Recent Changes, Trends, and Developments, in Segregated Funds

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1 Recent Changes, Trends, and Developments, in Segregated Funds New Disclosure Requirements and Rescission Right for Segregated Funds The new Fund Facts and Key Facts disclosure documents are being implemented in January 2011, and these documents make it easier for consumers to understand and make informed investment decisions concerning individual variable insurance contracts (IVICs) and segregated funds. Fund Facts and Key Facts provide consumers with information before they make the decision to invest. The new documents help consumers by providing an explanation of the potential benefits, risks, and costs of investing in a fund. All Fund Facts must be presented in a standard format, and since all insurers will be using the same Fund Facts format, consumers will be able to easily compare funds offered by several insurers. Key Facts replaces the Executive Summary of the information folder. Fund Facts is now part of the information folder. The agent must provide consumers with the new information folder developed under these new rules. The agent is also required to explain the contents of the information folder to the consumer. The other delivery requirements for the information folder are unchanged. The agent must provide the information folder to the consumer prior to taking an application for an IVIC and obtain the client s acknowledgement of receipt in writing or in electronic or recorded oral form. Consumers may still choose to receive the information folder in person, by mail, or by fax, or they may choose to receive the information folder electronically, via , or by viewing the folder online. If the information folder is delivered electronically, the consumer must be specifically directed or linked to it. Rescission Right Consumers also have a new cooling off period that allows them to change their mind and rescind, within two business days of receipt of the confirmation of the purchase of an IVIC and/or segregatedfund selection made under the IVIC. The agent must ensure that the clients are aware of this right. Copyright Oliver Publishing Inc. All rights reserved 1

2 Other Recently Introduced Provider-Based Changes The Guaranteed Minimum Withdrawal Benefit (GMWB) and the Guaranteed Lifetime Withdrawal Benefit (GLWB) Products Since early 2009, the guaranteed minimum withdrawal benefit (GMWB) and the guaranteed lifetime withdrawal benefit (GLWB) products have been introduced to the Canadian Markets. These products are not new, but are enhancements to the standard segregated funds products. There are two reasons why these products are receiving such attention: 1. The Baby Boomers are now in the process of retiring, and they want to ensure that their lifetime savings provide them with guaranteed lifetime income so that they will not outlive their resources. 2. Recent market downturns as a result of the recession have forced providers to offer alternatives and guarantees to retirees. The concept of the GMWB and the GLWB are not new. They have in the past been applied to deferred annuities. The segregated fund contract or an IVIC is a form of deferred annuity contract that hitherto gave only a guarantee on the accumulations or account value. Recall that the maturity guarantee and death benefit guarantees offered by segregated funds make up a minimum of 75% of the premiums paid into the contract. GMWB and GLWB products now offer, in addition to these accumulation guarantees, an income guarantee for retirees. These products generally have two phases: 1. The investment, or accumulation, phase, in which the consumer is free to invest new premiums into the contract. The Maturity and Death benefit guarantees apply, as in all segregated fund contracts. The accumulation phase may extend until the retirement of the accountholder. Generally this is 15 to 20 years. 2. The retirement, or payout, phase, in which the fund guarantees a minimum payout from the fund for a stated period (say 15 years). This is called a Guaranteed Minimum Withdrawal Benefit (GMWB) or, if it covers the lifetime of the accountholder, called the Guaranteed Lifetime Withdrawal Benefit (GLWB). The minimum age at which a person may begin the payout phase is generally fixed by each insurer (a common example would be at age 55). Copyright Oliver Publishing Inc. All rights reserved 2

