The High-Water Mark Method and Annuities

What is the High-Water Mark Method?

The high-water mark method, also known as the look-back method, is one indexing method that insurers can use to calculate the interest on a fixed index annuity. A fixed index annuity accumulates growth based on the performance of an underlying index like the S&P 500, and annuity providers measure index performance in a few different ways.

Insurers calculate interest using the high-water mark method at the end of a fixed index annuity’s term. The annuity provider will look back at the underlying index’s value on the contract’s anniversary date each year of its term. The provider then takes the highest of these anniversary values and subtracts from it the index value on the first day of the annuity contract.

If the total change in the index is positive, then a percentage of that growth is credited as interest to the contract. But if none of the anniversary values were higher than the starting value, the insurer will typically credit the contract with the guaranteed minimum return.

The high-water mark design may be thought of as a variation of another indexing method, the point-to-point design, where the annuity provider simply subtracts the starting value of the index from the value on the last day of the contract term. These two contract designs are similar in that both credit interest at the end of the contract term. 

However, the high-water mark method tends to show better returns than point-to-point because it can pull from the highest value on an anniversary date rather than wherever the index falls at the end of the term.

Read More: Indexing Methods for Fixed Index Annuities

Rising market conditions can benefit annuities that use the high-water mark method to calculate interest credited; whereas stable market conditions may result in lower returns or interest credited.

Marguerita M. Cheng, CFP®, CRPC®, CSRIC®, RICP®CEO of Blue Ocean Global Wealth

Marguerita M. Cheng, CFP®, CRPC®, CSRIC®, RICP®, is the chief executive officer at Blue Ocean Global Wealth. As a CFP Board of Standards Ambassador, Marguerita educates the public, policymakers and media about the benefits of competent and ethical financial planning. She is a past spokesperson for the AARP Financial Freedom campaign.

Example of a High-Water Mark Fixed Index Annuity

The following table shows how an insurance provider might use the high-water mark method to measure the growth of an annuity’s underlying index. 

Fixed Index Annuity With High-Water Mark Design

In the example above, the highest anniversary value occurred on the contract’s third anniversary date. Although the index has actually declined since the contract’s issue date, the provider will still credit the annuity 25.50% interest, assuming a 100% participation rate. 

Because it capitalizes on the highest performing point of the term, the high-water mark design performs best in a volatile market with lots of ups and downs. A bull market, or a market in which equity prices are generally on the rise, can also greatly benefit annuities using the high-water mark method.

Retirees who want to take advantage of a bull market while protecting their savings from market volatility might consider a fixed index annuity with the high-water mark design. The potential returns from the high-water mark method may help offset the effects of inflation, allowing investors to maintain their retirement lifestyle.

Pros and Cons of the High-Water Mark Method

The high-water mark method can benefit fixed index annuity investors in a rising market, but different conditions could make this contract design much less advantageous. 

The main advantage of the high-water mark design is protection against index declines. With the point-to-point method, for example, a drop in the index during the final weeks or months of the contract could mean little to no interest credited to the contract. High-water mark contracts avoid this by always taking the highest anniversary value.

For this reason, investors with concerns about the liquidity of their fixed index annuity might prefer the high-water mark design over point-to-point. Some high-water mark contracts have a vesting schedule that allows part or all of the anniversary gains to be excluded.

Matt Lewis, Certified Long-Term Care specialist and vice president of insurance at Carson Group, told Annuity.org, “In a high-water mark crediting strategy, the pros are really twofold. It can provide some downside protection, as the interest that is credited cannot go below the index value that was previously established. It also provides upside as interest credited can also be higher than the high-water mark.” 

That said, there are still some downsides to the high-water mark method. Lewis said that the biggest disadvantages of this contract design include a “more complex” crediting strategy and “lower potential returns in a stable market.”

Essentially, fixed index annuities provide a guaranteed minimum rate, ensuring that even if the underlying index performs poorly throughout the contract term, the annuity owner will still receive a certain amount of credited interest.

As with any annuity product, it’s important to weigh the pros and cons before deciding to move forward. Consulting with a financial advisor can help you understand all the ins and outs of a high-water mark fixed index annuity and decide if it’s right for you.