The expected wave of large initial public offerings (IPOs) in 2026 officially kicked off in mid-June with SpaceX topping a $2 trillion market valuation on the opening day. Anticipated IPOs for Anthropic and OpenAI also are garnering significant attention in financial markets, with their debuts potentially exceeding $1 trillion in valuation. Insurers of variable annuities (VAs) sit in an interesting position amidst this excitement, as the backdrop of mega-IPOs offers a timely opportunity to evaluate their implications on hedging basis risk.
Listing of newly public companies and their potential inclusion in major equity indices are events that can initiate a divergence between actively managed funds and hedging indices, as the evaluation criteria that guides fund managers’ positions in these companies will not align with the timing and formulation that drives the allocation within the indices. VA insurers typically operate dynamic equity hedging programs using derivatives on major indices such as the S&P 500, NASDAQ-100, and Russell 2000. Policyholders gain market exposure through investments in VA sub-accounts (VA funds), which are similar to mutual funds. The hedging programs are intended to manage the equity risk embedded in the present value of guaranteed living benefit riders attached to base VA contracts. Basis risk emerges from the misalignment of the VA fund returns and the index returns captured by an insurer’s basket of hedges.
If risk practitioners operating VA equity hedging programs are proactive in monitoring and combatting this risk with effective techniques, they can reduce fund basis mismatch, leading to a more stable capital base and better balance sheet outcomes. In light of the IPO volume expected this year and in 2027, this paper reviews some real-world examples and discusses basis risk management techniques that VA equity risk managers should keep in mind.
Key takeaways:
- Recent expectations for large IPOs present a valuable opportunity for hedging practitioners at VA insurers to evaluate basis risk management practices due to their potential allocation differences between VA funds and equity indices.
- It is common for active equity fund managers to take positions that introduce over- or underweight exposure relative to what the insurer is hedging.
- The existing private investments of funds in mega-IPOs could create a notable mismatch with the indices that are available to hedge.