An alternative asset mix may suit conservative clients

Historic low rates have made guaranteed interest accounts less attractive. But new alternatives mean investing within a universal life policy shouldn’t be written off. Here are some investments to use within UL policies.

Guaranteed Market Indexed Accounts

Guaranteed Market Indexed accounts are similar to market-linked GICs or principal-protected notes. Clients can participate in the upside of an equity index (e.g., S&P/TSX 60 or S&P 500) but get the security of knowing returns will never be negative, even if the underlying index is. What’s more, gains from previous years are locked in until maturity.

These are ideal for clients who don’t need to outperform the market, but need to beat inflation and have guaranteed annual returns. They also help clients reach their goals without the risk of losing everything when markets drop. Most importantly, these accounts work well in a low-interest-rate environment, because as bond rates increase in yield, market participation in the upside increases without any lag. Within a universal life policy, these types of accounts do well because you eliminate negative returns, which makes it hard to break even.

LIMRA’s American sales survey found indexed universal life sales increased 22% in Q2 2013, followed by whole life at 5%. In Canada, we do not have indexed universal life, but guaranteed market indexed accounts operate on a similar basis.

Mortgages

Pooled mortgage funds have low correlations to equity markets, and provide investors with capital preservation and moderate to high rates of interest by investing in a diversified portfolio of commercial mortgages. They also have low correlation to equity and bond markets. Ideally, mortgages are for commercial properties in major urban markets. They typically carry higher interest rates and are paid off within 12 to 18 months. Investors earn much better returns than traditional GICs—about 6% to 9%.

If your client holds mortgage funds inside a UL policy’s indexed account, the income is fully tax exempt; it would have been taxed as interest income outside the policy.

Low-volatility ETFs

These ETFs are built on holdings that are less sensitive to market swings. High-volatility stocks are struck off the list, and those that remain are weighted based on their sensitivity to the market, with lower sensitivity names getting a higher weight. This changes the ETF’s risk and return profile relative to the broad market. If clients don’t have as steep downturns, not as many positive returns are required to bring them back up. For example, in a traditional equity fund, if you get a 5% loss in your portfolio, you need a return north of 5% to break even. For a 20% loss, you need a return north of 25% to break even.

Low-Volatility Market-Indexed

Some clients are happy to give up upside if it means minimizing the downside. That’s because the negative effect of large losses influences long-term performance more than the positive effect of gains. Major losses magnify the subsequent upswing needed just to return to pre-loss levels. Low-volatility market- indexed accounts are linked to equity markets for growth potential, with a risk management overlay that consists of exchange-traded short futures contracts. This manages the client’s equity exposure by minimizing losses during major market downturns.

Case study

One of your clients receives an after-tax bonus of $51,825. You divide it equally into a UL policy ($17,275), a whole life (WL) policy ($17,275), and an open non- registered account ($17,275).

The client’s conservative, so you’ll maintain an asset mix of fixed income, with some equity (but no more than 20%). You use the asset mix of a typical WL account and create it in an open non- registered account, as well as inside a UL policy. By using a diverse asset and product allocation, clients have a much better chance of achieving the upside potential of rising long-term interest rates and improving equities. The client’s participating WL policy has a $500,000 guaranteed death benefit, and a matching amount into a UL policy for $500,000 (Death Benefit: Sum Insured plus Fund Value). In the table below, we compare the values between the two policies. The non-registered account provides liquidity, UL provides higher estate value and WL offers security of guaranteed cash values.

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Whole Life Policy (Current Dividend Scale 6.75 %)		Open Account/ Conventional Investment (6.3% weighted/ blended rate of return) (83% Interest Income, 9% Dividend Income, 4% Realized Capital Gain, 4% Unrealized Capital Gain, 1.5% probate)	Universal Life (4.3% weighted/ blended rate of return)
AGE	Total Estate Value / Death Benefit Current -1%	Total Estate Value, net of Taxes & Probate	Total Estate Value / Total Death Benefit
60	$585,175	$207,612	$678,620
70	$896,074	$504,933	$959,634
80	$1,245,237	$931,986	$1,307,674
90	$1,609,116	$1,543,538	$1,825,385
100	$1,944,104	$2,435,397	$2,936,884

The non-registered account, while not tax-exempt, does provide liquidity should the client need it. The UL policy provides higher estate value, and whole life offers security of guaranteed cash values and insulates them from the next big market crash. by Pierre Ghorbanian, CFP, FLMI, an advanced markets senior business development manager at BMO Life Assurance Company.