Life Insurance Module

Financial Impacts of Death

Agents should address the financial consequences of death when they assess the client's needs and explore the risk of death with a client such as loss of income, Debt repayment, Income taxes, estate creation, business impact, etc.

Different risks can be managed in different ways:

• Loss of Income
• Debt repayment
• Income Taxes
• Estate creation (Providing funds for education of the children, establishing legacies and charitable giving)
• Business Impact

Life Insurance death benefit proceeds can be used to help

• Minimize the financial impact of death on the surviving family
• Repay debt
• Pay tax liability and more

Risk management Strategies

Risk management is the choice or choices a person makes in regard to the risk

1. Risk Avoidance: Avoid the situation or circumstance that exposes them to risk. For example, not smoking avoids risks associated with smoking

2. Risk reduction: This strategy is used when risk cannot be entirely avoided. Wearing a seat belt reduces your risk of personal injury in a car accident

3. Risk retention: Strategy where the individual accepts some or all of the risk

4. Risk transfer: When some or all of the risk is transferred - that is, moved from one to another.

Essential understandings

A life insurance policy is a contract and an insurance contract may vary

Universal Insurance

Permanent Insurance

Term / Temporary Insurance

A term Life insurance is a contract that promises to pay a death benefit over a set period of time or to a specific age

A permanent provides coverage over the lifetime of the life insured and ends upon the death of the insured. It does not need to be renewed.

A permanent life insurance with tax advantaged investing. Policyholders do not pay premiums, they make deposits to the policy.

Expand - Term life insurance

• Term Insurances can be issued for 1,5,10,15,20 or 30 years (Depending on the company)
• Longer terms have higher premiums because the risk of death will increase over time
• Term insurance can be issued to a specified age - depending on the company

• Lives insured: Single life, Joint first to die (death benefit is paid out to the named beneficiary when the first person dies) and Joint last to die (Both life insureds must die before the death benefit is paid to a beneficiary)

• Death benefits: Level Term (Set death benefit), Decreasing term (death benefit that becomes smaller over the life of the policy) and Increasing term (benefit that grows over the length of the policy).

• Renewable vs Non renewable Term Insurance: Renewable term policy is set to renew, guaranteed regardless of the health of the life insured (limited to a certain age, Ex. 70), Non renewable is one that expires at the end of its term.
• Convertible Term insurance can be switched from a Term policy to a permanent life insurance policy without evidence of insurability.

Expand - Term Life Insurance

• Attained-age vs Original Age conversions - When a policy is converted, the permanent life premium may be based on:

1. Attained Age: the age of the life insured on his last, nearest or next birthday

2. Original Age: the age of the life insured when the policy was first issued

Example: Manuel bought a term life insurance policy on Aug 12 2018. His DOB is

Nov 1 1984. His premium will be based on:

Age 33, if attained age is based on his last birthday

Age 34, if " based on his nearest birthday

Age 34, "" "" next birthday. (Almost the same as nearest birthday)

*Rule of thumb*: [6 months prior or during]

Expand - Term Insurance

• Premiums - cost of the life insurance for the life insured named in the policy. Can be paid monthly, quarterly, semi-annually or annually by cheque or pre-authorized withdrawal.

• Premiums are determined by the mortality cost (risk factors; age, gender and health) of life, face amount ($50,000 life coverage vs $100,000 life coverage) of the policy and the administrative expenses (Paying commissions, marketing, salaries, applications, investigating claims, paying death benefits, etc.)

• Incontestability period - 2 years following issue date of the policy, the insurance company can void a policy if the information regarding the insured was incomplete, inaccurate or omitted. After 2 years, a policy can be voided if fraud has been committed by the policyholder.
• Suicide period - 2 years following the issue date of the original policy, if the insured commits suicide during the first 2 years, the insurance company can deny claims

Expand - Permanent Insurance

• Description - Premiums, death benefit and minimum cash surrender values for the policy are guaranteed as long as premiums are paid. Coverage is lifelong, does not expire and cannot be cancelled by the life insurance company.

