Chapter 13 - Insurance Based Products - 7%

Question 1

What are Segregated Funds?

Answer 1

Segregated funds are investment pools similar to mutual funds but with maturity and death
benefit guarantees provided to contract holders. Legally known as an individual variable insurance contract (IVIC), a segregated fund gives the beneficiary an insurance contract that pays out certain specified benefits based on the value of one or more specified pools of assets. The life insurance company which issued the contract holds these pools of assets separate and apart from other similar pools and its general assets. An IVIC gives a purchaser the right to choose among various
segregated pools.

Question 2

What are Maturity Guarantees?

Answer 2

One of the fundamental contractual rights associated with segregated funds is the guarantee that the beneficiary will receive at least a partial return of the money invested. Provincial legislation requires that the guarantee be at least 75% over a minimum 10-year holding period. Some providers of segregated funds top up the maturity guarantees to 100%. These guarantees –
whether full or partial – appeal to people who want specific assurances about the return of the principal amount invested and a limit on their potential capital loss.
Maturity guarantees, particularly those that offer full protection after 10 years, alter the normal risk-reward relationship associated with many investments. With a maturity guarantee, a client may participate in rising markets without a limit on potential returns. At the same time, subject to the 10-year holding period, the client’s invested capital (that is, the principal amount) is protected from losses.

Question 3

What are the three types of guarantees?

Answer 3

There are basically three types of guarantees:

1. A deposit-based guarantee will give every deposit made by the client its own guarantee amount and maturity date.
2. A policy-based guarantee makes record-keeping simpler by grouping all deposits made within a 12-month period and giving them the same maturity date.
3. A policy-based guarantee (the most generous type) bases all maturity guarantees on the date that the policy was first issued. With this type of guarantee, there may be restrictions on the size of subsequent deposits to prevent clients from making minimal deposits at account opening, and much larger deposits several years later. Doing so would effectively shorten the holding period required for the maturity guarantee and increase the potential risk to the insurer.

Question 4

What are the age restrictions?

Answer 4

For the industry as a whole, provincial insurance legislation does not specify a maximum age limitation. However, RRSP segregated fund contracts are subject to the traditional rule:
termination by the end of the year in which the contract holder (the person who purchases the
contract, also known as the policy owner) turns 71. For non-registered contracts, companies may set maximum ages for contract ownership, such as 90.

Question 5

What are Guaranteed Minimum Withdrawal Benefit (GMWB) Products?

Answer 5

Guaranteed Minimum Withdrawal Benefit (GMWB) products protect an investor’s retirement savings from downside risk while at the same time providing participation in the markets and the potential for market gains. GMWBs have maximum annual withdrawal limits (typically 5% of
the initial investment) until the initial deposit amount has been recouped over a minimum period of 20 years.

Question 6

How are Guarantees Calculated?

Answer 6

The guaranteed withdrawal balance is 100% of the initial deposit amount and represents the base for which income and bonuses are based on. This amount does not fluctuate with the market value. Additional deposits increase this amount dollar-for-dollar, and withdrawals within the allowable amount for the year will reduce this balance dollar-for-dollar. Every three years, on the contract anniversary date, which is the date of the first deposit into the contract, the guaranteed withdrawal balance is compared to the market value on that date. If the market
value is greater than the guaranteed withdrawal balance, the guaranteed withdrawal balance will be reset to the same amount as the market value. The reset allows the investor to increase their guarantees based on positive market performance. However, the window to lock in these gains is limited to one specific day, the contract anniversary date, every three years. Income will continue until this balance reaches zero, or beyond for contracts where income is guaranteed for the life of the annuitant(s). The guaranteed withdrawal amount (GWA), if the annuitant is under age 65, or lifetime withdrawal amount (LWA), if the annuitant is age 65 or older, is the guaranteed income amount paid for the life of the contract. As mentioned previously, this amount is typically 5% of the guaranteed withdrawal balance. If a withdrawal is made that is in excess of the GWA or LWA, the Guaranteed Withdrawal Balance will be reduced proportionately for the withdrawal and the
GWA or LWA will be recalculated based on the new Guaranteed Withdrawal Balance.
The death benefit guarantee is at least 75% of the initial deposit, but can be as high as 100%. The death benefit is the minimum amount that is guaranteed to be paid to the beneficiary. The death benefit guarantee is reduced proportionately for withdrawals.

