Risk Management- Life Insurance

by Geoff Sgarbossa, CD,CFP,RIS, Financial Planner

Going back through history, when misfortune struck a family, it was common for others in the community to collectively aid in an effort to manage through crisis. Through time, it became evident that the degree of risk could be estimated, it was possible to share the risk of economic loss. Starting in the 1500's, experts have continued to collect and analyze data to develop more effective tables of mortality. This has allowed insurance carriers to enhance their long-term financial stability, which is essential for ongoing solvency to ensure money will be available when it comes time for your survivors to put in a claim.

As discussed in Risk Management- A 5 Step Process, the purchase of an insurance policy is a Risk Financing strategy that results in the transfer of risk from the individual to an insurance carrier. However, finding the right coverage for your needs can be a daunting task! There is a wide variety of insurance products available in the marketplace, each focused on different needs. However, they can ultimately be categorized by the period for which the insurance product is designed.

• Temporary needs are those that have a definable end date. Mortgage paid off, Children done School.

• Permanent needs tend to be constant, regardless of when death happens. Funeral and burial expenses would be a good example of a permanent need.

Term Life Insurance provides temporary life insurance coverage for a  specified period and will have a very clear end date. While there are a variety of term policy types on the market, they will all offer similar features and carry similar limitations.

• Term Length- Most common term lengths come in the 10- year, 20-year, or 30-year range, but there are many custom term lengths available.

• Policy expiration- Carriers normally set a maximum age with regards to the life insured, after which the term policy completely terminates with no further eligibility for renewal. Term policies generally expire in the 75-to-85-year range.

• Renewable- A renewable policy will allow you to renew for another term without proof of insurability, but premiums are increased based on new attained age when renewed.

• Convertible- The insured is given the opportunity to convert term to permanent, without the need to provide evidence of insurability, but premiums are increased based on new attained age.

• Planning considerations- Focus on the goal, not the initial premium rate. Matching the term length to the need, will minimize the number of renewals needed, and ultimately save you money over the lifetime of the plan. A 10-year term policy will start at a lower premium rate, but cost you more over a 20-year period, than a single 20-year term with no renewals would have. It is also important to understand the maximum age to which a term insurance policy provides coverage. Term insurance is a cost-effective, no frills option to provide coverage until the need is gone, or you build your wealth to a point where you are self-insuring.

  
  

Permanent life insurance is designed to provide coverage until death, no matter what happens. Insurance coverage continues until death, and it also adds an additional investment component to the policy. The main reason for the investment component is it allows you to pay more now so at a certain point in time, the investments can start to pay the ongoing insurance premiums. A common strategy is to load investments up early on, so the investments can start to pay insurance premiums later - typically in retirement. There are 3 main types of permanent life insurance available in Canada:

• Whole life insurance is the least complex option that generally provides the least number of surprises and meets the needs of most consumers seeking permanent insurance coverage. The face amount of the insurance policy and the premium amounts are set up at the time that the policy is bought and remain fixed throughout. The premium payment period can be varied according to the insured's needs.

• Universal life insurance, commonly referred to as UL, is a much more complex solution that separates all components of the policy to be managed separately. It requires much more active oversight but provides more flexibility for consumers with features such as payment flexibility, but it also provides a higher level of risk. If investments do not perform as well as planned, there may not be enough to cover ongoing insurance premiums later in life. It is important that you review this policy regularly like you would any other investment portfolio.

• T-100 Insurance is a relatively new type of coverage available. It is a hybrid between term and permanent insurance. It is a no-frills, pure insurance with no investment component like other term policies, but unlike term insurance it provides coverage to 100+ years of age. The premium payment period can be varied in some cases according to the insured's needs.

• Planning Considerations. The investments are primarily designed for ensuring continuing insurance coverage until you die. Pulling money from the policy early may cause it to run out of money, causing the policy to lapse unless you start paying the premiums again. Permanent insurance can provide additional tax advantages and investment growth when other registered options are maxed out, but it should not replace other wealth accumulation tools such as a RESP, or a TFSA.

Now that we have basic a understanding of the several types of life insurances available in Canada, we can address common planning considerations.

Keep it simple- Insurance is for risk financing, investments are for wealth accumulation, and banks are for banking.

