Segregated Funds Guarantees

Segregated (seg for short) funds like mutual funds are pooled investments. But the insurance component in seg funds provides the following basic differences between segregated funds and mutual funds:

◊     Death benefit guarantee

The principal guarantee on death provides the policy beneficiary will be guaranteed to receive, at the least, a part or all of the initial invested capital (minus withdrawals) as specified in the seg fund policy, upon the death of the life insured under the policy. In the case of 75% guarantee, for example, the beneficiary will receive the greater of the policy’s fair market value at the time of death, or 75% of the gross principal deposits to the plan to date of death. Insurance companies may offer 75-100% death benefit guarantee.

◊    Maturity Guarantee

The principal guarantee available at maturity is essentially the same as the death guarantee, except that the maturity option only applies at a fixed date in the future, which must be not less than 10 years after the date of the principal deposit.

If the policyowner has to surrender the policy before the 10-year period the guarantee is null and he or she will receive only the policy’s fair market value.

At maturity, regardless of market performance, you are entitled to receive most or all of your initial invested capital back, less any withdrawals (or more, if the market has performed well). Legislation states that at least 75% of the initial investment must be returned, but some companies offer 100% maturity guarantee. Note: Examine the conditions of the contract.

This is of particular value when an investor is nearing, or has begun retirement, and cannot afford to lose any of the original capital invested, in a volatile market. Even if the fund's actual unit value declined, the seg fund investment guarantees that the investor will get back a very high percentage of the initial capital invested. This is just as agreed in the contract (some up to 100%).

Example. Peter invests $60,000 in segregated fund policy and names his wife as plan beneficiary.  The policy offers a 75% guarantee on death and maturity. If at the time of Peter’s death, the plan is worth $100,000, his wife will receive the full $100,000. If at the time of Peter’s death, the plan is worth $40,000, his wife will receive $45,000 (the guaranteed amount).

If in 10 years the contract is worth $100,000, Peter will receive the full $100,000. If in 10 years the plan is worth $40,000, Peter will receive the guaranteed amount $45,000.

◊  “Refreshed” (Reset) Guarantees at Death and Maturity

Refresher or reset option allows the policyowner to re-establish the principal guarantee (for death, or maturity, or both) at the current fair market value of the assets of the segregated fund, rather than the amount of the principal deposit. Normally, exercising the reset option restart the 10-year maturity period for the whole policy, as of the date of the exercise of the option.

Example. Katie invested $60,000 in a seg fund policy three years ago and received a 100% death and maturity guarantee on her principal deposits, under term of her policy. Today, the investments in her plan are worth $80,000. Because her policy has a reset option for death and maturity guarantee, she is able to elect to refresh her guarantee to the current level of $80,000.

Now, if at the moment of Katie’s death the fund had dropped to $70,000, her beneficiary would receive $80,000 under the reset option.

If in 10 years the value of her investments is less than $80,000, she will receive guaranteed amount $80,000

Typically, at the time of maturity, some companies permit a resetting of the new guaranteed capital amount, and a renewed maturity date.

The reset can be a valuable tool for investors with a longer time horizon, or when funds appreciate significantly.

◊     Probate Bypass Opportunity

Segregated fund policies allow an investor to designate one, or multiple beneficiaries much like a life insurance policy. At the time of his/her death, the proceeds from the seg policy are not included with the rest of his/her estate. The proceeds of the segregated fund pass directly to a named beneficiary, and are not subject to probate, lawyer's or executor's fees. (Not applicable in Quebec)

◊    Potential creditor protection

Established under life insurance legislation, some seg fund policies might be protected from creditors for an investor's lifetime - if the policyholder ever faced a lawsuit or bankruptcy. There must be an irrevocable, or preferred beneficiary (or multiple preferred beneficiaries) - a child, grandchild, parent or spouse named on the contract. The creditor protection is allowed as long as money was not placed in the seg fund with the intent to protect the capital from an impending financial crisis. You should seek legal advice regarding this issue.

◊    Insurer insolvency protection

Assuris  (www.assuris.ca), the insurance company protection association, protects Canadian life insurance policyholders against loss of benefits due to the financial failure of a Member Company. Assuris guarantees that you will retain at least 85% of the guaranteed amount on your segregated fund policy. For policies that have a guaranteed amount of $60,000 or less, you will retain 100% of your guarantee.