“Crediting method” is the contract’s rule for measuring an index and turning that measurement into interest. The cap, the participation rate, and the spread are limits applied to that measurement. They are not, by themselves, the method. Two owners can buy contracts on the same well-known index and see different credits because the methods, the terms, or the limits differ.
What every method has in common
The SEC’s July 31, 2020 bulletin describes the shared idea. The insurer credits interest based on the change in an index. You do not own the index or the stocks inside it. Dividends are usually excluded, so the change is often a price change rather than a total return. The SEC’s teaching illustration — total return of 7 percent, dividends of 2.5 percent, so many indexed annuities would use 4.5 percent — belongs here as well as on the rates page. It shows what is being measured. It is not a typical yield.
The NAIC Buyer’s Guide adds the result when the measured change is down. For the usual fixed indexed design, that term’s credit is zero if you do not withdraw. Interest already credited is usually locked and is not taken back because a later term is negative. A withdrawal before the term credits can forfeit the uncredited index interest for that term. Those three sentences are the guide’s consumer point. They do not depend on whether the contract measures the index with two dates or with an average.
Point-to-point, described without a ranking
One way to measure a change is to compare the index on the first day of the term with the index on the last day. People call that a point-to-point method. If the ending value is higher, the percentage increase is the raw change. The contract then applies its cap, participation rate, or spread. If the ending value is lower, the raw change is negative, and the typical fixed indexed result if you stayed in is a zero credit, not a deduction of that negative percentage.
The length of the two points is whatever the contract says. It might be a year. It might be longer. This page does not say which length is most common, because that would be a product survey this site has not done. A longer point-to-point term means you wait longer to see a credit locked, and a withdrawal in between may forfeit uncredited interest under the NAIC’s warning. A one-year term locks more often and also gives the insurer more renewal dates on which it may change the cap or the spread. FINRA said insurers may change those limits. More renewal dates are not automatically worse or better. They are more moments when the non-guaranteed pieces can move.
Averaging, described without a ranking
Another approach samples the index more than twice and uses an average. A contract might average monthly values and compare that average with the start, or average the monthly percentage changes. The only general statement that stays honest is this: averaging uses more than the single ending value. In a term that ends at a peak, an average can be lower than a simple start-to-end change. In a term that ends in a dip after higher months, an average can be higher than the start-to-end change. Neither outcome is a reason to prefer averaging in the abstract. You would have to know the path of the index in advance, and you do not.
Some marketing materials show a monthly method that adds monthly index changes and then applies a cap to each month. That design can produce a raw sum that is negative even when several months were positive, because uncapped down months can outweigh capped up months. If the contract floors the annual credit at zero, you might still receive zero rather than a negative credit — and you might receive zero in a year when a simple annual point-to-point method would have been positive. That is a structural possibility, not a claim that any current contract works this way. If a proposal mentions “monthly,” ask whether each month is capped, whether down months are floored, and whether the annual result can be zero after a year the index itself finished up.
The limit sits on top of the method
Whatever the raw change is, the cap, participation rate, or spread still applies. The SEC’s hypotheticals are the right numerical vocabulary: 75 percent participation on a 10 percent change is 7.5 percent; a 7 percent cap on a 12 percent change is 7 percent; a 3 percent spread on a 9 percent change is 6 percent; 75 percent participation and a 3 percent spread on 10 percent is 4.5 percent. FINRA’s matching cap example is 12 percent against a 7 percent cap, and its separate spread example is 3.5 percent on a 10 percent gain. Use those when you want numbers. Do not replace them with a rate you heard in an advertisement.
Renewals and the worksheet you should keep
At each renewal the insurer may set a new cap, participation rate, or spread, within whatever minimums the contract actually guarantees. Keep the declarations page from the year you bought and from each anniversary. If you ever replace the contract, those pages are the record of what you are giving up. A replacement can start a new surrender schedule. FINRA warns about that in its annuities materials; the tax side of a replacement is on the tax page, including when a 1035 exchange is, and is not, tax-free.
A useful worksheet has six lines: index name; whether dividends are included; term length; measurement (two dates, or an average, or something else the contract defines); the limiter and its current number; and the date that number can change. If a line is blank, you do not yet know how the contract works, even if you know the brand name.
Sources
- U.S. Securities and Exchange Commission, Updated Investor Bulletin: Indexed Annuities (July 31, 2020)
- National Association of Insurance Commissioners, Buyer’s Guide for Deferred Annuities (revised 2013)
- FINRA, The Complicated Risks and Rewards of Indexed Annuities (July 14, 2022)
- FINRA, Annuities