Saturday, June 19, 2010

Fixed Indexed Annuity Performance

Indexed annuities, also commonly called fixed indexed annuities or equity indexed annuities, are a unique type of retirement investment vehicle.

By linking the annuity account’s performance to a common stock market index, like the Dow Jones Industrial Average or S&P 500, but not actually investing any of the owner’s money into the stock market, the annuity company can offer clients the ability to participate in most of the market’s gains while still protecting their money from any declines.

The concept has gotten more popular in the late 2000s and early 2010s as the nation’s economy becomes more volatile, and countless investors have taken advantage of indexed annuity guarantees.

The Basic Concept

While every indexed annuity company’s products are designed differently, they all follow the same generic concept of tying the client’s account performance to a stock market index. On the day the annuity contract is actually issued and the account is opened, the insurance carrier notes the value of its chosen index.

Based on the specifics of the individual annuity contract, interest is credited when the index value increases, but the account balance does not decrease if the index value declines.

Annual Point-to-Point

The most common indexed annuity performance calculation is the “point-to-point” method. An initial index value is recorded on the day the annuity is opened and again on the contract’s yearly anniversary.

If the index value is higher on the anniversary than it was on the previous contract date, interest is added to the annuity balance. If the index value is lower on the anniversary date, the annuity balance remains the same.

Regardless of what happens throughout the year and how high or low the index value ranges, only the value on the contract anniversary is relevant for performance calculations.


The other common performance crediting method for indexed annuities is an averaging technique. Depending on the specific annuity contract, index value notations are made at the end of every month or quarter, then averaged to determine the appropriate interest rate to credit to the account.

If the averaged index interest rate is positive, the annuity value increases; if the averaged index return is a negative number, the annuity value remains unchanged.

High Water Mark

Some indexed annuity products calculate performance returns based on a “high water mark.” In these policies, the carrier notates the index value on the last day of every month or quarter throughout the contract year, then compares them individually to the index value on the previous anniversary. The month or quarter with the largest interest gain, the high water mark, is used for performance crediting calculations.

Participation Rate

Many indexed annuity contracts contain participation rates ranging from 50 to 100 percent. The participation rate is the percentage of the actual index value’s positive performance that is credited to the account.

For example, if an indexed annuity contract had an 80-percent participation rate, and the S&P 500 value increased by 10 percent, only an 8 percent gain would be recorded in the annuity account, and any actual excess remains with the annuity provider.


In addition to participation rates, indexed annuities often have a cap on the total earnings that can be credited at one time. Every indexed annuity carrier designs its products differently, but common caps range from 8 to 15 percent.

The presence of a cap on earnings only becomes relevant if the chosen index performs extremely well over the course of an individual year. In such scenarios, after calculating the interest percentage earned and factoring in the participation rate, the result is credited to the annuity account if it is below the cap limit. If the calculated result is higher than the cap, only the cap percentage is added to the annuity value.

References Fixed Index Annuity Investment Equity-Indexed Annuities Explained

This article is a Twisted Nonsense Exclusive! (06/19/2010)

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