Indexed Annuity Caps, Participation Rates and Spreads Explained

Some strategies combine limits, for example a participation rate with a cap. Others use no cap but a lower participation rate or a spread. Which method credits more depends on how large the index gain turns out to be, which no one knows in advance.

Many indexes used in annuities track price changes only and do not include dividends. Contract disclosures explain exactly how each strategy works.

• Annual point-to-point: compares the index value at the start and end of each one-year term.
• Monthly averaging or monthly sum methods: use values or changes measured through the term, which can smooth or cap monthly moves.
• Multi-year terms: measure the index over two or more years, sometimes with different limits.
• Index choice: many contracts offer a broad market index, and some offer volatility-controlled indexes designed by banks, whose results can behave very differently from a familiar index.

The rates in effect when you buy are usually guaranteed only for the first term. At each renewal, the insurer typically declares new caps, participation rates or spreads for the next term. These renewal rates often move with interest rates and the insurer's costs of buying index options, and they can go down as well as up.

The contract usually states guaranteed minimum or maximum limits, such as a lowest possible cap or a highest possible spread. Those guaranteed limits, not the first-year rates, tell you the worst case. Asking how an insurer's renewal rates have moved historically, and reading the minimums, is part of understanding what you are buying.

• Which limits apply, and for how long are today's rates guaranteed?
• What are the guaranteed minimum cap and participation rate, or maximum spread?
• Does the index include dividends, and who designed it?
• Can I move money between strategies at each renewal?
• How do rider fees, if any, affect the account value in years with zero credited interest?