New white paper urges annuity policyholders to understand and set the right expectations on volatility control indices in the current rate cutting cycle.

The American insurance market has been struggling to explain custom indices to financial professionals as volatility control indices gain in ground with over 100 offered in the fast-growing indexed-linked annuity space in the recent years.  

As the segment’s convergence with traditional structured products continues, The Index Standard (TIS), a New York-based independent provider of ratings and forecasts on indices, has released a white paper ‘Beyond the benchmark, innovations in custom indices’ in collaboration with BlackRock. 

The 16-page paper seeks to demystify the volatility control feature along with excess return indices, which are frequently used in combination, while shedding light on the fundamentals of index design and governance.  

A volatility control technique adjusts exposure between a set of assets and notional cash/fixed income with an aim to tame index fluctuation and attain stable returns. “Target volatility control is widely used in indices designed for annuities,” said Laurence Black (pictured), founder of TIS who also acts as an index strategist to Professor Robert Shiller at Yale University.

Traditional benchmark indices like the S&P 500 can be highly volatile, making it difficult to provide steady pricing for annuity-linked options, particularly in fixed index annuities (FIAs) where policyholders are more conservative, according to Black. 

“This paper has been very well received by insurance carriers and financial professionals,” said Sarah Garrity (right), director, head of retail insurance at BlackRock. “Because education is so essential in turning sophistication into simplicity of helping financial professionals and policyholders understand not just what a custom index is, but how it works.”

The FIA market delivered record sales of US$60.6 billion for H1 2025 while registered index-linked annuity (Rila) contributed to US$37.6 billion, as SRP reported.

TIS currently tracks over 400 custom indices offered or sold in the US annuity market, 125 of which have a volatility control overlay.  “The two biggest groupings in the volatility control indices are multi-asset and equity bonds. A lot of these indices are designed to be blended in with major benchmark indices,” said Black.

Diversification

The paper asserts that a high-quality custom index should feature diversification across geography and sector, which is potentially the only free lunch in finance.

“You may have your main portfolio that’s diversified across fixed income, equity, alternatives, commodities, and then you’ve got your insurance or structured products. Why should you just put all of that into a benchmark index when your main portfolio is diversified?” said Black.

For the volatility control indices tracked by TIS, 21 of them come with a decrement feature, a pre-defined reduction of synthetic dividend from a total return index. The overlay is being increasingly adopted in US structured notes but is yet to take off in the annuity space, said Black.

 “[Insurance carriers] are very sensitive to the complexity of the indices and to anything that could be construed as a fee,” added Garrity.

Compared with decrement, intraday mechanism has been more widely accepted in both markets as it demonstrates outperformance, added Black.

Excess return

To understand the volatility control, investors must grasp the concept of excess return indices which caught on during the low-yield decade from 2011 to 2021 when it was often difficult for insurers to generate enough yield to purchase options, writes the paper.

“I think excess return is a really topical thing right now. Not a lot of policyholders really understand them. It’s a very important feature to understand with interest rates being at the level that they are,” said Black.

Excess return indices subtract a borrowing cost based on policy rates from either a price return (excluding dividends) or total return (including dividends) index. It measures a return above risk-free rates, allowing option prices to be more affordable.

The paper resembles it buying a house with a mortgage. “You must pay interest on the money you have borrowed.”

Branislav Nikolic, head of insurance at TIS, points to the current high interest rates environment. “Today excess return indices are extracting around 4.5% to 5%. It’s a high bar that you have to cross to get into positive credit territory,” he said. “It requires careful consideration of multi asset, volatile control, type of return nature altogether.”

Furthermore, a well-designed custom index should follow transparent rules and have a solid underlying thesis that relies on proven investment insights from academic research or successful fund strategies, notes the paper.

An example is the disclosure amount of intraday rebalancing for an index which can be achieved through different techniques depending on the observing frequency and trading time.

“Transparency transforms the complexity and sophistication into confidence, and confidence is what drives adoption in the space,” said Garrity.

Click here to read the full white paper. 

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