Insurance invasion

Back in the late 1990s, it looked liked segregated (“seg”) funds were the wave of the wealth management future. After all, they had some huge advantages over conventional mutual funds such as creditor-proofing, guarantees of principal, and exemption from the foreign content rule, which was still in force.

Insurance companies, the only ones legally permitted to offer seg funds, aggressively promoted their superior features. Manulife Financial took the marketing lead with its GIF brand and other companies followed, particularly Great-West Life, London Life, Transamerica, Maritime Life, Empire Life, and Industrial Alliance. Investors started to pay attention. Tens of millions of dollars that would normally have flowed into mutual funds went instead to seg funds.

In defence, many major mutual fund companies entered into alliances with insurance firms to offer co-branded products through their own distribution networks. At one point, the president of a fast-growing mutual fund company confidently predicted that seg funds would account for 25% of the total market within a decade.

But the insurers overreached themsves. Spurred by investor demand, some companies began offering ultra-aggressive funds with 100% capital protection. Entering 2000, people could buy guaranteed seg funds based on the Tokyo Nikkei, Nasdaq, emerging markets, and Pacific Rim stocks. Normally volatile securities suddenly had the risk element stripped away.

Investors loved it. Insurance regulators hated it. They felt some companies were assuming potential liabilities that might endanger their financial structure if stock markets collapsed and they were forced to pay off on those guarantees. New regulations were brought in, requiring much higher reserves to be maintained.

The insurers were caught between a rock and a hard place. They had to either cut their guarantees or raise their fees, or implement a combination of both. Most did the latter and the high-risk funds were withdrawn from public sale. The seg fund business went into a dive. As demand dried up, many mutual fund companies closed down their seg fund lines and returned to their core business.

Seg funds still can play a useful role in certain situations but they are unlikely to ever again be a strong market force. The costs are simply too high. In some cases, the management expense ratio (MER) approaches 6 per cent. That’s far too high to be competitive with a traditional mutual fund.

So what’s happening? Instead of retreating into a shell, some of the big insurance companies have decided to take on the mutual fund firms on their own turf. They’re launching fund lines of their own and, in some cases, throwing money around to grow by acquisition.

Leading the charge is Quebec-based Industrial Alliance (IA). No one thought much of it when the insurer set up a mutual funds subsidiary a few years ago to run a small family of funds it had acquired from Co-operators. Even when IA bought the R (for Rothschild) funds which are sold mainly through Laurentian Bank in 2004, it hardly raised an eyebrow. But everyone took notice in December when IA outbid CI Investments for control of Clarington Funds. In one stunning move, tiny IA Fund Management more than tripled its assets, to $5.7 billion, and vaulted all the way to number 20 in size among the member companies of the Investment Funds Institute of Canada.

IA is now in the process of digesting the acquisition. IA Fund Management president David Scandiffio says the new company, which he will head, will be created by June. It will carry the name IA Clarington and will retain three separate brand lines for now: IA, R, and Clarington, with the latter the primary brand. Full integration between all three lines, which will allow investors to switch freely between them, should be completed by July.

Other insurance companies that have established a foothold in the mutual funds business include Standard Life, Hartford Insurance, and Sun Life, which owns one-third of CI Investments. It’s a classic case of it you can’t beat ‘em, join ‘em.

Adapted from an article that originally appeared in Mutual Funds Update, a monthly newsletter that provides advice on fund selection and strategies. For subscription information: