Fundamentals of Canadian Life Insurance
Fundamentals of Canadian Life Insurance
163 Life Insurance Terms in
THE ESSENTIAL REFERENCE OF LIFE INSURANCE TERMS IN PLAIN ENGLISH Fundamentals of Canadian Life Insurance
Fundamentals of Canadian Life Insurance
The Essential Reference of Life Insurance Terms in Plain English
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Fundamentals of Canadian Life Insurance
Copyright 2012 The Financial Literacy Company
All rights reserved. Any reproduction of parts or all of this book and its contents by any means electronic or mechanical is prohibited.
The Fundamentals of Canadian Life Insurance is a collection of terms common to the Canadian life insurance industry and relevant to all those who work in the financial services industry or in association with life insurers. The definitions of the terms are “pure,” that is, they do not reflect the practices or policies of any insurance company. Thus, there may be some minor discrepancies between these definitions and how an insurer uses this terminology or interprets and applies these terms.
The information in this book is provided for educational purposes only; it should not be construed or interpreted as providing advice. Agents and advisors should always seek guidance from their principals and compliance experts in regards to informing themselves and others about details of the products they sell and other considerations of their business.
We welcome all feedback and suggestions for additions to the book. Please send your comments to [email protected].
ISBN: 0-9879002-0-5 CLIFE INC. 1595 Sixteenth Avenue Suite 301 Richmond Hill, ON L4B 3N9 www.clifece.ca
The Fundamentals of Canadian Life Insurance is also available for continuing education credits for life agents and accident and sickness agents. Please see the website for details or email [email protected].
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Fundamentals of Canadian Life Insurance
Fundamentals of Canadian Life Insurance
Table of Contents
Accident and Sickness 6 Ethics 47 Accidental Death Benefit/Accidental Exclusions 48 Death and Dismemberment Insurance 6 Adjusted Cost Basis 7 Face Page 49 Annuities 8 Fiduciary Duty 50 Application 9 Fixed-income Investments 50 ASO Plans 10 Fraud 51 Assignment 11 Assuris 12 Grace Period 52 Authority 13 Grandfathered Policies 53 Automatic Premium Loan 14 Group Disability Insurance 54 Group Health Insurance 55 Beneficiary 14 Group Insurance 55 Business Disability Insurance 15 Group Life Insurance 56 Business Life Insurance 16 Guaranteed Minimum Withdrawal Benefit Business Overhead 17 Plans 57 Guarantees 58 Canada Deposit Insurance Corporation 18 Canada Pension Plan 19 Holding Out 59 Canada Life and Health Insurance Association Income Splitting 60 20 Income Tax 61 Capital Gains 21 Incontestability 61 Cash Surrender Value 22 Index-linked Annuity 62 Certified Financial Planner 23 Inflation 62 Chartered Life Underwriter 23 Information Folder 63 Churning and Twisting 23 Insurable Interest 64 Claims 24 Insured 65 Co-insurance 25 Insured Annuity 66 Compliance 26 Interest 66 Conflict of Interest 27 Irrevocable Beneficiary 67 Continuing Expenses 27 Joint and Last Survivor Annuity 68 Contract 28 Co-ordination of Benefits 29 Last Expenses 69 Corporation 29 Law of Agency 70 Cost Illustrations 30 Leveraging 70 Creditor Protection 31 Life Annuities 71 Criminal Law 32 Life Income Funds 72 Critical Illness Insurance 33 Locked-in Plans 73 LLQP 74 Death Benefit 34 Locked-in Retirement Accounts 75 Death Benefit Guarantee 35 Long-term Care Insurance 76 Deductible 36 Long-term Disability 77 Defined Benefit Plan 37 Defined Contribution Plan 38 Marginal Tax Rate 78 Definitions of Disability 39 Maturity Guarantee 79 Deposit-based Guarantee 40 Maximum Tax Actuarial Reserve 80 Disability Income Insurance 41 Misrepresentation 81 Disclosure 42 Mistake 81 Disposition 42 Money Laundering 82 Morbidity 82 Earned Income 43 Mortality 83 Effective Date 44 Mortgage Insurance 84 Equity 44 Mutual Funds 84 Errors and Omissions Insurance 45 Estate 46 Needs-based Sales Approach 86
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Net Cost of Pure Insurance 86 Residual and Partial Disability Benefits 113 Non-forfeiture Options 87 Riders 114 Notional Units 88 Risk Tolerance 115 Rule of 72 116 Occupational Classification 89 Offset 90 Sales Charge 117 Old Age Security 90 Segregated Funds 118 Self-directed RRSP 119 Participating Whole Life Insurance 91 Settlement Options 120 Permanent Life Insurance 92 Short-term Disability 120 Personal Contract 93 Sole Proprietorship 121 Policy-based Guarantee 94 Spousal Plan 122 Policy Dividends 95 Spousal Rollover 122 Policy Loan 95 Stocks 123 Pooled Registered Pension Plans 96 Subrogation 124 Pre-existing Condition 97 Suicide Exclusion Clause 124 Premium 98 Prescribed Annuity 99 Tax-free Savings Account 125 Prescribed Retirement Income Funds 99 Taxation of Life Insurance 126 Present Value of Money 100 Temporary Insurance Agreement 127 Privacy and Confidentiality 101 Term Annuity 127 Probate 102 Term Life Insurance 128 Term-to-100 Life Insurance 129 Rated Contract 102 Time Horizon 130 Recurring Disability 103 Time Value of Money 130 Registered Disability Savings Plan 103 Trusts 131 Registered Education Savings Plan 104 Registered Pension Plans 105 Unbundling 132 Registered Plans 106 Underwriting 132 Registered Retirement Income Funds 106 Unfair Trade Practices 133 Registered Retirement Savings Plans 107 Uniform Life Insurance Act 134 Reinstatement 108 Universal Life Insurance 134 Reinsurance 109 Renewable Term Life Insurance 110 Waiver of Premium Rider 135 Replacement 110 Whole Life Insurance 136 Rescission 112 Reset 112 Yield to Maturity 137
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Accident and Sickness Insurance (A&S) Accident and sickness insurance is a broad category of insurance also known as health insurance.
A&S is available for both personal use and for groups.
All Canadians enjoy basic health insurance from their provincial health plans. A&S policies step in to provide: - Extended health care. Pays for semi-private or private hospital rooms, prescription drugs, medical appliances (such as a knee brace), and other services. - Travel assistance. Pays the cost of health care needed outside Canada above the amount provincial plans cover. Will also cover costs such as those incurred by a traveling companion, and the return of a body to Canada. - Prescription drugs. - Dental services. - Accidental Death and Dismemberment. - Critical Illness Insurance. Pays a lump sum when the insured is diagnosed with a critical illness covered by the policy and remains alive 30 days after diagnosis. - Long-term Care Insurance. Pays for care of those who are no longer able to care for themselves.
Advisor Resource: CLHIA guideline on travel insurance: http://www.clhia.ca/domino/html/clhia/CLHIA_LP4W_LND_Webstation.nsf/resources/Guidelines/$fi le/Guideline_G5.pdf
Related Terms: Group Health Insurance. Critical Illness Insurance. Long-term Care Insurance.
Accidental Death Benefit (ADB) Accidental Death and Dismemberment Insurance (AD+D) The accidental death benefit is a rider for life insurance policies that increases the death benefit paid to the beneficiary if the life insured dies because of an accident. The types of accidents that are covered are described in the policy, and death must occur within 365 days.
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When the accidental death benefit rider provides an additional sum when there is a loss of a body part (eye, arm, leg, etc.), it is called an accidental death and dismemberment (AD&D) rider. This rider is available on both personal policies and group policies.
Accidental death and dismemberment (AD&D) is also available as a form of accident and sickness insurance. It is a policy (not a rider) when it is offered this way.
Accidental death and dismemberment (AD&D) provides a death benefit to a beneficiary if the insured dies, or a benefit to the insured if dismemberment occurs. If the insured suffers from more than one dismemberment (for example, both legs) a greater sum is paid than for a single dismemberment (one leg).
Advisor Remarks: 1. A schedule accompanies the (AD&D) policy and rider that specifies the amount paid per loss (such as loss of leg). 2. The key word in these policies is accident. Death must be the result of an accident for the benefit to be paid.
Adjusted Cost Basis Adjusted cost basis (ACB) is a dollar amount that represents the net cost of the life insurance policy to the policy owner. It is made up of the gross cost of the policy (in other words, how much has been paid --- mostly, premiums) plus or minus other contributions that add to, or are subtracted from, that value.
ACB increases by costs incurred by policy owner and decreases by benefits received by the policy owner. ACB is used to determine the taxable gain on a policy loan and the taxable portion of a withdrawal.
Costs that increase the ACB include: - Premiums. - A policy loan repayment.
The ACB is decreased by: - Life insurance coverage, called the net cost of pure insurance (NCPI). - Dividends. - A policy loan.
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- A withdrawal.
The ACB calculation for a “plain vanilla” policy is: ACB = premiums – NCPI The ACB calculation for a par whole life policy with a policy loan is: ACB = premiums – NCPI – dividends – policy loan
When a life insured dies, the policy beneficiary receives the death benefit of the policy. The death benefit is not affected by the ACB.
