Branislav Nikolic: Indices Are the Fuel. Products Are the Engines.

Paul Tyler (00:01) Hi, this is Paul Tyler and welcome to another episode of the L&A Hub. I've got a great guest on the show today — somebody who's been on another podcast multiple times: Mr. Branislav Nikolic. Interesting background, so I'll start there. From Toronto. PhD in applied math — dissertation on retirement and annuity optimization. He was doing AI back when it was still called machine learning. Spent a good chunk of time with research groups, very well known in the industry, and is now a partner at The Index Standard. Branislav — welcome. Did I do your intro justice?

Branislav Nikolic (00:43) Thank you so much. Other than the "founder" part — I have to give Lawrence Black the credit for founding The Index Standard. And I have to mention our third partner, Jay Watson. It's been a phenomenal three years. Paul, you were an early supporter, and thank you for that. Maybe we can do a bit of an update there. But I would love us to chat about everything indexed annuities and indexed insurance.

Paul Tyler (01:27) Let's start with the problem. What is the problem your firm — The Index Standard — is trying to solve?

Branislav Nikolic (01:37) There are a few layers. The original thesis was that we wanted to start helping people understand indices. At the time The Index Standard was founded — roughly five years ago — around 100 to 150 new indices came into the market. All brand names, big investment banks, asset managers, and it was really hard to tell them apart. What do they do? How do they work? What kind of returns do they provide on their own? What kind of returns do they provide inside structured products, annuities, index-linked insurance? All that was very complex, and it formed one leg of The Index Standard.

The other leg is — and this is relevant now with the NAIC illustration guidelines hopefully reopening — that backtesting started to play a massive role in everything. We saw the opportunity to come at it differently, with an approach of forecasting. Looking forward, applying what we call "the wisdom of Wall Street" through our proprietary algorithms onto all these indices. And then lastly: how does that apply inside the products driven by these indices — annuities, IULs, RILAs? Helping people understand how to diversify, understand their options, and get consistent outcomes that are really the one true goal of retirement.

Paul Tyler (03:07) I'm a big fan of fixed index annuities. I've worked for carriers most of my career. From a carrier standpoint, the problem I saw you solving was: how do I make it easier to make good recommendations and protect somebody's retirement income? FIAs are very, very good at taking risk off the table going into retirement — sequence-of-return risk, the market suddenly going down the day you stop contributing. Guaranteed income is a great solution. But it's tricky for a carrier to say, "here's what you should do with your client's strategy" — first of all, what's right for one client may not be right for another, and the carrier's not really in a position to do that. We had a lot of agents asking us for assistance on this. You stepped into a real interesting space that hasn't really been occupied. Is that fair?

Branislav Nikolic (04:50) I would say yes. The key for us was to bring these products closer to the people who benefit the most — the retirees, or people saving for retirement. Carriers play in the space across different distribution channels and different products, and everyone is trying to diversify their offering. But sometimes those choices can be confusing. Without dating myself — when I started looking at FIAs, we had three indices and three crediting strategies. Any combination of those was considered good diversification. Now you're looking at annuities with five to seven indices, different types of indices, different strategies feeding credits to the consumer.

So it's much harder to make an informed choice. Carriers are making a good effort to help people understand their products better, trying to funnel premium not into a single index or whatever illustrated the best last quarter, but into something that provides consistent credits over a long run. These products are five, seven, ten years in duration — you want credits in most of those years. Diversification is the keyword. And then: how do you achieve diversification without actually providing a recommendation? That's where we step in — helping people evaluate options, understand the indices, and giving them suggestions on how to allocate, working with their advisor who understands their situation.

Paul Tyler (06:42) Let's talk about that. The last time I looked there must have been 155, 160-plus indices across all FIAs. Has that number held steady, or is it still increasing?

Branislav Nikolic (07:04) There was a massive increase in the last five years, but I think we may have tapered off. We're getting into the second generation of similar indices. The economic environment changed quite a bit — we went from a period of low rates, where it was natural to have lower volatility targets, to slightly higher rates now. Carriers are pulling some indices off the menu and adding similar indices with higher volatility targets. So your number is roughly in the ballpark.

Some products err on the side of simplicity. Others basically try to capture everything and anything that could happen over the next five, seven, ten years — so you have the options to choose strategies that conform to the market environment. Different carriers take different approaches.

