A step rate in a structured annuity is a specific, predetermined return the policyholder receives if the underlying index performs positively or remains unchanged over a set period.
Understanding Step Rates in Structured Annuities
Structured annuities often link their potential returns to the performance of a market index, such as the S&P 500 or Nasdaq 100, without directly exposing the policyholder to market losses. One way these annuities can provide growth is through a step rate, sometimes also referred to as a trigger rate.
According to reference information, "Policyholders receive a specific, predetermined return if the underlying index is either up or unchanged from its initial level." This means that if the chosen index experiences any positive growth or stays at its starting point at the end of the annuity's term (or segment term), the policyholder locks in a predefined return percentage, regardless of how much the index actually grew beyond that initial level.
How a Step Rate Works
The mechanism is relatively straightforward:
- An annuity segment is established, typically for a specific period (e.g., one year or two years).
- An underlying index (like a stock market index) is chosen.
- A step rate (e.g., 5% or 7%) is set for that segment.
- At the end of the segment term, the performance of the index is reviewed relative to its starting level at the beginning of the segment.
- If the index value is equal to or higher than its starting value, the policyholder is credited with the fixed step rate (e.g., 5%), not the actual index gain (if higher than the step rate).
- If the index value is lower than its starting value, the policyholder receives 0% for that segment, but typically does not lose principal unless the annuity has a specific downside provision (structured annuities are designed to protect principal).
Example
Consider a structured annuity segment with a 1-year term, linked to the S&P 500 index, and a step rate of 6%.
| Scenario | S&P 500 Performance | Return Credited | Explanation |
|---|---|---|---|
| Scenario A | Index is +10% | 6% | Index is up, so the predetermined step rate is applied. |
| Scenario B | Index is 0% | 6% | Index is unchanged, so the predetermined step rate is applied. |
| Scenario C | Index is -5% | 0% | Index is down, so the policyholder receives no return for this segment term. |
In this example, the step rate provides a known potential return in positive or flat market conditions, capping the upside but offering a predictable gain without requiring significant market growth.
Benefits of a Step Rate
- Simplicity: Easy to understand the potential return condition.
- Predictability: Offers a fixed return when the index meets the trigger.
- Downside Protection: Coupled with the annuity's structure, it helps protect against market losses, even if the index falls significantly.
Step rates are just one of several indexing strategies that a structured annuity might employ, offering a distinct risk-reward profile compared to options like participation rates or caps.