Advisor Remarks: 1. As of Dec. 2, 1982, the method for calculating the ACB changed. Policies issued prior to this date are called grandfathered. These policies have preferential tax treatment compared to those issued after that date. 2. ACB is a difficult concept. It is best thought of as how much the person is “out of pocket” in terms of expense for the product. 3. For non-insurance purposes, the ACB is the adjusted cost base. Only in insurance is “basis” used.
Related Terms: Net Cost of Pure Insurance. Grandfathered Policies.
Annuities An annuity is an investment contract, usually made with a life insurance company. A single lump- sum deposit or a series of deposits funds the annuity. The deposits are called the capital.
The capital grows due to the interest provided by the insurer, for instance at 3%. This means 3% interest is applied to the capital. The interest rate is fixed.
Annuities are a guaranteed investment because the contract owner is guaranteed to receive his capital plus interest. The exception to this is if the contract owner has chosen to deposit his capital into a variable annuity. Instead of receiving a guaranteed interest rate, he will receive annuity payments based on performance of the stock market. The amount of benefit from a variable annuity is not guaranteed.
Annuities pay a regular income, called the annuity benefit to the contract owner, who is called the annuitant. The contract owner can choose to receive the benefit monthly, quarterly, semi- annually, or annually.
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If an annuity is funded with a single deposit, the annuitant can begin to receive a benefit on the first annuity period he has selected. This is called an immediate annuity.
Alternatively, if a series of deposits are made to the contract, the benefit will begin at a date in the future. An annuitant may also choose to make a single deposit but begin to receive benefits at a future date. This is called a deferred annuity.
Annuities are available for a specified term, such as 10 years or to age 80, or for life.
Advisor Remarks: 1. The annuity benefit paid to the annuitant is determined by a number of factors. They include the rates offered by the insurer (there are differences between companies), the total amount of capital, how often the benefit is paid, and the age, gender and health of the annuitant. 2. All provinces define annuities as a form of life insurance. This gives them creditor protection. 3. Annuity benefits are paid monthly, every three months (quarterly), twice a year (semi-annually) or annually. The contract owner makes this decision on the application. 4. Withdrawals or surrender of the annuity contract is to be avoided since the annuitant will be financially penalized.
Related Terms: Life Annuities. Term Annuity. Prescribed Annuity.
Application After the life insurance agent has presented insurance options to the client, and calculated the correct amount of insurance required in a fact-finding interview, the client may then proceed to apply for the insurance policy.
Completing the application form correctly is a key job for the agent because its details, together with other information, form the basis for underwriting the policy. - The concept of constructive notice applies to the agent during the application process. This means the insurance agent must disclose all information about the proposed policy owner and proposed life insured to the insurance company. - A power of attorney may complete an application for a physically or mentally disabled person. (A power of attorney is appointed in a legal document as a person who assumes decisions for another.)
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- After the application is completed, it must be reviewed with the proposed insureds, and signed by the proposed policy owner and agent. The agent must not sign on behalf of the client; this is forgery. - If the agent believes that the standard premium rate will apply, he or she will ask for a cheque in the amount of the first premium to accompany the application. - The agent must promptly deliver the application to the insurance company, and be prepared to acquire more information if requested by the underwriters. - All details of an application are highly confidential and must never be shared with another person without the consent of the proposed insureds. - When the application is approved, the policy is issued. - The application together with the policy forms the entire contract between the policy owner and the life insurance company.
Advisor Remarks: 1. The policy owner provides information about his or her income and finances on the application to prove that premiums can be paid. 2. The underwriting of the policy determines premiums. This will include medical information from the Medical Insurance Bureau (MIB). 3. If the agent thinks that the life insured presents a higher risk than is covered by the standard premium, the agent should not ask for payment to accompany the application. 4. The agent may be required to complete an Inspection Report, Drug and Alcohol Questionnaire, or Hazardous Sports and Occupations Questionnaire to go along with the application.
Related Terms: Cost Illustrations. Underwriting. Contract. Temporary Insurance Agreement.
ASO Plans (Administrative Services Only) When a company has group insurance, the company either pays a premium to the insurer and the insurer pays the claims made by company plan members, or the company pays the claims.
A company that chooses to pay claims itself is called self-insured. Such a company will often take out an administrative services only (ASO) contract so that it does not have responsibility for administration of the contract.
ASO sees the company pay an administration fee to an insurer or third-party provider. The group members do not experience any difference in coverage. An ASO contract can save a company
10 Fundamentals of Canadian Life Insurance considerable expense because the company is paying actual claims instead of a premium charged (and that must be paid) whether there are claims or not.
The company limits its risk in terms of how much it will pay for claims by taking stop-loss insurance. The stop-loss insurance is used if a claim exceeds an agreed-upon limit that would arise from a catastrophic event. This is specific stop-loss insurance. If the insurance pays once a general threshold is reached for claims, it is called aggregate stop-loss insurance.
Advisor Remarks: 1. The alternative to a self-insured plan is a fully-insured plan. 2. In a fully-insured plan, the company pays the premium to the insurer. Such a plan may be structured on a refund or non-refund basis. 3. A fully-insured plan that provides a refund, if premiums exceed claims plus expenses, is called a retrospective rating arrangement or refund accounting method of funding. 4. A fully-insured plan that does not provide a refund is called a retention method of funding.
Related Term: Group Insurance.
Assignment When a life insurance policy is assigned, it is turned over to another person, company, or organization. In effect, ownership changes hands and the original policy owner loses his or her rights to the benefits of the policy.
- An absolute assignment sees a policy switched from its owner to another owner. It could be used if a business held a key person life insurance policy on a senior executive in which the business was named as the beneficiary, and that executive leaves the company. Part of a compensation package could include transfer of the policy so that the executive assumes the obligation for premium payments but is able to name a beneficiary for the life insurance coverage. This is a permanent change.
- A collateral assignment sees a policy switched from its owner to a financial institution. This would occur if a person was taking a loan for business purposes. Collateral (or security) for taking the loan is provided to the lender by the policy. If the borrower dies with the loan unpaid, the death benefit of the policy goes first to the lender and the balance to the beneficiary of the policy owner. The collateral assignment could be terminated when the loan is repaid.
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- A charitable assignment sees a policy switched from its owner to a charitable organization. When the charity becomes the beneficiary, the policy owner receives the tax benefit that applies to a charitable gift. If a policy owner assigns the policy and continues to pay premiums, each premium is a charitable gift for the year and receives a non-refundable tax credit.
Advisor Remarks: 1. Some or all of the premiums paid for a life insurance policy used as collateral may be an allowable tax deduction. 2. Tax specialists should be consulted when assignment is contemplated.
Assuris Assuris is a life insurance organization that ensures coverage for policy owners will continue if a Canadian insurance company goes bankrupt or cannot meet its financial obligations.
The amount Assuris guarantees is based on the type of policy: - up to $200,000 of a term life insurance policy or term-to-100 life insurance policy is covered in full. If the face amount is greater than $200,000, then the policy owner will receive the greater of 85% of the death benefit or $200,000.
- universal life insurance policy owners receive the same guarantee as term life but the investment account of the policy owner receives additional coverage: the greater of 85% of the account or $60,000.
- whole life insurance policy owners receive the same guarantee as universal life except the additional coverage is based on the cash value of the policy. Dividends will continue but may be reduced in value.
- disability insurance policy owners receive the greater of $2,000 per month or 85% of their benefit.
- health insurance policy owners receive the greater of $60,000 or 85% of their benefit.
- segregated fund contract owners receive the greater of $60,000 or 85% of their maturity or death benefit guarantees.
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- annuitants receive the same amount as disability income insurance owners; but if the annuity has a guaranteed interest rate, then 100% of the value of the annuity up to $100,000 is received.
Advisor Remarks: 1. In 2012, Union of Canada Life Insurance Company was liquidated due to insufficient capital reserves. Its 22,000 policy owners did not completely lose the money invested in their policies, or lose their insurance coverage, thanks to Assuris. 2. Assuris does not settle policy disputes; it steps in to salvage corporate obligations if an insurance company becomes unable to meet those obligations.
Advisor Resource: http://www.assuris.ca
Related Term: Canada Deposit Insurance Corporation.
Authority A person has authority when he or she has the right to take certain actions. The agency contract gives the agent authority. Authority comes in four forms:
1. Express authority. When a written or verbal contract specifies the actions that can be pursued by the agent on behalf of the insurer.
2. Implied authority. The actions taken by an agent on behalf of the insurer based on what would normally be expected.
3. Actual authority. When an agent is authorized to act on behalf of an insurer, and clients are informed of this, then actual authority exists. It includes express authority and implied authority. For instance, an agent has actual authority to assist in the completion of a life insurance application.
4. Apparent authority. Clients expect an agent to have the authority to take certain actions based on industry practices, representations by the insurer, past dealings, and other similar information. When an agent appears to have been authorized to act on behalf of an insurer, and clients believe that the agent has received the authority of the insurer to do so, then apparent authority exists. Actions taken by the agent with apparent authority are just as binding on the
13 Fundamentals of Canadian Life Insurance insurer as those taken with actual authority. The insurer, however, can take legal action against an agent who has overstepped his or her apparent authority.
Advisor Remarks: 1. Apparent authority is the source of problems between clients, insurers, and agents.
Related Term: Law of Agency.
