Risk management top of mind for investing Canadians

(March 2006) A recent Investor Economics report identifies risk management as “a key theme for Canadian households in the next decade. “Those facing retirement must compromise between growth in investments and the ever-decreasing time available for recovery from investment losses. While they likely won’t articulate a specific need for segregated funds, they can be expected to increasingly ask advisors about wealth-protection solutions.

But guarantee levels for segregated funds vary, which means each has a different practical application, explains Julie Warren, vice-president, production development at Toronto-based CI Investments Inc., a wholly owned subsidiary of CI Financial Inc. “With 75/100 (75% capital return guarantee and 100% death benefit guarantee), you’re more concerned with your death benefit than your maturity benefit,” she explains, adding the focus here is risk protection. On the other hand, a 75/75 product (75% capital return guarantee and 75% death benefit guarantee) might suit clients who want to ensure sufficient funds are available to settle the estate on death.

Taken together, these factors have begun producing a new interpretation of what insurers call the “cafeteria approach,” which refers to the individual’s ability to select specific types of coverage from a broad list of available choices. It can be expected this approach will become a fact of life in segregated fund decisions. The emphasis and attractiveness of risk protection lends appeal to the portfolio approach by several insurers, explains Paul Bourbonniere, principal partner at Toronto-based Polson Bourbonniere Financial. “I think the trend to managing the risk, and therefore the cost, of the guarantee means there will be more innovative portfolio solutions,” he says.

Bourbonniere adds this approach benefits both parties, since it provides the client with asset diversification in a guaranteed (and therefore reassuring) context and relieves the advisor of the pressure of constructing a customized segregated fund portfolio. However, it also increases pressure on the advisor to ensure the guarantee arrangement selected correctly fits the client’s needs. “There are those that reset, those that don’t, those that are 75% [guarantee] and those that are 100%,” he says. “Then there are some that are generous on the death benefit and not so much on the maturity [benefit] and vice-versa. So there are a lot of variables that change the price, nature of the contract and fit with the client.”

The Quebec Factor

Segregated fund holders in Quebec and their advisors will rest more easily about the creditor protection advantage starting next month, says Margo Fairburn, director of compliance training and quality control for the Savings and Segregated Fund Network in the Toronto office of Desjardins Financial Security Life Assurance Company. That follows the passage of Bill 136 in Quebec’s National Assembly just before last Christmas, which is expected to take effect next month.

The Bill followed a May 2004 decision by the Supreme Court of Canada upholding an earlier decision by the Quebec Court of Appeal in September 2001. The case involved Quebec resident Guy Thibault, who established a self-directed RRSP containing a segregated fund investment. He had designated his wife as beneficiary. Following a judgment against him, a bank had obtained court permission to seize funds in the RRSP.

The Quebec Court of Appeal had ruled Thibault’s contract did not qualify as an annuity under the Quebec Civil Code and therefore did not automatically have creditor protection. This unfortunate subtlety is not a problem in the other provinces, usually referred to as the common-law provinces, where insurance legislation differs from the Quebec Code.

The court’s decision left one million similar segregated fund contracts (holding an estimated $21 billion in assets) in a questionable position concerning creditor protection, while other segregated fund contracts conformed to the Code definition of annuity.

But Bill 136 clarifies and standardizes the definition of annuity and therefore reinforces the creditor protection aspect in Quebec. So, advisors can now feel assured about the creditor protection feature, Fairburn explains.

Other Things to Watch For

Amendments to the Canadian Life and Health Insurance Association’s segregated fund requirements come into effect on June 30. One emphasis is harmonizing segregated fund prospectus language rules more directly with mutual fund rules, especially language used to describe fundamental investment objectives. “There are tighter requirements around what should be in the investment objective of the fund,” Fairburn says. While these changes do not have a direct cause-and-effect bearing on advisors and clients, their value lies in the insurers’ requirement to tighten the language of the prospectus.

Later in the year, advisors may see an updated version of a discussion paper known as 81-403, Rethinking Point of Sale Disclosure for Segregated Funds and Mutual Funds, first released by the Canadian Securities Administrators and Canadian Council of Insurance Regulators in February 2003. In keeping with the current focus on full disclosure, the CSA-CCIR paper examines requirements for point-of-sale disclosure. The next version will focus mainly on suggested requirements for timing, extent, and delivery of disclosure to the client, Fairburn says.

The previous version recognizes changing times in that it allows the possibility of document delivery systems other than paper-based materials. But it does not present any economic or cost/benefit analysis to underpin its statements about the need to revise point-of-sale formalities. It also doesn’t appear to provide for integration with the Fair Dealing Model and generally treats the entire advisor-client relationship in clinical terms.

And, there are other amendments to the Canadian Life and Health Insurance Association’s segregated fund guidelines contained in a document known as Guideline G2, which also comes into effect on June 30.

One change will allow advisors to move their segregated funds business into the Internet age by permitting electronic delivery of the information folder (prospectus). This change will save advisors time in handling both existing and new contracts — if a client loses the paper document, an advisor can replace it quickly via e-mail or by directing the client to a website. Moreover, where changes in an underlying mutual fund call for alterations in a segregated fund client’s portfolio while the advisor has limited trading authorization, he or she can send the information folder, indicate recommendations, and follow up by telephone.

“It could be a time saver, especially when you look at how busy the first quarter can be, during the run-up to the RRSP deadline,” Fairburn says.

Electronic delivery was not allowed previously, since regulations required a formally signed receipt for the information folder, because it embodies point of sale disclosure requirements. The G2 guidelines reflect Ontario regulations, so companies are unlikely to make this change before June 30, she explains, noting companies can be expected to provide a formal electronic receipt indicating the client has received the folder and understands its contents.

While the place of segregated funds in the advisor’s product roster and in the guaranteed portion of a client’s portfolio seems assured, what appears questionable is their share of the total guaranteed products market. The Investor Economics report predicts this market will expand to $1.3 trillion in 2014. As an “early product entry in the risk management arena with an ability to deliver upside growth potential in a risk-controlled fashion, segregated funds are therefore uniquely positioned to benefit from this theme,” the report says.

However, segregated funds will continue competing with newer instruments, such as market-linked GICs and principal protected notes, two categories of investment products also believed positioned for new changes and enhancements in 2006. As competition heats up, segregated funds have advantages besides being first in place, according to Bourbonniere. These include greater transparency in the product documents. “The advisor would be able to explain the segregated fund fee structure more easily than how the principal-protected note is priced,” he says.

This article originally appeared in Advisor’s Edge. Al Emid is a freelance writer specializing in financial services reporting. advisorsedge@rmpublishing.com.

(03/03/06)

Al Emid