Group Savings Plan Returns are NOT the Same as Private Plan Returns

Did you know that Group Retirement Savings Plans, namely Pensions, Group RRSPs, Group TFSA and Deferred Profit Sharing Plans (DPSP) report their gains differently than privatly invested RRSPs, TFSAs or other investments?

In the private or "retail" space, everyone pays the same fee's the only exception to this are very high value clients typically with excess of a quarter million dollars invested. You, me the guy down the street, we all pay the same fee for the same investment fund. Members in the same Group Plan all pay the same fee as each other, but each group plan is different.

Group pensions or RRSPs can easily amass a quarter million dollars, most pensions are measured in  millions of dollars. Because these plans are so large they receive a "bulk discount" on the fees they pay. The fee's each plan pay depend on the invested assets of that plan, each plan is a different size, and therefore pays different fees. There is an obvious challenge in providing each and every group plan with their own specific rates of return, especially in the days before computers, so group returns are reported GROSS of fees. When you see a return from a fund held by a group plan to find your true rate of return you need to subtract your plan specific fees.

In the retail channel since everyone pays the same fee, it is easy to simply subtract the fee from the gross return and post the NET return. Everyone paid the same fee so only one statement is needed.

Lets compare a retail fund to the same fund held inside a pension plan. I manage a pension plan with a value of approximately $6 Million in invested assets. Because of the large dollar amount the fees charged for each given fund are greatly reduced compared to retail funds. I have randomly selected the Great West Life Diversified Fund it is available through both retail channels such as brokers as well as it is currently held inside the pension fund I managed.

Fees

Great West Life Diversified Fund (No Load, Retail)
Management Expense Ratio (MER) 2.78% 

Great West Life Diversified Fund (No Load, Pension)
Management Expense Ratio (MER) 1.535%

The retail MER is nearly double the pension MER. The 1.245% difference is added return for the pension fund member. Remember, it is the same fund, but the person in the pension made an extra 1.245% more this year than the retail investor. A little over 1% doesn't sound like much, but it can definitely add up over time.

Returns

Great West Life Diversified Fund (No Load, Retail)
One Year Return (as at Sept. 30, 2009) =  -1.22%

Great West Life Diversified Fund (No Load, Pension)
One Year Return (as at Sept. 30, 2009) = 1.31%

Now recall that retail fund returns are published NET of fees and Group funds are published GROSS of fee's. Without remembering this fact it looks like the Pension fund has out performed the Retail fund by almost 3%.

To find the NET return of the pension fund we need to subtract the MER from the published GROSS rate of return.

Gross rate of return - fund MER = Net rate of return
1.31%                  -   1.535%   =            -0.225%

Obviously, neither of these funds have performed very well over a one year period, regardless of performance though, the fact remains the person invested in the pension fared better than the retail investor.

The group plan lost only a little less than one quarter of one percent, the retail investor lost nearly one and a quarter percent.

TL;DR Group savings plans have better rates of return for the same fund as retail investment funds, all thanks to lower fees.

How Group Insurance is Funded

There are four ways of funding a benefits plan. They essentially fall along a continuum of risk and reward. Fully pooled benefits are the least risky as if your group has a catastrophic claim, it does not impact your premium at all. The downside is that you have no idea if you are getting good value as your premiums may be much higher than the claims you incur. Prospectively rated benefits plans are the most common, they involve an annual review of claims incurred and premiums paid. Premiums tend to track closely to claims incurred. Rates are more volatile than pooled plans but Prospectively funded plans are often less expensive in the long run. Retention Accounting is more commonly known as Refund Accounting, having lost favor with the insurance carriers Refund is currently only offered by a selective few carriers. Refund provides, in my opinion, the best possible arrangement from the clients perspective. Premiums are calculated similar to Prospectively rated groups, however, if claims are lower than predicted, a refund of the difference is paid to the group. More frequently the refund is help inside a trust account and used to smooth future rate fluctuations. ASO plans offer the most possible savings as there is no "cost of insurance" however, they trade potential savings for certain risk. Only very large groups should consider ASO funding. ASO also brings with it certain other possible problems such as cost sharing, pay roll deductions and the treatment of a surplus or deficit.


FULLY POOLED BENEFITS (Less than 10 members)

The policyholder pays whatever premium is charged by the insurer. The premiums are pooled among all of the policyholders for the insurer, and all claims and administrative expenses are taken out of the pool. All renewals are based on how the whole pool does, each policyholder has no control or input as to how the premiums are allocated. Cost-containment measures available to policyholders are to add deductibles, reduce reimbursement percentages by the insurer, or reduce or eliminate particular benefits. The advantage of fully-pooled plans is that they help spread of catastrophic claim for smaller policyholders. This disadvantage of fully-pooled plans is the lack of control over the allocation of premium dollars.

