Other Life Insurance Topics

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Other Life Insurance Topics
K. Hartviksen
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Life Insurance and Estate Planning

• Life insurance may also be a valuable tool in
  estate planning as it can
• build an instant estate
• create liquidity for an estate to fund taxes
  arising from death (capital gains on deemed
  dispositions) and administration costs (probate
  and legal fees) thereby avoiding liquidating
  assets to meet payment obligations.
• Facilitate transfer of an interest in a private
  business.

K. Hartviksen
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Life Insurance Businesses

• In a partnership or private corporation,
  management or even the business future can be
  disrupted by a partner or shareholder death.
• This disruption can be exacerbated when the
  deceased heirs inherit part ownership of the
  business.
• In such cases, it makes sense for partners and
  shareholders to take out insurance policies on
  each other. At the same time they enter into
  buy-sell agreements with each other. Upon death,
  insurance proceeds are used by those remaining to
  purchase the deceased interest in the business
  from the estate.

K. Hartviksen
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Types of Life Insurance

• Term
• Permanent

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Term Insurance

• Is like a wager. The insured pays the insurance
  company a premium. If the insured dies before
  the policy expires, the insurance company pays
  the beneficiary. If the insured is still alive
  when the policy ends, coverage ceases and the
  insurance company pays nothing.
• Term insurance policies are generally issued for
  one, five, ten, 15 or 20 years. Often they
  terminate at age 65.
• The biggest single advantage of term insurance is
  its price.

K. Hartviksen
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Term Insurance...

• Most term insurance policies include the right to
  convert to permanent insurance or to renew
  without having to prove insurability. Although
  the premium after conversion is always higher, it
  may be well justified if the life insured has
  suffered a medical impairment or taken up
  hazardous work. Insurance companies normally
  refuse to offer coverage when these conditions
  exist.
• To avoid automatic expiry of term insurance,
  renewable term insurance provides an option to
  extend coverage for a similar period. The
  premium for the second term will be higher
  because of the age of the insured.
• Yearly renewable term insurance can be renewed
  annually for a specified number of year, usually
  to a maximum age of 60 or 65.

K. Hartviksen
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Permanent Insurance

• Permanent insurance provides coverage for the
  whole of life with a level premium payment.
• During the early years, premiums are more than
  enough to cover the risk so the difference is
  invested to form policy reserves. These reserves
  subsidize what would otherwise be an inadequate
  premium in later years. This concept forms the
  basis for premium calculations for all permanent
  insurance contracts.
• If a policy owner terminate a permanent insurance
  contract, the company is released from future
  obligations and returns an equitable share of the
  accumulated policy reserve. This is known as the
  policys cash surrender value (CSV).
• The CSV is guaranteed and stated in the policy
  ususally for years three to 20 and for ages 60
  and 65.

K. Hartviksen
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Cash Surrender Value (CSV)

• Whole life policy reserves increase each year and
  at advanced ages (say 95 to 100) they generally
  equal the sum insured.
• Under some circumstances, the CSV is also
  creditor-protected when an insured files for
  personal bankruptcy. Generally the policy must
  have been in force for more than five years
  preceding the bankruptcy and the beneficiary must
  be a member of the insureds immediate family.
  In this case, the CSV is deemed to be held in
  trust for the benficiary.

K. Hartviksen
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Term vs. Permanent

• The main benefits of permanent insurance over
  temporary insurance are
• coverage is available until death whereas most
  term policies expire at age 65
• premium payments dont change whereas term policy
  premiums increase with each renewal
• in time the premium payments build up a
  creditor-protected cash surrender value and make
  a variety of ancillary benefit possible such as
• automatic premium loan - if the insured forgets
  or cannot pay the premium within the specified
  days grace period, APL charges unpaid premiums as
  a loan against the CSV so coverage can continue.

K. Hartviksen
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Term vs. Permanent ...

• in time the premium payments build up a
  creditor-protected cash surrender value and make
  a variety of ancillary benefit possible such as
• Extended term insurance - when a whole life
  policy holder dies, only the insured amount is
  paid, not the policy reserve. However, ETI
  allows the insured to increase coverage by using
  the reserve to purchase additional term
  insurance. The amount and policy term purchased
  is directly proportional to the policy reserve
  size.
• Paid-up Insurance if a policy owner is unwilling
  or unable to pay premiums, rather than cancelling
  the policy, coverage can be reduced to an amount
  equal to whatever the CSV can purchase as a
  single premium based on the insured age. Paid-up
  insurance also contains cash values which
  accumulate and are payable if the policy is
  surrendered before death.

K. Hartviksen
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Term vs. Permanent ...

• in time the premium payments build up a
  creditor-protected cash surrender value and make
  a variety of ancillary benefit possible such as
• Loan Values - Banks or the insurance company
  itself are willing generally to lend the policy
  owner up to 90 of the CSV.

