The "annual reset" provides a second benefit aside from safeguarding the principal and subsequent interest gains, it also prevents the policy from having to recover from any sort of loss to the outside stock index in the previous policy year. For instance, if the S&P 500 index were to drop 40% during a policy year, the annuity would be credited with no interest for that policy year. However, if the S&P 500 had a calculated return of 10% the following year using an annual point-to-point calculation with a 6% cap, the annuity would earn 6% on top of where it had left off the policy year prior. An example of this benefit can be seen in this simple example that ignores dividends:
A direct investment in an index with an initial investment $100,000, a 40% loss after one year takes the value to $60,000, a 10% gain the following year would increase the value to $66,000. The same investment being tracked in the index annuity with an initial investment of $100,000, a 40% loss after one year is replaced with a 0 and the account balance is still $100,000, the subsequent 10% gain the following year is reduced to 6% due to the cap, which would be a $6,000 gain, so the $100,000 investment would be worth $106,000. This particular example illustrates why these annuities tend to be marketed more heavily towards seniors/retirees, as an indexed annuity provides a true safeguard against market losses but still offers a level of exposure to market-based returns.