3 Essentially the GMWB and GLWB are percentages of a guaranteed benefit base (GBB), which is a notional amount. The Guaranteed Benefit Base (as we are calling it here) is named differently by various insurers, and the way they calculate it may vary among them. The base in general is calculated by most insurers as: GBB = Deposits + Bonuses and/or Crystallized gains Surrenders Bonus: During the accumulation phase, the GBB is increased by a bonus (say, 5%) of the current GBB, for each year in which surrender was not made. The bonus only increases the value of the GBB, which, as mentioned, is a notional amount and has no impact on the market value of the account. Crystallized gains: These are gains that are added to the deposits when a reset occurs. Most insurers offer an automatic reset periodically (say, every three years), when the premiums will be made equal to the account value, in case the account value is more than the current GBB. The Guaranteed Minimum Withdrawal Amount (GMWB) = A percentage of the year-end GBB Assume GMWB = 7% 0f GBB Note that a surrender of less than or equal to the GMWB does not affect GMWB for future years. However if the withdrawal is more than the GMWB, it may reduce the GMWB for the future. The GBB can be increased by bonuses, resets, and new premium deposits. The GBB is decreased by surrenders, and the GMWB is adjusted downward if the surrender is more than the GMWB. If the surrender amount is less than the GMWB, some insurers allow for a deferral of the difference and a future surrender can be for the GMWB + the deferral, without affecting the GMWB. Copyright Oliver Publishing Inc. All rights reserved 3

4 Example of calculation of the GBB: Date Transaction Amount Market Value (after Transaction) GBB Bonus Calculated on GBB Bonus GBB (After Transaction) GMWB (Assume 7%) Remarks 4-Jan-09 Initial Premium $100,000 $100,000 $100,000 - $100,000 $7, Dec-09 End-of-year - $108,000 $100,000 $5,000 $105,000 $7,350 5-Apr-10 Premium $50,000 $170,000 $150,000 - $155,000 $7, Dec-10 End-of-year - $180,000 $150,000 $7,500 $162,500 $11, Jun-11 Surrender ($10,000) $172,000 $150,000 - $152,500 $11,375 No effect on GMWB, since the amount surrendered is less than the GMWB of $11, Dec-11 End-of-year - $175,000 $150,000 No Bonus $152,500 $11, Dec-12 End-of-year Reset $180,000 $180,000 $9,000 $189,000 $13, Jun-13 Surrender ($20,000) $155,000 $155,000 - $155,000 $13,230 No bonus, as there was a surrender in 2011 Reset considers the GBB to be the higher of the current GBB or the reset value. GBB is affected, since withdrawn amount is greater than GMWB. GBB will be the lesser of (current GBB Surrender or Market Value after surrender) 31-Dec-13 End-of-year - $155,000 $155,000 No Bonus $155,000 $10,850 Once the accountholder enters the payout phase, or on maturity of his contract, the accountholder has an option of converting the contract to a payout phase. The account holder may opt to receive benefits in one of two ways: 1. A fixed period, such as 15 or 20 years, as stated in the contract. 2. A lifetime withdrawal base on the account holder s life or a joint option. For the fixed-period option, the GMWB calculated based on the date of maturity will be applied, generally after a special reset on maturity. No bonus will be calculated once the payout phase has commenced. The plan holder may withdraw more than the GMWB, but this will have a downward effect on the GMWB. However, if the plan holder has a RRIF or a LIF account, there will be no downward adjustment to the GMWB if the RRIF or LIF minimums are more than the GMWB. Copyright Oliver Publishing Inc. All rights reserved 4

5 For the lifetime withdrawal benefit, however, the GLWB is calculated as a percentage of the Guaranteed Benefit Base (GBB), based on the age of the plan holder when the option is exercised. The GLWB is naturally a smaller percentage than the GMWB, because it provides for the life of the annuitant. Typically, the GWLB rates are as follows: Age of the GLWB Rate annuitant when option exercised Age 55 to % Age 60 to % Age 65 to % Age 70 to % Age 74 to % GLWB is calculated, much the same way as GMWB. Any surrender in excess of GLWB will lead to a downward adjustment of future GWLB. The advantages to be obtained from these products is peace of mind, because the GMWB and GLWB are guaranteed amounts that can be withdrawn every year in the payout phase, even if the market value of the account would be inadequate to provide the benefit otherwise. Thus, these products provide a protection against market downside risk while the consumer enjoys the upside of the market through resets. This is of particular importance to people nearing retirement or to retired persons, as they cannot afford to see their lifetime savings eroded by a wild market downturn. The disadvantage is, of course, that the fees one pays for these products are a little more than for products without GMWB and GLWB benefits. As an agent you must bring out these features to the consumer. Copyright Oliver Publishing Inc. All rights reserved 5