Current Trends and Issues in Financial Planning
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Transcript Current Trends and Issues in Financial Planning
Current Trends and Issues
in Financial Planning
Roxanne Eszes, CFP
Cleartech Documentation & Training
2005 Edition CE Course
Over 160 pages of new material
Consolidates new developments all in
one place
Covers a wide range of topics across the
CFP syllabus
Qualifies for 12 CE hours if you complete
the exam
20 question M/C exam
– circle responses on answer sheet
– fax answer sheet to the CIFP
– obtain a score of 12 out of 20
Course Highlights
Practice Issues
– FPSC Practice Standards
– Joint Forum’s Principles and Practices
– Fair Dealing Model
– Privacy Act
– Iso Standards for Financial Planners
More Course Highlights
Economic Developments
– a review of Canada’s economic
framework
– recent Canadian economic
developments
– current trends in the value of the
Canadian dollar
– world economic conditions
– the Canadian economic outlook
More Course Highlights
Personal Finance Update
– recent statistics on consumer
spending
– the cost of raising children
– draft spousal support guidelines
– proposed increase to CDIC coverage
limits
More Course Highlights
Income Tax Update
– federal personal income tax parameters for 2005
– a synopsis of Budget proposals of interest to CFPs
– other tax changes that have been implemented
recently
Retirement Planning Update
– elimination of need to convert LIFs to annuities at age
80
– elimination of the foreign content limit
– increases in the contribution limits for registered
plans
– rules for unlocking small pension fund accounts
– the status of the Canada Pension Plan
– a recent ruling on creditor-proofing RRSPs upon
death
More Course Highlights
Estate Planning & Risk
Management Update
– an overview of living wills, including
several samples
– a discussion of critical illness
insurance
Investment Planning Update
– an overview of income trusts
– an overview of hedge funds
Today’s Presentation
Spousal Support Guidelines
Critical Illness Insurance
Income Trusts
Hedge Funds
Spousal Support Guidelines
Federal draft in January 2005
Apply to Divorce Act cases
Voluntary, NOT mandatory
Guidance for spouses, lawyers and
judges in setting initial award
Do not deal with the issue of
entitlement, just amount and
duration
Do not apply retroactively
Spousal Support Guidelines
Basic premises are
– income sharing, not equal division
– merger of economic lives
– priority given to child support
Two formulas
– “Without child support” formula
– “With child support” formula
Formulas identify ranges of amount
and duration, not definite numbers
“Without Child Support” Formula
Applies to marriages of all lengths
where spouses never had children
Applies to long marriages where
children are no longer dependent
2 crucial factors:
– the gross income difference between
spouses
– the length of marriage (including
cohabiation prior to marriage)
“Without Child Support” Formula
Amount = 1.5% to 2% of gross
income difference for each year of
marriage, to a maximum of 50%
Range for marriages of 25 years or
more is thus 37.5% to 50%
“Without Child Support” Amount
Example:
– Fred and Wilma were married for 10
years and never had kids, Fred has
gross income of $20,000 more than
Wilma
– Applicable percentage is 15% to 20%,
calculated as 10 years × (1.5% and 2%)
– Range of support is $3,000 to $4,000
per year ($250 to $333 per month)
– Refining factors discussed later
“Without Child Support” Duration
Duration = 0.5 to 1.0 years for each
year of marriage
Indefinite if marriage is 20 years or
longer
Indefinite if marriage lasted 5 years
or more and age of recipient at time
of separation + years of marriage =
65 or more (rule of 65)
“Without Child Support” Duration
Example:
– Fred and Wilma were married for 10
years
– Duration = 5 to 10 years, calculated as
10 years × (0.5 and 1.0)
– Wilma’s support should be in the
range of $250 to $333 per month for 5
to 10 years
“Without Child Support”
Refining Factors
– strong compensatory claim
– recipient’s needs
– matrimonial property division
– payor’s needs or ability to pay
– self-sufficiency incentives
– other
“Without Child Support”
Restructuring
– can vary amount and duration as long as the
product of amount × duration falls within
global range
Example:
– Wilma’s support of $250 to $333 per month
for 5 to 10 years
– $250 × 12 × 5 = $15,000
– $333 × 12 × 10 = $40,000
– as long as restructured award has a product
of amount × duration between $15,000 and
$40,000, it fits the guidelines
“With Child Support” Formula
More complicated
Basic formula assumes lowerincome spouse has custody and
receives child support
Determine each spouse’s individual
net disposable income (INDI), which
is “guidelines” income less child
costs
“With Child Support” Amount
Add INDIs together, determine
range of spousal supports that
would leave recipient spouse with
between 40% to 46% of combined
INDI
Needs computer software
Amount can be refined within range
using factors discussed earlier
“With Child Support” Duration
Initial support orders tend to be
indefinite
Maximums based on:
– length of time until kids finish
highschool
– length of marriage
Less opportunity for restructuring
Spousal Support Guidelines
Variations for joint or split custody
Income ceiling ($350,000 for payor
spouse) gives way to discretion
Income floor ($20,000 for payor
spouse) usually results in no
support
Critical Illness Insurance
Lump-sum payment upon
diagnosis of covered illness
First developed in 1983 by a heart
surgeon named Dr. Marius Barnard
First introduced in Canada in 1995
10 companies by 1997
More than 20 companies today,
even after consolidations and
mergers
Not Another Insurance Product!
