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In previous annuity articles I have addressed the trade-offs advisors must consider when weighing a recommendation such as a fixed versus fixed indexed annuity (FIA) or non-fee versus fee options within a FIA. In this article, I’ll explore the tradeoffs when choosing between Cap Rate, Performance Trigger Rate and Participation Rate strategies on a FIA, as well as the market environments in which each of these strategies would be expected to perform best.
Let’s start with a hypothetical FIA that offers the following options on a one-year point-to-point on the S&P 500 Index. All of the rates were available on specific products as of 6/20/25:
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10% Cap Rate where the client receives 100% of the change in the price of the S&P 500 up to 10%.
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65% Participation Rate where the client receives 65% of the change in the price of the S&P 500 no matter how much it increases.
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8.0% Performance Trigger Rate where the client receives a fixed 8% if the price of the S&P 500 does not decline from its initial level.
The bar graphs below demonstrate the range of possible annual returns for each of these three strategies.
From these charts we can conclude that because the Performance Trigger strategy will result in only two possible outcomes – a positive return of 8% whenever the index does not decrease in price or 0% when it does - it provides the most consistent returns of the three strategies. On the other end of the spectrum, is the Participation Rate strategy. Since this strategy will always provide a return of 65% of the positive price change in the index, the range of the possible positive returns is as variable as the index itself. The most the price of the S&P 500 has increased in any one-year period since the beginning of 1965 is 76.12% (3/23/20 – 3/22/21). That would have provided a return of 49.48%. And of course, the worst return on this strategy is also 0%, which creates a broad range of outcomes. The Cap Rate strategy falls between the other two strategies in terms of year-to-year return variability because while the client would have received the full 1)% cap in many of the years, the strategy provides a positive, but lower return anytime the index is up between 0% and 10%.
Another aspect to be analyzed and considered is the historical average returns of each strategy. I utilized iCapital’s Index Strategy Backtesting Comparison annuity tool to create the chart below. This tool allows an advisor to easily see not only the range of outcomes for each strategy, but also the average return that would have been achieved assuming no change in the rates over time.
Source: iCapital annuities platform as of 6/19/25. For illustrative purposes only. Past performance is not indicative of future results. Future results are not guaranteed.
Let’s use the 10% Cap Rate strategy to explain the above data. Since the strategy is capped in any one-year period at 10%, that is the single best historical return the strategy can deliver. Over the 60-year period, the strategy experienced a 6.43% average return. Since the annuity return is 0% when the S&P 500 falls in price, the worst return in any one-year period would be 0%. It’s important to also note that the strategy produced a positive return 74.25% of the time. Or put another way, 3 out of every 4 one-year periods. It experienced a zero percent return 25.75% of the time. Since the strategy has 100% downside protection, there were no years when the client would have received a negative return. In fact, all 3 strategies have the same frequency of returns. Only the actual returns from year to year differ. Therefore, once we conclude that the client is ok with getting a 0% return approximately 1 out of every 4 years, the only remaining question is how much variability of return is the client willing to accept in return for more potential upside?
One would expect that as the variability of returns increases, so do both the best and average returns. In fact, the Participation Rate strategy does indeed have the highest average return of the three. However, while the 8% Performance Trigger Rate strategy is the least volatile of the three, at these rates it actually provides a slightly higher average return than the slightly more volatile cap rate strategy. Change this rate from 8% to 7%, however, and we would see a different story. This is why this type of analysis is so important. Index annuity rates may change together, but they can vary over time relative to each other. Therefore, it’s important to run such an analysis each time rates change. With this historical data in hand, a financial advisor can have an insightful conversation with their client and make a more informed decision on the approach.
Other Considerations
While the data that technology can deliver is a powerful tool for making better recommendations, advisors should also factor in:
1. The data above is based on historical average returns. While this context can help inform decisions, the actual future returns will most likely differ.
2. The initial cap and trigger rates are not guaranteed in subsequent years. Rates typically renew each year and are based on prevailing market conditions.
3. Since most FIAs have a surrender charge period of seven years or longer, they are typically suitable only if the client has an expected holding period of at least the length of the surrender charge period.
Conclusions
Much of the appeal of FIAs comes from the comfort clients find in 100% downside protection. One could argue that as long as the downside is fully protected, the best option from a financial point of view would be the one that has historically provided the highest expected average positive returns, which would likely lead to the participation rate strategy. But more conservative clients may take greater comfort in the idea of more stable positive returns, even if it means less total upside potential in the long run. The most important takeaway in this analysis is that without the relevant historical data, it becomes difficult to match the appropriate strategy with the risk/reward profile of each client. The data allows us to better weigh the trade-offs between the various upside strategies.
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