In a jousting match that pits the need for transparency against the right to withhold competitive information, insurance carriers want regulators to scrap reforms designed to make disclosure of insurance costs part of new point-of-sale documents.

Those issues will probably come to the fore early this year, when the carriers meet with the Joint Forum of Market Regulators in Toronto to discuss their complaints — and possible solutions.

In June 2007, the JFMR released its first draft of POS documents aimed at harmonizing and simplifying disclosure for consumers. When the new format is finally ironed out, probably later this year, advisors will deliver similar documents to clients every time they sell mutual or segregated funds. The industry responded to the JFMR proposal this past October by delivering more than 80 submissions. Among them are those from the legal departments and executive offices of 14 insurance companies. In addition, the Canadian Life and Health Insurance Association made a general submission that summarized most of the same points.

Much of the praise, challenges and quibbles that mutual fund manufacturers, dealers and individual advisors expressed in their submissions are similar. Most generally like the direction of the new disclosure requirements, designed to help consumers understand what they are buying. Arguably, no view is more important than that of Tom Hamza, president of the Investor Education Fund, which is funded by the Ontario Securities Commission. And he seems to be onside. “It’s pretty close to what they need to have,” he says.

The submissions express concern, however, about the potentially heavy paper burden, the delivery of requirements in a practical and timely manner, and a general streamlining of the new POS rules with documentation that already exists. The insurers argue, in particular, that the JFMR should apply a “principles-based approach” to the model documents. This will give the insurers more flexibility when it comes to the delivery of the documents in combination with the individual variable insurance contracts, they say.

But the insurers’ submissions are unique in another crucial area — the cost of providing an insurance guarantee. In a hypothetical example, the draft disclosure document lists Giant Financial’s “Choice Insurance” and breaks down the product’s fee structure. It reads: “Annual expenses, as a percentage of the fund’s total value: 3.10%.” The document then breaks the costs down into “fund expenses (MER)” at 2.25% and “insurance costs” at 0.85%.

The insurance industry makes at least two major complaints about this line. First of all, the calculation is a clumsy one that doesn’t properly describe what it is aiming to describe. The cost of insurance is not found by subtracting the cost of the underlying fund from the total management expense ratio of the segregated fund, the industry argues.

Embedded in that figure is the insurance cost, which can vary depending on the year, sales, market performance, the exact features that the seg fund product provides and other parts of the actuarial formula that are variable and — insurers emphasize — competitive. The cost of paying employees and advisors and a company’s profit margins are nestled in there, just as they are in a mutual fund companies’ MERs.

Further, if the carriers are forced to break out their costs from the management fees they pay to the underlying fund providers — at least a few basis points lower, at the institutional level — they’ll effectively release competitive information to the market, they say.

“For Transamerica, and probably other insurance companies, [this type of disclosure] would potentially reveal proprietary pricing information with respect to institutional partners and actuarial pricing policies,” writes Paul Raeburn, president of Transamerica Life Canada in Toronto.

The JFMR may also have pasted over a more troubling point: many segregated funds don’t wrap third-party funds at all. Insurance carriers develop products that simply don’t exist as stand-alone funds. In many cases, separating the fund’s management costs from the rest of the product could be pointless.

As an alternative, providing a ballpark estimate for the variable insurance cost might be a good idea, but insurance carriers haven’t been offered that option, they say. Instead, they are being asked to forgo setting a cost for insurance altogether. “The fund facts for a segregated fund should simply show the MER,” writes Raeburn in his submission, and the insurance industry echoes that sentiment.

@page_break@Apart from the theoretical fees posted in the draft document, there’s no denying the relevance of the cost to funds. According to Toronto-based data provider Morningstar Canada, the median MER on the Canadian equity mutual fund is 2.33%, whereas the segregated fund weighs in at 2.81%. The average 10-year return for the two products, inclusive of fees, is 9.8% and 9.3%, respectively. In a more volatile investment class such as global equity, for example, the difference stretches: median MERs are 2.6% and 3.2%, respectively; the 10-year performance, 3.4% and 1.8%, respectively.

Hamza likes the proposed disclosure document’s box score for fees — it’s like reading the hockey scores in the sports pages, he says: “One of the highlights of the document is that the costs are out in front.”

Despite the obvious fee discrepancy, Moshe Milevsky, a finance professor at the Schulich School of Business at York University in Toronto and a long-time analyst of the industry, sympathizes with the carriers when it comes to assigning a cost to insurance. “I’ve spent the past 10 years trying to do it,” he says, “and I’ve learned that the attempt to quantify what you’re getting is a devilishly difficult exercise.”

Milevsky stands by the statistical modelling that he did some years ago. The model shows that the capital markets can assign a fair price on an option that provides a 10-year guarantee on an equity growth fund: about 0.45 percentage points in fees, or $45 a year on a $10,000 investment. The option on more volatile securities — such as those in emerging markets — are more expensive and less appropriate for fixed-income investors.

It’s another matter when it comes to quantifying the actual cost of manufacturing insurance inside an insurance business, he says. The cost of insurance products that offer income guarantees and death benefits can vary, to say the least.

“Think of the actuary that’s doing the reserves on an annual basis,” says Milevsky. “Suddenly, the market has dropped or interest rates have gone down, and they have to put aside more reserves. They may have to take that out of profit. Then you have something called ‘surplus strain’, which means that the entire line can become unprofitable.”

Milevsky says a qualitative description of the cost and benefits of insurance should suffice: “Just tell consumers the total amount they’re paying. That’s what they’re ultimately losing.”

Sheldon Lin, associate chair of graduate studies in the department of statistics at the University of Toronto, concurs that insurance product features can make all the difference in assigning costs, a tricky task.

He adds however, that several non-profit groups and studies in the U.S. have roughly pegged the cost of segregated funds with death benefits at approximately 15 to 35 basis points. Living benefits cost significantly more. IE