PARTIALLY-EXPERIENCE RATED BENEFITS (PROSPECTIVELY RATED) (10+ Members)

This method is a hybrid to the experience-rated policy and the fully-pooled plans. Insurers like these
policies because they can use the policyholder’s own experience to determine the renewal rates, yet they do not have to disclose the individual charges in which their premium dollars are used. Partially-experience rated plans can run up deficits, but should expect to face renewal increases to ensure future deficits do not occur. The advantage of the partial experience-rated plan is that the policyholder may run a deficit and terminate without financial repercussions. The disadvantage of the partial experience-rated plan is the limited information provided by the insurer. Although a break-even or target loss ratio is often provided to the policyholder, this does not reveal all of the charges being levied.

FULLY EXPERIENCE-RATED BENEFITS (RETENTION & NON-RETENTION ACCOUNTING) (100+ Members, or $100,000 in annual premium)
Under this method, the insurer works out each policyholder’s premium rating, based solely on the
policyholder’s own past experience for the benefit. At renewal, the insurer takes the paid premium for the year and then allocates various expenses against it. Apart from the actual utilization, there are claims paying charges, administration fees, taxes, insurer profit and agent/broker commissions. There are also requirements to fund reserves to pay for all of the outstanding claims that have not been submitted, or processed, and which must be paid by the insurer. There can also be a claims fluctuation reserve in which the insurer puts excess premium, if there is any. The advantage of the fully experience-rated plans is that all of the charges are fully disclosed. If retention accounting is used, the policyholder participates in the financial results of the group. This means that the policyholder owns both the surplus and deficit over the policy year. On a non-retention accounting basis, the policyholder would not participate in the financial results. The ideal policyholder for fully experienced-rated benefits is generating approximately $100,000 in annual claims, this will ensure that the utilization is “credible”. To protect against catastrophic claims by any individual plan member, the policyholder can purchase stop-loss protection from the insurer.

ADMINISTRATIVE SERVICES ONLY PLANS (ASO) (100+ Members or $100,000 in Annual Premium)

With this funding method, a policyholder pays an insurance company or third-party administrator to provide only certain services (i.e., adjudication, booklets, and wallet certificates). All charges are fully disclosed and negotiable. Stop-loss coverage can be purchased by the policyholder to reduce the risk of catastrophic claims by any individual plan member. The savings being generated may not be substantial in light of the additional resources required to provide the identical level of communication to the plan members, but the policyholder will never forfeit surplus premium. The advantage of the ASO funding method is the amount of control gained by the policyholder. The disadvantage of the ASO funding method is the potential risk of deficit funding. Dental Care can often be ASO funded at a lower level of approximately 25 members or $25,000 in premium. These lower levels are possible due to Dental Care claims being non-catastrophic in nature.

Funding explanations taken from Advocis Best Practice Manual.

Maximum Retirement Income

You have saved all your life for retirement, you have a nice little nest egg of cash and are ready to start drawing an income. How do you get the best bang for your buck while taking a minimum amount of risk?

People at or near retirement are naturally more conservative with their money and investments, they like to color within the lines. Most retirees gravitate towards guaranteed investments like GIC’s. While safe, GIC’s provide poor returns and notoriously bad after tax returns. GIC’s are treated as income, and fully taxed at your marginal tax rate. This can be as high as 43.7% in BC. Why give up almost have of your gains to taxes if you don’t have too.

Enter stage left, the Insured Annuity. Annuities provide a guaranteed stream of income just like GIC’s but, they are far more tax efficient than a GIC and they provide a substantially higher ROI than a GIC.

A brief primer on annuities.

Annuities pay the highest ROI of any guaranteed investment product. An annuity, in a nut shell is a backwards life insurance policy. Instead of paying a small monthly premium and getting a big payout from the insurance company at death, you give the insurance company a big cheque now, and they agree to pay you for the rest of your life. There are lots of options and guarantees which can be added but in its simplest form a life annuity will pay you from today to the day you die, be it next week or decades from now. The catch, if you do die next week, the insurance company keeps all your cash, even if you only received a single payment. Flip side of that coin is, if you live a long time, the insurance company has to keep paying you even after your money is long gone. The people who die young subsidize those who live to a ripe old age. Because some people die before their money is paid back, there is more money to go around, which is why annuities pay such a high rate of return.

