Wednesday, November 26, 2008

Manulife IncomePlus Reader Comments

A reader had some thoughtful comments and questions about my analysis of the Manulife IncomePlus annuity. Here are his comments (edited for brevity) followed by my thoughts.

1. You describe the worst case scenario in which an investor makes withdrawals beginning in the first year. The product is best suited to the investor who leaves cash in the investment for at least 15 years so that the guaranteed income grows at 5% per year (albeit simple rather than compounded) for that period.

An example will help here. Our investor Ida puts $400,000 into IncomePlus. In my earlier analysis of IncomePlus, I focused on the case where Ida draws a guaranteed income of 5% or $20,000 per year for the rest of her life. But, suppose that Ida is only 50 years old and doesn’t need any extra income until she is 65.

IncomePlus rules permit Ida to defer payments for 15 years and then collect a guaranteed $35,000 per year for the rest of her life. This figure came from increasing the $20,000 by 5% (not compounded) for each year Ida deferred payments.

On the surface, $35,000 per year sounds not too bad. But this ignores inflation. Even if inflation averages only 3%, Ida will only get $22,500 in today’s dollars in the year she turns 65. By age 90, this drops to $10,700. If inflation averages 5%, this is $16,800 at age 65 and less than $5000 at age 90. Pass the cat food.

If Ida lives to age 90, her guaranteed $35,000 per year amounts to a 3.03% per year return on her original $400,000 investment. If she dies younger than this, her return is even worse. This investment has all the inflation risk of a long-term government bond, but with lower returns than a bond.

2. You describe scenarios where the market performs poorly for 20 years.

It’s true that I’ve focused on the income guarantees. The point is that the guaranteed income is very low because of decades of inflation. However, it is possible for the guaranteed level of income to rise if our investor Ida’s mutual funds within IncomePlus perform well. Unfortunately, they have to perform very well to overcome the very high fees charged. The market could perform reasonably well and still not trigger any increases in Ida’s payments.

3. Some of the funds available to IncomePlus investors charge lower MERs than you quoted.

The funds with lower total fees are the ones containing a lower percentage of stocks. The only way to have a chance at doing significantly better than the minimum guaranteed payments is to have as much exposure to stocks as possible.

4. The product might enable some investors, who would otherwise be too skittish, to buy into today's markets or to feel comfortable maintaining some exposure to markets during volatile times.

It is true that this product’s guarantees may draw in nervous investors. However, IncomePlus behaves more like a bond than like stocks. The high fees charged prevent investors from participating in very much of the market’s upside. In the future, IncomePlus investors are likely to see positive news about stocks, but see their payments increase minimally or not at all.

5. The fact that Manulife had to inject new capital partly to boost its reserves for products of this kind suggests the product is not as one-sided as you suggest.

Let’s try an analogy here. Suppose that I offer people a $1000 bet on the flip of a coin. But, they don’t realize that I’ve rigged the coin to come up my way 90% of the time. If I happen to lose the first flip and scramble to raise the $1000 I owe, is this evidence that the bet wasn’t one-sided? Manulife lost one round of a bet stacked in their favour. I like their chances in future rounds.

6. Those who bought earlier this year may be glad they did that rather than investing directly in mutual funds or equities.

You are right that these people are probably glad, particularly those who need money right now. However, if our 50-year old investor Ida, who doesn’t need income until she is 65, just stays invested in a low-cost stock index and waits out the current downturn, she is likely to be better off than investors who bought into IncomePlus early this year.

Despite our differences, I appreciate comments from readers. I’m more interested in learning the truth than I am in trying to argue than I’m right.


  1. The obvious conclusion is that you should retire on the dividends from Manulife stock!

  2. Excellent point Richard. The dividend yield on Manulife based on the last 4 quarters is currently 5%, same as the IncomePlus payout.

    Prospective IncomePlus investors would probably do better buying Manulife common stock.

  3. I agree with much of what you say concerning the Manulife GIF but your bias against MERs (which I generally share) may disable you from giving this product a fair shake. Odds are that Manulife will indeed profit from selling this product but that alone is a feeble reason for choosing not to buy it or any other product. You probably have insurance on your house even though home insurance companies invariably profit from issuing insurance policies. Moreover you would probably be better off financially at the end of 15 years if you did not carry home insurance and thus saved 15 years of premium. That’s because your house probably won’t burn down in the next 15 years. And in fact an insurance analogy is far more apt than the analogy you propose for the Manulife product. (When an analogy like the one you use seems so much more compelling than the circumstances it is meant to mimic it is usually because the analogy is inapt.)

