ETFs for insurance advisors? They do exist

In the final quarter of 2011, Canadian-listed ETFs posted net sales of nearly $3 billion.

It’s clear there is a growing segment of investors seeking products that offer low management fees, transparency and tax efficiencies.

Advisors can take advantage of ETFs to diversify a client’s portfolio, including options such as a gold index, an oil and gas index, or an emerging-market index. In addition, bundled ETF portfolios can be purchased to meet your clients’ risk tolerances.

“Utilities has been one of the top sectors to be in over the last three years as investors are looking for yield,” says Kevin Prins, vice president, BMO ETFs. “Utilities also have lower volatility—something that most investors want in today’s markets.”

Insurance advisors can also participate in the popularity of ETFs. Some companies now offer a range of ETFs through their universal life (UL) policies, which can complement an existing mutual fund or guaranteed investment option allocation.

But what about the fees?

One reason ETFs are popular is their low management fees. The underlying ETF MERs can typically range from 25 to 50bps, which makes a big difference. If you purchase it through a universal life insurance policy, there are higher fees, from 2% to 3%, due to the UL policy fee.

Case study

Johnny is a single, 40-year-old male, and a non-smoker. He:

• will require a $500,000 permanent life insurance policy for short-term risk and eventually capital gain taxation;
• is interested in the Equal Weight Utilities Index ETF;
• will deposit $15,000 into the policy for the next 20 years; and
• will assume an annualized return of 9% for the underlying ETF given the history of this particular ETF.

Consider the case study (right) that features Johnny. The UL policy return projects the aggregate return rates on a yearly basis as either positive or negative, but with an average return of 6%. This means the 3% difference is the higher MERs associated with the UL policy fee for the fund inside its policy.

Outside the UL policy, the Equal Weight Utilities Index ETF taxation is 60% dividend and 40% unrealized capital gain.

The ETF values in the chart “Taxation implications” assume a 30% dividend tax rate applied to the returns on an annual basis and the unrealized capital gains are applied on disposal of the ETF (either sold or on death). The comparison also assumes 1.5% probate tax on death.

This case study shows Johnny is able to secure insurance coverage while, at the same time, keeping all accruals taxation-exempt by investing the ETF inside the policy.

ETF/GIC hybrid options

As Johnny ages and his risk tolerance changes, there are ETF/GIC hybrid options available through selected Canadian insurers. In UL plans, these are referred to as Guaranteed Market Indexed Account (GMIA).

GMIAs participate in an index such as the S&P / TSX 60 Index. It guarantees it will not have any negative returns, and participates in a portion of the positive gains in the index. Over time, the returns fall between those of a GIC and the market index.

This would appeal to Johnny in later years since he won’t lose any of his gains should the market go down. It also provides an inflation hedge because results show it generates annualized returns greater than a traditional GIC.

Johnny is now 55, and is thinking about partial or full retirement in the next five-to-10 years. He has little interest in matching or beating the market index, and he remembers how bad 2008 was on his portfolio. He knows he needs to be proactive and develop a good defence against volatility since a big drop in the market could jeopardize his retirement plans.

Insured retirement planning

Johnny is 65 and ready to retire. His employer-sponsored Group RRSPs have been funded through payroll deductions, and his TFSA has a healthy balance.

A behavioural finance perspective

Clients don’t always go with the most logical decision, and behavioural finance research shows a client’s decision-making process is often influenced by emotions, and even biology. As reported in Advisor’s Edge, single males are more likely to take on riskier investments than married men or women.

So if Johnny eventually marries and has children, he’s not the same bullish investor he once was, especially as he gets closer to retirement. The older he gets, the more risk-averse he is. For example, in a recent study by Dr. Eric Johnson of Columbia University, retirees were shown to be five times more sensitive to losses than the average person.

He decides to draw from his TFSA for the few years until he transfers the Group RRSP into a LRIF at 71. He wants to supplement his LRIF income to maintain his lifestyle, but he wants to maintain a certain amount of capital in his LRIF so it can roll over to his spouse upon his death. Luckily, his lender will loan 90% on the GMIA, and 75% on the remaining funds in the ETFs inside the UL policy.

Assuming an annualized 5% return in the GMIA and 6% in the ETF in the UL policy, and a very conservative bank loan interest rate assumption of 8% (the interest is being capitalized), we can see how the IRP provides a tax-free income of $153,224 from age 72 to 80 (the projected life expectancy of a 40-year-old male, non-smoker at time of underwriting).

If he stuck with a stand-alone ETF, an after-tax income of $153,224 would leave $795,286 at age 80 to his estate. In comparison, the insured retirement plan would result in a $1.1 million death benefit to his estate. This is in addition to the death benefit protection for the last 40 years.

Insurance advisors shouldn’t shy away from incorporating ETFs into their practice. Adding ETFs to your existing strategy in a UL policy provides stronger asset allocation, a greater level of financial security, and tax efficiencies.

Pierre Ghorbanian, CFP, FLMI, is an advanced markets business development manager at BMO Life Assurance Company.