CMFAS M9A Suitability, Sales Process & After-Sales question: Beyond the early-redemption/reinvestment risk

CMFAS M9ASuitability, Sales Process & After-Sales

In Case Study 1 the maximum return is capped at 20% while the capital is protected (barring the owner's own early termination or failure of guarantor XYZ). Beyond the early-redemption/reinvestment risk, this feature illustrates that the policy owner:

A bears no cost for the capital guarantee, since XYZ provides it free of charge
B gives up the stocks' full upside in exchange for the guarantee, an opportunity cost
C is assured of outperforming a direct holding in the same six stocks over the full term
D pays for the guarantee only in the years when the six stocks fall below 100%

Show the answer and explanation

Answer: B. gives up the stocks' full upside in exchange for the guarantee, an opportunity cost

Guarantees come at a price: ABC uses part of the premium to pay XYZ for the guarantee, which is why the plan cannot deliver the stocks' full upside. The owner therefore surrenders the full upside potential of the six stocks in return for the guarantee and should judge whether the forgone potential is commensurate with the protection offered.

Common mistake

The guarantee is not free — its cost is the surrendered upside (an opportunity cost), and it is paid for regardless of how the stocks perform.

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