Segregated funds are long term investment products, similar to mutual funds, but offered exclusively by life insurance companies. The unique mechanism that differentiates segregated funds from mutual is the fact that they come with a guarantee that limits the risk for investors.
In addition to the guarantee that segregated funds offer, investors might also invest due to other various advantages such tax benefits, diversification, professional management and much more.
Guarantees of Segregated Funds
Segregated funds are known to provide two guarantees to protect investors from market losses, a maturity guarantee and a death benefit guarantee.
Maturity Guarantee
On the maturity date of the contract, which is typically 10 years, the policy owner is guaranteed to receive at least 75% of the amount that they deposited to the contract.
Example: Jim invested $10,000 in a segregated fund. Upon maturity, the investment had a market value of $6,000. This amount is less than the maturity guarantee. Jim would be receive 75% of the initial deposit, which is $7500. The difference between $7,500 and $6,000 is known as the top-up.
Death Benefit Guarantee
The death benefit guarantee would also provide the beneficiary an amount equal to at least 75% of the initial deposit. The only difference is that the death benefit applies throughout the entire term of the contract. Depending on the insurance company, some companies may offer 100% guarantees but you’ll find that these contracts often have a longer time horizon.
Example: Jim is 45 years old and recently purchased a $10,000 segregated fund contract with 75% death benefit guarantee. At age 54, Jim passes away. At the time of death, Jim's investment had a value of $13,000. Since $13,000 is greater than $7,500 death benefit guarantee, Jim receives the greater amount. If Jim's investment had fallen to $6,000 at the time of death, his named beneficiary on the contract would've received $7,500.
As stated in our example above, if the value of the contract at maturity or death is less than the guarantee, the insurance company will top up the difference. This is one unique desire of segregated funds.
- If the market value is greater than the guaranteed amount, the policy holder receives the market value.
- If the market value is less than the guaranteed amount, the policy holder receives the guaranteed amount.
| MARKET VALUE OF CONTRACT AT MATURITY | AMOUNT RECEIVED BY POLICY OWNER |
| Higher than guaranteed amount | Market value |
| Lower than guaranteed amount | Guaranteed amount |
Benefits of the Guarantees
- The guarantees of segregated funds protect the beneficiary from downside market risk throughout the term of the contract.
- The guarantees start from day one of the contract. Segregated funds are long term investments but if there ever is a drop in market value of your investment, you can reset assured knowing that 75% of the principal is protected.
- Alternatively, as segregated funds are a long term investment of 10 years or more, there is no limit in how much the beneficiary might receive at the end of the term if economic conditions are favorable.
Segregated Funds Resets
Another unique features of segregated funds is the availability of resets. Keep in mind that not all insurance companies offer resets. A reset allows a policy holder to take advantage of an increase in the market value of the investment and lock in the guarantees.
Example: Jim deposited $30,000 in a segregated fund meant to be held for 10 years. The fund has a 75% maturity and death benefit guarantee, $22,500. In the fifth year of the contract, the investment has grown to $50,000. Jim locks in the reset and his maturity and death benefit guarantees are now $37,500.
Keep in mind that a reset would extend the maturity date for another 10 years but you’ve successfully locked in the growth of the account value.
Advantages of Segregated Funds
- Professional Management
- In a similar fashion to mutual funds, seg funds are managed by professional money managers. These managers are compensated via the management expense ratio that a segregated fund would charge. Segregated funds have higher fees than mutual funds.
- Diversification
- Seg funds are highly diversified. For example, a North American equity fund may invest in a basket of North American companies stock. The more diversified an investment is, the less the volatility.
- Tax Benefits
- We’ve discussed the benefit of resets that an investor utilizes but it’s important to know a distinguishing feature between mutual funds and segregated funds. Mutual funds distribute income and segregated funds allocate income.
Withdrawing from a Segregated Fund
An segregated fund contract is often held for at least 10 years. However, investor have the flexibility to withdraw at any time during this 10 year period. Seg funds are known for their investment flexibility.
The investor would inform the insurance company of the amount that he wishes to withdraw. Upon withdrawal, the maturity guarantee and the death benefit guarantee are reduced and new guarantees are calculated.
Probate Protection
As seg funds are a life insurance product, the policy owner is allowed to name a qualified beneficiary on the contract in order to avoid probate. The beneficiary can be the spouse, parents, children and grandchildren of the contract owner. Upon death, the value of the account will be received by the beneficiary rather than the estate which may be subject to probate fees.
Assuris Protection
To protect investors, Assuris offers their own guarantee if an insurance company becomes insolvent and cannot meet its financial obligations to pay guarantees. Assuris will pay $60,000 or 85% of the guarantee amount, whichever is higher.