Paul Tyler (08:24) Before we talk about the future, let's talk about 2025. The S&P 500 still — and you know the stats — how much money goes into S&P-related strategies versus others? S&P did pretty well last year, right?

Branislav Nikolic (08:47) Yeah, it was a rocky year. It depends on the channel — bank broker-dealer versus independent — but I would say eight or nine of every ten dollars in premium are going into the S&P. There's more diversification in the independent channel because you have more freedom to set up these policies. Overall, S&P did really well — over 16% on the year. In isolation, that's great.

But my partner Lawrence has been saying for years that there were opportunities elsewhere, and our forecasts in the last two or three years pointed to those opportunities. Last year actually showed it. Gold did really well — over 60%. Silver was over 120, 130, 140%. Indices that combine gold and silver did very well. Emerging markets did really well, and on a risk-adjusted basis — what kind of return do you get for a unit of risk — you got maybe twice as much bang for your buck out of international indices than from the S&P. We are talking about retirement products. We're talking about diversification. Some of that premium could have been exposed to it, and the credits could have been really, really good for people.

Paul Tyler (10:44) These products are complicated to manage. The S&P was up, but I think this must have been one of the most volatile years for the S&P in history. So option prices are way up. From a carrier standpoint, if everybody puts their money in the S&P 500, the carrier has got to get value out somewhere else. So economically it's in the carrier's interest to diversify too.

Branislav Nikolic (11:20) That goes without saying. Risk-control indices and excess-return indices provide that stability — and a more consistent usage of what we call the option budget, basically the money the carrier gets to spend to provide exposure to potential credits. But you're right. Every time we quote the annual return of the S&P, that means if you bought your policy on January 1, that was 16%. We had events in April — a sharp decline, a sharp recovery. I'm not sure people who bought in February, March, or April will have the same experience as those who bought in January. Context matters. S&P did well; the only message is there were other pockets of value that did even better.

Paul Tyler (12:38) There's nothing like working with actual customers. Let me give you a story. I had a woman — somehow she got my name and decided I was going to be her personal customer service rep. She had a two-year vol-control strategy. Her family kept saying, why don't you put your money in this, look how it's going up, you haven't been credited. And honestly, I felt lucky — the market went way down right before her index was credited. I was able to show her the value of the FIA. I said, look — yes, you got credited nothing, but if you'd put the money in the S&P like your brother told you to, you'd be down 20%.

Branislav Nikolic (13:32) That's the key. "Going to zero is your hero" — the FIA mantra. I don't think it's ever fair to compare these to investment in an ETF, even if you had all those indices available to you. It's a different profile.

You brought up another important distinction we usually don't talk about: the duration of these strategies. Some are a year. Some are two or three years. A lot can happen, and you don't get interim credits — you only get them at term end. Diversification doesn't have to come only from index selection. It can come from strategy selection — staggering strategies so you get benefit from temporal diversification. Even if an index is on a steady pace up, you don't need a boom year. You can have two pieces of the same index in two shorter-term strategies and get the benefit. Many ways to put this product together. And the goal is always consistent credits that are slightly higher than your typical fixed annuity or MYGA. Never compare this to market returns.

Paul Tyler (15:06) You can't say it enough — these products are not investments. They're insurance. There's a reason for it. Speaking of which — vol control. The woman I just mentioned had her money in one of these vol-control funds. That was through the whole pandemic period, where volatility was just not what anybody had expected. How is that part of the market evolving?

Branislav Nikolic (15:52) The way we used to talk about getting credits from risk-control or excess-return indices was in baseball terms — singles and doubles, not aiming for home runs. It's a different type of play. When you have heavy hitters, bases loaded, you go for a home run. With risk control we've seen a lot of innovation — intraday risk-control indices coming into play. The analogy I'd use is flying on a plane. It has its risk-management capabilities, but flying on a modern jet versus something from 70 years ago makes a difference. One is going to be bumpier than the other.

There are benefits to the insurance company too — they can give you consistent annuity parameters; they know what they can count on. With the excess-return feature they can neutralize the effects of interest rates. We forget that we were in a historically low interest-rate period — option budgets were almost non-existent. People were trying to get exposure out of nothing. You needed it to be stable, and you needed it insensitive to interest rates.

