A fixed index annuity (FIA) is a type of annuity currently enjoying popularity among many investors. However, it wasn’t always that way. The truth is the current generation of fixed index annuities was introduced in early 1995.

Over the last ten to twelve years FIAs have not only grown but morphed into a type of annuity offering huge potential returns. They also come with expenses and risks.

There are two broad categories of annuities - fixed and variable annuities. There are many benefits to both. The following chart lists the main differences between these two categories.

Fixed Annuities:

Declare a current interest rate, Participation Rate, and/or Index Margin (depending on type of fixed annuity)
Guarantee a minimum rate of return*
Regulated as an insurance contract
No securities license is needed to sell
Includes fixed index annuities
*This amount may be zero but will never be less than zero.

Variable Annuities:

Separate Account returns are based on market performance
Investor bears the market risk
Prior earnings and principal are subject to loss
Regulated as a security and an insurance contract
Securities license is necessary to sell

Fixed annuities include both traditional fixed annuities and fixed index annuities. Because fixed index annuities include similar guarantees as a traditional fixed annuity, they are not considered a variable product, and therefore a securities license is not necessary to sell them. This means your local life insurance agent can offer this product to his/her clients.

The main difference between a traditional fixed annuity and a fixed index annuity is that a fixed index annuity's interest earnings are based on the performance of an external index, subject to Caps, Margins and / or Participation Rates, and the index accounts do not include a declared interest rate.

Fixed Index Annuities Features:

May credit excess interest based on index performance
Do not include a declared interest rate (in index account crediting method/Index Account option)
No securities license is needed to sell
No loss of premium due to market downturns
Guarantee a minimum rate of return of 0% or higher

In order to fully understand how a fixed index annuity works, it is important to understand their basic terms and definitions. These will be helpful when comparing different products and when trying to understand the different designs offered.

Index: Underlying external benchmark that is used to measure the growth of a fixed index annuity.

Participation Rate: The percentage of index gain credited to the annuity.

Margin or Spread: Percentage deducted from the index gain prior to crediting the index interest to the annuity. This is often used in products that have a 100% Participation Rate.

Cap: The maximum interest that can be credited to the index account for the period (caps may permit a higher Participation Rate or a lower Margin).

Minimum Guaranteed Contract Value ("floor" or MGCV): This value grows independently from the Accumulation Value and earns a specific interest rate. The MGCV provides a standard of comparison for the annuity values throughout the life of the annuity. Should the market incur a downturn and the annuity achieves no growth during the entire surrender charge period, the client would be guaranteed to receive at the end of the surrender charge period the original amount of premium back. Please see the product-specific brochures for details regarding the surrender charge period.

Surrender Value (SV): The Surrender Value is the amount that is available at the time of surrender. The Surrender Value is equal to the Accumulation Value, subject to the Interest Adjustment, less applicable surrender charges, Premium Bonus Recapture if applicable and state premium taxes. The Surrender Value will never be less than the minimum requirements set forth by state laws, at the time of issue, in the state where the contract is delivered.

All fixed index annuities have at least one thing in common, they link to an external index. But what exactly is an index and what is indexing?

An index is a benchmark or relative measure of performance. An index's value is an average, or weighted average, of the stocks included in the index. It offers diversification through multiple securities across various sectors. This reduces the volatility and risk associated with owning only one, or a few securities. An important point to understand when studying fixed index annuities is that the index does not sponsor, endorse, or sell any fixed index annuity.

The most common index utilized with fixed index annuities is the S&P 500®.

The S&P 500® is widely regarded as the standard for measuring large-cap U.S. stock market performance. It includes a representative sampling of leading companies in leading industries, including the industrial, utility, financial and transportation industries.

Although the S&P 500® Index is the dominant external index utilized, other indices are used. Today, many insurance companies offer indices beyond the S&P 500®. These indices include:

The Dow Jones Industrial AverageSM (DJIA) - Includes 30 of the largest U.S. stocks and leaders in their respective industries.

The NASDAQ-100® - Represents 100 of the largest non-financial U.S. and non-U.S. companies listed on the National Market tier of the NASDAQ-100® Stock Market.

The S&P MidCap 400® - Measures the performance of the U.S. mid-size company segment.

The Russell 2000® - Measures the performance of the U.S. small company stocks.

The EUROSTOXX® - Measures stock market performance on a Euro-wide basis. This index represents the largest and most liquid stocks in the market.

The Hang Seng Index – Used to monitor daily changes of the 45 largest companies of the Hong Kong stock market index.

Blended Index Strategies – A single strategy which contains a combination of different indices.

Inverse Performance Trigger – A strategy which pays a set rate of interest in negative or flat market years.

As with any type of insurance or investment product, a person should always perform their due diligence. Don’t be afraid to ask questions of the agent and be sure to read all the information you can find not only on the product but the company offering the product.

Author's Bio: 

Tom Koziol owns an insurance agency in Northern Nevada. For more information on annuities you can visit http://www.nevada-annuities.com