K. Hartviksen
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Permanent Insurance ...

• May be issued as either participating or
  non-participating.
• Participating means the policy owner is entitled
  to a portion of the companys surplus earnings.
• Surplus earnings arise from primarily three
  sources
• actual operating expenses are lower than
  anticipated.
• Claims experience is lower than anticipated.
• Investment income is higher than required to
  maintain policy reserves.
• The surplus is distributed to policyowners as
  dividends.

K. Hartviksen
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Permanent Insurance ...

• The surplus distributed to policyowners is called
  dividends. Generally policy owners have up to
  six ways of receiving dividends
• cash - paid annually to policyowners
• accumulation - left with the insurance company to
  accumulate interest
• premium reduction - applied towards the next
  yearly premium
• paid-up additions - increased whole life
  insurance
• term additions - applied towards one-year term
  insurance
• investment fund - applied to purchase the
  companys segregated fund (similar to an equity
  mutual fund)

K. Hartviksen
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Permanent Insurance Riders

• For additional premiums, policy riders can be
  added such as
• Accidental Death Benefits sometimes called
  double indemnity, pays two times policy face
  value if death is caused by accident.
• Total Disability Waiver of Premium premium
  payments are waived if the insured becomes
  totally disabled by sickness or accident prior to
  a predetermined age (usually 60) and remains so
  disabled for three to six consecutive months.
• Total Disability Monthly Income (TDMI) in
  addition to waiving premiums, some policies also
  pay disabled policy owners a monthly income,
  generally equal to 10 per month for each 1,000
  insured.

K. Hartviksen
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New Money Policies

• Also known as interest-rate sensitive policies
• premium rates are based on assumptions
  (estimates) of future claims, operating expenses
  and investment earnings.
• Since premiums and benefits for traditional whole
  life policies are guaranteed throughout the
  contract term, investment earnings estimates are
  conservative.
• In the late 1970s and early 1980s, interest rates
  rose to unprecedented levels. For competitive
  reasons, insurers began offering policies based
  on their new (higher return) investmentshence,
  the origin of the term new money.
• New money or adjustable policies usually
  guarantee premiums and death benefits for a
  specified time (eg. Five years) and re-adjust
  premiums and/or death benefits at the end of the
  period. Premiums may be increased or decreased
  depending on the insurance companys investment
  income.

K. Hartviksen
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New Money Policies ...

• In contrast with whole life policies that have
  level premiums, new money policies have premiums
  that vary inversely with interest rates
• when interest rates are high, premiums decline
• when interest rates fall, premiums increase.
• The only feature not guaranteed is policy
  dividends in a participating policy.

K. Hartviksen
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Universal Life

• Is the most popular and flexible
  interest-sensitive policy.
• It consists of two parts term life insurance
  and an investment account.
• With each premium, a portion is used to cover
  administrative expenses and the mortality factor
  (ie. To purchase term insurance). The balance is
  credited to an investment account.
• The investment account is the source of the
  policys flexibility.

K. Hartviksen
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Universal Life ...

• A unique universal life feature is it contains a
  tax sheltering component.
• Life insurance proceeds payable upon death are
  tax exempt
• within limits investment income in a universal
  policy is tax sheltered.
• Policy owners decide what to do with each of the
  policys two parts. If the investment account is
  interest bearing, a portion of the interest
  income is not subject to income tax.
• Typically the interest investment is either
  similar to a savings account or is tied to a
  benchmark such as 95 of the TSE 300 Index
  appreciation.

K. Hartviksen
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Variable Life

• Variable life policies are the insurance
  industrys equivalent of mutual funds, but with
  one exception at death or maturity they
  guarantee at least a 75 return of the amount
  paid in. This proviso exempts then from being
  subject to provincial securities acts.
• Variable contracts come with or without life
  insurance. They can be purchased with regular,
  single or intermittent premiums and generally
  have the same contract provisions as regular life
  insurance policies.
• As with many mutual funds, sales charges can be
  front-end or back-end loaded and a fee is charged
  for managing the fund. An insurers investment
  fund supporting variable contracts is segregated
  from all other funds.

K. Hartviksen
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Variable Life ...

• Every variable contract contains two main
  elements
• an insurance element as either life insurance or
  an annuity, and
• a reserve which varies in value depending on
  segregated fund performance (the equity element).
• As with mutual funds, any interest, dividends or
  capital gains realized by the segregated fund are
  taxed in the policyowners hands as the insurance
  company issues T-5 receipts.

K. Hartviksen
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The Insurance Contract
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The Insurance Contract

• The Application
• determining and pricing risk under a life
  insurance policy begins with an application.
• The application, policy and any document attached
  to the policy collectively form the insurance
  contract.
• It is imperative the insured provide accurate and
  complete personal informationfailure to do so
  may invalidate a policy.
• If a fact has been omitted or innocently
  misrepresented on the application, the insurance
  company should be informed immediately so any
  necessary adjustments can be made.
• By law, a life insurance policy, is incontestible
  after two years. After that time, a company
  cannot deny a claim except in the case of fraud
  or if the life insureds age was misstated. An
  example of fraud is a smoker who declares himself
  a non-smoker in order to get a reduced premium.