Developed to meet a need brought
about by demographics and
changing medical technology
85% of people who suffer a stroke
or heart attack now survive
Similar increases in the
survivability of cancer
Survival does not mean back to
perfect health!
Critical Illness Insurance Uses
Income replacement
Debt reduction
Medical expenses
Access to faster/innovative
treatments
Family holiday
Home renovations
Attendant care
Most Common Conditions Covered
Alzheimer’s disease
benign brain tumor
blindness
cancer
deafness
heart attack
HIV infection
(occupational)
kidney failure
loss of speech
Lou Gehrig’s disease
major organ failure
while on a waiting list
multiple sclerosis
organ transplant
Parkinson’s disease
paralysis
severe burns
stroke
Other Conditions Covered
Partial benefits for less serious or
non-fatal versions of previous
diseases
Childhood illnesses
Riders for additional illnesses
Every policy is different!
Watch the definitions!
Benefits
Paid as a lump sum
Waiting period of at least 30 days
May be longer in slow onset
diseases (e.g., Alzheimer’s), or
illnesses that may resolve (e.g.,
paralysis)
Milder illness benefit?
Coverage Amount
Typically $50,000 to $500,000
Amounts of about $100,000 or
$150,000 being most common
Coverage as low as $25,000 and as
high as $2 million is possible
Riders
Return of premium, without interest
– upon death
– upon end of term
– upon termination of contract
Disability waiver
Additional illnesses
Child rider
Automatic benefit increases
Term of Coverage
To age 75
To age 100
5-year
10-year
20-year
Renewable with fixed premiums
Renewable without guaranteed
premiums
Convertible
Pricing
Initially under priced
– underestimated claims
– wanted to promote the product
Need 50% increase in premiums
Opted for more moderate increases,
coupled with:
– tougher underwriting
– more restrictive definitions
Justified increases to consumer with
“bells and whistles”
Current Premium Rates
Highly variable and changing daily
Priced per $1,000 of coverage
Increases significantly with age
$100,000 of coverage for healthy,
non-smoking male:
– 30 years old $236 to $892 per year
– 50 years old $960 to $3,469 per year
Needs Analysis
Loss of earnings
Reduced spousal income
Increased childcare costs
Medical care expenses
Home care or attendant care expenses
Renovation expenses
Debt reduction
Early retirement/career change
Key person replacement
Business creditors
Buy/sell agreements
Income Trusts
Definition: commercial trusts that invest
in the shares or assets of one or more
operating companies, with the objective
of distributing cash flow to the investors
Phenomenal growth:
– largely due to new business trusts
– market cap of income trusts increased by
50% in 2004, to over $121 billion
– more than 175 income trusts listed on the
TSX, making up 9% of total market cap
Types of Income Trusts
REITs (real estate income trusts)
Royalty trusts (energy, gas, other
natural resources)
Business trusts (operating
companies)
Stock market investment trusts
(invest in other income trusts)
Are they Stocks or Bonds?
