interestcrediting WP

Understanding Interest Crediting and Indexing

It’s nearly impossible to meet with a financial professional today and not hear about indexing–whether it’s a fixed indexed annuity used to help accumulate money for retirement, or a fixed indexed universal life product that provides valuable death benefit protection for your family or business. Indexed products can play an important role in helping you accumulate money for your future goals with the valuable protection* of not losing any money because of the volatility of the stock markets.

Sound too good to be true? Let’s break it down.

The first thing to understand is that your money is not directly in the stock market. The index accounts on your policy are credited interest based in part on the movement of market indexes like the S&P 500®, the Russell 2000 or the MSCI Index. Think of the indexes like a measuring stick or a ruler. As the indexes move up and down, the change is used to calculate how much interest is credited to your policy.

The reason people choose indexed products is the ability to accumulate cash value with downside protection. Indexed products are designed to have a 0% floor offering protection from those nasty market downward turns, which no one can predict. Most indexed products are designed to never lose a penny if the indexes (or markets) take a downward turn as long as no withdrawals are taken from the policy during the surrender charge period. Most indexed products have surrender charges that are assessed during the early years of the policy or contract if it is surrendered. The indexed policy will be credited 0% for that index period. Looking back at the recent past to 2008-2009, when the markets experienced 20 to 40% negative returns, indexed products that offer this 0% floor—ours included—never lost a penny of value due to the market volatility. Indexed policies during that time were credited 0%. This is when Zero is your Hero. This is the value of an indexed product.

While indexed products offer protection against the downside of market volatility, like everything in life there is a trade-off. The first is the potential for earning 0% interest during a crediting period, unlike a traditional fixed annuity or universal life insurance policy where a minimum guaranteed interest rate is promised.  However, most indexed products do apply a guaranteed interest rate if the contract or policy is surrendered.  The second“cost” of the downside protection of a 0% floor is the caps and participation rates on the upside potential. So what are caps and participation rates?

How does the cap work?

A cap is a maximum growth or upper limit that may be credited to the index account in the policy. What this means is that if there is a 5% cap, the policy can be credited up to 5% but nothing higher, regardless of how the index perform. If the index performs at 15% and the cap is 5%, the index account in the policy will be credited 5%.

What is a participation rate?

The participation rate is the maximum percentage that an index account shares in the positive change of the index. This percentage is multiplied against the index returns to determine the interest credited to your account. if you choose a crediting strategy with a 50% participation, you’ll multiply by .5. If you choose a strategy with 100% participation, then you’ll multiply by 1. If you choose a strategy with 140% participation, then you’ll multiply by 1.4. Keep in mind that caps and participation rates always play together. Regardless of the participation percentage, you can never be credited interest above the cap. Let’s look at an example. An indexed policy has a cap of 8% and a participation rate of 140%. The market index performs at 7% for the index period.

7% (index performance) x 1.4 (participation rate) = 9.8%

But the policy has a cap of 8% so 8% is what will be credited to the policy.

How do I know which Index Strategy to choose?

No one can predict how the markets and indexes will perform. Understanding how the different strategies of a product work can help you decide which ones to choose. Remember, your financial professional may share information about how strategies have performed in the past but that does not mean that they will perform that way in the future.

Here are some guiding principles that can help when deciding which strategies to pick.

If you believe the growth of the index (S&P 500®, Russell 2000 or MSCI) will be:

  • at or near the caps: consider a strategy that focuses on higher caps
  • below the caps: consider a strategy that focuses on higher participation rates
  • significantly outperform the caps: consider a strategy with no caps
  • experience volatility and possible declines: consider a strategy that uses averages.

There are a lot of indexing strategies on the market from different companies for both life and annuity products. At their core they all have the same moving parts: an index they track, caps, participation rates and a floor. Understanding the basics can go a long way in having a meaningful conversation with your financial representative about implementing solutions that will meet your needs.


*Guarantees are dependent upon the claims-paying ability of the issuing company.

This information is intended to be educational in nature, and does not constitute an endorsement or recommendation of any financial product, service or the suitability thereof for you.

“Standard & Poor’s®”, “S&P®”, “S&P 500®”, and “Standard & Poor’s 500™” are trademarks of Standard & Poor’s and have been licensed for use by National Life Insurance Company and Life Insurance Company of the Southwest. This Product is not sponsored, endorsed, sold or promoted by Standard & Poor’s and Standard & Poor’s makes no representations regarding the advisability of investing in the Product. The S&P Composite Index of 500 stocks (S&P 500®) is a group of unmanaged securities widely regarded by investors to be representative of large company stocks in general. An investment cannot be made directly into an index.

Certain features of our select policies and contracts may be indexed to an MSCI Index. These policies and contracts are not sponsored, endorsed, sold or promoted by MSCI, Inc. and MSCI bears no liability with respect to any such contracts. A more detailed description of the limited relationship MSCI has with National Life Insurance Company and Life Insurance Company of the Southwest accompanies the contract. The MSCI Emerging Markets Index is a free float adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand and Turkey.

The Russell 2000 Index is a trademark of Russell Investment Group and has been licensed for use by Life Insurance Company of the Southwest. The Products are not sponsored, endorsed, sold or promoted by Russell Investment Group and Russell Investment Group makes no representation regarding the advisability of purchasing the product.