Equity-Indexed Annuities Explained
An equity-indexed annuity is an annuity that earns interest
that is linked to a stock or other equity index. One of the most commonly used
indices is the Standard & Poor's 500 Composite Stock Price Index (the
S&P 500).
HOW ARE THEY DIFFERENT FROM OTHER FIXED ANNUITIES?
An equity-indexed annuity is different from other fixed
annuities because of the way it credits interest to your annuity's value. Most
fixed annuities only credit interest calculated at a rate set in the contract.
Equity-indexed annuities credit interest using a formula based on changes in the
index to which the annuity is linked. The formula decides how the additional
interest, if any, is calculated and credited. How much additional interest you
get and when you get it depends on the features of your particular annuity.
Your equity-indexed annuity, like other fixed annuities, also
promises to pay a minimum interest rate. The rate that will be applied will not
be less than this minimum guaranteed rate even if the index-linked interest rate
is lower. The value of your annuity also will not drop below a guaranteed
minimum. For example, many single premium annuity contracts guarantee the
minimum value will never be less than 90 percent (100 percent in some contracts)
of the premium paid, plus at least 3% in annual interest (less any partial
withdrawals). The insurance company will adjust the value of the annuity at the
end of each term to reflect any index increases.
WHAT ARE SOME OF THE CONTRACT FEATURES?
Two features that have the greatest effect on the amount of
additional interest that may be credited to an equity-indexed annuity are the
indexing method and the participation rate. It is important to understand the
features and how they work together. The following describes some other
equity-indexed annuity features that affect the index-linked formula.
Indexing Method
The indexing method means the approach used to measure the amount of change,
if any, in the index. Some of the most common indexing methods, which are
explained more fully later on, include annual reset (ratcheting), high-water
mark and point-to-point.
Participation Rate
The participation rate decides how much of the increase in the index will be
used to calculate index-linked interest. For example, if the calculated change
in the index is 9% and the participation rate is 70%, the index-linked interest
rate for your annuity will be 6.3% (9% x 70% = 6.3%). A company may set a
different participation rate for newly issued annuities as often as each day.
Therefore, the initial participation rate in your annuity will depend on when it
is issued by the company. The company usually guarantees the participation rate
for a specific period (from one year to the entire term). When that period is
over, the company sets a new participation rate for the next period. Some
annuities guarantee that the participation rate will never be set lower than a
specified minimum or higher than a specified maximum.
Cap Rate or Cap
Some annuities may put an upper limit, or cap, on the index-linked interest
rate. This is the maximum rate of interest the annuity will earn. In the example
given above, if the contract has a 6% cap rate, 6%, and not 6.3%, would be
credited. Not all annuities have a cap rate.
Floor on Equity Index-Linked Interest
The floor is the minimum index-linked interest rate you will earn. The most
common floor is 0%. A 0% floor assures that even if the index decreases in
value, the index-linked interest that you earn will be zero and not negative.
Averaging
In some annuities, the average of an index's value is used rather than the
actual value of the index on a specified date. The index averaging may occur at
the beginning, the end, or throughout the entire term of the annuity.
Margin/Spread/Administrative Fee
In some annuities, the index-linked interest rate is computed by subtracting
a specific percentage from any calculated change in the index. This percentage,
sometimes referred to as the "margin," "spread," or
"administrative fee," might be instead of, or in addition to, a
participation rate. For example, if the calculated change in the index is 10%,
your annuity might specify that 2.25% will be subtracted from the rate to
determine the interest rate credited. In this example, the rate would be 7.75%
(10% - 2.25% = 7.75%). In this example, the company subtracts the percentage
only if the change in the index produces a positive interest rate.
HOW DO THE COMMON INDEXING METHODS DIFFER?
Annual Reset
Index-linked interest, if any, is determined each year by comparing the index
value at the end of the contract year with the index value at the start of the
contract year. Interest is added to your annuity each year during the term.
High-Water Mark
The index-linked interest, if any, is decided by looking at the index value
at various points during the term, usually the annual anniversaries of the date
you bought the annuity. The interest is based on the difference between the
highest index value and the index value at the start of the term. Interest is
added to your annuity at the end of the term.
Point-to-Point
The index-linked interest, if any, is based on the difference between
the index value at the end of the term and the index value at the start of the
term. Interest is added to your annuity at the end of the term.
WHAT ARE SOME OF THE ADVANTAGES AND DISADVANTAGES OF DIFFERENT INDEXING METHODS?
Generally, annuities offer preset combinations of
indexing features. You may
have to make trade-offs to get features you want in an annuity. This means the
annuity you choose may also have some features you don't want.
WHAT IS THE IMPACT OF SOME OTHER PRODUCT FEATURES?
Cap on Interest Earned
While a cap limits the amount of interest you might earn each year, annuities
with this feature may have other product features you want, such as annual
interest crediting or the ability to take partial withdrawals. Also, annuities
that have a cap may have a higher participation rate.
Averaging
Averaging at the beginning of a term protects you from buying your annuity at
a high point, which would reduce the amount of interest you might earn.
Averaging at the end of the term protects you against severe declines in the
index and losing index-linked interest as a result. On the other hand, averaging
may reduce the amount of index-linked interest you earn when the index rises
either near the start or at the end of the term.
Participation Rate
The participation rate may vary greatly from one annuity to another and from
time to time within a particular annuity. Therefore, it is important for you to
know how your annuity's participation rate works with the indexing method. A
high participation rate may be offset by other features, such as averaging, or a point-to-point indexing method. On the other hand, an
insurance company may offset a lower participation rate by also offering a
feature such as an annual reset indexing method.
HOW DO I KNOW WHICH EQUITY-INDEXED ANNUITY IS BEST FOR ME?
As with any other insurance product, you must carefully
consider your own personal situation and how you feel about the choices
available. No single annuity design may have all the features you want. It is
important to understand the features and trade-offs available so you can choose
the annuity that is right for you. Keep in mind that it may be misleading to
compare one annuity to another unless you compare all the other features of each
annuity. You must decide for yourself what combination of features makes the
most sense for you. Also, remember that it is not possible to predict the future
market behavior of an index.
To speak with a live, licensed
AnnuityAdvantage Specialist regarding
Equity-Indexed Annuities, please call toll-free at 1-800-239-0356.
