Per last week's post, Fixed Index Annuity Indexing Method Similarities, most indexing methods share three features: (1) Reliance on a stock market index, (2) Measurement of percentage changes between two points in time, and (3) Use of cap rates.
All three of these features are common to the annual and monthly point-to-point cap methods. The latter method is also often referred to as the monthly sum crediting method. These two methods are the most common indexing methods that are used to calculate annual interest crediting on fixed index annuities.
When analyzing any fixed index annuity indexing method, it's important to keep in mind that there are two steps associated with all methods: (1) Calculation and (2) Limit. In the case of both the annual and monthly point-to-point cap methods, the calculation involves the determination of the percentage change, or changes, between two points in time. The limit applies cap rates, or maximum percentages, to the result of the calculation(s) to determine the amount of interest that is credited during a particular contract year.
With both methods, if the annual result is negative, no interest is credited during that particular contract year. In addition, if the date on which the change is being measured falls on a weekend or holiday, the price for the most recent date on which the stock market was open is used to measure the change.
The remainder of this post will discuss the annual point-to-point cap method, including an illustration of how this method works, with a discussion of the monthly point-to-point cap method, or monthly sum crediting method, deferred to next week.
The annual point-to-point cap method is the simplest fixed index annuity indexing method. The two steps that are used to arrive at the annual interest amount that is credited are as follows:
1. Calculation: Determination of annual percentage change of selected stock index.
2. Limit: Application of a cap rate.
To illustrate the annual point-to-point cap method, let's assume that you purchased a fixed index annuity on September 16, 2010 and you selected the S&P 500 stock index as the market index and the annual point-to-point cap method for determination of the annual interest to be credited to your contract. Let's assume that the contract's cap rate is 4% which is in the range of many annual point-to-point cap method cap rates today.
With the annual point-to-point cap method, the calculation measures the difference between an index price on the contract date in the first year or contract anniversary date in subsequent years and the day before the contract anniversary date. On September 16, 2010, the contract date, the S&P 500 closed at 1,124.66. On September 15, 2011, the day before the contract anniversary date, the S&P 500 closed at 1,209.11. The difference in prices on these two dates is 84.45 points, or 7.5%. Since the assumed limit, or cap rate, is 4%, you would be credited with interest of 4% during your first contract year.
The annual point-to-point cap method is easy to understand and apply, however, it's only one of several fixed index annuity indexing methods available for use in determining annual interest crediting amounts. Next week's post features the monthly point-to-point cap method, otherwise known as the monthly sum crediting method.