What are interest-crediting methods?

Interest-crediting methods are formulas used to calculate interest in fixed index annuities. 

This article discusses what interest-crediting methods mean and the different interest-crediting method types.

Indexed annuity providers use various interest-crediting methodologies and provisions – such as yield caps and participation rates – to calculate interest rates for annuity contracts before it is credited to contract holders. Provisions, such as yield caps and participation rates, limit the interest paid out to cover administrative costs and protect annuity providers against market risks. 

Interest-crediting methods explained 

To define interest-crediting methods, let’s consider how they affect the interest received from an indexed annuity over a given time. Interest-crediting method examples include:  

1. Point-to-point interest-crediting method

Point-to-point interest crediting calculates how much interest is due by measuring the percentage change in the underlying index between two dates. 

For example, if the S&P 500 Index (US500) starts at 4,000 points and ends at 4,200, the point-to-point method calculates this as a 5% increase (200/400 x 100). The point-to-point interest-crediting method is considered the simplest.

2.  Annual point-to-point interest-crediting method

Annual point-to-point interest crediting calculates the percentage change in an underlying index between the beginning and end of the annuity contract year. 

3. Monthly point-to-point interest-crediting method

Here, the percentage change in the underlying index value is calculated each month. 

4. Daily averaging  

With this interest-crediting method type, interest is calculated by comparing the index value on the first day of the contract year to the daily average of the index at the end of the contract year. The daily average index value equals the sum of daily index values divided by the total number of days in the period.

5. Monthly averaging 

The monthly averaging interest-crediting method takes the index value at the end of each month and averages them out for the year. It means summing up all the month-end values and dividing them by twelve.