Automatic Premium Loan (APL)
An automatic premium loan (APL) is one non-forfeiture option for policy owners with whole life insurance.
A policy owner can stop paying premiums and the automatic premium loan (APL) will continue premium payments on his behalf. The APL uses the cash surrender value of the policy to pay premiums.
Once the cash surrender value (CSV) is used for the final premium and it is exhausted, there is a 30 or 31-day grace period.
If the life insured dies during the grace period, the death benefit (minus amount taken from the CSV and interest) will be paid to the beneficiary. But, if the premium is not paid during the grace period, the policy is finished and the whole life policy owner receives no money because no CSV exists.
Advisor Remark: 1. The other non-forfeiture options are the extended term insurance option and the reduced paid-up insurance option.
Related Terms: Non-forfeiture Options. Whole Life Insurance. Grace Period.
Beneficiary The policy owner (also called the insured) names the beneficiary on the application for life insurance.
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The beneficiary can be a person, group of people, the estate of the policy owner, a business, a trustee, or a charity who receives the death benefit of a life insurance policy. The death of the life insured triggers the payment to the beneficiary.
A policy owner may name a primary beneficiary and a contingent beneficiary. The contingent beneficiary receives the death benefit if the primary beneficiary has died.
The beneficiary may be revocable or irrevocable. The policy owner may change a revocable beneficiary at any time.
It is appropriate for an agent to regularly review the beneficiary named in his or her client’s insurance policy.
An irrevocable beneficiary must give his or her written consent to be replaced as beneficiary. Also, the irrevocable beneficiary controls how the policy owner can deal with the policy. His or her permission is needed if the policy owner wants to receive the cash surrender value of the policy, to take a loan against the policy, or to assign the policy.
The beneficiary of the policy receives the death benefit tax-free.
Advisor Remarks: 1. A minor can be a beneficiary. 2. A business will be named as a beneficiary when life insurance is used to fund the transfer of a business to a new owner after the first owner dies or for key person life insurance.
Related Term: Irrevocable Beneficiary.
Business Disability Insurance Businesses need disability insurance to accomplish these objectives:
1. Business protection if the key person becomes disabled. The key person, or key employee, is an employee who is essential to a business, and whose disability would have a financial impact on the company. Key person disability insurance pays the disability benefit to the business to use as it chooses.
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2. An orderly sale of the business if an owner is disabled. A buy/sell agreement must be in place between an owner of a company and a potential buyer. The disability buy-out insurance buys out the disabled owner according to the terms of the buy/sell agreement.
3. Business protection if the owner is disabled. A business overhead insurance policy will begin paying the overhead expenses of a business when the business owner is disabled, after an elimination period. Overhead expenses include employee wages, rent, and hydro and telephone bills. They do not include inventory or a payment of the salary to the business owner. The policy benefit will be paid for up to three years.
Advisor Remarks: 1. The buy-sell agreement is essential because it establishes the price to be paid for the company, and other terms of payment. 2. Overhead insurance is available for professionals in private practice, such as lawyers and doctors, and self-employed business people with a good track record.
Related Terms: Business Life Insurance. Business Overhead Insurance.
Business Life Insurance Businesses need life insurance to accomplish these objectives:
1. Business protection if the key person dies. The key person, or key employee, is an employee who is essential to a business, and whose death is likely to have a financial impact on the company. Key person life insurance names the business as the beneficiary of the policy and the key person as the life insured. If the key person dies, the business receives the death benefit. The money can be used for the cost of hiring a replacement employee, or to bridge the financial transition between the key employee’s death and the contribution of the “new” key employee.
2. An orderly sale of the business if an owner dies. A major part of the estate of a business owner can be the value of the business he or she owns. Surviving family members need to have a way to receive that value, without resorting to a sale of the company. To do so, a buy/sell agreement must be established between an owner of a company and a potential buyer. It can be structured as:
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- A cross-purchase agreement. A life insurance policy is then acquired that names the buyer as beneficiary. The buyer uses the money from the policy to pay survivors. - A criss-cross agreement. A life insurance policy is acquired that names all partners as beneficiaries. - A cross-purchase, tax-free dividend agreement. The business is named beneficiary of a life policy. Shares of the business are transferred to the estate of the deceased owner and surviving shareowners use a promissory note to buy the shares. The company then issues a dividend in the amount of the promissory note.
Advisor Remarks: 1. The buy-sell agreement is essential because it establishes the price to be paid for the company, and other terms of payment. 2. A cross-purchase, tax-free dividend agreement can only be used by an incorporated company since only incorporated companies can issue dividends. 3. A variation on key person insurance is split dollar life insurance. Such insurance sees the business receive the death benefit of a policy if a key person dies, and the key person contributing to the cash value of a policy. The cash value may be accessed during life, or upon death, may be received by a surviving spouse.
Related Terms: Business Disability Insurance. Capital Gains. Business Overhead Insurance.
Business Overhead Insurance Business Overhead Insurance is a form of disability insurance for a business owner. The insurance does not pay a benefit to the owner, instead, the benefit is used to pay ongoing fixed expenses of the business. In this way, an owner who generates revenue for the business is able to protect his business if disability should occur. The owner will protect himself or herself with a personal disability policy.
Benefits begin after the elimination or waiting period is over. They are paid monthly. Payments are limited to actual expenses incurred for costs such as: - rent - utilities - employee salaries (this does not include a salary for the disabled owner)
There will be a maximum to the number of benefit payments received.
Advisor Remarks:
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1. Key to the use of this insurance is that the owner must produce income for the company, or business. Therefore, it is very useful for professionals such as lawyers, doctors, accountants, and engineers. 2. Premiums may be tax deductible as a business expense.
Related Term: Business Disability Insurance.
Canada Deposit Insurance Corporation (CDIC) Canada Deposit Insurance Corporation (CDIC) is a Crown Corporation that provides protection on balances up to $100,000 in Canadian currency that are held with its member financial institutions. Those institutions include banks, Canadian trust and loan companies, and deposit-taking associations governed by the Cooperative Credit Associations Act.
CDIC does not cover credit unions and caisses populaires, Canadian branches of foreign banks, and some Canadian chartered banks.
CDIC reimburses account owners for losses up to the $100,000 limit on eligible deposits if the financial institution, such as a bank, becomes bankrupt. Eligible deposits include: - savings and chequing accounts; - Guaranteed Investment Certificates (GICs) and similar term deposits with a maturity date of five years or less; - money orders - certified cheques - bank drafts - traveller’s cheques (when issued by a CDIC member)
Ineligible deposits include: - mutual funds; - stocks; - bonds; - treasury bills - GICs with a maturity date of more than five years.
CDIC coverage is automatically provided to depositors; they do not need to apply for coverage.
Advisor Resource: http://www.cdic.ca
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Advisor Remarks: 1. The insurers of deposits at financial institutions are: - Assuris for insurance products; - CDIC for banks, trust and loan companies, and some deposit-taking associations; - Canadian Investor Protection Fund (CIPF) for investment dealers who sell stocks and securities; - the Mutual Fund Dealers Association (MFDA) Investor Protection Corporation (IPC) for mutual funds. 2. All insurers across the industry provide protection against insolvency of firms; they do not insure against losses suffered by investors.
Canada Pension Plan The Canada Pension Plan (CPP) is a program delivered by the federal government and is in place in all Canadian provinces except Quebec. In Quebec, the Quebec Pension Plan (QPP) provides the equivalent of the CPP.
The CPP provides five forms of income to those who qualify: 1. Retirement income. All Canadians who are employed or self-employed contribute to the CPP when they earn more than an amount established as the minimum for contributions. There is also a maximum amount above which contributions cease. The full retirement income is paid monthly at age 65. CPP can begin as young as age 60 but at a reduced amount.
2. A survivor’s pension. This monthly payment is made to the spouse of a CPP contributor who dies.
3. A children’s benefit. This monthly payment is made to the child of a CPP contributor if the contributor dies. It is paid to age 18 or age 25 if the child attends school full time.
4. A disability benefit. When disability is proven to be both severe and prolonged, CPP will pay a monthly income to the disabled person.
5. A children’s disability pension. This is payment made to a disabled contributor and his or her child.
CPP also provides a lump-sum payment as a death benefit when a contributor dies. The amount, to a maximum of $2,500, is paid to the contributor’s estate.
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Advisor Resource: http://www.servicecanada.gc.ca/eng/isp/cpp/cpptoc.shtml
Advisor Remarks: 1. An employed person shares his or her contribution to CPP with his or her employer. Those who are self- employed contribute the full amount. 2. Contributions can be made to CPP to age 70 if a person continues and work, and whose income is greater than the minimum for CPP contributions. 3. The CPP disability pension begins after a four-month waiting period once disability has been proven.
Related Term: Old Age Security.
Canadian Life and Health Insurance Association (CLHIA) The Canadian Life and Health Insurance Association (CLHIA) is a voluntary trade association that represents the collective interests of its member life and health insurers. The Association’s membership accounts for 99 per cent of the life and health insurance in force in Canada and administers about two-thirds of Canada’s pension plans.
The Association compiles industry statistics, develops and publishes guidelines on key issues for financial advisors, and provides consumer publications and resources.
