Fixed index annuities may have similar labels, but one size does not fit all. It’s what is under the FIA hood that really counts–in particular, the interest crediting strategy. We’ll look at some of the most common strategies here.
A FIA is an unregistered fixed product that relies on a specific index, usually the S&P 500 Index, to provide increased interest earning potential. Those potential earnings are tied to the overall movement of the stated index through interest-crediting strategies, or indexing methods.
The interest crediting strategy selected for an FIA determines several factors, especially those shown in the box. The differences are what set fixed index annuities apart from each other, as will be seen below.
Keep in mind that with the index-linked interest crediting strategies, interest is credited annually at the end of the contract year. Since market shifts can’t be predicted, the amount of interest to be credited at the end of each contract year is unknown. Once interest credits are made, however, they are protected. Neither the initial premium nor any earned interest credited can be diminished by the market or the index.
There are many interest crediting strategies in use today, but here are some of the most popular ones:
Point-to-Point Cap: This strategy provides 100% index participation up to a predefined cap; the cap is typically guaranteed for one year and, in some products, is subject to change annually.
Example: If the cap was set at 6% and the index increases 10%, the point-to-point cap strategy would credit the full 6%. If the index increases by only 3%, this strategy would provide 3%. Typically, if the index decreases over the period–whether by 1%, 2%, or more–the point-to-point cap strategy provides that the FIA holds its beginning value (that is, the account value does not reflect the index loss for the period).
Point-to-Point Participation: This strategy imposes no limit (cap) on the annual interest credit. Instead, it credits a set percentage of any increase that occurs.
Example: Assuming the participation rate is 50%, if the index increases 12% in an annual period, the strategy would result in the FIA being credited with 6%. Or, if the index increases 8%, the point-to-point participation strategy would result in a credit of 4%. However, if the index decreases over the period, the point-to-point participation strategy will provide that the annuity holds its beginning value (not reflect the index loss for the period).