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
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 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!
Read the 2005 Edition of Current
Trends
Submit your exam
Obtain 12 CE credits