Indexes must evolve with inflation, rising rates, says NAFA panel

Indexed funds must adapt to inflationary times.

By John Hilton

Many popular indexes supporting annuities and life insurance today might not work as well in a recessionary, high-inflation, and rising interest rate environment.

Those indexes underpin many big-selling products through a strong historical performance record. With the market on a strong 15-year growth run, most of the historical periods chosen for sales tools like illustrations show nothing but positive news.

Until recently.

To summarize the situation the industry finds itself in, Sarah Garrity recalled a quote from the 1988 movie, "Hoosiers": "Don't get caught watching the paint dry," she said during a recent panel discussion at the National Association for Fixed Annuity's Annuity Leadership Forum in Washington, D.C.

"I think that's where we are right now in terms of product development and what we're thinking about the future, that it's not a time to stand still," said Garrity, director of national sales for the annuity distribution team within BlackRock’s Retirement Group. "A lot of custom indices were perfectly positioned for outcomes of the past. And they, quite frankly, don't address the challenge of inflation or the opportunity of rising rates."

During a conference session last month in Washington, D.C., a similar panel posited that rising rates could open the door for annuities sold with risk-controlled indexes. These types of products will utilize, for example, a heavy bond component in order to reduce the risk elements.

Garrity agreed that volatility controlled indexes are sure to increase going forward. "There is no protection without performance with inflation where it is," she said. "So I think that's the first thing that we're seeing in terms of how is this affecting product design."

Inflation hedge

Industry veteran Sheryl Moore noted the growth of indexes during a recent Wink, Inc. webinar. When Moore started Wink, a industry intelligence firm, 17 years ago there were a dozen indexes. Today, there are at least 150 different indexes, many of them proprietary indexes developed by major carriers.

Most of these indexes are a mix of different indexes, and other assets like bonds. A standard index, such as the S&P 500, has a lengthy history of returns, upon which a reasonable projection can be made simply by looking back. Most proprietary indexes do not have this type of history.

Phillip Brzenk is global head of multi-asset indices at S&P Dow Jones Indices. He told the NAFA audience that gold is a great inflation hedge to have in an index mix.

"Gold is positive year to date 3% or 4% last time we checked," he said. "So it's thinking about how can you incorporate something like that into a broader benchmark to actually have that exposure, actually have a more direct inflation hedge in your index."

Laurence Black is founder of The Index Standard, a firm that provides ratings on indexes. In a changing environment, indexes need to change as well, he said. Black used the analogy of a family who owns an SUV for when it's raining, a sedan for country driving and a convertible for casual outings in nice weather.

"In the past, what maybe you had was one index that could cope with one environment," he explained. "Unfortunately, we live in a much more complex world today. So I think what everyone needs to look for is more diverse packages. So if you think about an FIA, maybe what you want to see is different types of indices.

"Maybe what you want to see is a bunch of diverse indices that you can select that can give you those better outcomes."

Themed indexes more popular

The panel agreed that "themed" indexes are resonating with conscientious investors. The most common example is environmental, social and governance (ESG) investments. Clients are asking specifically for ESG options, Brzenk said.

"I'll tell you in the U.S., it's definitely not going to be as prominent as in Europe," he added. "In Europe, what we're seeing is you basically need to have an ESG tilt in your offering, otherwise it won't be looked at. I don't think the U.S. will ever get to that point, but we definitely see merit to exploring some of these themes in isolation."

An ESG investment is a stock that is rooted in values relating to environmental, social or governance issues, such as climate change, human rights, and data protection and privacy. For a stock to qualify as an ESG, it must undergo a rigorous evaluation process and adhere to certain principles set out by investment houses.

If the stock passes the initial evaluation, it is then scored based on the MSCI ESG index. ESGs can fall under three different categories in the U.S.: AAA-AA: Leaders, A-BBB: Average, and BB-B-CC: Laggard. This index rates organizations based on their exposure to ESG risks and how they manage those risks, and then assigns them one of the three categories above.

BlackRock had "a very successful launch" of its first ESG index within a fixed-index annuity last year, Garrity said. But it's not so much the themes as the basic thought and construction put into an index, she added.

"When we think about product construction, what it should come down to at the end of the day, is how can we create the best index that's going to create the best client outcome, regardless of a theme or a tilt?" she said. "At the end of the day, at least from our perspective, it really does come down to how can we create the most thoughtful index."

InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected]. Follow him on Twitter @INNJohnH.