Question 7

What is Assuris?

Answer 7

Assuris provides protection to policy holders in the event that the insurance company becomes insolvent. Membership is required for all life insurance companies in Canada who are authorized to sell insurance policies in Canada, as dictated by the federal, provincial, and territorial
regulators.

The coverage for a GMWB policy depends on whether the contract is in the accumulation phase or payout phase. According to Assuris:
• The accumulation phase is defined as a contract where there has not been a withdrawal for at least 12 months.
• The payout phase is defined as a contract where a withdrawal has occurred in the past 12 months.

Coverage for a policy in the accumulation phase:
• Up to $60,000 per contract or 85% of the guaranteed withdrawal balance, whichever is higher.
Coverage for a policy in the payout phase:
• Up to $2,000 per month or 85% of the guaranteed withdrawal amount, whichever is higher.

Question 8

Which statement about segregated funds is correct?
A. Segregated funds are best-suited for clients who are young and have an aggressive risk profile.
B. Payments from a segregated fund contract’s maturity guarantee are tax exempt because they form part of a contract with an insurance company.
C. Segregated fund contracts have a maximum 10-year term.
D. Withdrawals from a segregated fund contract may be made at any time the annuitant is alive.

Answer 8

D.
Withdrawals from a segregated fund contract may be made at any time the annuitant (the person on whose life the insurance benefits are based) is alive. Guarantees do not apply to amounts that are withdrawn or redeemed from a segregated fund contract prior to the maturity date. The value of the guarantees would be reduced by withdrawals, and the insurance company must track the ongoing value of the guarantees.

Question 9

Which entity regulates segregated funds?
A. Investment Industry Regulatory Organization of Canada.
B. Ontario Securities Commission.
C. Mutual Fund Dealers Association of Canada.
D. Provincial insurance regulators.

Answer 9

D.

Segregated funds are regulated by provincial insurance regulators because they are insurance contracts.

Question 10

Segregated funds have which of the following unique features that mutual funds do not?
I. Maturity guarantee.
II. Death benefit.
III. Diversification.
IV. Professional investment management.

Answer 10

I and II only.
Like mutual funds, segregated funds offer investors professional investment management, diversification and the ability to invest in small amounts. Segregated funds, however, also have unique features that enable them to meet special client needs, such as maturity guarantees, death benefits and creditor protection.

Question 11

According to provincial legislation, what is the minimum maturity guarantee of the client’s money invested in a segregated fund?
A. 75% of the money invested over a minimum 5-year holding period.
B. 100% of the money invested over a minimum 5-year holding period.
C. 75% of the money invested over a minimum 10-year holding period.
D. 100% of the money invested over a minimum 10-year holding period.

Answer 11

C.

Provincial legislation requires that the guarantee be at least 75% over a minimum 10-year holding period.

Question 12

Which of the following methods could be used to determine a maturity guarantee?
I. Every deposit made by the client has its own guarantee amount and maturity date.
II. All deposits made by the client within a 12-month period are given the same maturity date.
III. All deposits made by the client have a guarantee based on the date that the policy was first issued.
IV. All deposits made by the client have a guarantee based on the date of the last deposit.

Answer 12

I, II and III.
There are basically three types of guarantees:
1) A deposit-based guarantee will give every deposit made by the client its own guarantee amount and maturity date.
2) A policy-based guarantee makes record-keeping simpler by grouping all deposits made within a 12-month period and giving them the same maturity date.
3) A policy-based guarantee (the most generous type) bases all maturity guarantees on the date that the policy was first issued.

Question 13

What is the typical maximum annual withdrawal limit from a Guaranteed Minimum Withdrawal Benefit product?
A.	2% of the initial investment.		 	 
B.	3% of the initial investment.		 	 
C.	4% of the initial investment.		 	 
D.	5% of the initial investment.

Answer 13

D.

GMWBs have maximum annual withdrawal limits that are typically 5% of the initial investment.

