This paper explores the use of the CBOE Volatility Index® (VIX)® in setting the risk charge (“fee”) for a variable annuity (VA)
product guarantee, and will demonstrate the potential advantages – both to variable annuity carriers and to policy holders – of
calculating the fee as a function of VIX.
This paper will analyze the use of a dynamic fee that more closely matches the guarantee and hedging costs in different
market environments, to address some of the difficulties faced by variable annuity carriers.
We first discuss the problems typically faced by carriers in matching fees and costs on typical VA products, even with a
hedging program in place.
We then explain how using a fee linked to VIX can help resolve these problems. Finally, we provide an illustrative example
where we apply this approach to a simple guaranteed minimum withdrawal benefit (“GMWB”) product.
We demonstrate how carriers may have improved ability to manage cash flow for hedging purposes, and more stable reserve
and capital outcomes under certain regulatory regimes. We also show that this may allow policyholders to benefit by having
more money exposed to equities in low volatility, rising markets.