A company's yield spread is stated as a percentage deduction from the amount of indexed interest. It is used to cover the expense of purchasing index options and other underlying expenses. The yield-spread deduction has the same effect as a participation rate of less than 100 percent. For example, if the index increases 10 percent, an indexed annuity contract with a yield spread of 2 percent would net interest of 8 percent after deducting the fee.
A cap is the maximum amount of indexed interest credited to an indexed annuity. Typically used in conjunction with a participation rate and an annual reset interest crediting strategy, a cap can limit the upside market potential to a contract holder. Many contracts allow annual readjustments of their caps, based on index-option pricing and how much the company can purchase for index participation. Some indexed annuities place a cap between six and 12 percent on how much can be gained. With a 10 percent cap, for example, the contract can only provide up to a 10 percent return for a given period. Caps can be lowered to limit rate of return, but adding a cap to a product can allow the issuing company to guarantee participation rates or asset fees.
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