The mission of the CLHIA is to serve its members in areas of common interest, need or concern. In carrying out this mission, the Association ensures that the views and interests of its diverse membership and of the public are equitably addressed. Its strategic objectives include: - To build consensus among members on issues and concerns of importance to the industry. - To promote a legislative and regulatory environment favourable to the business of its members. - To foster sound and equitable principles in the conduct of the business of its members. - To inform and educate members about domestic developments and, where warranted, international developments of importance to them. - To preserve and advance the industry's reputation. - To promote, on behalf of its members, public policies that contribute to the betterment of the Canadian economy and society.
Advisor Resource: http://www.clhia.ca
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Capital Gains A capital gain is the difference between the cost of certain investments and their selling price, when the selling price is greater than the cost. If the selling price is less than the cost of the investment, then a capital loss occurs.
Investments that may experience a capital gain include: - real estate bought for investment purposes (but not the principal residence) - stocks - some mutual funds - some segregated funds - capital property, such as art or fine jewellery
Capital gains are taxed, but less than other types of investment returns, such as interest.
Let’s call what is received by the investor as a capital gain the “profit.” The taxable capital gain is half of the profit. Therefore, if the capital gain (the profit) is $1,000, the taxable capital gain is $500.
Capital gains tax is then calculated by applying the marginal tax rate (also called the MTR) of the investor to the taxable capital gain. In this example, the marginal tax rate of the investor is applied to the $500.
Marginal tax rates vary according to the amount of income earned and by province. If our investor had a 25% marginal tax rate, her capital gains tax on her $1,000 capital gain would be: $1,000 divided by 2 = $500 $500 multiplied by 25% = $125
Advisor Remarks: 1. Make sure you note the difference between capital gain and taxable capital gain. 2. The cost of investments to their owner is called their adjusted cost base. 3. Life insurance agents must know about capital gains and taxable capital gains so that they can ensure an estate is properly funded with life insurance to pay capital gains tax when the estate owner dies.
4. People who own shares of private companies, or qualified farm or fishing property can enjoy a lifetime exemption from capital gains tax up to $750,000.
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Related Terms: Marginal Tax Rate. Mutual Funds. Segregated Funds.
Cash Surrender Value When a policy owner pays whole life insurance premiums, a small portion of each premium creates what is called the cash reserve. The cash reserve belongs to the policy owner. It can be used for cash surrender value.
- Cash surrender value is also called CSV. - It is the amount received by the policy owner who wishes to discontinue his or her insurance policy. - CSV increases with every premium payment. - Once the CSV has been paid, the life insured is no longer insured. - Creditors cannot claim the cash surrender value of a policy if an irrevocable beneficiary is named or the beneficiary is preferred (spouse, child, parent or grandchild). - When the policy owner receives the CSV, it may be taxed. The amount of tax is based on what is received as the CSV, minus what the policy owner paid as premiums. - If the policy was issued after 1982, the amount attributed to pure insurance (called the net cost of pure insurance or NCPI) is also deducted in the calculation of tax. - If the policy was a participating whole life policy and dividends had been received, they are also subtracted from the CSV. - The amount remaining is the taxable gain of the CSV, and it is declared as income on the income tax return of the policy owner.
Advisor Remarks: 1. Taking CSV terminates the life insurance policy. 2. The policy owner will pay tax on what is received after deductions are made for premiums the policy owner paid for the policy. 3. Only policies issued since 1982 also deduct the net cost of pure insurance in the calculation of tax. 4. Par policy owners will also see dividends subtracted from the CSV to calculate tax. 5. Universal life policy owners use the account value of their policy to provide cash surrender value.
Related Terms: Non-forfeiture Options. Whole Life Insurance. Universal Life Insurance.
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Certified Financial Planner (CFP)
A Certified Financial Planner (CFP) designation is recognized around the world. In Canada, certification is obtained through the Financial Planning Standards Council.
Requirements for a CFP include: - completion of education in financial planning; - successful completion of rigorous standardized examinations; - financial planning work experience; and, - an ethical commitment to put the client's interest first.
CFP professionals are also held to ongoing rigorous standards through continuing education requirements and enforcement processes.
Advisor Resource: https://www.fpsc.ca/earn-certification
Chartered Life Underwriter (CLU)
A Chartered Life Underwriter (CLU) designation is a highly-regarded Canadian title in the financial services industry awarded upon completion of the CLU program administered by Advocis. Graduates are able to provide clients with advanced advice regarding wealth transfer and estate planning.
Advisor Resource: http://www.advocis.ca/content/education/clu.html
Churning and Twisting Churning and twisting are actions that can be taken by life agents that are prohibited.
- Churning describes the process of an agent replacing a policy with the same insurer that issued the original policy for the sole purpose of generating a commission. - Twisting is also policy replacement for the purpose of generating a commission but the policy is switched from one insurer to another.
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Replacement of policies is carefully monitored for evidence that the agent is replacing the policy only to generate a sales commission. Replacement is valid only when it is in the client’s best interest.
Advisor Remark: 1. Client interests must always be put first.
Related Terms: Replacement. Unfair Trade Practices.
Claims A personal policy owner makes a claim with the insurance company to receive the benefit of a life insurance policy, disability income policy, or A&S insurance policy. - A life insurance claim can only be made once: when the life insured dies. It must be supported by proof of death. The death benefit (face amount minus any deductions) is paid to the beneficiary.
- A disability income insurance claim must include a claimant’s statement that details the date of the accident or when illness began, the cause of the disability, its nature, and its treatment. The name of the claimant’s doctor is required. The policy owner will then go through a waiting period, also called an elimination period, after the disability began and before benefits are received.
- The claim for an A&S insurance policy depends on the type of policy. Some claims are made many times. - Some extended health care will be billed directly to the insurer; some will require receipts; - Prescription drug coverage when provided as a reimbursement plan requires the claimant to complete the necessary forms and provide receipts; - Prescription drug coverage when provided as a pay direct plan sees the pharmacy billing the insurer directly; - Dental plans often bill the insurer directly; - Travel assistance may require receipts; - Critical Illness Insurance requires proof of a diagnosis of a critical illness covered in the policy, and that the insured is still living 30 days after diagnosis. - Long-term care insurance reimburses payment.
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- Group plan members may make their claim directly with the insurer or through the employer.
Advisor Remarks: 1. The policy owner does not make a claim to receive the maturity guarantee from a segregated fund, or the benefit from an annuity. These payments are issued automatically. The death benefit guarantee of a segregated fund would require proof of death. 2. A claim for long-term care insurance benefits is made once after it is proven that the insured is impaired in his or her thinking (called cognitive impairment) or is unable to perform two of the activities of daily living. See the topic on long-term care insurance. 3. Claims for government insurance, such as the Canada Pension Plan disability benefit, require claimants to provide all necessary documentation to the relevant government agency.
Related Terms: Long-term Care Insurance. Co-ordination of Benefits.
Co-Insurance (Co-pay) Co-insurance, also called co-pay, is when an insurer will only compensate an insured for a percentage of their claim. For instance, if a group policy has a 90% co-insurance factor, each claim will be reduced by 10%.
Co-insurance does not reduce a claim by a flat dollar amount. It is always a percentage of the claim.
Unlike a deductible, which is only taken until the full deductible for the year has been satisfied, co- insurance applies to every claim and reduces the amount to be reimbursed.
Claims on a policy with both a deductible and co-insurance will be processed by first subtracting the amount of deductible, and then applying the co-insurance factor to the balance.
Co-insurance reduces the premium cost for the policy owner.
Advisor Remark: 1. Co-insurance is a percentage of every claim that is paid by the group insured. A deductible is a flat dollar amount only charged at the beginning of each year until the full deductible has been subtracted from claims. The rest of the claims in a year will not have a deductible. But, every claim can have co-pay.
Related Term: Deductible
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Compliance Life insurance agents are expected to follow compliance directives; in other words, they must comply with, or follow, the standards, rules, and regulations that pertain to the life insurance business.
Compliance is not an option; it is a requirement. Compliance manuals are developed and constantly updated outlining requirements and compliance departments are in place to ensure that agents follow the instructions in the manuals.
The consequences of non-compliance are potentially severe. Advisors who want to preserve their reputation, that of their firm or firms, and that of the industry will follow compliance directives to the letter.
Advisor Resource: Sound Business Practices for Life Insurance Agents to Stay Compliant, J-P Bernier, CLIFE Continuing Education Course, http://clifece.com/index.php/component/content/article/177
Conflict of Interest A conflict of interest occurs when private interests (usually financial) or personal considerations of an agent are incompatible with the interests of a client. As a result, if the situation or circumstance in which the conflict of interest continues, the agent does not treat the client objectively, and the agent has put his interests ahead of those of the client.
An example of conflict of interest would be to recommend replacement of a policy solely for the purpose of obtaining a new commission. The acts of replacing for a new commission are called churning and twisting.
Conflict of interest can also occur if an agent acts as a power of attorney, or a policy beneficiary --- either personally or, for instance, on behalf of a charity the agent may be involved with.
The standard management of conflict of interest is to: - recognize a conflict when it arises; - disclose the conflict to the client; - eliminate the conflict by being removed from the decision or situation where the conflict has arisen.
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Advisor Remark: 1. If in doubt, bow out.
Related Terms: Ethics. Churning and Twisting. Unfair Trade Practices.
Continuing Expenses Many individuals take out life insurance to “take care of the family” if death should occur prematurely.
