Chapter 5 - Segregated fund contract and annuity recommendation

Segregated Fund Contract and Annuity Recommendation

Competency Components

  • Analyze available products that meet client needs.
  • Implement a recommendation adapted to the client’s needs and situation.

Competency Sub-components

  • Analyze the types of investments that can constitute a segregated fund and that meet the client’s needs.
  • Propose a recommendation adapted to the client’s needs and situation.

Agent's Role in Investment Strategy

  • Recommend suitable investment strategies to meet client needs after completing the individual investor profile.
  • Weigh various factors and ensure the client understands the rationale behind the investment choices.
  • Prepare recommendations for groups.

Fair Treatment of Customers

  • Regulators provide guidance on fair treatment, including ethical behavior and acting in good faith.
  • Key Principles:
    • Prioritize clients’ interests over those of the agent, insurer, and intermediaries.
    • Provide accurate, clear, and sufficient product information before, during, and after the sale.
    • Offer ongoing information to enable informed decisions throughout the contract's life.
    • Avoid or manage conflicts of interest.
    • Minimize the risk of unsuitable sales.
    • Ensure advice is relevant.
    • Handle claims, complaints, and disputes fairly and promptly.

Recommendation Presentation

  • Recommendations can be presented as a single option, a comparison, or multiple options.
  • Disclose pros and cons in a reason-why letter, as required by regulators and insurers.
  • Discuss the letter with the client to ensure understanding, and record the discussion in client notes.

Finding a Segregated Fund Contract

  • A segregated fund contract may be the best recommendation when the client seeks:
    • An investment with the benefits of an insurance contract.
    • Exposure to capital market performance.
    • A long-term investment.
  • Other factors include guarantees or the ability to bypass probate.
  • Analyze benefits and limitations in view of client’s needs and compare suitable funds.
Fund Analysis
  • The agent must methodically analyze available funds based on the client’s investor profile.
  • Stay up-to-date on new fund introductions through industry channels, including journals, marketing materials, and wholesalers.
  • Client suitability is the only standard, irrespective of commission rates or trailing fees.
  • Analysis should be based on current information, supplementing insurer details with other research.
  • Verify the accuracy of third-party information and obtain compliance officer approval when necessary.
  • Distinguish between fact-based and opinion-based information.
Supporting the Segregated Fund Contract Recommendation
  • Determine and prioritize product factors most important to the client based on their investor profile.
  • Align segregated fund contract features with client needs.
  • Example: if the client prioritizes capital protection, emphasize the maturity guarantee.
  • Reiterate fund characteristics that align with client objectives and point out limitations.
Making the Recommendation
  • A meeting is required to substantiate findings, answer questions, and provide direction.
  • Meetings can be in-person or virtual.
  • Virtual meetings require planning, technological competence, and a good internet connection.
  • Consider a hybrid approach: send physical documents and meet virtually.
  • Provide documents to clients prior to virtual meetings to ensure receipt and review.
  • Follow proper etiquette for virtual meetings.
Electronic Signatures
  • Used in place of physical signatures, with options including scanned documents, pasted signatures, typed names, stylus signatures, or electronic confirmations.
  • Secure electronic signature technology uses algorithms and encryption for authenticity.
  • Be alert to red flags indicating a lack of consent and ensure the client understands their obligations.
  • Maintain hard copies of meeting notes and relevant documents.

Segregated Fund Contract Recommendation

  • The recommendation must focus on fund specifics and seek consensus with the client.
  • The client makes the final decision.
  • Document the client’s reasoning if their decision differs from the recommendation and seek manager input.
  • Reassess needs and objectives for subsequent investments.