When interest rates went up, that was the biggest shock — people didn't necessarily understand what excess return meant. It means you're borrowing to invest. There's a hurdle of borrowing cost. Three, four years ago, the illustration for an excess-return index and the regular price-return version were almost identical because the spread was a tiny interest rate. Now you have a 4.5–5% interest rate creating a gap — a massive hurdle the index has to cross to get into positive territory. We've published a few papers with NAFA, partnered with BlackRock, trying to help people understand. You always get that counteracted with better annuity parameters — higher participations. But at the end of the day, if you give me 500% participation on an index that returns zero, that's still a credit of zero. There's multiple things in play here, and that's where we try to help.

Paul Tyler (18:53) Let me change the dialogue to look forward. How does the 10-year forecast impact allocation strategy? Most of these products are intended to be held eight, ten, or more years.

Branislav Nikolic (19:30) It's tricky to think about this in one- or two-year terms. You're effectively locking in your money — which is a good thing. Over the last decade we had a phenomenal run in US equities. I still think we have huge valuation gaps, issues with the US dollar weakening, global shifts, increased volatility. All of that points to the fact that the next ten years are not likely to look like the past ten.

Using the last 10 or 15 years — historically phenomenal — as the expectations-setting exercise for someone in their early retirement is flawed on its own. Even if you take that compounded return — S&P average around 14% — repeating that over the next ten years is a huge "if." We'd be looking at ballooning valuations. Is that really the only scenario we should look at? It's a possible scenario, not a likely-only one.

You start looking into where returns come from — US, around the world, commodities. We try to bridge the gap between forecasts for the asset classes themselves and how those affect the index or crediting strategy inside an annuity. Then you see whether that alters how you place premium. If you only look backwards, put 100% into the S&P because that's what did phenomenally well. We held an event last year and one of the panelists said something along the lines of: we've been preaching diversification for the last 10 years and we've been wrong 10 years in a row. That said, I believe that's the story for year 11. People need to look beyond, and forecasts are pointing to other directions in addition to US equities.

Paul Tyler (22:16) From my perspective, I've skewed my personal portfolio toward AI. Three years ago this looked like the Industrial Revolution. Who made money in the Industrial Revolution? Steel makers, the coal companies, energy. Today it's the hyperscalers, data centers. Right now that's a bet. Will Nvidia, Microsoft, Amazon be the factories of the future? Or will industries across the S&P 500 be rewritten as code-driven businesses and we see a broad rise in productivity? Have you pushed that far in your thinking?

Branislav Nikolic (23:33) Rising productivity is going to happen no matter what. I'm thinking more about the transformation than overall gain or loss — there's going to be repositioning.

Paul Tyler (23:50) Will it be jagged, with a few companies emerging that have created all the wealth, or will we see a lot of these industries reinvigorated?

Branislav Nikolic (24:05) I think it will reinvigorate a lot of industries. We can talk about our own industry that's been operating in the 19th century for the last century or so. There's going to be massive change in what people can do — and what people can do on their own. That's a cost-benefit analysis. You can go to Claude or ChatGPT, ask for legal advice, and it will provide some. The question is, when is the moment to talk to the lawyer? Same holds for the advisor, doctors, veterinarians. I think it's going to empower all those other industries to do more with less and do it better. But this is a long transformation. We're living through the first few innings.

Paul Tyler (25:30) If we said: what are the impacts of AI on the FIA business — there are at least three or four layers. One: how you sell, market, and learn. Two: how you pick indices based on how AI is going to impact the overall industry. Three: the indices themselves — does machine learning open up vol-control opportunities we can't imagine? You did the machine-learning portion in your dissertation. Now we've taken machine learning to another generation. How is it going to impact all these problems?

Branislav Nikolic (26:27) Interesting question. It's making things simpler on one end and more complicated on the other. In index design, you have an open architecture — you can do whatever. The beauty of machine learning is you don't have to be rigorous about what goes in. It's all parameterized. When I did grad school and was writing that piece of my dissertation, that was part of my pitch — you don't have to do rigorous math to understand the index.

The hypothesis was that at the end of the day, the methodology document told you what the index was about — you could explain to your aunt or uncle looking to invest their hard-earned retirement money: there's going to be mostly US equities, but it's going to tilt back and forth depending on risk profile, dialing it down when markets are booming, dialing it up when you see crashes on the horizon. The problem is that a lot of these indices are black boxes to begin with. We have a better ability to catch events. But how do you explain it? It goes back to the airplane analogy — Kitty Hawk-era airplanes, you could explain every lever you pulled. Now I have an eight-year-old at home asking, "Dad, how do they control a Dreamliner?" It does most of this work on its own. We've gained on safety and smoothness, but we've lost the ability to explain it all. Here, because we're talking about people, their money, their retirement accounts, they still want to understand what's under the hood. Some of this innovation will have to work to explain what's already there, rather than creating more of the less-explainable kind.

