(February 2006) With more and more major protected bonds and market-linked GICs currently making headlines, many clients may not be thinking about segregated funds. And while they serve a different purpose than the next generation of guaranteed products, they could face a challenge from newcomers over the next few years.
“The first segregated funds were introduced to the market with a 10-year term and a 10-year guarantee, and they really started to gain popularity in 1997 and 1998,” says John Lutrin, executive vice president and chief marketing officer at Hub Financial. “Over the next year or two or three, we will see the first wave of seg funds mature.”
As these funds mature, will investors leave their capital in the hands of the company that has brought them this far, or will they seek out the newest major protected products?
“Will these impact the seg fund market? I don’t expect that to happen, but it’s impossible to tell because we get investors who see protection but maybe also want some better benefits,” says Sandra McLeod, CFP, director of succession and estate planning at Grant Thornton in Toronto. “This is how they will be sold.”
“My concern is, do people really understand what these things are and how they impact their current and future portfolios?” she asks. “Because they are so readily available, there is a risk that some people may not know what they are buying. The counselor may explain it well, but the client may not understand what the implications are.
In the late 1990s, some of the most popular seg funds were based on index funds, which provided exposure to the rapid growth of technology, and the guarantee gave investors a level of comfort. Lutrin argues that as the influx of products has increased, manufacturers have become overly competitive in the features they offer.
“What happened was that segmented funds took on an absurd structure because they became more and more attractive as life insurance companies became less and less concerned about risk,” Lutrin says. Maturity guarantees were increased from 75% to 100% and resets were introduced, allowing investors to lock in profits.
However, when the markets crashed in 2000, producers had to keep their finger on the pulse. Suddenly they found themselves in need of a 100% guarantee that could be reset at the top of the market.
“The irony of these resets is that they have served the company very well,” Lutrin says. “Thanks to this, although they are still interested in profit, the maturity dates are spread over time. This will also, to some extent, limit the impact of the huge wave of maturities.
“If you had asked carriers two or three years ago what they thought about this, you would have found that they were really hesitant, which is why so many of these products were increasing their MER, doing different things to minimize exposure, to deal with the onslaught of simultaneous payout of these warranty. It won’t be as difficult as initially expected. “
Not just another warranty
Since then, the industry has matured greatly, Lutrin says, to the point where seg funds are now essential products that cannot be easily replaced by a proper financial plan.
“At first the craze was about underwriting, but over time I think life advisor has grown in sophistication around other features of a segmented fund,” Lutrin says. “It is now sold as an integral part of a financial plan.”
While mainstream protected bonds and market-linked GICs may make mainstream headlines, clients need to be educated on the difference between new structured products and the benefits of segregated funds.
“The benefits of estate planning and the life insurance aspect are much more discussed in client conversations,” Lutrin says. Unlike protected notes, a death benefit incorporated into a SEG trust allows the principal to be paid immediately to the beneficiary, bypassing inheritance and estate taxes.
“Because you can name a beneficiary, just like you would with a life insurance contract, you can bypass probate,” he says. “Nothing is liquidated in an estate – there are no delays or probate fees – so the aspect of being in a segregated fund is extremely attractive.
However, if the client is simply looking for a guaranteed investment product, he admits that secured bonds have some advantages over segment funds. A typical seg fund offers only a 75% guarantee at maturity, with 100% guarantee being available mainly for the death benefit.
Additionally, the new wave of structured products typically offer shorter maturities than the typical 10-year maturity of segmented funds. The shorter maturity reduces the main source of risk in guaranteed products: opportunity risk. Because the investor recovers his capital faster, he will be able to redistribute his funds faster.
“The amount of competition that overlaps between seg funds and PPNs, due to guarantees, is really relatively small,” Lutrin says. “I don’t think they have enough in common to argue with the linked notes and stuff.
“What I’ve noticed is that all these alternative products that are coming out all the time are very often appealing to a slightly more aggressive market rather than the typical life insurance customer.”
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For more information on segregated funds, read this article Electronic supplementation of distributed funds.
Submitted by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com
(21/02/06)
