Current Trends and Issues in Financial Planning

1. This presentation will probably involve audience discussion, which will create action items. Use PowerPoint to keep track of these action items during your presentation • In Slide Show, click on the right mouse button • Select “Meeting Minder” • Select the “Action Items” tab • Type in action items as they come up • Click OK to dismiss this box • This will automatically create an Action Item slide at the end of your presentation with your points entered. Current Trends and Issues in Financial Planning Roxanne Eszes, CFP Cleartech Documentation & Training

2. 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

3. Course Highlights • Practice Issues • FPSC Practice Standards • Joint Forum’s Principles and Practices • Fair Dealing Model • Privacy Act • Iso Standards for Financial Planners

4. 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

5. 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

6. 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

7. 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

8. Today’s Presentation • Spousal Support Guidelines • Critical Illness Insurance • Income Trusts • Hedge Funds

9. 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

10. 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

11. “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)

12. “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%

13. “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

14. “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)

15. “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

16. “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

17. “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

18. “With Child Support” Formula • More complicated • Basic 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

19. “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

20. “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

21. 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

22. 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

23. 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!

24. Critical Illness Insurance Uses • Income replacement • Debt reduction • Medical expenses • Access to faster/innovative treatments • Family holiday • Home renovations • Attendant care

25. 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 Most Common Conditions Covered

26. 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!

27. 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?

28. 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

29. 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

30. Term of Coverage • To age 75 • To age 100 • 5-year • 10-year • 20-year • Renewable with fixed premiums • Renewable without guaranteed premiums • Convertible

31. 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”

32. 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

33. 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

34. 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

35. 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)

36. 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

37. 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

38. 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

39. 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

40. 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

41. 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

42. 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

43. 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

44. 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)

45. 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

46. 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

47. 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

48. 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

49. 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

50. Indirect Investments in Hedge Funds • Fund of funds • additional fees • professional management • access to inaccessible hedge funds • diversification • lower volatility • lower minimum investments