Key Elements of a Segregated Fund Contract Recommendation

  • Identification of fund and its characteristics.
  • Deposit and funding.
  • Value of guarantees.
  • Contract maturity date.
  • Principal risks of recommendation.
  • Reset.
  • Contract riders.
  • Fund taxation.
  • Fund sales charge.
  • Fund management expense ratio (MER).
  • Fund details.
  • Fund penalties.
Identification of Fund and its Characteristics
  • Identify the insurer and how the fund is invested (e.g., equity, income, bond).
  • Ensure the investor understands the pooled investment and how returns are achieved (capital gains, dividends, interest).
  • Compare "like" to "like" (e.g., balanced income fund to another balanced income fund).
  • Explain the rationale for recommending different types.
Deposit (Premium) and Funding
  • The investor must reveal the intended deposit amount.
  • Adhere to minimum and maximum premium amounts.
  • Follow the client’s lead and avoid pushing for more than what is suitable based on needs analysis.
  • Allow the client to develop comfort before making a larger commitment.
Deposit Allocation
  • Deposit is allocated to fund units at their net asset value (NAV) on the valuation day.
  • The number of units received varies based on the NAV per unit of each fund.
  • Differences in unit numbers do not reflect fund quality or performance.
  • NAV per unit is a benchmark for future performance monitoring.
Example
  • Lump-sum deposit: 10,00010,000
  • Fund A:
    • Guarantees: 75%/75%, NAV per unit: 12.8912.89, Units received: 10,000÷12.89=77510,000 ÷ 12.89 = 775
  • Fund B:
    • Guarantees: 75%/75%, NAV per unit: 11.1611.16, Units received: 10,000÷11.16=89610,000 ÷ 11.16 = 896
  • Fund C:
    • Guarantees: 75%/100%, NAV per unit: 11.4711.47, Units received: 10,000÷11.47=87110,000 ÷ 11.47 = 871
  • Recommendation C has a different guarantee structure and must be pointed out to the investor.
Lump-Sum Deposit
  • A one-time deposit, potentially with subsequent periodic deposits.
  • The maturity guarantee is based on the single sum deposited if there are no subsequent deposits.
  • The investor needs to satisfy the minimum deposit stated for the fund.
  • Received via cheque or transfer.
Transfers
  • Initiated by the receiving firm, requiring client details (name of organization, account number, contact details).
  • Use investment statements for accurate information.
  • Registered investments must be transferred to registered contracts to maintain tax deferral.
  • Non-registered funds can be transferred to RRSPs or TFSAs as contributions, subject to contribution room.
Periodic Deposits
  • Ongoing deposits must meet minimum requirements set by the fund manager.
  • The client’s cash flow statement indicates suitability.
  • Can be made to non-registered, RRSP, and TFSA contracts.
  • Deposits received throughout a year are RRSP/TFSA contributions, requiring available contribution room.
Maturity Dates
  • Periodic deposits may create a series of maturity dates and guarantees.
  • A client may align needs with maturity dates.
Example
  • Chris deposits 250250 monthly into a 75%/75% segregated fund.
  • Each of the 12 deposits is guaranteed at 187.50187.50 (250×75250 × 75%) on its maturity date.
  • Chris’s time horizon should correspond to the series of maturity dates.
Value of Guarantees
  • Recommend guarantees based on the client’s risk tolerance.
  • Some clients may invest in higher-risk equity funds due to the guarantees.
  • Ascertain the dollar value of guarantees based on the investor’s commitment.
  • Point out that guarantee rates are either 75% or 100%.
  • The guarantee may change if a switch is made during the contract.
Maturity Guarantee
  • Automatically provided as 75% or 100% of deposits at maturity.
  • Reiterate the percentage in dollar value.
  • The investor receives market value if it is greater than the guarantee.
  • The investor loses the benefit if they surrender before maturity or if a withdrawal is made.
  • Compare the effect of a lower or higher MER.
  • Stress that upside for growth is unlimited.
Death Benefit Guarantee
  • An automatic part of the contract.
  • Helps the investor to know the dollar amount that would be received.
  • Can have great value in the peace of mind it brings to those whose health is impaired or to those who are older.
Contract Maturity Date
  • Can range from 10 years after the deposit to the annuitant’s 100th birthday or beyond.
  • State the actual maturity date (month, day, year).
  • Clarify the relationship between guarantees and maturity dates.
  • Disclose these details to the client.
Principal Risks of Segregated Fund Contracts
  • Any amount allocated to a segregated fund is invested at the risk of the contract holder and may increase or decrease in value.
  • Fund risk is plotted on a scale with six classifications: very low, low, low to moderate, moderate, moderate to high, and high.
  • Insurers tend to adopt a five-band classification scale (without the «very low» class) similar to the mutual funds’ one.
  • Funds are subject to specific risks, such as interest rate risk or market risk.