• Policy reserves/account - Premiums collected by the insurance companies are used to cover the risk of death. The the policy is in its early years, the premium charged is higher than the amount needed to cover the risk of death. Excess premium creates a policy reserve which is then used to invest by the insurance company. In the later years, where the mortality cost (risk of death) is high, the premiums collected do not adequately cover the risk of the death. Therefore, the growth from the investment growth is used to offset the shortfall.

Expand - Permanent Insurance

• Premiums - calculated based on assumptions about mortality costs (Mortality rate and face amount), investment returns (Insurance companies invest the policy reserves to achieve positive investment returns which can then be used to offset higher mortality costs later in the life of the insurance contract. Stock market history has shown that investment returns in reality can differ greatly from projections) and expenses (Marketing, salaries and commissions, medical exams, paying death benefits, etc). These assumptions are projected over the life of the insurance contract.

• Premium options: Single premium (Paid once in a lump sum), Limited Payment (premium payment may be limited to a set number of years to a set age. At the end of the period the policy is then paid up)

Expand - Permanent Insurance

• Types of Permanent insurance: Whole life (provides coverage for the entire lifetime, premiums remain level, builds up cash surrender value (CSV)), T100 (Also called Term-100 which is a Term insurance but built to last for a lifetime, premiums lower than a Whole life and does not accumulate cash value) and Universal (Provides lifetime coverage, has 2 parts - insurance and savings component, premiums can be manipulated where excess goes into the savings component, death benefit with an option to increase, offers variety of investment options and accumulated savings are tax sheltered and form part for the death benefit)

• Whole Life: Guaranteed Whole Life (Guarantees the death benefit and a set premium) and Adjustable Whole Life (Death benefit and premiums are guaranteed for a certain period of time. At the end of the guarantee period, the insurance company will increase or decrease the premiums, the death benefit or both depending on the updated assumptions)

• Participating vs. Non-participating: Participating (offers the policyholder the option of receiving a share of the insurance company's surplus revenues in the form of dividend), Non participating (keep surplus revenues as retained earnings which increases the company's shareholder equity

• Dividend Payment Options for Participating Policies: Cash, Premium reduction, Accumulation, Paid up additions, Term insurance, Impact on death benefits and cash values. See Section 3.4

Expand - Permanent Life Insurance

• Non Forfeiture benefits: Advantages received by the policyholder that result from paying premiums and building a cash reserve. See section 3.5 These benefits are not forfeited when the policy is cancelled; Cash value, Policy Loans, Automatic premium Loan (APL), reduced paid up insurance and extended term insurance

• Cash surrender Value: A whole life policyholder can surrender his policy at any time. He will receive the cash surrender value of the policy from the insurance company.

• APL (automatic premium loan): it uses the cash value accumulated to make premium premium payments if the policyholder fails to make a scheduled payment.

• Surrender Charges: Usually levied against a policy's cash value to discourage the policyholder from cashing in the policy before the insurance company can recover the expenses incurred for issuing the policy. A fee is charged by the company to surrender the policy, deducted from the CSV before it is paid out. Surrender charges decrease over time and are eventually eliminated.

Expand - Universal Life Insurance

• Deposits go into an investment account, that account pays expenses and is the source of funds for investing
• UL is considered a highly flexible type of policy
• UL is also more complicated due to its insurance/investment nature

• Factors that determine premium for all life insurance: Mortality costs, Administrative expenses (of the insurance company), Investment income
• UL policies reveal how each of the three cost factors is calculated and applied to an individual policy thus providing transparency and unbundling since the factors are clearly separated from each other.

• Expand - Administrative expense: it's the costs of "Doing business" of the insurance company including marketing, commissions paid to agents, underwriting and issuing policies, paying claims, etc. These costs are deducted from the policyholder's investment account as a percentage of the annual deposit or as a flat monthly fee

• Premium tax: Provincial tax between 2%-4% is charged on all deposits into a UL policy. This premium tax reduces the amount deposited to the investment account, the remainder goes into the investment account.