An annuity will pay you a big income, but what good is it if you die tomorrow and your spouse gets nothing? Risk of dying too soon, sounds to me like you need life insurance...

Life Insurance, more specifically low cost, permanent life insurance.

Term 100 or minimum pay Universal Life will provide a guaranteed premium, and a guaranteed payout. Remember retiree’s life guarantees! Purchasing a permanent life insurance policy for the face amount of the annuity will allow us to preserve our original capital in the event of dying too soon. There is an insurance premium that needs to be paid of course, we take part of the annuity payment and earmark it for the insurance cost. As luck would have it the insurance costs are about half of what the annuity will pay us.

To summarize, we buy a Single Life Annuity to get the highest income from our capital, we have a risk that we could die too soon and lose our capital before it’s repaid so we buy life insurance which replaces our capital when we die. Still following along?

Now, the bright crayons in the box will be thinking, “why pay all that insurance premium, when I could just live off the capital in the first place?” good job Burnt Sienna, one word, taxes. I have to harken back to the beginning of the post, retiree’s like guarantees. Other than annuities, GICs are the main player, and they are a tax nightmare. The insurance cost pales in comparison to the brutal tax bill CRA is going to exact from your GIC’s.

Math time.

(FYI, current annuity payout as of Oct 26 2009 $46,578.00, current 5 year GIC rate 3.925% so the example above is fairly accurate)

Starting with the same amount of capital, $500,000 we compare an annuity payout to the annual return of a long term GIC. All of the GIC earnings are spent and the original capital is reinvested.

Right off the bat you can see that the annuity provides more than double the pre-tax income of the GIC, $45,668 vs $20,000. This increased payout is due to those people who died young, subsidizing the rest. Other than the superior ROI, the tax situation is very noteworthy. As previously mentioned the GIC earnings are treated as income, and are fully taxable at your marginal tax rate. The Annuity in its “prescribed” form, includes a Return of Capital, which basically means you are spending a portion of your own money (tax free), and a portion of investment earnings (taxable). This greatly reduces the tax bill in the early years of the annuity. Tax payable at the end of the year, $4023 for the annuity and $9000 for the GIC’s. The annuity can produce a net after tax income to nearly FOUR TIMES that of the GIC $41,645 compared to just $11,000.

Carnation Pink has pointed out that while the Annuity has a better cash flow; if you die early you lose all your capital, while the GIC retains its capital every year. When you have a risk of dying too soon you buy insurance. That insurance costs $21,305 in this example, which again is accurate as of today’s date. As long as you pay your insurance premiums your capital will be restored tax free with a death benefit. So while you have lost your original nest egg to the annuity gods, your heirs receive a brand new infusion from the insurance fairy.

What’s the catch? You have to pay your insurance premium, if you let the life insurance policy lapse the whole plan falls apart. If you are uninsurable or have health problems, you can’t get the insurance in the first place; this strategy is not for you.

Lastly, Insured annuities used to be really popular about 20 years ago, they have recently reared their heads again due to the global economic crisis. The reason they fell out of practice for so long comes down to two words, lapse rates. Permanent insurance is only as cheap as it is because some of the policies lapse, people paid premiums but never collected. Lapse rates need to be predicted accurately to know how to set the life insurance rates, problem is; insured annuity strategies necessitate NOT lapsing a policy, which skewed the predicted lapse rates. Insurance companies either lost money or had to increase their premiums. Most companies stopped offering both the insurance and the annuity, as doing both was a losing game; Multi-Company insured annuities were still available but the added complexity, as well as the better performance and taxation of equities made GICs and insured annuities less popular. BMO Insurance (formerly AIG Canada) has recently started promoting Insured Annuities again, they are providing both the annuity and the insurance, their rates for both products are quite good as well. I am not entirely sure how they plan on making a profit given the lapse rate problem I mention above, I can only assume their underwriters and actuaries have accounted for it.

TL;DR – Double your retirement income, guaranteed. Maintain your capital, guaranteed. Pay less tax, guaranteed.

E.O.&E.

And now for something completely different

I, like many people, have an iPhone and use MS Outlook for emails, calendar and contacts in the office. Both are wonderful pieces of technology, but without an Exchange Server they do not like to talk to each other. I wanted to post here on how I finally made the iPhone and Outlook play nice together.

Goal: Real time 2-way sync of email, contacts and calendars between iPhone and Outlook. (for free)

Prerequisites:

IMAP email account

Google Account (Gmail and Calendar)

Nueva Sync account

Soocial.com Account

Step 1: The cloud

Register a Gmail and Google Calendar account if you don’t already have one. Gmail is going to act as the middle man between the iPhone and Outlook, it also provides a great webmail service if you are away from your phone or office.

