Equity Indexed Annuities Cap and Participation Rates

Equity index annuity accounts will often either have a participation rate or cap placed on the index interest rate.

With the participation rate, the insurance company only allocates a portion of the growth of the index to the annuitant.  This portion is called the participation rate.  Participation rates will generally range from 35% up to as much as 100%, though at 100% participation there is generally a cap (see below on caps).

Consider an annual point-to-point strategy on an equity-indexed annuity.  This strategy compares the S&P 500 value at the beginning of the year and the end of the year.  If the market increases 12% over this period, a 65% participation rate would credit the annuitant 7.8%.

Similar to a participation rate, a Cap is a way for the annuity company to skim off some of the bonus growth that an annuity acquires.  Many insurance companies offer an equity-indexed annuity strategy that has 100% participation in market upswings, but places a Cap, or maximum interest rate that the annuitant can acquire.  The Cap is simply that, a maximum rate that the insurance company is willing to pay.

If an insurance company has a Cap of 6%, and the market increases 11%, the annuitant will only enjoy market increases of the 6%.  These accounts will generally have a minimum interest rate as well, and will almost never allow a negative interest rate.  This permits the equity index annuity owner to enjoy protection of capital, as well as participation in market upswings.

The reason that the insurance company only allows a portion of the growth is so that they may offset the losses they receive when the market decreases.