The Basics of Annuity Part Three : Fixed and Equity Indexed Annuities

Equity Indexed Annuities

The type of annuity, which provides the advantages of guaranteed interest as well as benefit of good performance of stock market.

Index

A system that tracks the performance of a group of similar investments. Insurer use a portion of their equity-indexed premiums to purchase investments closely linked to the well-known and well-respected index.

Term

The length of time over which the interest will be calculated.

Calculating Excess Interest:

Annual Reset Method (Ratchet Method)

This involves comparing the value of the index at the start of the contract year and at the end of the contract year. The value at the start of the next contract year is set to the value of the index at the end of this contract year. At the beginning of each contract year during the term of the contract, the value is reset. The insurer determines the amount of any index-based excess interest credits by averaging the results of each contract year of the contract term.

High Water Mark Method

Involves comparing the value of the index at the beginning of the term of the contract with the highest value that the index reaches at certain points, usually contract anniversary dates, during the term. If the index has gained in value on an anniversary date, the contract will be credited with excess interest for that year. However, if there is a loss then no excess interest will be credited.

Point to Point Method

Compares the value of the index at the start of the annuity contract term to its value at the end of the term to determine any excess interest because of change in the index.

Participation Rate

The percentage of the index gain that will be credited to the contract. Insurers offer different rates based on investment strategies and crediting method. This can be specified for a term or contract year. If it is defined for each year then insurer will declare the participation rate each year of the contract term.

Cap

The upper limit or maximum interest limit on the amount of excess interest that can be accrued by a contract.

Vesting Schedule

The timetable that specifies how much the contract owner can withdraw before the end of the contract term – of the gain in the index’s value that has been credited to the contract. The percentage increases over the term of the contract and eventually becomes 100%.