Push Calendar from Outlook to Gmail

                Download and install the Google Calendar Sync app
 

Push contacts from outlook to Soocial.com
Add a connection for Outlook to your Soocial.com account. Install the outlook add-on and sync contacts to Soocial. Add a second connection for Gmail to your Soocial account; Soocial will now 2-way sync contacts from Outlook to Gmail.

            

Gmail Account setup

                If you go into the "Accounts and Import" settings in Gmail you can add your IMAP email to Gmail. Google will log into your email account and periodically pull any new emails into your Gmail account.

You should now have all of your Outlook data synced to your Google Account. Now that we are talking to the cloud we need to pull it down to the iPhone.

Step 2: The iPhone
Email: I connect to my email directly through the IMAP server, I don’t bother going through Gmail for this, I find going through Gmail adds a 20 minute lag, and sending and receiving directly through the IMAP server works best.

 A copy is still stored in Gmail in case you need it.

Log into your Nueva Sync account and add a connection to your Gmail account. Choose to Sync calendar and contacts, but not email (see above).

Nueva Sync will now pull contact and calendar info from Gmail to its free hosted exchange server. On your iPhone go to settings, and create a new Mail, Contacts and Calendar Account. Choose Exchange from the presets.

 Enter your NuevaSync account information.

Once everything is set up correctly anything you add to Outlook is replicated to Gmail, synced wirelessly to your iPhone and vice versa. I find the contacts and calendar sync is almost instant, I can add a contact to my phone and within 30 seconds it shows up in Outlook. Having everything replicated to Gmail is another nice feature, I have been at a clients house with no laptop and a dead cell phone battery, and was still able to pull quotes I had emailed myself just by logging into my Gmail account from their home computer.

It is unfortunate that to do what should be such a simple task takes no less than 5 different pieces of software. Google has recently added a new Apps Sync tool which accomplishes everything above, but it is not free.

Risk, sometimes it’s worth it.

Insurance is all about risk, more importantly, paying someone to take a risk for you. In group insurance, the risk is that your employee’s might incur a large and costly medical claim. You would then have to pay it, even if you didn’t have the funds available. The insurance company takes the risk of paying for catastrophic claims, but charges a premium on everyday claims. 9 times out of 10 you pay more with insurance than without it. However, it is that 1 out of 10 that saves your butt.

I had a group which had excellent claims history, very stable and very low, especially when compared to their premiums. While I did everything I could to keep premiums down, I eventually reached a minimum premium which the insurance company refused decrease further. The claims of the group still warranted a rate decrease so I began looking for alternatives.

Self insurance came to mind, simply pay the claims, and be done with it. You will never overpay and as long as claims are low you have nothing to worry about. Except risk. Without an insurance company, any large claims are now the responcibility of the business. Risk reward, big rewards usually require big risks.

We needed some kind of insurance, but there must be something out there less expensive than what this client currently had. Their premium was more than twice what their claims were, they were not getting good value.

I found a product called Benaccount from a company I work with regularly, Benefits By Design. Benaccount lets you self insure what you are comfortable with and insure the rest. This way you get the best of both worlds, low insurance costs, but protection in case of catastrophic claims.

Benaccount relies on a health spending account for each employee; each account is funded to $1000 for a single employee and $2000 for an employee with family. This money is the first payor, every claim will reduce this account until the money is gone. The account is used for both health and dental claims. Once the account is empty, the employee switches to an inexpensive stop-loss insurance plan ($8/month single, $22/ month family) the stop loss doesn’t provide dental, paramedical or other small coverages however, it does provide coverage for prescription drugs, hospital, and large ticket medical items like electric wheelchairs etc.

A good way to think of the plan is as a stripped down health plan, with a high deductible of either $1000 or $2000. You take the risk that you might have to pay the deductible yourself, but after that you are protected. Speaking of risk, there is certainly a potential downside here, if every employee maxed out their claims, the total cost for this little 5 life group would have been $7700. When the insurance company guaranteed a rate of a only $6000. Giving up the rate guarantee was a risk the business owner had to agree to take, this plan could cost him more, while not likely to happen, it is still possible.

When agreeing to take on any risk, there needs to be a return involved. The return is if claims are lower than $6000, the company saved money.

At the end of the day, this group claimed, about what they always do, $2205.59 over the year on health and dental expenses. They paid $671.14 in insurance about 10% of their old premium, for the security that if a catastrophic claim occurs they will be safe.

