An equity-indexed annuity is an annuity linked to a stock or other equity index. One of the most commonly used indices is the Standard & Poor’s 500 Composite Stock Price Index (the S&P 500).

An equity-indexed annuity is different from other fixed annuities in the way interest is credited to the value. Most fixed annuities only credit interest based on a fixed calculated rate as set forth in the contract while equity-indexed annuities accrue interest using a formula based on changes in the index. This formula then decides how interest is calculated and credited. The actual interest earned and when it is credited depends on the contract.

An equity-indexed annuity, like other fixed annuities, also promises to pay a minimum interest rate. The rate paid will not be less than this minimum guaranteed rate even if the index drops lower. In addition, the value of your annuity will not drop below a guaranteed minimum. For example, many single premium annuity contracts guarantee the minimum value will never be less than 90 percent (100 percent in some contracts) of the premium paid, plus at least 3% in annual interest (less any partial withdrawals). The insurance company will adjust the value of the annuity at the end of each term to reflect any index increases.

**Terms to Know Regarding Indexed Annuities:**

**Indexing Method
**The indexing method means the approach used to measure the amount of change in the index. There are several methods which should be explained to you prior to your purchase of an indexed annuity.

**Participation Rate
**The participation rate determines how much of the increase in the index will be used to calculate interest. For example, if the calculated change in the index is a positive 9% and the participation rate is 70%, the index-linked interest rate for your annuity will be 6.3% (9% x 70% = 6.3%). A company may set different participation rate for annuities so you’ll want to review this feature carefully. The company usually will guarantee the participation rate for a specific period (from one year to the entire term) and when that period is over, the company will set a new participation rate for the next period. Some annuities guarantee minimum and maximum participation rates.

**Cap Rate
**Some contracts may put an upper limit, or cap, on the index-linked interest rate. This is the maximum rate of interest the annuity will earn. In the example above, if the contract has a 6% cap rate, the interest credited would be 6%, and not 6.3% that was calculated using the index multiplied by participation rate. It should be noted that not all annuities have a cap rate.

**Floor
**The floor is the minimum interest rate you will earn. The most common floor is 0% which assures that even if the index decreases in value, the interest earned will be zero and not negative.

**Margin/Spread/Administrative Fee
**In some annuities, the interest rate is computed by subtracting a specific percentage from any calculated change in the index. This percentage, sometimes referred to as the “margin,” “spread,” or “administrative fee,” might be instead of, or in addition to, a participation rate. For example, if the calculated change in the index is 10%, your annuity might specify that 2.25% will be subtracted from the rate to determine the interest rate credited. In this example, the rate would be 7.75% (10% – 2.25% = 7.75%). The insurance company subtracts the percentage only if the change in the index produces a positive interest rate.