Current Trends and Issues in Financial Planning Roxanne Eszes, CFP Cleartech Documentation & Training This presentation will probably involve audience.

Current Trends and Issues in Financial Planning

Roxanne Eszes, CFPCleartech Documentation & Training

2005 Edition CE Course

Over 160 pages of new materialConsolidates new developments all in

one placeCovers a wide range of topics across the

CFP syllabusQualifies for 12 CE hours if you

complete the exam20 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 GuidelinesCritical Illness InsuranceIncome TrustsHedge Funds

Spousal Support Guidelines

Federal draft in January 2005Apply to Divorce Act casesVoluntary, NOT mandatoryGuidance for spouses, lawyers and

judges in setting initial awardDo 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 complicatedBasic formula assumes lower-

income 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 softwareAmount 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 custodyIncome ceiling ($350,000 for payor

spouse) gives way to discretionIncome 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 199510 companies by 1997More 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 replacementDebt reductionMedical expensesAccess to faster/innovative

treatmentsFamily holidayHome renovationsAttendant care

Most Common Conditions Covered

Alzheimer’s diseasebenign brain tumorblindnesscancerdeafnessheart attackHIV infection

(occupational)kidney failure loss of speech

Lou Gehrig’s disease major organ failure

while on a waiting listmultiple sclerosisorgan transplantParkinson’s diseaseparalysissevere burnsstroke

Other Conditions Covered

Partial benefits for less serious or non-fatal versions of previous diseases

Childhood illnessesRiders for additional illnessesEvery policy is different!Watch the definitions!

Benefits

Paid as a lump sumWaiting period of at least 30 daysMay 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 $500,000Amounts of about $100,000 or

$150,000 being most commonCoverage 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 waiverAdditional illnessesChild riderAutomatic benefit increases

Term of Coverage

To age 75To age 1005-year10-year20-yearRenewable with fixed premiumsRenewable without guaranteed

premiumsConvertible

Pricing

Initially under priced– underestimated claims– wanted to promote the product

Need 50% increase in premiumsOpted 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 dailyPriced per $1,000 of coverageIncreases 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 AnalysisLoss of earningsReduced spousal incomeIncreased childcare costsMedical care expensesHome care or attendant care expensesRenovation expensesDebt reductionEarly retirement/career changeKey person replacementBusiness creditorsBuy/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 investmentsIncome 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 TrustsNew method of obtaining capitalInvestors are wary of new stock

issues, but are hungry for yieldLow interest rates make it difficult

to float new bond issuesCan 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 investmentVolatility of commodity marketsChanging interest ratesLower financial leveragePayout ratio – should be less than 100%Lack of diversification – trusts with few

customers or located in a single geographic area

Poor managementRefer to 3rd party stability ratings

New Income Trust Developments

Investor liability issue settled– removes barriers for institutional

investorsProposed 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 1949Editor for Fortune magazine, researching

trends in financial forecastingRecognized vulnerability in buy-and-hold

strategyWanted to develop strategy that

eliminated or minimized market correlation

Started with $100k ($40k of his own)

The Jones Hedge

Long positions on undervalued stocksShort positions on overvalued stocksAdjusted 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 returnsMarket 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 FundsFund of funds– additional fees– professional management– access to inaccessible hedge funds– diversification– lower volatility– lower minimum investments

Indirect Investments in Hedge FundsPrincipal-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 June 2004

Direct Investments 1.3 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 managersInexperience managersHerd instinct on part of investors

Risks of Hedge Funds

Misjudging the market– compounded by leverage

Disclosure– potential for fraud and

mismanagementGuarantees– only as good as creditor

Liquidity/Lock-upNeed for Due Diligence

Thank You!

Read the 2005 Edition of Current Trends

Submit your examObtain 12 CE credits