The family of such a person who dies will face two forms of expenses: last expenses (also called final expenses) and continuing expenses.
Last expenses occur once. Continuing expenses are ongoing.
Continuing expenses are the costs of living paid by the surviving spouse for family upkeep, month after month, year after year. Among other expenses they include food, clothing, home maintenance, property taxes, transportation costs, holidays and recreation, and can include saving to cover future education costs of a child or children, and future retirement income for a spouse.
Continuing expenses will be higher during the period of time the children are dependent. This period is called the dependency period.
Continuing expenses are not taken into the calculation when doing a life insurance needs’ analysis using the capitalization of income approach. However, the capital retention approach does take these expenses into consideration.
Neither approach takes inflation into account. If the children are young when death of the parent occurs, the actual sum of money needed at that time to pay continuing expenses will be much lower than ten years’ later thanks to the effect of inflation. This factor will be accommodated by the needs’ software you will use as an agent to calculate the correct amount of insurance.
Advisor Remark: 1. Be very clear about what expenses are considered to be continuing expenses.
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2. Remember, the mortgage is not a continuing expense; it is a last or final expense.
Related Terms: Last Expenses. Inflation.
Contract The idea of “contract” is the basis for contract law. A life insurance policy is a type of contract.
A contract is an undertaking between parties that describes a promise or promises that will be enforced by law.
A life insurance policy can be issued as a single party contract, a two-party contract, or a three- party contract.
Both the application and the policy are considered the entire life insurance contract. If they disagree in their details, the policy details are used, not the details in the application.
For a life insurance policy to be enforced as a contract, it requires: - Insurable interest: The person named as the life insured in the policy must agree to the insurance in writing. - Mutual assent: This means one party must make an offer in the contract and the other party must accept that offer. This is also called offer and acceptance. - Consideration: This is an exchange of value. In everyday language, it means money must change hands. It must be provided by one party and accepted by the other. - Legal capacity: This requires the person who is entering into the contract to be legally able to do so. To satisfy this requirement, a person must be 16 years of age or older, and mentally competent. - Meeting of the minds: There cannot be a mistake or misrepresentation of facts. - No evidence that forgery, theft, or fraud has occurred.
Advisor Remarks: 1. Contracts, including insurance policies, are subject to Canadian law. 2. Misrepresentation includes fraud. Fraud is also known as fraudulent misrepresentation. Fraud immediately and irrevocably terminates a contract. 3. The Criminal Code of Canada applies to issues of theft, forgery and forgery. This will mean anyone convicted of these activities can face fines and jail.
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4. Contract law is one of the most important laws in Canada.
Related Terms: Insurable Interest. Criminal Law. Misrepresentation. Mistake.
Co-ordination of Benefits (COB) Co-ordination of benefits (COB) coordinates the benefits an insured may receive as a result of being covered by more than one insurance plan. This could be true of a wife who has an extended health insurance plan where she works, and is also covered by her husband’s plan where he works.
The goal of COB is to ensure that no one receives more for services or benefits than what they have paid for.
Complicated guidelines exist to determine the primary carrier, or primary payor, for COB purposes, and the secondary carrier, or secondary payor.
A person submits a claim to the primary carrier first. If he or she does not receive 100% reimbursement, then the claim can be submitted to the secondary carrier.
Deductibles and co-insurance may also reduce the claim.
The group insurance administrator always calculates co-ordination of benefits.
Advisor Remark: 1. COB protects insurers from overpaying claims.
Related Terms: Deductibles. Co-insurance. Group Insurance.
Corporation When a business is formed, it can be structured as a: 1. Sole proprietorship: Sole means one and proprietorship means owner: hence, this is a business with one owner. That owner may be the only employee, or there may be two, three, or thousands of employees. Sole proprietors have a need for life insurance and disability insurance for the owner, business overhead insurance, and key person life and/or disability insurance (if a key
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person exists). Business succession can be a problem for the sole proprietor: in other words, who will buy the company at a fair price when the owner dies or wishes to retire? 2. Partnership: The word “partner” is often used loosely to describe a relationship between business colleagues. However, a partnership is a very distinct form of business structure based on the desire of the principals to operate as a partnership, and the contribution by each to partnership property and partnership interest. 3. Corporation: A corporation is a company incorporated either under provincial or federal laws as evidenced in its articles of incorporation. These articles spell out many legal details including the name of the company, its officers and directors, and the number of shares issued by the company that represent company ownership. The shares of a private corporation are held by a person or among a group of people and are bought and sold privately; the shares of a public corporation are traded on a stock market. Corporations may issue dividends to their shareowners; an increase in the value of shares is a form of capital gain. Insurance for private companies revolves around the need for the company to buy shares at a fair price from: - the estate of a deceased shareholder. - a shareholder who wishes to retire. - a shareholder who becomes disabled. They will also seek key person insurance.
Advisor Remarks: 1. Companies of all types are a major market for all forms of group insurance. 2. True partnerships are not frequently found among businesses. 3. Buy-sell agreements can exist in all three forms of businesses between the potential buyer(s) and the potential seller(s). Such agreements specify the terms under which the business interest will be sold. Life insurance is used to fund the transition between parties to the agreement. Its face value is used when there is a death and co-partners, co-owners, or a key person is named beneficiary. The cash value of life insurance is used when an owner seeks retirement.
Related Terms: Business Disability Insurance, Business Life Insurance, Business Overhead Insurance, Group Insurance, Capital Gains.
Cost Illustrations Cost illustrations, or policy illustrations, are used to show a set of future assumptions about an aspect of a life insurance or disability insurance policy. They are defined by the Canadian Life and
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Health Insurance Association (CLHIA) as “any communication to a current or prospective client that shows numbers or graphs of future policy premiums and/or values, or features that depend on them, for a policy.”
For instance, a cost illustration could be used to show dividends that would be received from a participating whole life insurance policy.
Cost illustrations may be used for both in-force insurance and new, or prospective, policies. They require great care in their use because they can be misleading when used to show future values that are not guaranteed.
Every cost illustration should state clearly the assumptions that have been used in its preparation, that the illustration is provided only for information purposes, and that future results may be worse, or better, than shown.
Cost illustrations will contain a primary scenario and supplementary illustration. The primary scenario is based on assumptions considered “reasonable.”
Advisor Resource: Guideline G6, Illustrations, CLHIA: http://www.clhia.ca/domino/html/clhia/CLHIA_LP4W_LND_Webstation.nsf/resources/Guidelines/$ file/Guideline_G6.pdf
Advisor Remarks: 1. Cost illustrations can be a source of client confusion and dissatisfaction because of the number of variables that may be presented. There may also be an absence of comparative information. 2. Cost illustrations are developed on a base of assumptions. Therefore, they may not hold true in the future.
Related Terms: Guarantees. Segregated Funds.
Creditor Protection When a person owes money, the person or company that is owed the money is a creditor. All assets of a person can be seized to repay a creditor, or creditors, except life insurance policies under certain conditions. Therefore, life insurance is said to provide creditor protection.
Creditor protection is enjoyed when:
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- an irrevocable beneficiary is named in a life insurance policy during the lifetime of a policy owner.
- a spouse, child, grandchild, or parent of the life insured is named as beneficiary in a life insurance policy during the lifetime of the life insured (not the policy owner).
- money from an annuity contract is paid to an annuitant.
Creditor protection is not available if the life insurance policy or annuity contract is surrendered by the owner for its cash value.
When the life insured dies, any beneficiary of the policy is protected from creditor claims unless the estate has been named as beneficiary.
Money cannot be deposited to a life insurance contract (such as universal life insurance or segregated funds) or used to prepay premiums to deliberately avoid creditors. Doing so is a form of fraud.
Advisor Resource: Guideline G7, Creditor’s Group Insurance, CLHIA: http://www.clhia.ca/domino/html/clhia/CLHIA_LP4W_LND_Webstation.nsf/resources/Guidelin es/$file/Guideline_G7.pdf
Advisor Remark: 1. Locked-in funds, such as deposits made to a registered pension plan, are protected from creditor claims.
Related Terms: Beneficiaries. Annuities. Estate. Locked-in Plans. Irrevocable Beneficiary.
Criminal Law The laws in Canada that address criminal behaviour and its consequences are found in the Criminal Code of Canada. The Criminal Code is federal legislation that applies in every province.
A person who breaks any section of the Criminal Code and is found guilty will be punished by a fine, and/or time in jail.
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Sections of the Criminal Code that affect life insurance agents include those that deal with theft, forgery, and fraud. The laws that relate to money laundering and terrorist financing activities are also part of the Criminal Code.
A life insurance agent who breaks the law can expect to be fined and/or spend time in jail, and will lose his or her insurance license.
However, the Criminal Code does not compensate victims of crime for their losses. For a victim to be compensated, he or she must make a claim in contract or tort. A tort is a civil wrong, other than a breach of contract, for which the law will compensate by an award in damages.
Errors and omissions (E&O) insurance is a requirement for life insurance agents. It will compensate clients who can establish liability for breach of contract or negligent errors or omissions under tort law. Therefore, an agent does not personally pay the client if he has breached the contract or made a compensable mistake or omission in regards to a policy.
Advisor Remark: 1. Criminal law convicts the wrongdoer. Tort law compensates the victim.
