Insurers May Be in for More Misery (Update)

An indexed annuity is a type of fixed annuity which simply uses a different formula to add, or "credit" interest to the policyholder's contract. An indexed annuity typically offers several interest crediting strategies from which to choose, including a fixed rate strategy and one or more strategies using an interest calculation based upon some type of market index. For the policyholder who selects interest crediting keyed to the performance of a market index, this product may offer the potential for higher interest crediting than the traditional declared interest rate product, but is always subject to state required minimum guarantees.

Like traditional fixed annuities, the premium deposited in an indexed annuity and all interest added to that premium is backed by the general account assets of the life insurance company. General account assets include predominantly fixed income securities, not equities, and the types of investments within the account are regulated by state insurance laws. Insurers that issue indexed annuities are required to maintain capital supporting those contracts at the same level as traditional declared rate fixed annuities.

In contrast, little capital is required to support variable annuities because the investment risk is passed through to the holder.

The company's budget for crediting interest to policyholders on both declared rate and indexed annuities typically will take into account the yield it receives on its general account investments as well as the company's target spread, or desired profit margin. For example, a company with an investment yield on its general account assets of 6.00% and a target spread of 2.75% would have a budget of 3.25% to pay out as either declared fixed interest or to utilize for purchasing index call options to fund the interest crediting in contracts with those index strategies.