Risk Considerations
  • The risk assessment of each recommended fund.
  • The forms of risk associated with the recommended products, e.g. exposure to equity risk and inflation risk.
  • The risk tolerance of the investor.
Reset
  • Allows the investor to lock in increases in market value at specified intervals.
  • The feature is not utilized if market value has declined.
  • Not all contracts offer reset.
  • Compare the cost of reset between recommendations through a higher MER.
  • Show the client how reset extends the maturity date and increases the maturity and death benefit guarantees.
  • Provide concrete examples.
Example
  • Nassir’s agent recommends a fund with a 10-year maturity date from April 23, 2020.
  • Nassir has a 5,0005,000 premium available and wants a 75%/75% guarantee structure.
  • The maturity date of his contract will be April 23, 2030.
  • The contract would have an automatic reset every two years on its anniversary date.
  • The first reset would be April 23, 2022.
Contract Riders
  • Address whether an income rider should be added to the contract.
  • Thoroughly describe the characteristics of Guaranteed Minimum Withdrawal Benefit (GMWB) or Guaranteed Lifetime Withdrawal Benefit (GLWB) riders.
  • Comparisons between providers may be difficult.
Fund Taxation
  • The taxation of the fund will depend on whether the contract is set up as registered or non-registered.
  • Deposits to a registered contract will generate a contribution if the contract is an RRSP or TFSA.
  • RRSP contributions are tax-deductible.
  • Withdrawals are taxed very differently depending on whether the contract is registered or not.
Sales Charge Options
  • Each fund contract will offer different sales charge options, such as front-end load, no load, advisor chargeback, deferred sales charge.
Fund Management Expense Ratio (MER)
  • The management fee covers management and operating expenses, taxes and, often, the cost of providing guarantees.
  • Trailing commissions are paid from the management fee.
  • The MER is the percentage of expenses relative to the average value of its assets.
  • MER is not based on performance and it is charged regardless of performance.
  • The real return on the fund is calculated as follows: Real Return=Reported Return+MER\text{Real Return} = \text{Reported Return} + \text{MER}
Example
  • Roberta invests 10,00010,000 in Fund A (MER 3.5%) and Fund B (MER 1.5%), both with a 5.0% return.
  • Fund A:
    • Real rate of return: 8.5% (5.0% + 3.5%).
  • Fund B:
    • Real rate of return: 6.5% (5.0% + 1.5%).
  • If Fund A has a reported return of 6.2%, the real rate of return is 9.7% (6.2% + 3.5%).
Fund Details
  • Discuss and explain the contents of the information folder including Fund Facts to the investor.
  • Fund Facts provide brief summaries of each fund.
Delivery of Fund Facts
  • Delivered before the application is signed, in person or electronically.
  • The client must acknowledge receipt.
Delivery of Financial Statements
  • Show key financial information about a fund for up to five years.
  • Clients may submit their request for financial statements to the agent or directly to the insurer providing the fund.
  • All funds release annual audited financial statements and semi-annual unaudited financial statements.
Total Value of Fund
  • The figure on which the MER is based.
  • Funds with a higher total value can potentially offer a lower MER.
Fund Units, Net Asset Value per Unit and Market Value
  • Shown in Fund Facts as at the date specified.
  • Market value of units will be the current value, or value as of the most recent valuation date.
  • This data is used for comparison in the recommendation and is not an indication of the quality of the investment.
Date of Inception
  • The date on which the fund began operations.
  • Funds with long track records offer more history by which investors can assess overall fund performance.
Performance Data
  • Always historical, never used to predict the future.
  • The average return states how much a 1,0001,000 investment with the most basic guarantee (75% maturity/75% death benefit) would be worth and its annual average return as a percentage for the years shown.
  • Year-by-year returns show the fund’s annual performance in a chart format.
Fund Manager
  • Some performance credit, or blame, can be assigned to the manager of the fund.
Portfolio Turnover Rate
  • Expressed as a percentage of the fund’s holdings that have been replaced during the previous year.
  • High turnover translates into higher expenses due to buying and selling costs.
  • A lower MER can improve investor returns.
Fund Penalties
  • The recommendation should be accompanied with a reminder of the long-term nature of the investment.
  • Point out fund penalties but don’t imply approval to withdraw or surrender prematurely.
  • Some charges or penalties include:
    • Account closing charge.
    • Frequent switching charge.
    • Fees to set up registered accounts or contracts.
    • Short-term trading fee.
    • Unscheduled withdrawal or switch fee.