Paul Tyler (28:48) I had one pitch — we made a hard pass — about three years ago when ChatGPT was popping up. It was an AI fund. I'm not making this up: the index was going to weight stocks based on how many times AI was mentioned in earnings transcripts. Not a smart strategy. But yeah — I would think AI could potentially generate daily trading strategies that do a better job controlling volatility than our brute-force "if the market goes up, weight a little towards the bond, if interest rates do this, buy bonds" approach. Imagine you had a quantum computer that did the best job ever at managing this stuff. How would you handle that? Illustration guidelines are coming up. Backtesting has always been controversial for good reason. Should you be able to show that to clients?

Branislav Nikolic (30:20) That's the key — how do you explain it. I've never seen a bad backtest. Almost all the indices — and I've spent five years on this with Lawrence and Jay — really do well in backtesting. We've also seen some back-to-basics movements in response to pitches like the one you described.

We developed a proprietary metric at The Index Standard that gauges the complexity of an index. We tried to figure out how good of an indicator that is for performance. Over five years, we've seen that indices on the simpler side tend to perform better. If you say you have super-simple indices like the benchmarks, and super-complicated indices like what you just described — we've seen that the indices that did the best work somewhere in the middle. People are going from the newest, flashy object they were going for two or three years ago, back to: let me use all this technology to do better what we know works. We're still early, but it's doing a better job than the world's vol-control indices, and frankly a better job than the benchmarks themselves. We get to use these phenomenal tools to make things we know work more efficient — as opposed to going for the next-best thing, which has proven to be hits and misses like anything else.

Paul Tyler (32:10) We're almost at the top of our time. When I first met you and Lawrence, you were 100% focused on fixed index annuities, but I know you've broadened. Talk to us about how your products and services have changed over the last couple of years.

Branislav Nikolic (32:28) Over the last few years we've broadened our focus. The core is still helping people understand index-linked investments. On the annuity-and-insurance side we look into FIAs, RILAs, and IULs — we work with a few distributors on IULs. We're turning to structured products on the investment side as well. We think of indices as a fuel and the chassis — insurance or investments — as engines. Our premise has always been that you cannot look at these things in isolation. You can't just count cylinders or check the compression ratio of the engine and look at the octane value of the fuel separately. What matters is how fast something goes and what miles per gallon you get. The only way to do that is to bring those two things together.

The mission is broadly the same. We work with distributors, carriers, and other industry participants to provide more data and research, but really to help people integrate our forecasts, ratings, and model allocations into their day-to-day practice — and ultimately help the end consumer achieve steadier and better retirement outcomes.

Paul Tyler (34:04) On a previous show we talked about you working with a carrier to put this material in the hands of independent agents. Without naming the company — how's that going? What's the sequel?

Branislav Nikolic (34:25) It's been about two years since we did the initial pilot project. Since then we've expanded the reach within that company and brought a few other companies on board with a similar message — they needed to help people do better with our products. Our products were complex for good reasons; let's help people use them more optimally.

We're expanding into RILAs. One thing we started looking at is helping people understand how the features of each annuity work together. How is this annuity doing as a diversification vehicle? How is it doing from a performance standpoint? How is the carrier doing on service — new business and existing business? What's their credit rating? Is there PE exposure? All these things people are talking about.

Then a big one for me: I've been passionate about renewal rate integrity for close to a decade. We're making some headway helping people understand how renewal rates work, and how the carrier of their choosing is doing on their particular rates. Broadening the scope, with the goal of helping carriers and distributors, but ultimately helping the end consumer.

Paul Tyler (36:05) Branislav — great to have you on. If people want to learn more about your company or contact you, what's the best way?

Branislav Nikolic (36:15) The best way is theindexstandard.com — and finding me or Lawrence on LinkedIn.

Paul Tyler (36:25) Thanks so much. I want to thank our listeners — be sure to share this with anyone you know marketing or building FIAs, RILAs, or IULs. You're providing a great service to the industry. A lot of carriers can't do this themselves; they need an independent third party. Thanks, and join us again next week for another great episode of the L&A Hub.

Branislav Nikolic (36:55) Thank you.

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