Segregated Funds – no they aren’t – they are Individual Variable Insurance Contracts!
IVICs – quite a mouth full – seg funds is so much easier and shorter. Despite the street name, these really are variable insurance contracts – they aren’t mutual funds or any other type of fund actually. Also noteworthy – they are not new either – some seg funds trace their roots back to the 1950s. So why all the hype these days? Well, the market is several billion dollars – but why?
One of the earliest with which I came into contact was one from North American Life back in 1971 and the next was the SunFund “A” (Sun Life of Canada) back in 1976. (I’m not that old that I recall specific funds from the 50s and 60s!) Many other companies had them too – Canada Life, Manulife, Investor’s Group, etc. These early versions were very uncomplicated compared to the current street models. They typically came with a very high front-end load or service charges, sometimes as high as 15% on new deposits. The maturity protection on the funds deposited was a flat 75% of net deposits and was available after 10 years and every 10 years thereafter. The Death Benefit guarantee was also easy to calculate – 75% of net deposits – period.
No resets, no GMWB, GLWB, no 100% Death Benefits or Maturity Benefits or combinations of 100% death benefits and 75% maturity benefits. Ah for the simple days of our youth.
While they operate in many respects as do mutual funds, there are significant differences too. First, they are issued by life insurance companies and the regulation of the products and their sale comes under the Provincial or Territorial Insurance Acts – they are not subject to the rules and regulations that relate to mutual funds or other securities like bonds or stocks, etc. Second, because they are considered life insurance (refer to their technically correct name above) they have the attributes of other life insurance products (whether they are non-registered or issued as part of RRSPs, RRIFs, TFSAs or RESPs) such as the ability to have a named beneficiary thus the proceeds on death pass outside the estate of the deceased. This saves time and money – no probate fees, no lawyer needed to claim benefits, etc. As a result of this feature, their third attribute can be important to many people, they enjoy enhanced creditor protection compared to mutual funds, bank accounts, GICs, Term Deposits, stocks or bonds.
All investments have costs associated with them and seg funds are no exception. Compared to mutual funds, the Management Expense Ratios (MERs) are generally higher than mutual funds due to the costs of providing guarantees on death and maturity. Additional costs are imposed by the “life insurance” wrapper involving creditor protection and beneficiary appointment provisions.
Some insurance companies offer various “add-ins” such as a guaranteed minimum withdrawal benefit or guaranteed lifetime withdrawal benefit plus the ability to “reset” your guaranteed values if you desire. Just as buying a car, the more bells and whistles, the more they cost. Be sure you understand these additional options, their costs and benefits before you make your final purchase decision.
GMWB – Guaranteed Minimum Withdrawal Benefit is a feature that is available for an additional cost and, as the name implies, when the contract matures (at a date of your choosing, within limits) the insurance company guarantees that a minimum monthly withdrawal benefit will be paid for a fixed period. The GLWB – Guaranteed Lifetime Withdrawal Benefit – also for an additional cost, provides a certain level of income for the rest of your life – regardless of how long you live.
“Resets” allow you to lock-in market increases, should you so desire. The result however, is that your 10-year maturity guarantee period starts at zero again – be careful how you use this feature. Some companies restrict its use to once or twice per year – check with your advisor before you buy.
All companies selling these products provide advisors with the ability to illustrate various scenarios that will show how these products perform – up markets, down markets – erratic markets – you name it!
Some of the reasons, other than the “life insurance” wrapper benefits, that clients choose seg funds over mutual funds are obviously the availability of guarantees. Having the guarantees in place allows people, perhaps, to invest above their “normal” risk tolerance level. The enhanced creditor protection is of great value to business owners and professionals in our increasingly litigious society. The ability to have named beneficiaries protects the privacy of the deceased, designations are not contestable (in the absence of fraud) and don’t require the owner to treat all beneficiaries either equitably or equally as is the case when distributions to heirs go via your Will.
Consider them carefully, they may be a good fit for some of the basics of your long-term plans!