My wife and I and some friends had the pleasure of experiencing New York City at Christmas this year. A centerpiece of the trip was the concert by Andre’ Boccelli at Madison Square garden. The virtuoso performance by the world-renowned blind Italian tenor was to weep for, as he was accompanied by a symphony, a choir and other soloists. The complex arranging of this event doesn’t even include the years of diligent practice and painstaking development of talent that was behind the scenes resulting in the simple beauty of the concert as we were entertained and transported by the soaring renditions.

I was conversing with an insurance company lawyer and acquaintance a while back.

He asked me, “What do you think of all of these new innovations in indexing, like the low-volatility strategies adopted by more and more companies?”

I told him I loved the innovation. He responded that having fought the SEC Rule 151a battle and won insurance regulation for qualifying FIAs via the Harkin amendment, wasn’t I concerned that these new complex crediting methods, with their securities similarities would reopen a debate over securities regulation. “How can an agent explain them, and how can a client understand them?” I told him they are simple, and in fact as transparent as traditional annuities, eliciting an incredulous look. Quite a number of these new crediting methods use the same S&P 500 but with a volatility management feature added to improve the results and the safety of the annuity. He asserted that these new crediting methods are security-like due to complexity.

My friend thought the “simple” old declared rate annuity was the easiest to explain: a simple rate of interest is declared by the company for the year. He said it was impossible for an agent to explain indexed crediting of the new type without becoming a securities rep. I asked him to explain in “non-securities” language, the company’s entire investment philosophy for a “simple” old declared rate annuity and how all of the types of securities they purchase work and how portfolio hedging and segmenting affects the simple interest rate. It can’t be done. In fact, the new and old FIAs have behind them these same typical insurance company assets. Those assets generate what becomes an “option budget” in an FIA that is used to buy the option or hedge assets, allowing the company to credit the interest by the rules-based formula. This one additional company asset, the index hedge, creates a delay in interest crediting (usually one year) until the formula is calculated at the anniversary or the end of the interest calculation period. The parameters of the formula are fully disclosed to the client, and access to current index information is available online. Beyond this should an agent stick to company materials to describe the index. Of course, the client has no more idea how the index will perform that year than anyone does, yet most FIA strategies have on the average credited more interest than average declared rate annuities.¹

In recent years, the innovation of low volatility strategies has allowed an “uncapped” strategy to capture more index gain potentially than the annual cap strategies very common today. Low U.S. investment interest rates and resulting lower interest option-hedging budget makes valuable a method with higher upside at lower hedging cost. Most of these designs have no current interest cap because of their volatility control feature, so they will behave like they have participation rates instead.² In some, the index is designed to shift between various categories of assets (equities, bonds, treasury futures) based on the recent volatility of those assets. What comes out of this process is a simple rules-based interest formula In any case, all that matters to a client is the interest credit based on an index (and any spreads deducted). Like all annuities, FIAs retain the protections and regulation of insurance only products – no securities-like gains or losses, no negative interest — with all the minimum requirements of state standard non-forfeiture laws and payout guarantees. Some critics remain unconvinced, perhaps believing it better to impede progress and innovation while desiring the simplicity of the lowest common denominator and we-know-better protectionism.

Do we wish for those innovations to be forestalled? Should innovation be stifled, and only the simplest of simple annuities required? Should we still be required to consume Ma Bell telephones, three network TV broadcasting stations, and cash-only house purchases? Shall the “manufacturing” complexity for insurance companies in the “production” of these evolved annuities prevent us from enjoying the simple financial benefits of them? I think not. A crusade for simplicity will neither stand in the way of my purchase of the concert ticket nor my recent purchase of the evolved FIA, at least for now.

Mike