re seeing a lot more choice and thought around the crediting strategies, the way some people have got ladders, you could lock them in. Then again, around the riders, there’s a lot more options, a lot more choice. Even one of the carriers today has a feature that can replace some of social security. That goes away. I think you’re right. You’ve seen a lot of improvement. It’s become much more competitive. That’s generally good for the end consumer.

Troy: I view them as tools. We always talk about financial tools, but if a client has a particular concern or objective, there’s usually going to be some type of niche product out there that has been designed to specifically address that. Long-term care doublers is one good example where the lifetime income doubles for up to five years if someone needs home health care or long-term care. As far as the evolution goes, when those first came out, and there are still some out here like that, where once the income starts, if the cash value of the product goes to zero, the income continues for life, but you no longer have that long-term care doubler.

Whereas now over the past three, four years, we’ve seen products where even if your cash value goes to zero because you’ve received so much income, you still have that doubling of the lifetime income benefit for home health care. Now, it can cover either spouse with certain carriers. That’s just a microcosm of the evolution of the industry, but also how these products are being custom created to fit specific circumstances.

Branislav: I think you’re making a great point there. I think what allowed for that is that now these products have been around the block for quite a long period of time. What carriers and pricing and product actuaries are seeing, they’re seeing what we call the location or utilization behavior. How many products actually are sold and then flipped into another product that are actually ever triggering any of these benefits.

How many of these benefits are underutilized from the efficiency standpoint of triggering income early or late? Those things and having experience now with a policyholder behavior, I think allows people to offer even more value than ever. My general recommendation is that these products these days carry so much value in them that I would personally recommend my grandma to keep it and trigger it optimally and enjoy the benefit of others not doing so.

Troy: Laurence, you look like you wanted to add something there.

Lawrence: Just such a great analogy. [laughs]

Troy: I’ve not thought about that previously, but it makes a ton of sense because if you’re pricing the product to bring to market, and now you have these utilization rates over the past 10 years since some of these unique features have been added to the products, and you see 70% of the ones that we sell that have this benefit that we previously priced at this cost, half of them are being rolled into something newer, and we don’t have that liability on the balance sheet anymore.

The other half maybe are utilizing the benefit. Now, you can build in this margin of error based on the utilization rates and provide an enhanced structure, more value because you can factor that in. Of course, insurance companies, we all know the actuaries, they know exactly when we’re going to die and how much care we’re going to need and the cost of it. That additional bit of information puts them in a position to provide more value. Okay, one last question, guys, and then we’ll have a summary at the end here because I think this is important because you mentioned it about the past 10 years being so good in the marketplace.

New products that are coming to the market. We’re seeing some illustrations with volatility-controlled indexes, maybe they’re a year old, but they have the hypothetical backtesting, and they show a 300% participation. The consumer can expect to average 15%, 16% per year, and we all know that that is unlikely. Based on the rules-based methodology of that index, if the next 10 years is just like the last 10 years, that is one of the possible outcomes. I just want you guys to speak to what should the consumer really expect with these types of products for their retirement and who is the type of person that could benefit from considering as a replacement, as part of the fixed income portfolio, a fixed indexed annuity.

Lawrence: Let me take the first part of that, and maybe Branislav can take the second. Just when I’m thinking about illustrations, let me make a couple of points. The first thing is, I know all three of us drive cars, and I’m pretty sure most of your audience drives cars. When I drive my car, I don’t look in my rearview mirror. When I drive my car, I look in my front windscreen as well, my windshield.

Just like when it comes to an investment product, you want to look at the illustrations, you want to look through your rearview mirror, but you also want to think about what’s coming to you in the future. At the Index Standard, what we do is we average forecast from about 40 asset managers, and we get a view across stocks, bonds and commodities. What we see is, as I said a little earlier, we’ve been treated to double-digit returns. When it comes to large-cap US equity returns, the average of these 40 asset managers, they’re expecting about 5%. Returns may come down. On the other hand, we expect returns now from fixed income to go up. We’ve had rates at sub 1%.

On fixed income, we’re now seeing you might get 3%, 4%, 5% return. You just have to look to the future. I would be really skeptical on a backtest. You want to blend that in with your future expectations. You may think that value as a factor is going to do well. You may think Athene’s going to do well. You may think emerging markets are going to do well.

You really want to think about what areas of the world you think are going to do well and then try tailor your choice to the crediting strategy to match those areas. That’s also why I think one really needs a financial professional, because financial professionals have got a really good hand on this, and they can guide you and help you make those diversified and optimal choices.

Branislav: Thank you, Laurence. I think this is the positives in how to do all of this. I’ll just hinge on your analogy. I would just like to be the sound of caution. Your analogy is like blasting down the highway and looking strictly in your rearview mirror. No one does that. Illustrations are really good at showing what the arithmetic is in a product. It tells you if index goes up, if index goes down, if you take income, if you add premium. I think they’re extremely valuable from that point of view.