Related Terms: Errors and Omissions Insurance. Misrepresentation.
Critical Illness Insurance (CII) Critical illness insurance (CII) is a type of accident and sickness insurance policy. It provides a lump-sum payment to the person insured under the policy, 30 days after that person has been diagnosed with an illness covered by the policy. The insured must still be living at the end of the 30 days to receive the benefit from the insurance.
- Illnesses included in all CII policies include some cancers, heart attack, serious strokes, and heart bypass surgery.
- Other illnesses that may also be covered include loss of eyesight, loss of hearing, kidney failure, major organ transplants, and many others depending on the insurer.
- Pre-existing conditions and HIV/AIDS are excluded.
- Policies are available as:
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o Renewable over a specified period of time, such as five years; o Level term to a specified age, such as age 65; o Lifetime; o Renewable, and convertible to lifetime coverage.
Advisor Remarks: 1. The insured must be living to receive the CII benefit. If death occurs before diagnosis or within the 30- day period after diagnosis, no payment is made. 2. The benefit is paid to the insured. 3. There is no need to establish a level of earned income as there is with disability insurance. 4. Also available on a group basis. 5. This is a form of insurance that provides a “living benefit.”
Related Terms: Accident and Sickness Insurance. Disability Income Insurance.
Death Benefit The death benefit is the amount received by the beneficiary after death of the life insured.
The death benefit is not always the face amount that appears on the policy. This is because adjustments can reduce the face amount due to: - an unpaid premium if death occurred during the grace period;
- an outstanding policy loan, plus interest owed on the loan.
Other adjustments can be made that will increase the death benefit. This would occur if: - riders were attached to the policy that were relevant to the death of the life insured, such as a term rider, or an accidental death rider (if death occurred from an accident);
- paid-up additions, term additions, or special term additions had been acquired as a result of dividends received;
- dividends were owed but had not been paid;
- the policy was a universal life policy and account values were to be paid.
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Advisor Remark: 1. The beneficiary receives the death benefit tax-free.
Related Terms: Universal Life Insurance Death Benefit
Death Benefit Guarantee A death benefit guarantee applies to a segregated fund (seg fund) contract. It is one of two seg fund guarantees: the other one is the maturity benefit guarantee. Together, they are called the principal guarantee.
The death benefit guarantee means that if the contract owner dies during the 10-year period of the contract, the beneficiary of the contract receives either 75% or 100% of the deposits the contract owner made. The seg fund contract specifies 75% or it specifies 100%; the contract owner gets the guarantee offered for the fund selected.
If the actual value of the contract (called the market value) is more than what would be received as the guarantee, then the beneficiary receives that (greater) value.
In other words, the death benefit guarantee is a minimum that will be received if the actual account value has declined since money was deposited to the contract.
The amount received as a death benefit guarantee can be: - increased by contract reset; - increased by ongoing deposits; - decreased by making withdrawals from the contract.
Example: Single deposit to seg fund: $10,000 with a 75% guarantee 1. Account value at time of death = $6,200 Amount received at time of death = $7,500 2. Account value at time of death = $8,500 Amount received at time of death = $8,500
Advisor Remarks: 1. All segregated fund contracts provide a death benefit guarantee.
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2. Very few insurers now offer a 100% guarantee; 75% is the norm. 3. Mutual funds offer no guarantees. 4. The death benefit guarantee applies from day one of the contract. 5. If a withdrawal is made from the contract during its 10-year term, the death benefit guarantee is adjusted based on the amount remaining in the contract. 6. The death benefit guarantee provides a measure of safety to investors.
Related Terms: Segregated Funds. Policy-based Guarantee. Deposit-based Guarantee. Reset.
Deductible A deductible applies to an accident and sickness policy in which the policy owner has chosen to pay a deductible, and may apply to group health insurance. The deductible reduces the premium cost.
A deductible reduces the reimbursement the policy owner receives by a dollar amount. It is applied against the first claim of each year. If that claim is large enough to pay the full deductible, there are no further deductions from claims in that year. If the first claim is not large enough to pay the full deductible, the deductible continues to be applied against claims until it is fully paid for that year. For instance, a deductible might be $100. If the first claim is $125; the amount the policy owner receives is $25. If the first claim is $75, then $25 is deducted from the next claim.
- A single deductible applies only to policy owner claims. When the first claim of the year is submitted the deduction is made. If the claim is more than the deductible, the deductible for the year is satisfied (for example: claim $125; deductible $100 = deductible satisfied) . If the claim amount is less than the deductible, the deductible continues to be applied to following claims until the full deductible has been satisfied (for example: claim $80, deductible $100 = $20 deductible on next claim).
- A family deductible is another form of the deductible. It is applied according to the policies of the insurer that has issued the policy. For purposes of the Life License Qualification Program, the family deductible is explained as: The single deductible, as described above, applies if the policy owner makes the first claim of the year. But, then, claims by other family members are reduced by this amount. If another family member makes the first claim of the year, the full amount of the family deductible is applied to that claim.
Example: $25 single deductible and $100 family deductible:
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First claim of year: Policy owner - claim minus $25 Second claim of year: Spouse – claim minus $75 Third claim of year: Spouse – no reduction in claim First claim of year: Spouse – claim minus $100
Advisor Remarks: 1. Deductibles reduce the amount of money received as a claim. 2. Deductibles reduce claims by a dollar amount. Co-insurance reduces claims by a percentage. 3. When both a deductible and co-insurance apply to a claim, the deductible is applied first.
Related Term: Co-insurance.
Defined Benefit Plan (DBP) A defined benefit plan (DBP) is one form of registered retirement pension plan provided by employers. It is a type of company pension.
A defined benefit plan accumulates contributions from the employer and employee over the years the employee works for that employer. - The employee has no say in how the contributions are invested. Note: this is a major difference from the Defined Contribution Plan.
- The employee will receive a pension statement every year that will report how much will be received as the pension. (This is also a major difference from the Defined Contribution Plan.)
- The amount to be received is determined as a combination of how many years have been worked and the amount of salary that has been received.
- On retirement, a pension is provided to the retired employee.
- If an employee stops working for that employer before retiring, all contributions made after the first two years of work belong to the employee. This is called vesting. The employee has a number of options available for those funds, but cashing out is not an option. The money will be locked-in until retirement.
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- A defined benefit plan commits the employer to provide the pension reported in the pension statement on retirement. If contributions over the years are lower than anticipated, the employer must make up the difference between the contributions and the pension promised. This can make a defined pension plan very expensive for the employer.
Advisor Remarks: 1. Agents must be aware of the basics about pension plans because such plans are a major asset to the individual who has one. The value of a pension must be taken into consideration when planning finances or planning for retirement. 2. Less than half of all employees are provided with a pension from their employer. 3. One of the largest groups in Canada with the defined benefit plan form of pension is Ontario teachers. 4. Contributions to a registered retirement plan (company pension) reduce the amount that can be contributed to an individual’s Registered Retirement Savings Plan.
Related Terms: Registered Pension Plans. Defined Contribution Plans. Locked-in Plans.
Defined Contribution Plan (DCP) A defined contribution plan (DCP) is one form of registered retirement pension plan provided by employers. It is a type of company pension.
A DCP accumulates contributions from the employer and employee while the employee works for that employer. - The employee chooses how the contributions are invested. Note: this is a major difference from the Defined Benefit Plan.
- The annual pension statement provided to the employee reports how much is expected to be received as the pension. There is no guarantee that this amount will be received because the pension will depend on the employee’s investment choices and investment performance. (Note: this is also a major difference from the Defined Benefit Plan.)
- If an employee stops working for an employer before retiring, all contributions made after the first two years of work belong to the employee. This is called vesting. The employee has a number of options available for those funds, but cashing out is not an option. The money will be locked-in until retirement.
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- On retirement, the employee must transfer the funds accumulated in the DCP to a locked-in account, such as a Locked-in Retirement Account (LIRA). The funds can reside in that account until the end of the year the former employee turns 71. They must then be transferred to a life annuity or a Life Income Fund (LIF), Prescribed Retirement Income Fund (PRIF), or Locked-in Retirement Income Fund.
- A defined contribution plan does not commit the employer to providing a specific amount of pension. For this reason, they are less expensive for the employer than a defined benefit plan and are becoming increasingly popular.
Advisor Remarks: 1. Agents must be aware of the basics about pension plans because such plans are a major asset to the individual who has one. The value of a pension must be taken into consideration when planning finances or planning for retirement. 2. Less than half of all employees are provided with a pension from their employer. 3. Contributions to a registered retirement plan (company pension) reduce the amount that can be contributed to an individual’s Registered Retirement Savings Plan.
Related Terms: Registered Pension Plans. Defined Benefit Plan. Locked-in Plans.
Definitions of Disability When a person applies for a personal disability income insurance policy, he or she will select a definition of disability. This definition describes what sort of work he or she would be prepared or willing to do if he or she should become disabled.
There is a great deal of controversy about these definitions. It appears there are three definitions that are used.
1. Total disability also called any occupation. The insured will receive a benefit when he is unable or unwilling to work at any job, and therefore will receive a disability benefit that can’t be supplemented by any form of income from working.
The following policy definitions assume that work could be possible in some form for the disabled person.
