Insurance carrier makes money on the upside of the market by giving the client less than the full upside

If the financial index return is 9% and the client is credited with 80% of that (or 7.2%), the client has received all of the upside that is available. The company buys options (or hedges) to cover the exact amount that can be supported by the underlying return on investments. The company does not profit in any way from the differential between the full upside movement of the index and the percentage that is credited back to the client.

The company does not invest financial assets in the instruments making up the index. The carrier invests primarily in bonds to provide the underlying guarantees as well as other financial instruments (or hedging strategies) that provide the pre-stated portion of the index return that the client will receive.

Adjustments to the full upside are necessary because rarely would the cost of providing the underlying guarantees leave enough available to exactly match the full upside potential. How much upside can be purchased depends on the rate of return on the underlying assets (bonds), the guarantee that is being provided and volatility of market.