Premium Advice — Using product allocation to your client’s long-term advantage

Since the introduction of the guaranteed minimum withdrawal benefit (GMWB) and the increase in popularity of structured products with forms of capital guarantee, along with numerous investment writers’ espousing the virtues of proper management of diversified portfolios, the idea of product allocation has taken on a momentum all its own.

One common theme you’ll hear at the various investment road shows this fall is that understanding product allocation and managing your clients’ money takes more diligence on your part than simply balancing equities versus fixed income and Canadian versus international exposure.

This spring at the 2008 Conference for Advanced Life Underwriting (CALU), financial guru Moshe Milevsky drove home the point that product allocation is far broader than what is usually assumed. He reminded the crowd that while investment products — annuities, mutual funds, segregated funds, managed portfolios, and individual securities — make up the bulk of an advisor’s work in developing a client’s portfolio, insurance products play an integral role as well. Most importantly, he says not to overlook living benefits products.

If you’re familiar with Milevsky’s work (and undoubtedly, many of you are), then you’ll know that he has recently spent much of his time educating the industry on the importance of understanding not just the returns on one’s portfolio, but the “sequence of returns.” For a full explanation of the theory, visit his website, The Individual Finance and Insurance Decisions Centre, at www.ifid.ca.

Briefly, though, the theory goes like this: in fluctuating markets, you want to avoid withdrawing money when a portfolio is down. Withdrawals or redemptions in down markets lock in a loss, and recovery from that loss is quite difficult, or even impossible. Unfortunately, one cannot always plan the timing and amount of every withdrawal. The timing of one’s retirement, which cannot be avoided, forces withdrawals to support income needs. If down markets occur during this window of time, your client may never recover and will be faced with some very difficult choices to avoid outliving his or her assets. Milevsky calls this window the “Retirement Risk Zone.”

As he assured the CALU crowd last spring, the same risk occurs and is potentially greater if a health event strikes your client and the only source of funds to deal with a disability, illness recovery, or long-term care is his or her investment portfolio. Milevsky shared the results of a survey his team conducted of Canadians aged 55 and over who had retired, asking them the reasons they retired. Although almost 37% of people had retired because they were financially secure and had reached the end of their working years, there was a startling finding in this survey: 23.7% of retirees left their jobs due to “family responsibilities.”

While not all of these people would have retired to care for an aging parent or unhealthy spouse, it would be logical to assume that some had. Even more stunning was that 22.8% of retired Canadians had stopped working for personal health reasons. No one in these two groups would have deemed these reasons for retiring as ideal, and certainly few would have planned for it. Almost half of the respondents retired for a non-financial reason, and most likely have had to adjust their plans because of this reality.

When a health event occurs, your clients will need to work with you to decide whether to take out a loan or to withdraw assets. Advisors say to me all the time, “Well, I’ve done a good job creating wealth for my clients, so if the portfolio is down, we’ll just take a loan. My clients will be fine.” That’s a task easier said than done. The cost of the loan is one matter — What is the interest rate? How long will it take to pay off this loan (if ever)? What is the total long-term cost of this debt? — but also consider the viability of getting a loan. If your client is off work, recovering from a stroke or cancer, or needs assisted-living, under what terms would a bank lend money to him or her? Without a steady income to support the servicing of the loan, most lenders would depend primarily upon existing assets as collateral to support the loan, potentially forcing redemption of those assets in a worst-case scenario.

Also, consider what the ultimate costs of the health event would be. Certainly some wealthy clients could be self-insured, but is redemption of a significant amount of assets the best use of their capital? In previous columns, I’ve discussed the excellent internal rates of return that insurance products provide at claim time, for the premiums they cost. In almost every situation, it would be very difficult for anyone to invest those premiums and safely create a large amount of capital in the event of a health event. Certainly you hope that you never need to claim on these products, but it is a fact of life that we all must face. Many emerging affluent or average middle class clients would not financially survive an untimely health event.

Acquiring a loan will be difficult and, at the very least, costly. Self-insuring takes time to accumulate wealth, and there are risks of locking in losses if a health event strikes at the wrong time. Insuring the risk of a health event is the only answer. It frees up assets to ride out any market volatility during personal health recovery and ensures that the assets are there for their originally intended purpose — to provide for the dreams of retirement. Today’s forward-looking advisors are incorporating risk management solutions involving insurance products on a more regular basis, and their clients will be better served because of it.

Chris Paterson is vice-president of sales for Manulife Financial.

(09/08/08)