Do you remember 2004? The economy was booming – well, bubbling – and we were all pretty sure it was never going to end.

Do you remember 2008? When the markets closed on December 31st, 2008, the S&P 500 was down 38.49% compared to its January 1st open. The wheels of capitalism ground retirement plans into powder and dreams into dust. It was a bad time. The recession was long and multifaceted. For a while every step we took forward seemed to be accompanied by two more back.

Meanwhile, indexed products earned a quiet 6-8% over the last ten years. That is, to put it mildly, impressive. It’s because indexed annuity and life insurance products take advantage of volatile indices, participating in gains but never returning less than 0% even when the markets are losing big. They’re not investments – they’re their own thing, and interest is credited to them based on the performance of their associated index. And that’s huge. Here’s what you need to know to quickly dissect an indexed product:

1. The Indexing Method

Different indexing methods can be used to calculate the interest due to an indexed product. We’ve got a detailed webinar on this in the archives, and since replicating that discussion here would take a few thousand words we’ll ask you to go watch the video instead.

2. The Cap

If your index gains 50%, does that mean you earn 50% interest? Maybe, maybe not. If there’s a “cap” on your indexed product, you can only earn up to a defined maximum percentage. No cap? The sky’s the limit!

3. The Spread

Also called the margin, this is a flat percentage amount deducted from the interest earned. For instance, gaining 10% interest on a product with a 1% spread means you’ll be credited 9%. If there’s no spread, you’d get the full 10%.

4. The Floor

Usually set at 0%, this is the minimum amount of interest the product can credit over an indexing period. A 0% floor may not sound like an impressive thing – but imagine a year where the associated index loses 38.49% like in 2008. Direct investments in the market saw massive losses that year. Indexed products? They simply got credited 0% interest and waited out the storm. When indices rebounded in the following years, those same indexed products participated in those gains.

5. Participation Rate

How much of the policy “participates” in the index gains? This is a multiplier that you apply to the interest gained by the index over the indexing period to determine how much the policy gets. For instance, if an associated index gains 10% and you’ve got a 100% participation rate, you’ll be credited the full 10%. On the other hand, if you’ve got a 50% participation rate, you’ll be credited 5%.

While the specifics and indexing methods vary slightly from carrier to carrier, one thing stays consistent: indexed products are hot and getting hotter. Want one more reason? We’ll close out this topic with a look at some real numbers over the period 2004-2008 comparing an investment in the S&P 500 to an indexed annuity tied to the same. The indexed product uses the sum of monthly changes to average, ratchets every year, has a 0% cap, floor and spread, and has a 100% participation rate. If you didn’t understand any of that, you haven’t watched the video on indexing yet. S&P Gains are expressed as a difference between Jan 1 and Dec 31 values for the year:

In 2004, the S&P 500 gained 8.99%. Our hypothetical annuity would have been credited 9.04%.

In 2005, the S&P 500 gained 4.69%. Our hypothetical annuity would have been credited 4.05%.

In 2006, the S&P 500 gained 11.65%. Our hypothetical annuity would have been credited 12.72%.

In 2007, the S&P 500 gained 3.65%. Our hypothetical annuity would have been credited 4.24%.

In 2008, the S&P 500 lost 38.49%. Our hypothetical annuity would have been credited 0%.

With an initial investment of $100,000 on January 1st 2004 directly into the S&P 500, participating in that massive 2008 loss, we end up with $81,220.49 on December 31st 2008.

However, with an initial premium of $100,000 on January 1st 2004, our hypothetical annuity has a policy value of $133,303.09 on December 31st 2008.

This data is a little cherry-picked, obviously, but the point remains: in a volatile market, indexing is powerful!