The insurance industry has responded to investor demand for steady, guaranteed retirement income with new versions of variable-rate annuities products, such as the guaranteed minimum withdrawal benefit products sold by several firms. Now a major bank has joined the fray with a “lifetime income” product.

Toronto-based Bank of Montreal’s BMO Lifetime Cash Flow product is considered to be a deposit, not an insurance product, but it has similar features to GMWBs. It’s sold by financial advisors in BMO branches to clients who must be 55 years of age or older. But if the product catches on, it could be imitated and sold by other providers.

“The product will compete with variable annuities like the GMWB products,” says Dan Hallett, vice president and director of asset management for Oakville, Ont.-based HighView Financial Group. “What these products have in common is an option for lifetime income.”

With a minimum investment of $5,000, BMO Lifetime Cash Flow allows clients to create what the bank calls a “personal pension” that provides steady monthly income. The initial deposit is invested in a portfolio of BMO mutual funds that is rebalanced annually and gradually moved toward a more conservative asset allocation over time. However, the cash flow is guaranteed at 6% annually for the client’s lifetime, based on the value of the initial deposit, no matter what happens to the market value of the underlying funds. The portfolio includes BMO Dividend, BMO U.S. Equity, BMO International Value Class, BMO Bond and BMO T-Bill funds.

For the first 10 years, the money is invested on a tax-deferred basis, and no withdrawals are permitted. For the subsequent 15 years, the client receives guaranteed cash payments equal to 6% of the initial deposit. The payments are categorized as return of capital, and so are tax-deferred. For example, if a 55-year-old client contributed $100,000 and began collecting at age 65, he or she would have received $90,000 in tax-deferred income by age 80. The income is based on the value of the original deposit, and investors are protected if the deposit loses a significant portion of its value due to poor financial markets.

In Year 26 and beyond, the client continues to receive 6% a year, but the income is now classified as interest and thus fully taxable. This income continues for the rest of the client’s life or as long as the product is held. If the client lives to age 95, he or she could receive another $90,000 in income. In Year 26, and during a brief annual window of opportunity on the anniversary date every year thereafter, the client may choose to redeem all or a portion of his or her remaining investment. The redemption value would be based on the performance of the underlying fund portfolio since inception, minus the 6% annual payments.

The performance of the underlying funds will be net of a 2.75% annual management fee. If the product is not redeemed, the remaining value would be transferred to the client’s estate upon death.

“In talking to customers heading into retirement, we found that their No. 1 concern is security of income,” says Caroline Dabu, vice president and head of retirement and financial planning strategy with BMO. “Many have been scarred by the financial crisis of 2008, when they saw their retirement savings erode.”





@page_break@Realizing that about 70% of Canadians have no defined-benefit insurance plan, says Dabu, BMO set out to develop a solution that would guarantee a rate of income no matter what happened to the underlying portfolio value. The goal also is to deal with longevity risk, continuing to provide an income no matter how long the client lives. Dabu suggests that the product is best used for about 30% of a client’s retirement income, particularly if they don’t have a DB pension plan, so at least a portion of their income is guaranteed.

“People could live 35 years or more after retirement,” says Dabu, citing insurance industry statistics that show one spouse of a 65-year old couple has a 50% chance of living past age 90.

One of the downsides of the new BMO product, says Hallett, is that there is no inflation protection for clients — the 6% rate of income remains fixed and based on the original deposit. Unlike some of the competing insurance GMWBs, there is no feature to lock in any portfolio gains along the way to increase the level of income. Hallett says clients may also want to consider investing another portion of their retirement assets in something that does provide inflation protection, such as equity mutual funds or indexed insurance annuities.

Another downside: the BMO Lifetime Cash Flow product is completely illiquid for the first 25 years — unlike a portfolio of regular mutual funds or other securities. “There is no feature for indexation or escalating income on the [BMO] product,” Hallett says. “Over 10- to 20-year periods, people may need their cash flow to increase because their cost of living is going up. The product could make sense for a portion of a portfolio, but retirees also need long-term inflation protection. Every product has its pros and cons, and the key is to know what the risks are and how significant they are for the individual client.”

Unlike insurance products, the BMO product doesn’t require the bank to set aside capital to meet future payment obligations. However, Dabu says, BMO has risk-management programs in place. In extreme cases, the deposit could be cancelled or repaid prior to maturity. In the remote chance of the failure of the bank, investors in the product would rank equally with other depositholders, although the product is not protected by Canada Deposit Insurance Corp.

BMO’s new product has similarities to some PPNs. For example, in 2007, Toronto-based Dynamic Funds Ltd. introduced Dynamic RetirementEdge Income Portfolios Deposit Notes — and, perhaps not coincidentally, they’re guaranteed by BMO. The Dynamic product is a series of three mutual fund-linked deposit notes, with a principal guarantee at maturity. The notes pay a regular income, but unlike BMO’s Lifetime Cash Flow product, the Dynamic notes mature after 15 to 25 years. Depending on the Dynamic note, the income could be adjusted to reflect a higher market value of the underlying portfolio. IE