Structured Products Americas Awards 2016
The variable annuity sector has been facing flagging growth prospects in recent months, with low interest rates and uncertain volatility dampening the attractiveness of some investment indexes. Insurers have instead been piling into fixed indexed annuities (FIAs), which provide capped exposure to higher-yielding indexes but with some downside protection.
Despite surging competition in the sector, Nationwide has established itself as a leading player. Having made a slow start in 2013, the US insurer boosted sales from $435 million in 2014 to $2.4 billion the following year, thanks to an exclusive deal with JP Morgan to license the bank's Mozaic index for its series of New Heights FIAs, and is the winner of the Structured Products deal of the year award.
"In 2014 we ranked twenty-third in FIA sales," says Michael Morrone, head of fixed and FIA product development at Nationwide. "But largely thanks to this deal, we climbed to sixth the next year and we were third for the fourth quarter."
Mozaic accounted for 66% of the premium allocations within Nationwide's New Heights FIA for the full year, and 76% since the index became available to Nationwide's customers in June 2015. This made Nationwide the fastest-growing carrier in the industry, ahead of the likes of AIG, American National and Lincoln National Life.
JP Morgan says the sales figures will probably double this year. The indexes became difficult to risk manage once they move beyond $2 billion in assets under management, so both companies are seeking ways to manage the risk. For instance, they're looking at more sophisticated ways to recycle the short volatility positions they have acquired from selling FIAs, by buying variance swaps or delta-hedged options on the S&P 500 from institutional clients who have a view on the implied versus realised volatility.
In 2014 we ranked twenty-third in FIA sales. But largely thanks to this deal, we climbed to sixth the next year and we were third for the fourth quarter
Michael Morrone, Nationwide
"The sales our partners have delivered have been really impressive and exceeded our initial expectations, which has led us to think about scale and capacity, and has brought new elements such as volatility recycling into the risk management process," says Brandon Igyarto, executive director in JP Morgan's structured investments team in New York.
Previously, Mozaic had only been linked to retail notes in China, Scandinavia and Switzerland, which were all live as active indexes from April 2009, but JP Morgan saw an opportunity to target insurance carriers looking to build products featuring volatility-targeted indexes.
Despite wrapping in 12 components across three asset classes - equities, fixed income and commodities – the Mozaic index uses just two functions to establish what to invest in: momentum and risk parity. The index is rebalanced every month to ensure the six components with the best positive performance are included in Mozaic the following month.
"Building indexes is kind of a balancing act," says Igyarto. "If you want something that always goes up, you can end up with complicated formulas that make allocations. It might have worked in the past, but who knows whether it'll work if market dynamics change? So, we try to focus on basic principles such as momentum and risk parity for this index. Momentum, in particular, is a basic investment concept. If it's working, leave it in; if not, rebalance it out."
The diversification of exposures also helps protect against an economic downturn, he adds.
"The case for broad diversification can be made looking at 2008, the main period of substantial volatility recently. As ‘risky' assets such as the S&P 500 were suffering losses, two-year US Treasuries were poised to benefit from the flight to quality. When you look at indexes like Mozaic, the objective, given nobody knows how the future will play out, is to try to have a broad asset base and an index that can adjust as the market dictates," he says.
In the year to date, Mozaic has generated a 5.41% return despite a comparatively poor first quarter for many investment firms. While the higher-yield returns going back to 2009 are impressive and certainly helped JP Morgan's case in selling the product to Nationwide, Igyarto pins the high sales figures on the bank's ability to look beyond just risk managing the client's exposure.
"We've tried to create a coverage model that meets the various needs of the carrier, including senior management, distribution, product development, actuarial and trading. We've learned there are many different aspects to a product launch and its ongoing maintenance, and we've tried to make sure we're responsive on as many of those fronts as possible," he says.
The US bank's willingness to follow up the deal with a support network of salespeople also won the favour of Nationwide's Morrone.
"JP Morgan was very willing to make sure Nationwide's members had every tool available to them to understand what they were investing in. They provided a team of four people that travelled to educate, and five more on a desk that our salespeople could call any time. That's been a key part of why we've been successful," says Morrone.
Igyarto says the aim was to avoid any scenario where a wholesaler is asked a question about the index and can't give an answer. "We've gone all over the country to help them understand this as best as possible, and our model is predicated on an overabundance of information. We have our own public website, historical allocation information, closing price data and even a YouTube video. All of that is public," he says.