Segregated funds generally have 3 stated advantages, compared to mutual funds:
- Creditor protection, if a parent, spouse, child, grandchild, or any irrevocable beneficiary is named.
- The ability to bypass probate with any named beneficiary.
- The maturity and death benefit guarantees.
In the case of non-registered funds, I would argue there is value to creditor protection, especially when it comes to business owners, who may have unusual liability exposure. The ability to bypass probate can have value, but the negative impacts of probate are often over-amplified, in my experience. And in some cases, probate can even have positive outcomes, allowing oversights in the estate plan to be corrected.
When it comes to registered funds (RRSP, RRIF, LIF, LIRA), creditor protection is almost as strong as it is for seg funds, regardless of the underlying investment. All these accounts allow beneficiary designations, so probate doesn’t have to be an issue here. With a TFSA, no creditor protection is available, but the ability to bypass probate is.
It’s the guarantees I would like to focus on here. While maturity guarantee dates have been, in most cases, pushed so far into the future to be meaningless, the death benefit guarantee can be useful. I’ve often wondered what the true value of these guarantees is, and I’ve recently completed an old Excel project that helps to quantify this.
In order to arrive at a rough approximation for the possible set of outcomes, I pulled the S&P TSX month-closing index value, inclusive of dividends, from June of 1979 to April of 2019. That’s 479 data points including at least 3 major corrections, which I figure is a reasonable approximation of any given investor’s likely experience in the market.
From there, I built scenarios replicating, with 75% guarantees and 100% guarantees:
- death 6 months after the initial investment;
- death 5 years after the initial investment;
- death or maturity 10 years after the initial investment;
- death or maturity 15 years after the initial investment.
For each of those scenarios, I further investigated:
- What if the fund underperformed the index by 3%? 2%? 1%?
- What if it performed the same as the index?
- What if it outperformed by 1%? 2%?
Understanding these outcomes should help the advisor determine the true value of guarantees. We can assess both the likelihood and value of guarantees paid in each scenario.
As an example:
- There are 473 6-month rolling periods covered in the data set.
- At 3% underperformance:
-
- A 75% guarantee would have paid 13 times, or 2.75% of the time.
- It would have paid an average top-up of $7,180.
- The maximum guarantee paid would have been $18,615, for an investor who invested $100,000 in August of 2008 and died in February of 2009.
- Whereas, if the seg fund achieved the same return as the index:
- A 75% guarantee would have paid 10 times, or 2.11% of the time.
- It would have paid an average top-up of $6,832.
- The maximum guarantee paid would have been $16,015.
At the 5-year mark:
- There are 419 rolling 5-month periods.
- At 3% underperformance:
- A 75% guarantee would have paid 13 times, or 3.10% of the time.
- It would have paid an average top-up of $2,403.
- The maximum guarantee paid would have been $5,107 for an investor who invested $100,000 in May 2007 and died in May 2012.
- Whereas, if the seg fund achieved the same return as the index:
- A 75% guarantee would never have paid.
And looking at a 100% guarantee, using 10-year data:
- There are 359 rolling 10-year periods.
- At 2% underperformance:
- A 100% guarantee would have paid 36 times, or 10.03% of the time.
- It would have paid an average top-up of $5,929.
- The maximum guarantee paid would have been $13,353 for an investor who invested $100,000 in August 2000 and died or hit maturity in August 2010.
- If the index performed the same as the index:
- A 100% guarantee would never have paid.