K. Hartviksen
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The Insurance Contract ...

• Recission Right is the lawful right of the
  insurance buyer to have 10 days to examine a
  policy and if not satisfied, return it and
  receive full premium refund. The buyer is not
  required to give any reason for doing so.
• The law also requires at least a 30 day grace
  period be provided for each premium payment other
  than the initial payment. Except for group
  insurance, any person to whom the policy is
  assigned or a beneficiary or a person acting on
  behalf of one of them or the insured may pay the
  premium.

K. Hartviksen
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Insurance Contract Reinstatement

• The law provides the right to apply for
  reinstatement (or revival) within two years of a
  policy lapsing.
• Such reinstatement is subject to a payment of
  overdue premiums, any unpaid loans plus interest
  and production of satisfactory insurability
  evidence.

K. Hartviksen
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Beneficiaries

• An insurance applicant designates a beneficiary
  which can be changed at any time unless
  designated irrevocable, in which case the
  beneficiary must consent to any change.
• The policyowner can also designate his or her
  estate as beneficiary.
• Beneficiaries may therefore be
• irrevocable
• revocable
• insured or estate of the insured

K. Hartviksen
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Beneficiaries...

• If the insured designates the beneficiary as
  irrevocable, the insurance money is not subject
  to control of the insured or the insureds
  creditors as it does not form part of the estate
  for probate purposes.
• The law also provides creditor protection where
  the beneficiary is not irrevocable but is a
  spouse, child, grandparent or parent. This
  special protection includes adopted children in
  most provinces but does not include ex-spouses
  unless he or she was named an irrevocable
  beneficiary.

K. Hartviksen
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Revocable Beneficiaries

• If the policy names a revocable beneficiary and
  is not one of the special class indicated prior,
  the policy has no creditor protection while it is
  in force. (ie. Creditors can attack the policy
  cash surrender value). However, when insurance
  money becomes payable, it becomes the
  beneficiarys asset and thus is not subject to
  the insureds creditors.

K. Hartviksen
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Settlement Options

• Typically, when an insured dies, beneficiaries
  have four settlement options
• lump sum payment (all proceeds received tax free)
• interest option (the proceeds remain in trust and
  the insurance company pays cash interest on a
  monthly or periodic basis)
• installment option (the company pays out proceeds
  together with interest over a pre-selected period
  of years.)
• life annuity option (this provides an income that
  cannot be outlived)
• settlement options may be pre-selected by the
  insured or elected by the beneficiary when life
  of the insured ends.

K. Hartviksen
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Term to 100

• Temporary insurance that lasts to age 100 sounds
  like an oxymoron term to 100 insurance is often
  categorized as permanent insurance.
• These policies provide the type of permanence
  normally associated with whole life policies.
  However, they typically do not pay dividends or
  include cash surrender values and thus are not
  subject to income taxation.
• Although these policies are more expensive than
  term policies for shorter periods, premiums are
  lower than traditional whole life products.

K. Hartviksen
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Taxes and Insurance

• In the absence of taxes, term insurance is the
  clear choice for consumers seeking life insurance
  for the purpose of protection (as a hedge)
• Permanent life insurance can be useful in the
  presence of taxes
• Used to pay taxes upon death of the insurance
  when the deemed disposition at fair market value
  rules come into effect. (ie. in the case of
  vacation properties, valuable antiques for a
  small family business)
• Savings sitting in whole life, universal life
  policies grow behind a tax shield. When the
  insured dies, the beneficiary receives the
  proceeds of the policy tax-free.
• In addition, you can borrow the using the cash
  surrender value (CSV) of the policy, and any
  money you borrow does not create a tax liability.

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Tax Arbitrage

• Is the science of taking investment positions
  that capitalize on quirks or inefficiencies in
  the income tax code.
• It is both widely practiced and legal

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Helpful Links

• http//www.desjardinsfinancialsecurity.com/vna/con
  tent/introduction/introSectD.aspCalculators
• http//www.iafp.ca/publicsite/aboutiafp/IAFP_Pract
  ice_Standards_Oct_2003.pdf

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Summary Lessons to be Learned

• Any insurance is a lousy investment.
• Probability and magnitude of the hazard are the
  two most important factors in pricing and
  analyzing insurance needs.
• Three reasons why insurance markets may break
  down and prevent you from getting the coverage
  you need at a reasonable price are
• Small numbers
• Moral hazard
• Adverse Selection
• Reduce insurance with age.
• Insurance to cover future tax liabilities only
  makes sense under limited conditions, otherwise
  they are simply tax prepayment plans.
• Life insurance may be more powerful than an RRSP
  for generating tax-favoured wealth.
• If buying insurance for tax reasons be very
  thorough in the analysis to ensure tax benefits
  exceed fees and commissions.