Their total annual cost was $2876.73
Vs. Their insurance quote of $6203.26
The reward for taking a little risk?

$3,326.53 saved.

On nom nom

Happy thanksgiving all.



- Posted using BlogPress from my iPhone

Great West Life - Segregated Funds with NEW Lifetime Income Benefit

I just got a huge package from Great West Life, on their new Segregated Fund product. They have jumped on the bandwagon and added a Lifetime Income Benefit similar to Manulife, IAP, DFS, Sun Life, Transamerica etc.

*BIAS DISCLOSURE*

I don't really like these products no matter who sells them, the fee's are just way too high.

Case in point, please see the MER (Management Expense Ratio) chart for the new shelf.



Lets look at the Mackenzie Financial Balanced Fund, once you add in all the bells and whistles and the Lifetime Income Benefit your MER is 4.01%

Yeah, no thanks.

More to come later.

Private Health Services Plans AKA Health and Welfare Trust AKA Health Spending Accounts

While each of the above names are in fact slightly different they are all fairly interchangeable and they all have the same goal at heart; making medical expenses tax deductible.

Government likes a healthy electorate, so they encourage business to provide health benefits by making benefits tax preferred. Health and Dental benefits are tax deductible to a business, AND non-taxable to the employee. Health insurance is basically tax free!

I use the words Health and Welfare Trust in the image below, it works the same way.

Back in the day, insurance companies would only offer insurance to businesses with at least 10+ employees. This was a problem to most small businesses because it meant they couldn’t offer medical benefits. So along comes Mr. Taxman and creates the Private Health Services Plan (PHSP). A private health services plan is essentially a trust fund set up by a company to pay employee medical expenses. Because the business pays into a trust, it is tax deductible, and because the trust pays the medical expenses for the employee, the benefit is non-taxable. It is NOT insurance, once you run out of money in your trust you are on your own. PHSPs save a heck of a lot of money in taxes.


Some of the rules that apply to all PHSPs is that all claims must be adjudicated by a third party, typically a trust company or an insurance company. There are two reasons for this requirement: First, so privacy is maintained for employees. Secondly, so that all claims are verified eligible. These plan administrators usually charge a small fee, typically 10%, to push the paper and process the claim.

PHSPs are very flexible, they will pay for expenses that no insurance company will touch. Rather than use a plan design, (we will cover 80% of this drug but only 50% of that drug) any prescription, medical device, dental expense or vision care is eligible. What is and is not covered is dictated by the Income Tax Act, the Act is very vague and if you can justify it as a medical expense it is probably eligible.

Sample List of Eligible Expenses (PDF)

With the PHSP now any size business can provide health benefits to their employee’s. Incorporated business are essentially unlimited to how much they want to provide in benefit, unincorporated businesses such as sole proprietors have a few rules to follow.

Unincorporated
If you are unincorporated Canada Revenue has a harder time tracking your actual business income. Because of this they impose some strict rules to prevent money laundering. If you are unincorporated, your benefit cannot exceed the following

$1500 per year for yourself
$1500 per year for your spouse (if any)
$750 per dependent child (if any)

The average family of four gets $4500 in tax free medical and dental each year. Of note is that the money can be spent by anyone in the family, if you are greedy and want to spend $4500 yourself and let little Timmy’s teeth rot, you can.

Incorporated 
If you have employee's you MUST provide a "like benefit" which just means give them a piece of the pie as well. The rule of thumb is that no class of employee should receive more than 10 times the next class. So if you are the owner and want $10,000 your employees should all receive $1,000. If you don't you risk creating a shareholder benefit, which is taxable.



My providers
I use two providers, Olympia Trust and Quikcard. I use two because they suit different needs.

Olympia Trust is excellent for sole proprietors or single person companies. They allow payment to be sent in at the time of claim, rather than requiring a trust fund be prepaid. Downside, they charge almost $400 to set up a plan. Their administration fee is 10% of the paid claims.

Quikcard, has no setup fee but requires prefunding of a trust, this means writing a cheque for $1500 to $4500 at the beginning of the year or making monthly contributions, and letting them sit on it. If you don’t spend the money you can have it back, it is yours after all, but not a lot of people like letting go of that much cash if they don’t have too. Their administration fee is 12% of paid claims.


TL;DR: If you are self employed incorporated or not, with any medical, dental or vision care claims you can save a boat load of tax dollars with a Private Health Services Plan

Edit: April 1, 2011 - I have changed providers away from Benecaid and to Quikcard, as Benecaid has implemented a $95 per year fee which started on April 1, 2011 and they provided very little notice of this change.