November 20th, 2008
It's no secret the stock markets are way off. The Dow Jones is under 8000 knocking off 8 years of progress.
On the other hand, life insurance companies offer guaranteed investment policies. Sounds like the perfect solution...
Life insurers have long guaranteed to return 75 per cent of a person's original capital after 10 years, or sooner if the investor dies during a period of low stock prices.
They enjoyed a flurry of sales when they stepped up the guarantee to 100 per cent and allowed investors the right to more frequent resets of their capital guarantees....
Later, in response to competition, Manulife extended the 5 per cent minimum withdrawal benefit for a lifetime, thus turning its investment funds into something closer to a company pension plan or an old-fashioned life annuity.
Investors can now be confident that a $100,000 investment will assure them $5,000 of income each year from age 65, plus they have the potential to collect a larger sum if their investments do well and thus have their income keep up with rising prices.
Not so fast.
James Daw at the Toronto Star dug a little deeper, crunched some numbers and it's not quite so clear cut:
The 5 per cent bonuses that guarantee a steady increase in the base used to calculate the minimum income withdrawals are less than meets the eye.
Bonuses are based on your guaranteed capital – the original amount invested or any increase due to periodic resets – and ignore increases due to earlier bonuses. So, this is equivalent to a lesser percentage of compound interest than 5 per cent.
"Some agents are saying to people at 50, here is what you need to put in to guarantee a certain income at 65," says Pereira.
"It sounds wise, but at the same time, over 15 years you are looking at a potential of two market cycles, in which case you are taking a one percentage point hit a year. You have the potential over 15 years to at least double, if not triple the asset base."....
"I think the product is wonderful, that it was necessary in Canada and that it is going to be around for a long time, if not become one of the most dominant areas in the industry," says Pereira.
"However, I do believe there are a lot of pitfalls due to the complexity of this product that a lot of advisers are going to burn themselves on due to misunderstanding with the client, because I don't think a lot of advisers understand what is going on with this thing."
Regardless of the extra cost, the experience with the stock markets this year may drive more clients to look for guarantees so they can sleep at night, he says.
I think Daw may be underestimating the value of peace of mind.
Guarantee Minimum Withdraw Plans (GMWP) can also be a great fit for people who want to invest in stock market but are looking for ways to minimize their risk. But Daw is quite right - these guarantees do come at a price as many of the funds have significantly higher Management Expense Ratios (MERs).
Whether a guaranteed policy fits an individual - and which guaranteed policy fits - is something which needs to be evaluated on an individual basis. It's also a question of optimism and pessimism. If you think the market is going to do nothing but go up from here, there's no point in taking a guaranteed policy.
If you think there might be ongoing long term turmoil in the economy then a guaranteed return policy is the safest place to keep your money.