Question 14

How often can Guaranteed Minimum Withdrawal Benefit products be reset?
A.	Every year.		 	 
B.	Every 2 years.		 	 
C.	Every 3 years. 	 
D.	Every 4 years.

Answer 14

The reset date occurs every 3 years.

Question 15

For a Guaranteed Minimum Withdrawal Benefit product, if the death benefit guarantee was $100,000 prior to a withdrawal, the withdrawal was $4,000 and the market value of the GWMB was $115,000 prior to withdrawal, what is the proportionate reduction to the death benefit guarantee?
A.	$3,478.26	
B.	$4,000.00		 	 
C.	$4,600.00	 
D.	$5,000.00

Answer 15

A.

$100,000 × $4,000/$115,000 = $3,478.26.

Question 16

What would occur on the reset date if the guaranteed withdrawal balance is $105,000 and the GMWB product’s market value is $114,000?

Answer 16

On the reset date, the market value of $114,000 is greater than the guaranteed withdrawal balance of $105,000. Therefore, the guaranteed withdrawal balance is reset to $114,000.

Question 17

For investors who delay receiving income and do not make a withdrawal from a Guaranteed Minimum Withdrawal Plan, what happens to the bonus received?
A. The bonus is treated as cash.
B. The bonus is added to the guaranteed withdrawal balance.
C. The bonus is added to the market value.
D. The bonus decreases the guaranteed income amount.

Answer 17

B is correct.
The bonus is added to the guaranteed withdrawal balance. This bonus increases the guaranteed income amount paid to the investor, but it is important to note that it is not added to the market value or treated as cash.

Question 18

What factor might have a negative impact on the potential creditor protection offered by a Guaranteed Minimum Withdrawal Benefit product?
I. The segregated fund contract has been assigned as collateral for a loan.
II. The beneficiary is the annuitant’s spouse.
III.The annuitant is in arrears with Canada Revenue Agency.
IV. There are claims against the annuitant for child support.

Answer 18

I, III and IV.
There are factors that may have a negative impact on potential creditor protections such as:
1) If the segregated fund contract has been assigned as collateral for a loan, the lender does have the right to seize the assets in the case of default on the loan.
2) Claims against the annuitant relating to child or spousal support.
3) The annuitant is in arrears with Canada Revenue Agency.

Question 19

Which organization provides protection to GMWB investors if an insurance company becomes insolvent?
A. Assuris.
B. Mutual Fund Dealers Association of Canada.
C. Canadian Life and Health Insurance Association.
D. Investment Industry Regulatory Organization of Canada.

Answer 19

Assuris provides protection to investors in situations where the insurance company becomes insolvent.

Question 20

At the time of a systematic withdrawal payment of $4,000, a Guaranteed Minimum Withdrawal Benefit product has an adjusted cost base of $100,000 and a current market value of $104,000. What will be the percentage of the withdrawal will be considered a capital gain?
A.	3.85%			 
B.	4.00%		 	 
C.	96.15%		 	 
D.	100%

Answer 20

$4,000/$104,000 = 0.03846 (in percentage terms, 3.85%).

Question 21

Which organization’s purpose is to promote public policy, legislation, and regulation, on behalf of its voluntary members which are life and health insurance providers?
A. Assuris.
B. Mutual Fund Dealers Association of Canada.
C. Canadian Life and Health Insurance Association.
D. Investment Industry Regulatory Organization of Canada.

Answer 21

C is correct.
Canadian Life and Health Insurance Association (CLHIA) represents its voluntary members, which consists of life and health insurance providers. CLHIA also has a responsibility to represent the best interests of the public. CLHIA’s purpose is to promote public policy, legislation, and regulation, on behalf of its members, that contribute to the betterment of the industry and economy.

Question 22

On the reset date, if the guaranteed withdrawal balance is $100,000 and the market value was $105,000, what would be the typical guaranteed withdrawal amount after the reset date?
A.	$5,000		 
B.	$5,250		 	 
C.	$8,000		 	 
D.	$8,400

Answer 22

B.
The guaranteed withdrawal balance is reset to $105,000. The typical withdrawal is 5% of the guaranteed withdrawal balance and therefore would be 5% of $105,000 which is $5,250.