• There are all sorts of enticing insurance sales tactics, recommending you use permanent insurance cash values to fund ongoing cash flow needs, post-secondary costs and a variety of other things typically associated with investing and banking activities. These strategies are available and do make sense for specific situations, but they can also add unneeded complexity to the plan. Quite often the simplest solution is the best solution.

No medical insurance- No medical does not mean no medical questions.

• Insurance companies have been increasing the coverage available without need for medicals in recent years. Medical will typically require fluids to be drawn and tested. No medical means no medical tests needed, and they trust you tell the truth when you complete the medical questionnaire.

Post claim underwriting means that eligibility for coverage is not being assessed until after a claim is made.

• A golden rule of insurance is the more questions they ask at time of application, the less they will ask at time of claim. The opposite is also true, so always question the claims process, especially if there were only a couple of questions at the time of application. People are looking for efficiency and convenience so they will be interested in purchasing a policy with only a couple of questions upfront. Not all simplified policies are post-claim underwritten, but make sure you determine when underwriting is being completed so there are no surprises when it comes time for your survivor(s) to make a claim.

  
  

Deferred coverage is also a possibility for folks with declining health. Deferred coverage will offer you a policy and start collecting premiums now, but you need to survive for a specific period before a death benefit can be claimed. If the insured dies before this period is complete, the premiums are returned with not further claims possible. It is important that you understand when coverage starts and stops and plan accordingly.

Medical information bureau (MIB) is like a credit bureau, but for the insurance industry.

• If you have a policy application rated or rejected, this gets reported to the MIB. If you then go apply with another company thinking you can “forget to mention” the illness, they will see the initial rejection due to illness on the MIB report. It’s always best to be upfront and honest because fraud is still a prosecutable offence.

Act of war- Act of war clauses are still quite common in living benefit policies discussed in a separate paper, but they have not been common in life insurance for some time.

• Act of war clauses have been removed from most life insurance policies over the last few years so military folks are eligible for a wide range of competitive options. However, if you are military or first responder, it is best to work with an experienced insurance advisor who understands the life. Insurance applications require you to be completely honest. However, this is not the time to pull out the helmet and make your job sound like the next Hollywood blockbuster. While common, it is still important to ensure you understand any exclusions since Act of War clauses do still exist in some polices.

Group vs. individually owned - Life insurance is commonly provided for in many employer group benefit packages. Group coverage can be a cost-effective solution, but also comes with risks. The employer typically owns the group policy and has full control and can change the terms or cancel without your permission. People are generally not staying with one employer anymore, so you may find gaps in coverage as you move from one job to another. You may need to complete a new waiting period before eligible for the new employer's plan, or that new employer may not offer benefits at all. You can own an individually owned policy, so you have full control, and it is not tied to employment.

Broker vs. Captive agent- Finding who to trust can be a daunting task. The insurance industry is well known for its aggressive sales tactics and questionable claims handling. Robo sites are popping up online, companies have their own captive sales forces and there is an independent channel all vying for your business. Insurance is one of the areas you should take the time and do your due diligence. It is recommended you use an independent broker who understands your lifestyle. Many companies offering a range of solutions for an even wider array of health profiles and lifestyles makes it difficult to know where to start. The broker will have access to most of the companies in Canada and can shop around for best rates or even do hypothetical applications for folks with less than perfect health so you apply at the right company the first time. This helps to avoid a list of rejections or denials being reported to the MIB which is more probable if going to a captive agent of the wrong company. Additionally, an insurance policy is a legal contract so having someone available to help you understand the fine print will always be a a good idea no matter how seemingly simple it may seem.

Insurance is an evolving industry with product and regulation changes being made daily it seems. While nobody ever wants to pay for insurance, survivors are grateful that you did when it comes time to make a claim. However, it is a risk financing tool and should be treated as such. Life insurance is an important part of many financial plans and can have a bigger part to play in more complex planning strategies. However, like mentioned above, the simplest solution is often best. Call our office today to see if life insurance would be a valuable addition to your financial plan.

Disclaimer and Notice to Reader: This Discussion Paper should not be construed as financial, legal or tax advice but rather only as a general statement and explanation of the topic matter. Professional financial, tax and legal advice should be obtained for the readers’ own personal situation. For more information on this topic or how it applies to your family, please contact our Wealth Advisory Team.