Mutual Funds Could Be Valuable If Issued By Life Insurance Firm
If you own mutual funds that were issued by a life insurance company, take a close look at the details and get some advice before you consider cashing any in. While they may be currently worth less than the amount you invested, the insurance company may be obligated to make up the difference at a certain date.
These funds have guarantees of value the insurance company must pay on death or on "maturity", which usually means 10 years after the original investment. Since many of these were issued around the "turn-of-the-century" and shortly thereafter, many of them mature over the next few years.
We have performed a review of several of our client portfolios since the correction and found segregated funds whose current value was more than 20 per cent below the adjusted cost base, with only one year to go to maturity. This means the insurance company is guaranteeing these clients a 20 per cent return over the next year or so.
That's valuable.
Segregated funds are mutual funds that are manufactured or sponsored by life insurance companies. As such, they are a life insurance contract, although they share most of the investment characteristics of a conventional mutual fund.
They allow a beneficiary to be named, even on non-registered accounts, and can therefore pass outside an estate and avoid probate fees or creditors of the deceased.
However, what attracted many investors were the guarantees. If the investor dies, the insurance company guarantees to return the full original capital to the estate, in the event that the fund value had decreased at the time of death. As well, there is a guarantee of original principal on maturity. Most of the funds have a 100 per cent guarantee, although some only have 75 per cent.
Cost-conscious advisers (like me) have often thought the cost of these guarantees was too high, except in the case of older investors. If a person had a limited life expectancy, the guarantee could be quite valuable in the event of a market correction.
In any event, check your segregated fund statements carefully. Most show the total invested capital, which is the guarantee amount (assuming it was all put in at the same time). Also check the maturity date and compare your current value with that guaranteed value. You may find that you have a very valuable investment on your hands.
Interestingly, two of the major players in this area are Manulife and Great West Life, especially through its Canada Life subsidiary. Manulife is a company whose common shares are very widely held, since policy owners were all issued free shares when the company demutualized several years ago and became a publicly traded company.
For years, shareholders received great benefit, as the shares rose in value each year and also paid dividends. However, the credit crunch and stock market correction have been a double whammy for Manulife and Great West Life, as investors have become nervous about the companies' exposure under their guarantees. If the markets do not recover before a large number of guarantees come due, it could potentially cost these companies billions.
On the other hand, a continued stock market rally could get them off the hook, and the stock prices could then rise at a much faster rate than the general market. Therefore, ownership of Canadian life insurance companies becomes a double bet on the stock market recovery (or lack of same). Keep that in mind when investing in the common (or preferred) shares of life companies.
* * *
David Christianson is a fee-only financial planner and investment counsel with Wellington West Total Wealth Management Inc.