What are some Fixed-Indexed Annuity contract features

Three features that have the greatest effect on the amount of additional interest that may be credited to a Fixed-Indexed Annuity are the indexing method, participation rate and cap rate. It is important to understand these features and how they work together. The following describes some other Fixed-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 watermark, high water with look-back, short term point-to-point, long term point-to-point, monthly average, daily average and monthly cap.

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 10%, and the participation rate is 70%, the index linked interest rate for your annuity will be 7% (10%x.70%=7%). 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 year to year or the entire period). 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 annuity contract has a 7% cap rate, 7%, and not 8% could be credited. Not all annuities have a cap rate.

Floor on fixed-linked interest

The floor is the minimum index-linked interest rate that 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. As in the case of a cap, not all annuities have a stated floor on index-linked interest rates. But in all cases, your Fixed-Indexed Annuity and or fixed annuity will have a minimum guaranteed value.

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.

Interest compounding

Some annuities pay simple interest during an index term. That means index-linked interest is added to your original premium amount, but does not compound during the term. Others pay compound interest during a term, which means that index-linked interest that has already been credited also earns interest in the future. In either case, however, the interest earned in one term is usually compounded in the next.

Margin/spread/administration 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 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 2.5% will be subtracted from the rate to determine the interest rate credited. In this example, the rate would be 7.5% (10%-2.5%=7.5%). In this example, the company subtracts the percentage only if the change in the index produces a positive interest rate.

Vesting

Some annuities credit none of the index-linked interest or only part of it, if you take out all of your money before the end of the term. The percentage that is vested, or credited, generally increases as the term comes closer to its end and is always 100% at the end of the term, unless free withdrawals or loans were taken during the contract.


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