Selecting A Fixed Index Annuity? Look Under The Hood

Monthly Average: Unlike the previous 2 strategies, where interest crediting is handled on an annual basis, the monthly average strategy compares the index value at the start of the contract year to an average of 12 index values occurring each month throughout the contract year. As with the participation strategy, there is no predefined cap. There is, however, an annual interest spread or fee.

Example: In 2003, the average of the 12 values in the S&P 500 Index was 967.93. This was 10.01% above the S&P 500 Index at the beginning of the year. Assuming an interest spread of .65%, the policy simply subtracts that spread number from 10.01%, leaving an interest credit of 9.36%.

Similar to the other crediting strategies, the beginning value will be protected and will not reflect index decreases.

Monthly Point-to-Point (a.k.a. Monthly Cap): Like the monthly average strategy (above), the monthly point-to-point strategy uses monthly values as opposed to annual values. However, the difference is that this strategy imposes a cap on each month’s earnings.

Example: Assume a 2% cap during the same 2003 period used for the monthly average strategy example above. The cap is applied to each month’s earnings as determined by the index, with no downside protection. In January 2003, the index fell by -2.74%. This negative return would have been directly applied to the strategy. In April, however, the index was up by +8.10%. With the cap in place, 2% is credited by this strategy. The sum of the strategy’s 12 monthly values is then calculated to produce the total return. In this instance, the strategy produces a gain of 8.45% in 2003. In instances where a total return is negative, a limit is placed at zero.

What’s the message here? Check under the hood to ensure selection of the right product.

Each method, while sharing some similarities, is unique and requires a little “kicking of the tires” before hopping in. Not every strategy is suitable, or desirable, for all market conditions.

If the index was up 10% year over year for 5 years, the point-to-point cap strategy would yield no more than 6% per year using the hypothetical stated earlier. In this same example, the point-to-point participation strategy would have increased 5% per year. Conversely, in a more moderate market, the reverse would be true. If the index was up 4%, the cap strategy would credit the full 4%, whereas the participation strategy would gain 2% or whatever the minimum guarantee may be.

Depending on the annuity carrier, investors have the ability to re-elect strategies on a set basis, usually annually. So while fixed index annuities aren’t available in various shades of red or blue like cars, they are built for the long haul and the road ahead. Many financial professionals and their clients can select an interest crediting strategy that fits their preferences.