Cont. Universal Life Insurance

• Mortality charges - these reflect the insurance company's cost of paying out the death benefits.
• Investment Income - details about the investments are detailed in the choices selection. Each will have their own management expenses that are taken into consideration when setting premiums. Their investment return's projection are also taken into consideration.

• Insufficient Account Value - if the account value cannot pay the mortality costs and policy expenses, the policy could lapse. This can be a result of minimum funding, withdrawals from the policy, few or no deposits to the account and low or negative investment returns.

Continuous Expand - Universal Life Insurance

• Expand: Investment income: The investment growth is tax-free, providing it is less than the limits set out in the Income Tax act. (Exemption Test Selection)

• Expand - Flexibility: Changes can be made to best suit evolving policyholder needs; the timing and amount of premiums, the face amount, the life or lives insured, etc.

• Expand - Face amount: The face amount or death benefit is specified when the policy is taken out. Changes to the face amount impact the cash value as the Mortality rate costs are directly linked to the face amount. Increased face amount lead to increased mortality charges. Decrease face amount leads to a decreased mortality charge.

Continuous Expand - Universal Life Insurance click to edit

• Expand - Life or lives insured: a universal life policy can be used to insure multiple lives, either on a joint life basis and/or riders depending on the company. The ability to substitute one life insured for another is also unique to UL (the substitute person must provide evidence of insurability.

• Cost of Insurance (COI): YRT (Yearly Renewable Term) and Level (LCOI). Cost of insurance under YRT is lower in the earlier years than the Level; the lower the cost under YRT means lower deduction from the investment account and more money remains in the investment account to allow investment growth. Therefore, a younger policyholder is well served during the early years of his policy by YRT costing because his mortality cost is low. In later years, mortality charges can be quite high and may erode the policy's cash value unless there are high investment returns to offset the higher costs. YRT is a good choice if the policyholder would qualify for low costs and wants more of his deposit to be invested in the early years of the policy.

Continuous Expand - Universal Life Insurance to edit

• Continuous - COI: with Level cost of insurance, mortality cost deductions are higher in the earlier years. This means that there are higher deductions from the investment account and less premium invested, which can result in lower investment account values. In later years, mortality cost deductions are lower with LCOI than YRT which will help preserve the policy's cash value. A switch from YRT to LCOI may be possible, the reverse is usually not permitted.

• Death benefit options: Level death benefit (comes in two forms; 1. regardless of the when the insured dies, death benefit is equal to the face amount, 2. death benefit equal to the policy's account value: face amount + investment account), Level death benefit plus cumulative premiums (Face amount + sum of all premiums paid), Indexed death benefit (face amount is indexed for inflation)

Continuous Expand - Universal Life Insurance to edit

• Expand - Exemption test: One of the main benefits of a UL policy is that it gives the policyholder a way to invest in a tax sheltered environment. A policy is tested annually to ensure it will be tax exempt (More information in ch 7). If it fails the test, or it appears that the policy will fail the test, the net premium may be reduced by the insurance company. If the maximum net premium is exceeded, the excess is deposited to a side fund which is taxable.

• Expand - Tax Deferral: Income earned in a UL policy is tax exempt as long as the income earned remains within the policy's investment account. Investment returns may be reinvested which leads to compound growth and an increase in account value.

• Premium offsets: Premiums are naturally offset by the investment income and the policyholder's deposits. Depending on the premium deposited and the investment returns earned, the investment account can grow to such size that it can be used to fund future mortality and expense deductions indefinitely. The policyholder can stop paying the premiums while maintaining his policy in force.

Continious Universal life Insurance

• Investment choices: Many different ypes of invesments are available. They include but are not restricted to the following: Daily Interest accounts, Guaranteed Investment account (GIA), Index Fund investments, Mutual Fund, and more.

• Non forfeiture options: Policy withdrawals, premium offset, policy loans, collateral for third party loans, Leveraging, distribution upon death

Riders that provide additional Benefits

The following riders increase the Death Benefit

Paid up additions (PUA) rider

Guaranteed Insurability Benefit (GIB)

Provides an option to increase coverage in the future without having to prove insurability

Pay an additional lump sum premium to purchase a small paid up permanent life insurance policy. No additional evidence of insurability is required and death benefit is increase with an increase csv

Accidental Death (AD) rider

Term Insurance

An accident increases the death benefit if death is a result of an accident

adds additional insurance coverage to an insurance policy for a limited period of time

Expand - Taxation of Dividends

Expand - taxation of Dividends

According to the Income Tax Act, Dividends are considered deemed disposition of an interest. Therefore, it is taxable.