High yield equity investments
Income distributed and unit prices
will vary in tandem with the
prospects of the underlying
business
Unit prices may increase if
distributions exceed projections,
and may fall if cash distributions
are not met
Why Companies Become Income
Trusts
New method of obtaining capital
Investors are wary of new stock
issues, but are hungry for yield
Low interest rates make it difficult
to float new bond issues
Can spin off low-growth cash
generating subsidiaries
Taxation of Income Trusts
Trust receives net income from
operating assets
Trust deducts management fees
and expenses
Trust passes income directly to unit
holders, WITH NO INCOME TAX at
the business or trust levels
Taxation of Investors
Income retains its character
– business income at 100%
– dividends result in gross-up and DTC
– capital gains at 50%
– return of capital tax-free, although it
reduces investor’s ACB
Flow through of CCA and depletion
allowance
Risks of Income Trusts
Lack of ongoing capital investment
Volatility of commodity markets
Changing interest rates
Lower financial leverage
Payout ratio – should be less than 100%
Lack of diversification – trusts with few
customers or located in a single
geographic area
Poor management
Refer to 3rd party stability ratings
New Income Trust Developments
Investor liability issue settled
– removes barriers for institutional
investors
Proposed Tax Changes Reversed
– Feds worried about tax leakage as
pension funds purchase income trusts
– 2004 Budget tried to limit pension
fund investments
– government has suspended
implementation pending consultation
New Income Trust Developments
Income trusts to be added to
S&P/TSX Composite Index
– transition complete by March 2006
– new parallel S&P/TSX equity index
– will create new demand as
institutional investors follow index
Hedge Funds
Hedge – “A strategy used to offset
investment risk”
Hedge fund:
– pool of investor capital
– professionally managed
– uses a variety of hedging strategies
– objective of providing positive or
absolute return in all market
conditions
History of Hedge Funds
Alfred Winslow Jones in 1949
Editor for Fortune magazine, researching
trends in financial forecasting
Recognized vulnerability in buy-and-hold
strategy
Wanted to develop strategy that
eliminated or minimized market
correlation
Started with $100k ($40k of his own)
The Jones Hedge
Long positions on undervalued stocks
Short positions on overvalued stocks
Adjusted long and short positions
depending on market swings (increase
short position in declines, increase long
position in rebounding markets)
Charged the first incentive fee (20% of
profits) in 1952
Hedge Funds versus Mutual Funds
Return Objectives
– absolute or positive returns versus
just beating benchmark returns
Market Correlation
– mutual funds are highly correlated
because of long positions, hedge
funds strive to minimize correlation
Regulation
– mutual fund prospectus, hedge fund
OM, less disclosure
Hedge Funds versus Mutual Funds
Manager’s Compensation
– mutual fund: management fee of 2% to
4% of assets under management
– hedge fund: management fee plus
incentive fee of 20% of profits
– hurdle rate
– high water mark
Hedge Funds versus Mutual Funds
Manager’s investment
– remember Jones’ 40%
Liquidity
– mutual funds offer daily redemptions,
hedge funds may have lock-up
periods
Fund Size
– mutual funds may be unlimited, hedge
funds tend to limit size
Direct Investments in Hedge Funds
Accredited Investor
– $1 million in net assets (excluding
home); or
– personal income of $200k (or
combined $300k with spouse)
Non-accredited investor with
minimum of $97k to $150k,
depending on province
Offering Memorandum instead of
Prospectus
Indirect Investments in Hedge
Funds
Fund of funds
– additional fees
– professional management
– access to inaccessible hedge funds
– diversification
– lower volatility
– lower minimum investments
Indirect Investments in Hedge
Funds
Principal-protected Notes
– take 60% to 70% of capital to purchase
a long-term bond (10 to 11 years)
– balance is leveraged and invested in
one or more hedge funds
– additional costs
– creditor rating of guarantor?
– must be held to maturity – erosion by
inflation
– only 30% is actively invested
Phenomenal Growth Rate
Assets ($billions)
Dec.1999
Direct Investments
1.3
June
2004
4.1
Funds of Funds
1.3
2.3
PPNs
0.6
7.7
Total
2.5
14.1
Problems with High Growth
Limited opportunities for managers
Inexperience managers
Herd instinct on part of investors
Risks of Hedge Funds
Misjudging the market
– compounded by leverage
Disclosure
– potential for fraud and
mismanagement
Guarantees
– only as good as creditor
Liquidity/Lock-up
Need for Due Diligence
Thank You!
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