I think over the last 10 years or so, they weren’t even that much misleading. They’re always misleading from a sense that you will never get what I say because past, it’s never indication of the future. What worries me today is the fact that we have clash of two environments. We had a bull run with near zero interest rates. Now, we have relatively volatile markets with, again, looking at the last 10, 15 years, historically, what’s considered high interest rates in that context. Now, your option budgets are high, your participations are high. That’s something that never existed 10 years ago.

They could not coexist with the zero interest rates. Yet you’re taking 300% participation that would never exist and applying it to a bull market performance of an index, multiplying the two and ending up with 20, 30, 40, in some cases, even more percent of annual return in a fixed annuity. To me, that requires a sound of caution. Basically saying, yes, that’s how arithmetic is panning out. When you take a number from today and a number from 10 years ago, you multiply them. It’s very important to understand that these two numbers are coming from two very different economic regimes. I think now we are in a position where this is as problematic as it ever was.

Troy: The clash of those two economic environments, that’s where the financial professional, it’s their responsibility to explain, this is what the illustration shows, but why you shouldn’t expect this is because we didn’t have 300% participation rates during the zero interest rate period because that’s not economically feasible. Those 0% interest rates is what fueled 10% average returns in the S&P 500. That’s the financial professional’s responsibility to really communicate that to the client and help them understand we’re designed to average 4%, 6%, 5%, maybe 7%. If you’re happy with that and no market risk, it may be a tool that you can add to the portfolio but not 15%, 20% a year.

Branislav: Absolutely. The way I think about these two economic environments is like it’s half a dozen or the other six. Now, when you’re putting this together on today’s illustration, you’re seeing a full dozen. It looks like there is no trade-off. Again, that looks appealing, that looks appealing to the end consumer. That sounds like an easy sell to a sales agent, but that’s where the sound of caution really comes into play.

Troy: One last thing here reminds me of life insurance policies that were sold in the late ’70s, early ’80s. In those illustrations, they would project forward high interest rate periods for the next 30 years. You had whole life policies or variable ULs, and we see them now 20 years later, 25 years later. The original illustration showed conservatively they’re going to make 12% a year.

Of course, interest rates came down substantially. The current rates inside those policies reduced, and the cash value performance was nothing like what the original illustration showed. That was another example of a clash of two different economic environments, resulting in consumers maybe having unrealistic expectations of what the actual product was designed to do. Anything in summary as we close up the interview here today, guys?

Laurence: I could quickly summarize some of the Athene research if you wanted, but I think otherwise it’s been a great conversation. We’ve hit a lot of key points, and I think it’s a very balanced conversation to educate people and be a little bit cautious against some of these crazy expectations. I think it’s been great.

Troy: We reached out to Athene, and we got permission to share that.

Laurence: Yes, I also asked them as well.

Troy: You guys did? We’re going to put a link to that in the video. If you want to maybe summarize any of that research that you guys did for Athene in that white paper, go for it.

Laurence: At The Index Standard, along with Trent McKinnon and Jay Watson and myself, we did some research into risk control indices because they’ve been around for 30 years. We really wanted to see how does a risk control index do over the last 100 years. I think there’s three points I’d like to highlight. Firstly, what we did was we went back, and we created a risk control index all the way back to 1900. Now, remember an index is rules-based, it’s algorithmic. We took the rules, and we ran them back to 1900.

We created a risk control index, and we compared it to a regular index. What we found was for when we looked at that on the equity side, 80% of the time, the risk control index outperformed. On the multi-asset side, 67% of the time, the multi-asset risk control index outperformed. When you go back 100 years, the risk control feature really works very well. The second observation I’d like to make is if I look at the top 10 drawdowns of the S&P, in fact, six of those times have happened since 1970. Anyone who’s been born after 1970, you’ve experienced these drawdowns, and this could happen again.

That’s a really important thing. Drawdowns in investing happen. Number two is drawdowns really hurt you because it can take a long time for you to get your money back or even get some positive money that you can get credited. I’ll give you an example. In 2020, we looked at 76 live risk control indices and what happened to them compared to the S&P. 2020, March pandemic, the S&P went down about 34%.

The risk control indices we looked at went down by 11%. They are cushioning, and they’re smoothing. They’re doing their job. Then finally, when we had this risk control index going back 100 years, the other thing we wanted to do was we wanted to recreate a fixed index annuity payoff over 100 years. We did that. We were able to figure out a budget, the cost of the option every year from 1900, 122 years.

My colleague Trent did a great job on that. What we found something really interesting, we found if you invested $100 into a fixed income index over 122 years, you got $325. If you invested that same $100 into a fixed index annuity, you got over $1,200, four times as much. You’re getting market safety, you’re not getting any drawdowns, and you’re getting the ability to enhance your return. Those are three features that I think are worth highlighting. Troy, as you said, the link will be in the bottom of the podcast

Troy: I encourage our listeners to go and check that out. Only question, the risk control index that you created with the index standard rate it platinum, gold or silver?

Laurence: That’s a great thing. We haven’t thought about that. Given it, I’ve performed a benchmark, I’m sure, to do pretty well.

Troy: Guys, thank you very much for your time today. I really appreciate it and look forward to talking with you soon.

Laurence: Thanks so much, Troy.

Branislav: Thank you, Troy.

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