How Does the Equity Indexed Annuity Work?
In a traditional fixed annuity, most of the premium is invested in long-term government or investmen grade (usually ten-year) corporate bonds. Assume that these investments return 7.5 percent. First the company takes deductions for company expenses, commissions, excess reserves, and corporate profit Then the company credits the remainder of the interest to the contract. If, for example, these deductions were 2 percent, then 5.5 percent compounded daily would be credited to the traditional annuity accumulation account. An equity indexed annuity works in a uniquely different way. Because it incorporates the same basic features found in a fixed annuity, plus the guarantee of participation in the gains of the selected market index, some changes in the company’s underlying investment philosophy are necessary. For an equity indexed annuity to work, two things must happen: A portion of the premium goes to buy a call option on some type of index. This call option works like any other in that i
