Final answer:
To measure the increase in an equity-indexed annuity, the annuity's returns are typically linked to a stock market index with specific limitations that help manage risk.
Step-by-step explanation:
The methods used to measure the increase in an equity-indexed annuity typically involve tracking the performance of a specific stock market index. This type of annuity is designed to provide a return based on the performance of an index like the S&P 500. The increase is usually subject to certain limitations, such as participation rates, caps, and spreads, which limit the maximum gain or loss to the annuitant.
Indexing in the context of annuities is similar to indexing in other financial applications where payments are automatically adjusted for inflation or linked to the performance of financial markets. For example, wage contracts may include cost-of-living adjustments (COLAs) and loan agreements like adjustable-rate mortgages (ARMs) may have interest rates that change with the market. In the public sector, indexing can be seen in tax brackets and Social Security payments. While these examples adjust for inflation, equity-indexed annuities are tied to the potential upside of the stock market while providing downside protection.