Hello all,

I trust everyone continues to fare well as we make our way through these crazy and unprecedented times in history. I refer you back to my last blog, which touched on many of the uses of life insurance covering both the use of the death benefit and the cash surrender value (CSV). In this blog, I will briefly review the types of life insurance and their application.

Firstly, the types of coverage: there is term insurance which is purely temporary insurance. Term coverage starts out at a relatively low rate and has the rates going up in a stepped fashion for a finite period of time. The steps could be one year (ART) which is rarely found as a stand-alone product, but more commonly as the COI type inside a permanent life plan, such as Universal Life (UL). There is also a ten-year term (10YRT) twenty-year term (20YRT) thirty-year term (30 YRT) and level term coverage for life (T100). Some carriers also offer a term product where the insured picks the length of time he/she wants the coverage to last for, for example, Term 23 or Term 19. Most term coverages are renewable and convertible (R&C) which means the coverage is guaranteed to extend at each renewal period, but at a higher rate than the period preceding. Renewals continue up until a specified time, such as age 80 when the coverage disappears. The convertibility feature means the term plan can be changed over to or “converted” to any of the permanent products the carrier offers. The convertibility feature also lasts for most of the insured’s life, but only for a time shorter than the expiry of the base term contract. Specifically, a term policy may have the feature of being convertible but only up to the insured’s age 70, but the base term plan will renew to age 80.

As stated above, term coverage starts out relatively inexpensively which makes it a great option for “starter” insurance or insurance where the coverage is only needed for a particular time period, like covering a mortgage or car loan. Many young people, especially in the family market, find the term an excellent option to provide greater levels of protection at a low cost while a new family is struggling to make ends meet or when a business is in its startup phase.

Now we turn to permanent coverage which includes Universal Life (UL) or Whole Life (WL), both participating and non-participating. A UL policy is a cost of insurance chassis connected to an investment body. The base insurance plan may be YRT to 100 or to age 90 or some other version thereof, such as Level Cost of Insurance payable for some specified length of time. The investment body is an investment vehicle that holds any premiums paid above the base insurance plan. The money in the investment portion of the UL policy grows on a tax-deferred basis, within limits set by CRA, and can be used to pay future premiums. The investment portfolio may grow to the point where the insured is not required to pay any future premiums, or the fund may keep growing such that it increases the death benefit. UL is very flexible as premiums can be stopped and started at any time within certain parameters and can be varied in size according to the insured’s wishes without proving insurability. While the flexibility of a UL plan is its strongest asset, it may also be its greatest weakness. If insufficient premiums are put into the policy, or the investment portfolio does not earn a sufficient rate of return, it may cause the policy to lapse.

WL policies fall into two basic groups, participating and non-participating. The non-par version has no flexibility in that the face amount of the policy is stated at the beginning of the policy and as long as the client meets his/her premium obligations the values of the fund do not vary from those stipulated in the contract. Participating policies “participate” in the performance of the carrier through dividends. I won’t go into too much detail here about how dividends impact a par policy but will just say that dividends can affect primarily the death benefit and the CSV of a par policy. Dividends are used almost like an investment return inside the policy. The stronger the dividend performance, the more positive the effect there is on the growth of the DB and the growth of the CSV. The dividend rate (DSIR) is set by the board of directors of the carrier once per year and is based on the company’s mortality experience, its return on the par fund, and its expense management.

Whole Life policies used to be referred to as “black boxes” because most of the internal working of the policy were not open to scrutiny by the public. The client paid their premiums and were expected to more or less take it on faith that the carrier was doing a proper job of managing the entire policy. With the advent of UL and its transparency, there has been increasing pressure for WL policies to follow suit and become more see-through. Now the insured can see what the actual charges will be, what the expenses associated with the policy are, what assets comprise the investment fund, and how it performs. In addition, many WL plans now allow for some additional deposits to maximize the tax sheltering room that we expect with UL. Unlike a UL policy, a WL policy, particularly a par policy, does not have all the flexibility of a UL policy. The owner of the policy is expected to make premium payments as outlined in the contract and missing payments may cause a reduction in the DB.

Both UL and WL policies are permanent policies and are therefore best suited to permanent needs. These needs include paying final expenses, creating a pool of capital for future generations, or making charitable gifts for the insured. In addition, the CSV of a permanent policy may be used for a few things, as well including providing collateral for leveraged loans, providing funds for business uses, or any other area where cash may be helpful. Due to the permanent nature of the product, it is more expensive than term coverage, but when compared to their long-term use, the added expense should be considered worthwhile in my opinion.

The above has been a very brief overview of insurance from somewhere about 30,000 feet, but hopefully has been beneficial. The final topic I suggested I would deal with is the calculation of the amount of insurance needed. I will save that for the next blog.

Take care, stay safe. 

Regards,

Ian Tod, B.A.(Econ), MBA, CFP, CLU
National Advanced Case Specialist
[email protected]