Policy gain = (dividend - amount used to pay an eligible premium) - ACB

In most cases where premiums are used for internal transactions (Paid up Additions, Term insurance, or repaying a policy loan), proceeds of disposition will be zero and therefore no policy gain.

Recall: Premiums paid by policyholder increases ACB

Dividends paid out in cash reduces ACB

Expand - Taxation of Surrender

Expand - taxation of Surrender

A policyholder is said to fully surrender a life insurance policy when he cancels or terminates the policy. If a policyholder surrenders his policy, the proceeds of this disposition are equal to:

Policy Gain = CSV - loans (including interest)/unpaid premiums - ACB

CSV of $24,000, ACB of $10,000, Death benefit$200K

Policy gain = $24,000 - $10,000 = $14,000

If Marginal tax is 35%

Tax Payable = $14,000*35%

Tax payable of $4,900

Remaining CSV = $24,000 - $4,900

Remaining CSV = $19,100 after taxes

Taxation of Partial Surrender

Expand - taxation of Partial withdrawal

Partial surrender occurs when

• Coverage is reduced
• A withdrawal is made

Expand - Taxation of Loan

Expand - taxation of Loan

If the policyholder takes out a loan that is less than the adjusted cost basis (ACB), he will not have a policy gain, but the ACB will be reduced by the amount of the loan.

No Policy Gain if, Loan < ACB

Alicia took a loan $4,000, ACB $10,000

1) New ACB = Initial ACB - Loan

2) Policy Gain = Loan - New ACB

New ACB = Initial ACB - Loan = $10,000 - $4,000

New ACB = $6,000

Policy Gain = Loan - New ACB = $4,000 - $6,000

Policy Gain = ($2,000)

Policy Gain = $0; no policy gain

Expand - Taxation of Exempt vs. Non Exempt policies

Issues of Tax exemption only applies to Permanent Life Insurance policies

It is important for a policy to be tax exempt to remain a tax-free growth on investment income. Taxes will only apply upon disposition with policy gains.

A non exempt policy will be taxed annually on income earned.

Expand - taxation of Exempt Status

Adjusted Cost Basis (ACB)

It is the cost of a life insuance policy for tax purposes*** The life insurance company calculates the ACB and informs the policyholder of the ACB amount (usually done when a taxable disposition has occured).

The larger the ACB, the lower the tax because the policy gain is smaller.

Example:

Marie surrendered her whole life policy. Proceeds (of the disposition) were $50,000. The ACB was $40,000. The policy gain was $10,000 and Marie reported the $10,000 as income.

Last Acquired Date

There are 3 ways to calculate the ACB on the date the policy was "last acquired" - latest of the following dates

• When the policy was purchased
• When ownership was transferred
• When a change to coverage was made

Ex: Leon acquired a policy on his wife's life and named his son as a beneficiary in 1962. When Leon died in 2006, ownership of the policy was switched to Leon's contingent owner. Last acquired date of the policy was 2006.

Cont. Last acquired date

Last acquired date is important to determine a policy's exempt or non-exempt status

There are 3 Categories of policies

• G1, policies acquired before Dec 2 1982 (No ownership transfer nor modification)

• G2, policies acquired after Dec 1 1982 but before Jan 1 2017 or previously G1 but lost its status (because of transfer or modification)

• G3, policies issued after Dec 31 2016

Non Arm's length

Non arm's length

When an Arm's length transfer happens, proceeds of disposition are deemed equal to the CSV the Policyholder would have received if he had fully surrendered his policy. (Policy gain [If applicable] for the previous owner on transfer of onwership)

The person who acquires the policy, will receive the policy with an ACB equal to the CSV the previous holder would have recieved if he had fully surrendered the policy. (ACB = CSV when new owner recieves the ownership)

Arm's Length Party

Arm's length

The original holder will acquire a Policy gain:

Policy Gain = Proceeds - ACB

during a transfer of ownership towards an Arm's length party - Parties with no mutual relationship.