The tables below summarize each period:
| 6-month data | ||||||
|---|---|---|---|---|---|---|
| 3% Below Index | 2% Below Index | 1% Below Index | Index | 1% Better | 2% Better | |
| Number of Events | 473 | 473 | 473 | 473 | 473 | 473 |
| 75% Guarantee would pay | 13 | 12 | 10 | 10 | 10 | 8 |
| Percent of Times when 75% pays | 2.75% | 2.54% | 2.11% | 2.11% | 2.11% | 1.69% |
| Average Value when 75% Guarantee Pays | $67,820 | $67,983 | $67,425 | $68,168 | $68,902 | $68,142 |
| Average 75% Guarantee Paid | $7,180 | $7,017 | $7,575 | $6,832 | $6,098 | $6,858 |
| Maximum Guarantee Paid at 75% | $18,615 | $17,735 | $16,869 | $16,015 | $15,173 | $14,343 |
| 100% Guarantee would pay | 188 | 177 | 168 | 161 | 155 | 138 |
| Percent of Times when 100% Guarantee Pays | 39.75% | 37.42% | 35.52% | 34.04% | 32.77% | 29.18% |
| Average Value when 100% Guarantee Pays | $90,810 | $90,810 | $90,889 | $91,057 | $91,276 | $90,785 |
| Average 100% Guarantee Paid | $9,190 | $9,190 | $9,111 | $8,943 | $8,724 | $9,215 |
| Maximum Guarantee Paid at 100% | $43,615 | $42,735 | $41,869 | $41,015 | $40,173 | $39,343 |
| 5-year data | ||||||
|---|---|---|---|---|---|---|
| 3% Below Index | 2% Below Index | 1% Below Index | Index | 1% Better | 2% Better | |
| Number of Events | 419 | 419 | 419 | 419 | 419 | 419 |
| 75% Guarantee would pay | 13 | 1 | 0 | 0 | 0 | 0 |
| Percent of Times when 75% pays | 3.10% | 0.24% | 0.00% | 0.00% | 0.00% | 0.00% |
| Average Value when 75% Guarantee Pays | $72,597 | $73,728 | N/A | N/A | N/A | N/A |
| Average 75% Guarantee Paid | $2,403 | $1,272 | N/A | N/A | N/A | N/A |
| Maximum Guarantee Paid at 75% | $5,107 | $1,272 | $0 | $0 | $0 | $0 |
| 100% Guarantee would pay | 120 | 87 | 62 | 48 | 35 | 18 |
| Percent of Times when 100% Guarantee Pays | 28.64% | 20.76% | 14.80% | 11.46% | 8.35% | 4.30% |
| Average Value when 100% Guarantee Pays | $87,643 | $88,333 | $89,099 | $91,351 | $93,802 | $95,247 |
| Average 100% Guarantee Paid | $12,357 | $11,667 | $10,901 | $8,943 | $6,198 | $4,753 |
| Maximum Guarantee Paid at 100% | $30,107 | $26,272 | $22,269 | $41,015 | $14,063 | $9,542 |
| 10-year data | ||||||
|---|---|---|---|---|---|---|
| 3% Below Index | 2% Below Index | 1% Below Index | Index | 1% Better | 2% Better | |
| Number of Events | 359 | 359 | 359 | 359 | 359 | 359 |
| 75% Guarantee would pay | 0 | 0 | 0 | 0 | 0 | 0 |
| Percent of Times when 75% pays | 0.00% | 0.00% | 0.00% | 0.00% | 0.00% | 0.00% |
| Average Value when 75% Guarantee Pays | N/A | N/A | N/A | N/A | N/A | N/A |
| Average 75% Guarantee Paid | N/A | N/A | N/A | N/A | N/A | N/A |
| Maximum Guarantee Paid at 75% | $0 | $0 | $0 | $0 | $0 | $0 |
| 100% Guarantee would pay | 52 | 36 | 8 | 0 | 0 | 0 |
| Percent of Times when 100% Guarantee Pays | 14.48% | 10.03% | 2.23% | 0.00% | 0.00% | 0.00% |
| Average Value when 100% Guarantee Pays | $88,331 | $94,071 | $98,387 | N/A | N/A | N/A |
| Average 100% Guarantee Paid | $11,669 | $5,929 | $1,613 | N/A | N/A | N/A |
| Maximum Guarantee Paid at 100% | $21,753 | $13,353 | $4,151 | $0 | $0 | $0 |
| 15-year data | ||||||
|---|---|---|---|---|---|---|
| 3% Below Index | 2% Below Index | 1% Below Index | Index | 1% Better | 2% Better | |
| Number of Events | 299 | 299 | 299 | 299 | 299 | 299 |
| 75% Guarantee would pay | 0 | 0 | 0 | 0 | 0 | 0 |
| Percent of Times when 75% pays | 0.00% | 0.00% | 0.00% | 0.00% | 0.00% | 0.00% |
| Average Value when 75% Guarantee Pays | N/A | N/A | N/A | N/A | N/A | N/A |
| Average 75% Guarantee Paid | N/A | N/A | N/A | N/A | N/A | N/A |
| Maximum Guarantee Paid at 75% | $0 | $0 | $0 | $0 | $0 | $0 |
| 100% Guarantee would pay | 8 | 2 | 0 | 0 | 0 | 0 |
| Percent of Times when 100% Guarantee Pays | 2.68% | 0.67% | 0.00% | 0.00% | 0.00% | 0.00% |
| Average Value when 100% Guarantee Pays | $88,401 | $93,132 | N/A | N/A | N/A | N/A |
| Average 100% Guarantee Paid | $11,599 | $6,868 | N/A | N/A | N/A | N/A |
| Maximum Guarantee Paid at 100% | $21,579 | $8,734 | $0 | $0 | $0 | $0 |
I suspect that most readers will apply some bias to this. If you liked seg funds previously, I’m guessing you’re focused on the 6-month and 5-year periods, and likely on the 100% guarantees. If you don’t like seg funds, you’re likely focused on the 75% guarantees on the 10- and 15-year tables. I hope that putting some numbers to this lets us all step back and assess the true value and likelihood of these guarantees.
If you want the original Excel document to play around with, feel free to send me an email at [email protected] I’m also curious to hear what I’ve overlooked in this analysis.
