Final answer:
One indexing method used by equity-indexed annuities is the hybrid indexing method which combines aspects of both fixed and variable annuities, offering a guaranteed minimum return with the potential for index-linked higher returns. Indexed bonds, offered by the U.S. government since 1996, similarly protect against inflation by promising a real rate of interest above the inflation rate. Indexing, in general, is an adjustment for inflation to protect the real value of payments.
Step-by-step explanation:
Equity-indexed annuities have several different indexing methods, and one of them is a hybrid indexing method. This method combines features of both fixed and variable annuities. It offers a guaranteed minimum return similar to fixed annuities, while also providing the potential for higher returns linked to the performance of a stock market index like variable annuities. Unlike traditional government bonds, which usually provide a fixed rate of interest, equity-indexed annuities with hybrid indexing methods offer returns that have a potential to be higher than inflation, offering a form of protection against the risk of inflation, much like indexed bonds. Indexed bonds promise to pay a certain real rate of interest above whatever inflation rate occurs, which can be reassuring for investors such as retirees planning for the long term.
Indexing in general, whether in equity-indexed annuities or indexed bonds, helps to address the risk of inflation. Payments that are indexed, such as Social Security payments and tax brackets in the public sector or wage contracts with cost-of-living adjustments (COLAs) and adjustable-rate mortgages (ARMs) in the private sector, are automatically adjusted for inflation. This automatic adjustment serves to protect the real value of the payments over time.