Finding for an Annuity

  • A likely candidate for a payout annuity would be one seeking a certain level of income.
  • A potential candidate for an accumulation annuity would be one that is looking for a more conservative approach without some of the limitations of segregated contracts.
Annuity Analysis
  • Is the annuity being created to pay income or for savings?
  • How many lives will be covered?
  • Will the annuity payments be made for a period of time or life?
  • When will income begin?
  • Will income be a level payment or variable?
  • How will the contract be funded?
  • Which form of taxation will apply?
  • The agent needs to keep himself apprised of new product introductions and innovations.
Supporting the Annuity Recommendation
  • The agent must have a sound basis for his annuity recommendation that is a result of client needs weighed against product features.

Annuity Recommendation

  • Logical starting point: the type of annuity best suited to the client.
  • Determine how the deposit will be made, when payments will begin, the payment schedule, whether payments will be level or variable, and the guarantee period best suited to manage the risk of the investment.
Key Elements of an Annuity Recommendation
  • Type of annuity and its characteristics.
  • Timing of payments.
  • Annuity rate.
  • Value of guarantees.
  • Principal risks of annuity recommendation.
  • Annuity penalties.
Type of Annuity and its Characteristics
  • Two fundamental types: payout or accumulation.
  • Payout Annuity: Recommended when income is indicated.
  • Accumulation annuity is recommended when the analysis indicates the suitability of an investment-return approach.
Minimum and Maximum Investment
  • A minimum investment for each type of annuity is stated by the insurer offering the product.
  • A maximum may also be specified by the insurer.
Maturity Date
  • Applies to both term and accumulation annuities.
  • Determining the length of time until the maturity date depends on the income need to be satisfied by the term annuity, and the time horizon for the accumulation annuity.
Example
  • Jane, age 60, receives a lump sum from her employer and purchases a five-year immediate term annuity.
  • Her retirement pension begins about the time her annuity payments end.
Timing of Payments
  • Payments may be recommended to begin immediately or at a later date (deferred annuity).
Immediate Payments
  • Recommended for those with immediate income needs.
  • If a registered retirement savings plan (RRSP) at maturity is being converted to an annuity, annuity payments must begin in the year following. They cannot be deferred to a later date.
Deferred Payments
  • Suitable for those who want to accumulate deposits before starting income or who wish income to begin at a future date.
Annuity Rate
  • Depends on the amount invested, interest rate, and contract length.
  • The rate offered by the insurer will be in force for the duration of the annuity.
  • Annuity rates vary between insurers.
  • Annuity rates used by insurers are different for fixed-income annuities and variable income annuities.
Fixed-Income Annuity
  • Best suited to an investor without the risk tolerance needed for a variable income.
Variable Income Annuity
  • An investor who has risk tolerance for the ups-and-downs of the stock and bond markets may prefer a variable income annuity over one that provides a fixed income.
Value of Guarantees
  • Customize an annuity contract to suit the needs of the policy owner.
Life Annuity Guarantees
  • The guarantee period of a life annuity minimizes investment risk for the investor.
  • A higher risk tolerance may indicate a shorter guarantee period.
Return of Premium Guarantee
  • Pays the beneficiary the full premium paid to the contract if the annuitant dies before the first payment.
  • Recommending the rider is suitable for those who have a low risk tolerance, when a deferred annuity is recommended, when the annuitant is in poor health, or to ensure return of principal invested to the estate.
Principal Risks of Annuity Recommendation
  • Annuity rate that improves in the future, due to an increase in interest rates.
  • Inflation risk.
  • Annuity allows little or no flexibility for the investor.
Annuity Penalties
  • Annuity is a commitment, for a period of time or life.
  • Payout annuities cannot be surrendered.
  • Accumulation annuities are generally redeemable, although penalties may apply.
  • A term certain annuity may be surrendered upon approval of the insurer.