Segregated fund sales have visibly increased since the first of the year. Manulife Financial Corp. reports an increase of more than 15% from Jan. 1, 2005, to the March 1 RRSP deadline over the same period in 2004. Desjardins Sécurité Financier reports a 6% jump for the same period. These increases could be related to confusion over other low-risk products, such as principal-protected notes, as well as to the usual concerns over equity market volatility.

Manufactured by insurers and sold by life-licensed advisors, segregated funds are insurance contracts in which the individual deposits one or more premium payments and receives benefits, including capital guarantees at death or maturity of the contract and exemption from probate fees.

At maturity, the investor receives market value or the predetermined guaranteed value, whichever is greater. If the investor dies before the fund reaches maturity, the estate receives death benefits of the market value at the time of death or a predetermined guaranteed value, whichever is greater.

Depending on the contract and its options, guaranteed value means one of: 75% of total premiums, 100% of total premiums or 100% of market value as determined by the reset feature. Where provided, the reset allows the investor to “freeze” the market value, meaning the final payout may be higher, but not lower, than the value at that time.

Performance, outlook and the fund manager’s track record are among the criteria considered in selecting a fund.
Choosing the best fund should also include
scrutinizing the money management approach, the management expense ratio and the guarantee structure, says John Lutrin, executive vice president of Vancouver-based Hub Capital Inc., a managing general agency that sees segregated funds as a core business component.

There are two basic schools of fund management. Some insurers, such as Montreal-based Standard Life Assurance Co. of Canada and Kingston, Ont.-based Empire Life Insurance Co., manage most or all of their funds. Others, such as Manulife and Canada Life Assurance Co., both based in Toronto, use third-party managers.

This can make a difference to the amount of the MER, Lutrin says. Compensation for the outside manager contained in the MER could reach as high 40 or 50 basis points, and may or may not be worth the money.
“There are examples in which external management outperforms what an insurance company would have done, but there are insurance companies managing their own funds that have beaten [outside] fund managers,” he says. Empire Financial Group’s funds have outperformed many outside managers, he adds.

Some current aspects of product design reflect earlier miscalculations, making fund selection more difficult. About a decade ago, competition for segregated fund investors began heating up as stock markets showed bullish returns. “It appeared as though there was a real rat race — a very competitive cut-throat world among seg fund carriers to get their name on the shelf,” Lutrin recalls.
Competition, bull markets and good returns meant that risks inherent in guaranteed values became overlooked, resulting in problems such as underpricing relative to future liabilities.

In some cases, those factors led some insurers to retreat. Zurich Life Insurance Co.
of Canada, for example, ceased marketing its segregated fund line.

In other cases, insurers repriced and restructured their funds to lower potential liability while raising customer appeal.
Manulife reduced its exposure by launching its GIF Encore with a maximum annual increase of 4%, non-compounded to the guaranteed value when paid as a death benefit. “From a marketing point of view that sounds great,” Lutrin says. Investors are assured of getting a guaranteed annual increase. “In reality what they’ve done is limit their exposure to 4% per year rather than market performance as a reset, which could have been anything.”

In some cases, the MER masks problems. Whereas the segregated fund comprises a mutual fund with a segregated wrap, the addition of segregated characteristics typically costs 80 bps on top of the mutual fund MER. “If you have a mutual fund MER of 2% wrapped into a seg fund, you would expect to see no more than about 2.8%,” Lutrin says. “If you did see more than that, you should be raising a red flag as to why.”

Depending on asset class, total MERs will vary. But a segregated fund wrap costing more than 80 bps over the normal MER for the underlying mutual fund may mean the insurer is compensating for overexposure to risk in the current product or a previous version.