Taxes applicable on policy gain

Death of the Policy Holder

Death of the Policy holder

If the policy holder is not the insured and dies, there is a deemed disposition. Original policy holder's death is treated like an absolute assignment for tax purposes; there will be tax consequences on policy gain added on other tax payable due for the original holder.

Exception - Rollover to Spouse, Rollover to a child and Contingent Policy Holder.

*** Contingent holder also known as a successor holder; probate (tax) on policy gain is avoided by naming a contingent holder but any policy gain must still be reported on the tax return of the deceased.

Calculation of Deductions

Deductions

Hellen borrowed $200k from a bank. Collateral of her $500k UL policy, ACB $160k, CSV $250k. Annual premiums $12k and NCPI $3,200

1) % NCPI Deductible = Loan / Face amount

2) Deductible = % NCPI deductible * NCPI

%NCPI Deductible = Loan/Face amount = $200k/$500k

%NCPI Deductible = 40%

Deductible = %NCPI * NCPI = 40% * $3,200

Deductible = $1,280

Agent's Role

Agents collects information needed to assess the risk. The informations is supplemented by other sources consulted by the underwriter.

Agents ensures the application is complete and accurate, identity of the applicaint is as stated by comparing name, date of birth and apprearance against government ID and signatures are true by witnessing the signatures on the application.

Agent's role in helping the client complete the application is somtimes referred to as "Field underwriting"

Agent also personally delivers the policy to the policy holder. The agent continues the process by ensuring the medical, personal and financial status of the policy holder and life insured have not changed since the application.

The Application

The agent helps the applicant to complete the application. Spending time with the applicant may reveal aspects of the individual that are not apprent from the written form.

The applicant is the person who wants to buy the policy and who will be the future policy holder. When the applicant is not the life insured, the name of a contingent or successor owner should be emphasized.

The applicant must identify a specific person as the life insured. An applicant can be the same person as the life insured.

Beneficiary is the person who will recieve the benefits when the life insured dies. They are revocable unless specified.

Mistakes in the application

Mistakes may happen through misunderstanding or carelessness. A mistake can lead to the policy being voided during its first 2 years after the issue. If 2 years passed without discovering the mistake, the policy stands as being incontestable unless fraud has been committed.

Fraudulent misrepresentation happens when false information is provided intentionally to receive a policy with a higher death benefit or lower premium.

Smoking is one habit that applicants persistently lie about. If discovered the life insurance company may void the policy and refund the premiums and/or adjust premiums or the death benefit to reflect what is accurate given the smoking habit.

Underwriting by the Insurance company

Attending Physician's statement (APS) is requested by an underwriter and provided by the personal physician of the life insured. The insurance company contacts the physician and pays any fees for the statement.

The underwriter may also request a medical exam especially if a large amount of insurance coverage is being applied for or the insured is older. The exam may include a range of physical tests.

Medical Information Bureau (MIB) exchanges medical information about applicants between insurance companies. The MIB is a membership of insurance companies and most life insurance companies in Canada and US choose to belong to the MIB.

Motor Vehicle Record (MVR) provides details of the insured's driving history, poor driving and correlation to higher risk of death.

Cont. Underwriting by Insurance Company

Inspection report is completed by an independent contractor by a telephone interview or personal visit. It focuses on non-medical issues that need more details or investigation such as personal finances or dangerous hobbies.

Financial underwriting, just like medical underwriting, establishes financial health - that is the ability to pay premiums and the need for coverage.

Different underwriting criteria may apply to those who are not Canadian citizens - Permanent residents, awaiting permanent residency and international students. Read section 9.4.9

Delivery of the policy

The policy holder must accept the policy by signing and dating an acknowledgement provided by the insurance company. Client has 10 days to rescind their policy rights; insurance company has 2 years to rescind the policy during the contestability period.