Check seg funds carefully
There’s volatility in the stock markets and increasing concern about asset protection. This may prompt some investors to take a new look at segregated funds, or seg funds, as they’re known.
These are similar to mutual funds. But they’re offered by insurance companies, either independently or in partnership with a regular fund company. The big attraction is the guarantees they carry that limit your loss potential.
Do your homework
But before you invest any money, do your homework. The entire field of segregated funds has been going through a major upheaval. This is as a result of changes by regulators to the reserve requirements for these insurance company products.
In effect, companies are now required to put aside more money for contingency purposes in the event that they have to make good on their guarantees of principal.
The result has been something approaching controlled chaos. Several seg funds have closed their doors to new business because they were no longer economical to operate under the revised rules.
Other funds have raised their management fees. However, in most cases the reaction of insurance companies has bn to withdraw their existing line of seg funds from sale and replace them with a new series that carries lower (and therefore less costly) guarantees.
In many cases, the 100 per cent guarantee of capital that was offered at the ‘maturity date’, usually 10 years, has been replaced by a 75 per cent guarantee.
The death guarantees have usually been left at 100 per cent, although it may be phased in over time. This means it will be a few years before the full amount is payable.
Predictably, this has taken a lot of the glow off what had been a booming market.
During the late 1990s, we witnessed a virtual explosion of new seg funds in this country. I believe that in the coming years, we will see the market contract as investors and insurance companies adjust to the new reality. Don’t be surprised if there are many mergers and closings to come.
Information too dense
All this turmoil suggests you should be very careful about investing in these funds. Make sure you understand exactly what the terms are. This isn’t always easy. The information folders supplied by companies offering segregated funds are often very dense and difficult to understand.
The mutual fund industry has made great strides in recent years in improving the quality of its prospectuses and assisting investors to better understand the nature of each fund they might be considering.
The insurance industry would be wise to emulate this. If it doesn’t do so voluntarily, regulators should force it to. As things stand now, investors aren’t receiving the required information in a form that can be easily comprehended and compared with alternatives.
Foreign content rules
One other important point to note: In the past, U.S. and international segregated funds did not come under the foreign content rules because of a legal loophole. That is scheduled to change as of January 1, 2002. So you must apply the 30 per cent rule to your registered segregated fund portfolios, just as you do with regular mutual funds.
The bottom line is that seg funds aren’t what they used to be. That doesn’t mean you should rule them out entirely, but be sure you understand what you’re buying.
From the Oct. 2001 issue of Mutual Funds Update.