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2. Regular occupation. The insured will receive a benefit when he is unable to perform the essential duties of his occupation. If the insured takes on work outside these parameters, the income he receives will be deducted from the disability benefit. 3. Own or regular occupation. The insured will receive a benefit when he is unable to work at the highly trained or skilled job, or equivalent job, that he had prior to disability. The insured will receive a full benefit plus whatever he is able to earn by working at another job. This definition can only be chosen by professionals whose occupational classification puts them at the lowest likelihood of making claims.
Advisor Remarks: 1. The any occupation definition provides the most leeway for interpretation, and consequently has the lowest premium. It requires the policy owner to be prepared to work at any job. 2. The own occupation is different for personal disability insurance than group insurance. 3. It appears that sometimes total disability and any occupations are used interchangeably, and that regular occupation is differentiated from own occupation. Use the definitions provided here as a guide only.
Related Terms: Occupational Classifications. Disability Income Insurance.
Deposit-based Guarantee A segregated fund contract is funded by a lump sum or on-going deposits, and the money is invested for a ten-year term. When on-going deposits are made, the contract offers two ways to apply the ten-year term. One way is on the basis of deposits made (called a deposit-based guarantee) and the other is on the basis of the policy (called a policy-based guarantee).
A deposit-based guarantee means that each deposit to the segregated fund will have its own ten- year period to maturity. The initial deposit establishes the first maturity date. Every subsequent deposit matures ten years from the date of that deposit. Therefore, if the initial deposit is made May 2, the maturity period for that deposit is ten years later, on May 2. If the next deposit is made May 5, that deposit matures on May 5 in ten years’ time.
A policy-based guarantee is also known as a contract-based guarantee. The maturity date is established by the initial deposit. Subsequent deposits do not change the maturity date but the guarantees will increase during the 10-year period due to deposits.
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Both guarantees increase the value of the maturity and death benefits since those benefits (75% or 100%) are recalculated on a higher amount due to the deposit(s).
Advisor Remark: 1. Guarantees provide security to contract owners.
Related Terms: Policy-based Guarantee. Segregated Funds. Maturity Guarantees.
Disability Income Insurance A personal disability income insurance policy provides a regular income to a person who becomes disabled as a result of sickness or an accident, and who loses the ability to earn an income. Disability insurance is only available to people who work. The amount that is received by the insured is 60-70% of gross income, and it is received tax-free.
The basis for determining gross income is income that is actively earned: in other words, money received as a result of working.
Policy types are: - Cancellable or Commercial. The insurance company can refuse to renew the policy on its anniversary, or can charge higher premiums because of claims made by the policy owner. - Guaranteed Renewable. Absolutely renewed by the insurance company but premiums for everyone in a certain class or category can be raised. Individual premiums cannot be raised. - Non-Cancellable and Guaranteed Renewable. Policy cannot be cancelled and the premium cannot be increased during the period of time set out in the policy.
Once the claim for the insured is approved and disability is established according to the definition of disability used in the policy, there is a waiting period before benefits begin. This is also known as the elimination period. During this time, the insured must be able to meet his financial obligations from personal resources.
The benefit period then begins. It is the length of time a benefit will be paid. It can be a period of time, such as five years, or to a certain age, such as age 65.
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Advisor Remarks: 1. The premium for disability income insurance is determined by the morbidity rate of the applicant. 2. The policy owner of a disability insurance contract is always the same person as the insured. Therefore, the contracts are always two-party contracts. 3. Riders are available that can ensure a benefit keeps up with increases in income (called a future purchase option) and increases in the cost of living (called a COLA rider). It is also possible to have premiums returned if a claim is not made with a return of premium rider. A waiver of premium rider removes the obligation of making premium payments for the disability policy if the insured becomes disabled. 4. Disability insurance provides a “living benefit.”
Related Terms: Morbidity. Definitions of Disability.
Disclosure Disclosure is the result of operating “in the open” with clients. In other words, it means not holding back on any information that would be pertinent to a client’s needs, and providing the client with full and appropriate information both about products and who they are dealing with.
Key aspects of disclosure include: - informing the client of which companies the advisor represents and the relationship the advisor has with those companies; - compensation for services provided - conflicts of interest
Advisor Resources: Reference Document, Advisor Disclosure, CLHIA, http://www.clhia.ca/domino/html/clhia/CLHIA_LP4W_LND_Webstation.nsf/resources/Financial+A dvisors/$file/AdvisorDisclosure_RefDoc_EN.pdf
And, for group benefits and group retirement business: http://www.clhia.ca/domino/html/clhia/CLHIA_LP4W_LND_Webstation.nsf/resources/Financial+A dvisors/$file/Ref_Advisor_dis_En_groupbenefits_and_retirement.pdf
Related Terms: Compliance. Conflict of Interest.
Disposition The disposition of a life insurance policy occurs: - when the policy is surrendered;
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- when a policy loan is taken; - when ownership is transferred, such as when there is an assignment; - on maturity; - when the policy lapses and is not reinstated within 60 days of the following calendar year; - when a policy is converted to an annuity except when the person insured is permanently and totally disabled; - by operation of law.
Disposition triggers tax. The amount of tax is determined as: proceeds of the policy minus adjusted cost basis
The amount received from disposition is considered income, and is therefore taxed at the marginal tax rate of the policy owner.
Advisor Remark: 1. Payment of a death benefit, a disability benefit, or annuity benefit is not a disposition.
Related Terms: Adjusted Cost Basis. Assignment. Marginal Tax Rate.
Earned Income Earned income has different meanings depending on where it is being used. There are three ways the concept of earned income is applied. 1. To determine Registered Retirement Savings Plan (RRSP) contributions. The annual contribution to an RRSP is the lesser of 18% of the previous year’s earned income or the dollar limit for the year. Earned income for RRSP purposes includes salary and commissions, net business income for a business owner, net research grants, royalties, alimony and support payments, net rental income, and CPP disability pension payments. It does not include investment income including withdrawals from an RRSP, RRIF, or deferred profit-sharing plan, pension benefits, severance, death benefits, or a retiring allowance.
2. To establish the benefit for a disability income policy. Earned income is what income is called when it is derived from activity, such as working. For this reason, it is also called active income. It is different from passive income in that passive income is received regardless of effort. An example of passive income is interest received on the balance of
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a savings account. Disability insurance will not pay more to the insured than his or her earned income.
3. To calculate income tax. This is a specialty area for tax experts.
Advisor Remarks: 1. Using earned income as the limit for disability income insurance benefits prevents the policy owner from over-insuring. 2. Agents should recognize when tax matters must be referred to a tax expert.
Related Terms: Registered Retirement Savings Plans. Disability Income Insurance.
Effective Date The effective date for a life or health insurance policy is the date that the contract is formed between the life insurance company and the policy owner.
The contract exists when there has been offer and acceptance between the company and the policy owner. Part of the process of offer and acceptance is consideration. Consideration is the premium.
This is why the effective date is not necessarily the date of the application nor the date on which the policy is delivered. It depends on when the premium for the policy is paid and when the life insurance company issues the policy.
It is, however, an important date since it will be the date on which insurance coverage begins incontrovertibly, and the incontestable period and suicide exclusion clauses begin for life insurance coverage.
Advisor Remark: 1. The effective date will appear on the face page of the policy.
Related Terms: Face Page. Contract.
Equity Equity has several different meanings though they are all based on the concept of ownership:
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Equity as company stock or shares: Equity represents ownership in a company. In this sense, it is considered a financial instrument. Therefore, when an investment fund describes itself as a Canadian Equity Fund, the investor can clearly see that the fund owns stock or shares of Canadian companies.
Equity as an asset class: When an investor owns company stocks or shares, that ownership becomes a class of assets in his or her total investment portfolio called equity. Equity is one of three asset classes used in the design of an investment portfolio. The other two classes are fixed- income investments (represented by bonds), and cash or cash-equivalents.
Equity in property: Equity is the difference between the value of property, such as a home, and the mortgage on the property. Every mortgage payment builds equity because it increases the amount of ownership.
A home equity line of credit (called a HELOC) is a sum of money made available to the homeowner that is based on the equity in the home.
Advisor Remarks: 1. Make sure you know which form of equity you are being asked about. Primarily “equity” will be encountered only as a descriptor for a type of investment fund. 2. Investment funds based on equities are considered, at a minimum, a fairly risky investment. The lowest risk equity funds invest in the stock of blue-chip companies, such as large Canadian banks. Many factors will determine the risk of an equity fund. For instance, if the equity fund is located in a less stable geo- political area than North America, its risk level may be enhanced. If the equity fund invests in the stocks of smaller or newer companies, it will definitely have a higher degree of risk.
Related Terms: Capital Gains. Corporations. Risk Tolerance. Fixed-income Investments.
Errors and Omissions Insurance (E&O) Errors and omissions (E&O) insurance is a type of policy that a life or A&S agent must take out. It is not optional. E&O is a form of professional liability insurance.
E&O insurance covers agents from client claims arising from a real or perceived mistake the agent has made. The insurance is provided by insurers who specifically provide E&O coverage. It protects personal assets of the agent because the agent will use the E&O coverage to satisfy a claim. It also protects the company the agent works for.
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For instance, an E&O claim could be submitted by a client who: - was underinsured; - was not presented with policies to meet his needs, for instance, if the client had not been made aware of critical illness insurance despite a family history of early deaths by disease; - was offered an annuity rate but received a different rate on the contract because the application had not been processed promptly.