    Investors who buy the Manulife product are buying insurance against the possibility, however remote, that the market downturn we have seen thus far will become much worse. For all I know, perhaps we are seeing just the beginning of a cataclysmic economic crisis in which blue chip companies end up failing outright, in which case. shares and corporate bonds go to nil. Some such companies in the US have already gone that way and buying and holding those investments is not a viable strategy. So there is an unlikely but realistic possibility that the guarantees of the product will outperform even low-cost equities, just as your house could burn down.

    On the upside, I accept that the fees built into the product make it difficult for the underlying funds to keep pace with the markets. Still some 30% of funds do somehow beat their benchmarks. There is a reasonable prospect that, with the 3 year reset feature, the mutual funds underlying the Manulife product will produce a life-long income well in excess of the guaranteed minimum. And don’t forget that the investor has the option to redeem the mutual funds at any time, and this can be achieved without a redemption fee. If the markets should perform extremely well during the next 3 to 5 years, for example, the investor could come out well ahead, even after fees, and even more so in the (admittedly unlikely) event that the funds happen to outperform the markets.

    Because of their high costs, I normally avoid mutual funds like the plague but a mutual fund that comes with guarantees like those offered by Manulife may have a place in the portfolio of a conservative investor in uncertain times. You have explained the very real costs but unfairly discount the possible benefits of the insurance. You must not expect this particular house to burn down, and you are probably right, but one does not know. I can see why some home owners are considering some limited home insurance, just in case, and despite the cost.

    Finally I question the calculations by which you arrive at the 3.03% effective minimum return. Based on Ida’s returns to age 90, I calculate that a compounding rate of 4.5% for 40 years would be required to produce returns on $400,000 equivalent to the Manulife’s minimum. It yields simple interest for the first 15 years. But compounding interest is appropriate for the period from age 65 to 90, since Ida could choose to reinvest the annual payments of 35,000, rather than spending them.

  4. A Dot in Thought: I'm afraid I'm going to have to disagree with most of what you have said.

    I have a clear understanding of the effect of MERs on long-term investment returns. This is not a bias against MERs. I'm quite capable of fairly evaluating the IncomePlus product.

    It's certainly true that in looking at this as an insurance product, Manulife must be compensated for taking on risk in much the same way that a company offering house insurance must be compensated for taking on risk. However, the cost of the insurance in the IncomePlus product is far too high and the guaranteed payouts too low to make them a reasonable choice for investors.

    If we are at the "beginning of a cataclysmic economic crisis," then IncomePlus investors are in trouble because inflation will make their guaranteed payouts too small to live on.

    You say that IncomePlus has a reasonable likelihood of producing "a life-long income well in excess of the guaranteed minimum." This is not true. Reasonable expectations for stock and bond returns less the very high fees charged by IncomePlus are such that the odds are against any single 3-year period leading to an increase in payments. The most likely outcome is that there are no increases in guaranteed payments or only a modest increase.

    You say that I "unfairly discount the possible benefits of the insurance." The insurance payouts are too low because of inflation. This isn't unfair; it is a fact.

    Your final point is baffling. The correct figure for the return is 3.03%. This is the rate at which one would have to discount a stream of 25 yearly payment of $35,000 starting 15 years from now to get a present value of $400,000.

    All this discussion has given me an idea. I wonder if it is possible to buy government bonds to give payments equal to the guaranteed payouts and invest the rest in stocks in such a way as to guarantee doing better than IncomePlus.

  5. Here's another comparison for the 50 year old who plans to retire in 15 years.

    A) Buy a $35,000 per year income stream from IncomePlus for $400,000, with unlikely upside potential, or

    B) Buy a $35,000 deferred fixed annuity for $295,000 (see quote below) and invest the remaining $105,000 in equity, with likely upside potential.

    Option B) is clearly the better choice.

    Quote from SunLife from their website (you need an account unfortunately)

    Annuitant Age: 50
    Annuitant Gender: Male
    Joint annuitant age: 50
    Joint annuitant gender: Female
    Age when annuity begins: 65
    Annuity income: $35,000 per year
    Guaranteed annuity period: 0 years
    Income to be paid to spouse upon death: 100% (IncomePlus appears to offer a 100% survivor benefit)
    Include cost-of-living expenses: No

    The lump sum premium required is $294,996.

  6. Blitzer68: Nice work! I had a feeling something like this was possible.

  7. The difference between insurance and an annuity is that with insurance you pay a small cost to avoid a larger one that you can't afford. With this annuity you would pay a large cost to avoid running out of money, while coming closer and closer in reality due to inflation.

    I compeletely understand people who don't want to deal with the uncertainty of investing in the stock market, but it's better than the near certainy of ending up with virtually nothing!

  8. Manulife Gif products do not appear to be a good investment, especially when you factor in the capital gains which is flowed-throu to the investor, and yet the capital gains is not actually received by the investor. The Gif products over a 10 year period have performed poorly and when the capital gains is factored in the investor actually loses money.

  9. fascinating conversation