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Guarantees in Mutual Funds Tamiko Toland Managing Director, Retirement Income Consulting Strategic Insight

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1 Guarantees in Mutual Funds Tamiko Toland Managing Director, Retirement Income Consulting Strategic Insight

2 Guarantees in Mutual Funds Principal protected products flatlined in mid-aughts (c. 2006) In the VA space, guaranteed living benefits were booming during this time Investment-oriented players (mutual funds, managed accounts) looking for ways to tap into the income guarantee trend In 2006, first standalone living benefit (SALB), aka contingent deferred annuity (CDA) conceived First products approved in early 2008

3 What is an SALB? Guarantee associated with non-annuity assets –Individual MF –Managed account (managed portfolio, UMA, etc.) Contingent deferred ANNUITY contract –A form of fixed annuity (the guarantee itself is fixed) –No contract value; pays only under a contractual contingency Filed with the SEC and states –Like a VA, requires securities and insurance licenses to sell Guarantees analagous to GLWB on VA –Could also be applied to different product designs Not embraced in all jurisdictions –Not allowed in NYS (must be changed legislatively) –Under review by NAIC’s A committee American Academy of Actuaries authored a white paper

4 VA vs. SALB VA Tax deferral Within VA (penalty for early withdrawal, etc) Separate account structure, generally able to change asset mix Some contracts offer no commission, CDSC option SALB Taxed on gains Directly owned assets Limited investment options; if options exist, tax and fee consequences for reallocation Guarantee divisible in divorce Separate account structures offer no commission, CDSC; varies with MF No death benefit (lower capital cost) Policyholder behavior uncertainty

5 Different, not Cheaper Common argument that SALB is cheaper than a VA Reality is that the managed account version is suited to the practice of many fee-only advisors Guarantees are typically less rich than guarantees on mainstream VAs Pound for pound, guarantee is more expensive on SALB Insurer does not have explicit asset-based fee income stream to cushion the cost of supporting guarantees Takeaway: innovation is creating income guarantee products that suit how different advisors do business

6 Are SALBs a failed product? Victim of unfortunate timing First issuers: –Phoenix –Allstate –Genworth –Nationwide Early filers (no approved products): –Allianz –Transamerica (on Merrill Lynch Life paper)

7 Individual MF vs. Managed Account Individual MF structure associates guarantee with funds/share classes specifically tailored for guarantee –Operationally more difficult because communications pipelines for MFs are extremely well established, streamlined, with no accommodation for information about guarantees –Distribution focused on middle market, various possible share class structures Managed account structure associates guarantee with managed portfolio or UMA –Managed account operations are generally messier, so not as onerous to add guarantee pipeline –Relationship with distribution/asset manager of managed portfolio is critical –Products cannot be easily translated onto different platforms –Distribution focused on fee- based and fee-only advisors, many of whom do not have necessary licensing

8 The Post-Crisis Wave Great-West Life –401(k)-based product introduced in early 2011 –Internal distribution, sits as an investment option on its own platform –Expanded to create very simple one-fund product for bank distribution –Developed VA to mirror SALB Transamerica/Aria: RetireOne –SALB 2.0 –Open allocation similar to common investment restriction model in VAs allows access to wide variety of MFs within stated guardrails –Distribution model includes third party sale of guarantee to obviate need for advisors to get proper licensing

9 The Future of SALBs Another product within the growing portfolio of guaranteed income solutions Not fundamentally competitive with VA Targets different markets from VA Less capital intensive but greater policyholder risk Resolution of regulatory issues will open the market What is insurer capacity for the general class of equity/longevity risk?

10 © Copyright 2012 Strategic Insight, an Asset International company, and when referenced or sourced Morningstar Inc., Lipper Inc. and Coates Analytics. All rights reserved. The information, data, analyses and opinions contained herein (a) include confidential and proprietary information of the aforementioned companies, (b) are provided solely for information purposes, and (c) are not warranted or represented to be correct, complete, accurate, or timely. Past performance is no guarantee of future results. The aforementioned companies are not affiliated with each other. This report has been prepared using information and sources we believe to be reliable; however, we make no representation as to its accuracy, adequacy or completeness, nor do we assume responsibility for any errors or omissions or for any results obtained from the use of this report, including any action taken with respect to securities referred to in this report. Our employees may from time to time acquire, hold or sell a position in securities mentioned herein. We may from time to time perform services for any company mentioned in this report. This report is not a prospectus or representation intended to use in the purchase or sale of any securities mentioned in this report. Strategic Insight is available by subscription and by single copy upon request to the publisher.

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