Morningstar: Our thoughts on Manulife's new guaranteed minimum withdrawal product

... Our thoughts on Manulife's new guaranteed minimum withdrawal product by David O'Leary 15 Nov 06

Income Plus addresses risk that retirees will outlive their money.With the recent launch of Manulife's new segregated product, Income Plus, we thought it would be useful to discuss the pros and cons of Canada's first guaranteed minimum withdrawal benefit (GMWB) plan. While the concept isn't unique, this product is the first of its kind in Canada. Here are what we believe to be the benefits and drawbacks of the product. Until very recently, the investment industry has had a one-track mind: help investors accumulate wealth. As the baby boomer generation begins to reach retirement, there is a swell of people who need advice on how to preserve wealth and divest their assets properly. This important topic has been largely neglected, which is why it was the focus of our annual Morningstar conference this past June. For more on the Morningstar conference, please click here. One of the biggest issues facing retirees is what is often referred to as shortfall risk -- the risk that an individual will run out of money before dying. Retirees have to balance their need for income with the need to achieve some minimum level of growth so they don't run out of money too soon. During our conference, York University professor Moshe Milevsky addressed this issue specifically by illustrating the importance of the sequence of returns to a retiree drawing an income from his or her investment portfolio. In particular, he showed that the early years of performance play a big role in determining how long an investor's portfolio will fund his or her living expenses. A quick example will help to illustrate this concept. Assume an individual invests $200,000 for three years and withdraws nothing from her portfolio during that time. If the investment portfolio returns 10% in the first year, 20% in year two but loses 30% in year three, then the ending portfolio value is $184,800 (scenario A). If we reverse the sequence of returns so that the 30% loss happens in year one, followed by a 20% gain and then a 10% gain, the value of the portfolio still ends at $184,800 (scenario B). However, if that investor is withdrawing $10,000 per year at the end of each of those three calendar years, then the order of returns matters greatly. Under scenario A, the ending portfolio value is $159,400 while under scenario B it falls to $150,600. In short, it is very important that an investor do well in the early years of their retirement or they may outlive their investment portfolio. The Income Plus product currently offered through Manulife's GIF Select product addresses this risk specifically. The offering aims to provide investors with a guaranteed income stream through the retirement years with the potential for capital appreciation and all the usual benefits of a segregated fund. Income Plus guarantees that investors will receive their investment principal back through regular payments over a period of no less than 20 years. The money invested in Income Plus can be spread across a line-up of segregated funds managed by a variety of third-party managers. The investor is able to capture the upside potential of those investments through a mechanism that locks in what Manulife calls the "guaranteed withdrawal balance" (GWB). This is the amount that the investor is guaranteed to receive from the plan. This reset takes place every three years after the initial fund purchase is made. Thus if the segregated funds in 19/09/2008 http://www.morningstar.ca/globalhome/industry/news.asp?popup=y&isprint=y&articleid ...Page 2 of 3 Morningstar: Our thoughts on Manulife's new guaranteed minimum withdrawal product ...the portfolio perform well, this GWB will rise and the investor will receive a higher regular income for the remaining life of the plan. Another feature worth mentioning is that investors in the plan who delay the commencement of their regular withdrawals receive a 5% increase in their GWB each year that they defer withdrawals, to a maximum of 10 years. This serves to increase the value of the future regular payments the investor receives from the plan. This is an attractive proposition for risk-averse investors since other guaranteed investments of a similar term are paying significantly less (check bank rates on a one-year GIC). It also offers the investor the upside of the segregated funds in which they invest. Thus if the portfolio averages a 7% return after three years, the new GWB gets increased and the investor locks in that return. The plan also includes the standard segregated fund benefits, including creditor protection, estate benefits and a death benefit guarantee equal to 100% of the deposit value. The marketing literature put out by Manulife provides powerful case scenarios that highlight the benefits of this product. However, it is important to determine whether this product is right for you. First and foremost, we don't believe this investment is a valuable proposition for investors in the capital accumulation phase of their life. It specifically addresses risks faced by investors who depend on the income from their portfolio to fund their living expenses. Income Plus serves a useful function, but it isn't magic. It simply combines some of the benefits of an annuity with those of a segregated fund. Although the plan boasts that it guarantees the investor's principal, it does this through payments over the course of at least 20 years. Simply receiving your money back after tying it up for 20 years shouldn't comfort many investors. Inflation alone will ravage the portfolio's value if it earns nothing for such a long period of time. Prominently missing from Manulife's marketing literature and even the company's website is any specific information on the investment options available within the plan. Clearly the focus of the marketing campaign centers on the guaranteed income stream and the protection it offers investors. And that certainly serves a valuable role for a particular type of investor. However, investors should be aiming to do better than the guaranteed minimum. Just how well investors do will depend critically on the portfolios they construct. When we met with the folks at Manulife, all they told us was that the program offers a selection of just 20 funds across fund families such as CI Investments, AIM Trimark and Mackenzie Investments. The fees on these segregated funds are higher than on their mutual fund counterpart. It isn't uncommon for a segregated fund to be priced 50 to 60 basis points higher. The higher MER on the underlying investments isn't the only cost to this program. The Income Plus product itself comes with its own fees on top of those paid on the underlying segregated funds. The range of fees for Income Plus depends on how aggressive the portfolio is positioned. The higher the equity weight of the overall portfolio, the higher the fee. This additional annual fee ranges from 0.25% to 0.75% of the guaranteed withdrawal balance. Investors have to determine whether the security that Income Plus offers is worth its cost. The answer will differ for each investor depending on their risk tolerances, time horizon and the size of the nest egg they have built. David O'Leary is Manager of Fund Analysis with Morningstar Canada. Previously he held various positions with Canada Trust. He spent several years working as a financial advisor providing advice on investment, 19/09/2008 http://www.morningstar.ca/globalhome/industry/news.asp?popup=y&isprint=y&articleid ...Page 3 of 3 Morningstar: Our thoughts on Manulife's new guaranteed minimum withdrawal product ...credit and insurance products. As a result of his industry experience David is frequently quoted in the media as an expert on the Canadian mutual fund industry, is a regular guest on Business News Network (BNN), and travels the country as a guest speaker at various industry conferences. David holds a B.A. from the University of Toronto and an MBA from U of T's Rotman School of Management. He also holds the Chartered Financial Analyst (CFA) designation. 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