3.7.2 Equity-Indexed Annuities
An equity-indexed annuity (EIA) is a type of fixed annuity that tracks the performance of an index. The upside return of an equity-indexed annuity is limited in a couple of ways, one of which is the fact that a participation rate often comes with an equity-indexed annuity. A participation rate is the rate at which the annuitant can participate in the returns of the index. For example, when an annuity has a participation rate of 60%, the investor will benefit to a maximum of 60% of the increase in the annuity’s index. If the index goes up 10%, the investor will receive 60% of 10%, or 6% (0.1 x 0.60 = 0.06).
Equity-indexed annuities also may be subject to caps on performance. If an EIA has a cap, the annuitant will not receive a return higher than the cap, even if the increase in the index return times the participation rate is higher than the cap. For example, suppose an EIA has a 90% participation rate with a 12% cap. At the end of the year, the benchmark index has increased by 20%. Without the cap, the investor would receive 90% of 20% or an 18% increase in rate of return (0.9 x 0.2 = 0.18). With the cap, however, the investor would receive a 12% increase.
Some EIAs use a spread, margin, or asset fee in addition to or instead of a participation rate. When one of these is used, the percentage stated in the contract is subtracted from any gain in the index linked to the annuity. For example, if the index gained 10% and the spread, margin, or asset fee is 3.5%, then the ga