Why volatility control makes sense in FIAs

Fixed indexed annuities have become a popular tool for those seeking both protection and market-linked growth in retirement. Many FIAs today include volatility-controlled indexes, a feature that has drawn interest but also criticism. Although past performance of these indexes has not always met expectations, the purpose of volatility control is often misunderstood.

Understanding fixed indexed annuities

A FIA is a retirement savings product that offers a unique combination of principal protection, tax-deferred growth and market-linked interest potential. Unlike traditional fixed annuities, FIAs credit interest based on the performance of a market index — such as the S&P 500 — while protecting the investor from market losses. The gains are typically limited by features such as caps, spreads or participation rates, which define how much of the index’s performance is credited.

FIAs can also provide guaranteed lifetime income through optional riders, making them a popular choice for individuals seeking both security and the opportunity for moderate growth in retirement.

How FIAs use volatility control

FIAs offer a way to earn interest based on the performance of a market index, without the risk of losing principal. But how much interest is credited depends largely on participation rates, which are tied to the cost of options insurers use to hedge these guarantees. One major factor that affects option costs? Volatility.

When expected market volatility is high, options become more expensive. This pushes participation rates down, which can reduce potential returns. The problem is that volatility estimates are often higher than what actually happens, especially in rising markets, meaning policyholders may earn less interest than expected during strong market periods. That’s where volatility-controlled indexes come in.

The potential benefits of volatility control 

Volatility control indices automatically adjust their exposure based on current market conditions. When markets are calm, they increase exposure to capture more upside. When things get rocky, they dial it back to manage risk. The result? A smoother ride — and lower option costs.

Ultimately, volatility control is a response to a structural inefficiency in option pricing. Lower volatility means lower option costs, which allow insurers to offer higher participation rates. This can boost the amount of interest credited to your annuity.

Rather than dismissing these strategies as overly complicated or limiting upside potential, policyholders should view volatility control as a thoughtful enhancement to participation rate strategies within FIAs, allowing for more stable rate setting and reactivity to market volatility.

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Daniel Getler, is vice president of index and fund solutions, Group 1001, New York. Contact him at [email protected].