Oct 8, 2008
https://www.advisor.ca/insurance/living-benefits/income-guarantees-2/
Necessity is the mother of invention, as the proverb says. Whenever there’s a need, someone will invent a device to meet that need.
While the expression generally refers to things mechanical, it’s also true in the investment management market. Mutual funds, exchange traded funds, linked notes and many other structured investment vehicles all represent innovations that were developed to meet the needs of investors and help them accumulate wealth.
Now, in response to the aging of the baby boomers, necessity is again showing its hand by driving innovations aimed at a different need: stable retirement income. As the demographic inches closer toward retirement, its need for stable post-career income is taking centre stage and creating a new market for innovative structured products.
Guaranteed income variable annuities, and other insurance-based investment products, have been marketed in the United States for years. But the concept didn’t arrive in Canada until 2006. The first products initially offered a 20-year guaranteed income from a segregated fund portfolio but later evolved to include a lifetime income guarantee, much like their U.S. counterparts. The products pioneered a new category of investment vehicles known as Guaranteed Minimum Withdrawal Benefits (GMWBs). In exchange for a percentage of the total account value, these products guarantee investors an income from the portfolio for a 20-year term, or life, regardless of market performance, even if the account value hits zero.
However, advisors are required to perform due diligence, and when considering these products for client portfolios, they must ask three questions:
• Is there a need for such guarantees?
• What is the value of these guarantees?
• How does the guarantee
To make a determination, an advisor should first examine segregated funds and assess their potential benefits, including GMWBs, and then analyze the applications for the product in a specific client’s portfolio.
Segregated Funds
On the surface they look just like mutual funds. Most seg funds are run identically like mutual funds, which bear the same name and manager, while some others offer a completely unique portfolio. The key difference is that seg funds, as insurance products, carry maturity and death benefits as well as several other optional benefits such as guaranteed life income streams. The insurance benefits are paid for by way of an annual percentage of account value fees, which are added on to the basic management fee that a client would pay for owning a mutual fund.
But, perhaps one of the best ways to look at GMWB guarantees is in the context of insurance. We purchase insurance in order to indemnifyourselves against worst-case scenarios: death, disability, critical illness, accident, fire, etc. In essence, portfolio ruin is another worst-case scenario and there is a very real possibility of disastrous results to the investor’s livelihood. In that context, is $7-to-$10 over the course of 20- to-30 years too much to pay for protection? With all the other benefits of GMWBs, including potential for market upside and liquidity, these are likely acceptable costs.
Given the demographic shifts facing Canada, GMWBs are likely to not only remain present in the marketplace, but to thrive and spawn new issues. For the right clients, these products offer a real value—the peace of mind and certainty that they provide investors. That security does, however, come at a price and advisors must weigh the need versus the cost before recommending them to clients.