What is the Index Cap Rate?
The index cap rate is a limit placed on the potential gains that an indexed universal life (IUL) insurance policy or an indexed annuity can earn. These financial products are linked to a specific stock market index, such as the S&P 500, allowing policyholders or annuity holders to benefit from stock market gains up to a certain limit, which is the cap rate. If the index’s performance exceeds this rate, the credited interest is capped at the index cap rate. Conversely, if the index performance is lower, the policy’s actual gain will reflect this lower rate but will generally not go below zero, providing a degree of protection.
For example, if an IUL policy has a cap rate of 8% and the linked index gains 10% during the period, the credited interest for the policyholder will be capped at 8%. In contrast, if the index only gains 6%, the policyholder receives the full 6% credited to their account.
The cap rate is a crucial feature to consider in indexed universal life insurance and annuities, as it directly impacts the potential growth of the policyholder’s cash value or account balance. Insurers set these caps based on various factors, including market conditions, the cost of hedging, and the expected risk involved.
Additionally, understanding the cap rate is essential for policyholders to evaluate the potential returns and limitations of their investment. While the cap rate limits potential gains in high-growth years, IULs and indexed annuities also generally feature a “floor” rate that provides a safety net, ensuring that the account does not lose value in periods of negative market performance.