Advisor Remarks: 1. Ontario requires E&O insurance $2 million in coverage for agents, plus additional coverage to protect against claims of fraud by the agent. 2. There may be a deductible on the policy.
Advisor Resource: Corporate Errors and Omissions, CLHIA, http://www.clhia.ca/domino/html/clhia/CLHIA_LP4W_LND_Webstation.nsf/resources/Financial+Ad visors/$file/EO_Insurance.pdf
Related Terms: Mistake. Misrepresentation
Estate An estate is the “property” a person acquires during his lifetime. Property does not mean real estate, though real estate may be one type of property within an estate. Property includes items of value such as: - investments - ownership of a business - cash - life insurance - art, jewellery, antiques, or classic cars
At death, the estate property passes through the will of the person who has died to those who have been named as inheritors in the will unless a beneficiary has been named, such as would appear in a life insurance policy.
Life insurance proceeds become estate property only when the estate has been named as the beneficiary of the policy. At death, the value of an estate is subject to income tax and probate tax.
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Probate tax applies to estates in all provinces except Quebec. If life insurance proceeds go to the estate, they will face probate tax.
Naming the estate as beneficiary provides the estate with cash that may be distributed according to the will or used to pay estate expenses, including taxes.
Advisor Remarks: 1. The objective of estate planning is to ensure that the taxes to be paid on the assets of the estate are reduced as much as possible within legal boundaries. 2. Segregated funds do not form part of a person’s estate unless the estate has been named as the beneficiary. 3. The value of an estate can be significantly eroded by costs for long-term care, such as the expense to keep a person in a nursing home. This is a reason that long-term care insurance is important as a tool for wealth preservation because it can be used to pay the costs of long-term care.
Related Terms: Long-term Care Insurance. Capital Gains.
Ethics Ethics are the principles of the life insurance agent. Those principles must be based on honesty, integrity, and the willingness of the agent to treat others the way he or she would want to be treated. This is called the golden rule.
Ethics are reflected in laws that protect client privacy, and prevent theft, fraud, or forgery.
However, ethics as practiced by a life insurance agent must meet a standard higher than imposed by laws and regulations. They will impact everything an agent says or does.
Ethics must also be practiced by the agent outside “office hours.” An agent cannot learn confidential information during a business transaction that he then shares with colleagues, or family and friends.
Advisor Resources: Ethics in the Insurance Industry, CLIFE, http://www.CLIFEce.ca and Advocis Code of Professional Conduct: http://www.advocis.ca/pdf/Advocis-CPC.pdf
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Advisor Remarks: 1. Agents must be cautious they do not contravene ethical standards on social media, such as their personal Facebook page. 2. The Advocis Code of Ethics is a list of standards all agents should strive to meet.
Related Terms: Fiduciary Duty. Replacement. Errors and Omissions Insurance
Exclusions Exclusions are included in an insurance policy to protect the insurer against the likelihood of claims, or higher or more frequent claims. However, when policy claims are limited because a claim arising from a specified event or health condition has been excluded from coverage, the insured also benefits because insurance premiums will be less.
An exclusion is a condition or activity that increases the risk of insurability. For instance, if a life insurance applicant participates in a risky sport as a hobby, such as car racing, he or she might be turned down for life insurance. The chance of a claim being made is too great because racers are more likely to die and die at a younger age. But, if death by car racing is excluded from coverage, then the same applicant can be assessed according to standard mortality tables, a premium determined, and a policy issued.
Exclusions for health or disability insurance include pre-existing conditions. Pre-existing conditions are health conditions that could affect the likelihood or severity of a claim. Some pre- existing conditions are quite common, such as high blood pressure, or asthma.
Other exclusions for accident and sickness policies include self-inflicted injuries, injuries sustained while committing a crime, AIDS, injuries received while serving in the armed forces or from a war, etc.
An exclusion may be permanent or temporary. If temporary, after the period of time has concluded, the restrictions applying to claims from even a pre-existing condition will be lifted.
Advisor Remarks: 1. Having an exclusion written into a policy could make the difference between an applicant receiving a policy or being rejected. 2. Policy exclusions will vary between insurers.
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3. An agent must clearly disclose any exclusions in a policy to a potential insured to avoid the possibility of conflict. 4. Exclusions are a good example of risk management.
Related terms: Disclosure. Pre-existing Conditions. Underwriting.
Face Page The face page of the life insurance policy is a summary of all the important details of the policy. It can be the front page of the policy.
The face page will: - name the policy owner; - name the life insured; - name the insurer; - specify the type of policy and any riders; - set out the premium amount(s) for the policy and riders, the method of payment, date of premium payment, premium frequency, and duration; - describe the amount of coverage (the face amount); - provide a the policy number; - state the date of issue; - include other less important details, such as a signature by an executive of the insurer.
The details of the policy, provided in this summary format, allow for quick review by the life agent and policy owner that the policy has been issued correctly.
If a mistake is identified on the face page, the policy must be returned to the insurer for correction.
When the policy delivery is finalized, the two-year contestable period and suicide exclusion period begin.
Advisor Remark: 1. The face amount will not necessarily be the same amount as the death benefit if the policy owner has reduced the face amount by having an outstanding loan, or has used the automatic premium loan option, or is behind a premium payment.
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Related Terms: Death Benefit. Incontestability. Mistakes. Misrepresentation. Suicide Exclusion Clause.
Fiduciary Duty A life insurance agent is a fiduciary. A fiduciary is a person who is expected to be highly loyal to the person to whom he owes a fiduciary duty. As an agent, you are a fiduciary to your clients and you owe a fiduciary duty to them. Therefore, as a fiduciary, you are expected to show a high degree of loyalty to your clients.
Loyalty is demonstrated by acting in your clients’ best interests and sole benefit at all times. Use of ethical principles will show whether best interests are being served.
Fiduciaries are held to a higher standard for their behaviour at law, and will be punished more harshly for abusing their duties than those who are not fiduciaries.
Advisor Remarks: 1. Lawyers, doctors, and trustees are all fiduciaries. 2. The concept of fiduciary goes back to Roman times and is deeply ensconced in law.
Related Terms: Ethics. Authority.
Fixed-income Investments Fixed-income investments are a category, or class, of investments distinct from equity investments, or cash.
Fixed-income investments can be identified by their type of return, which is interest, and the high level of safety accorded to the principal invested. There is a potential to earn capital gains on some forms of fixed-income investments if interest rates fall.
They provide a source of regular cash flow in the form of interest, and reduce portfolio risk.
Fixed-income investments include: - Guaranteed Investment Certificates (GICs); - Term deposits;
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- bonds issued by federal and provincial governments, and Crown Corporations, such as the Bank of Canada or Farm Credit Canada; - bonds issued by corporations; - stripped bonds (when interest payment coupons are separated from the principal portion of the bond and both are sold separately) - mortgage-backed securities; - preferred shares.
Investment funds are created that invest only in fixed-income investments.
Advisor Remarks: 1. Because fixed-income investments are low risk, their returns will be less than a higher risk investment. 2. A Canada Savings Bond is not a fixed-income investment. 3. Fixed-income investment funds provide safety to their investors.
Related Terms: Equity. Risk Tolerance.
Fraud Fraud is the abbreviated term for a fraudulent act or fraudulent misrepresentation. It describes the intentional actions taken by a person that will provide him or her with a financial gain while disadvantaging another.
Fraud can be committed by policy owners, called external fraud, and life agents, called internal fraud. For instance, a fraudulent disability insurance claim by a disability insurance policy owner can occur. The claim may be fraudulent because disability did not actually occur or the extent of the disability is exaggerated.
If fraud has been committed and is discovered, the policy is immediately void. Coverage is terminated.
Life agents engage in fraud by: - forgery, such as by signing a customer’s signature to initiate a policy or claim, or forging the signature of another agent, or by signing as a witness to a signature when the signature was not witnessed or the signature was forged; - overstating policy benefits;
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- overinsuring a life insured in order to receive a higher commission; - failure of constructive notice --- in other words, they are aware of a condition or situation that affects the insurability of a proposed life insured but do not share that information with the insurance company underwriting the policy; - selling the wrong type of policy for a higher commission; - using confidential client information for any purpose other than for what it was intended.
Fraud is a criminal act and a person found guilty of fraud will be punished by a fine and/or time in jail.
Advisor Remarks: 1. Fraud is one type of financial crime. Others include theft and money laundering. 2. Fraud creates legal, regulatory, and operational risks plus it jeopardizes the reputation of the agent and the insurers with whom he works. 3. Ontario requires agents to carry additional errors and omissions insurance to protect against client claims that arise from fraud committed by the agent.
Related Terms: Misrepresentation. Errors and Omissions Insurance.
Grace Period The grace period is a standard part of every life insurance policy.
All insurance policies have a premium due date. Life insurance contracts apply a grace period to that due date to give the policy owner an additional 30 or 31 days after the due date to make their premium payment while insurance coverage continues.
- If a policy owner has a term policy or a Term-to-100 policy, and fails to pay the premium before the end of the grace period, the policy will lapse. The policy owner will then need to reinstate the policy.
- If a policy owner has a whole life insurance policy or a universal life insurance policy, and fails to pay the premium before the end of the grace period, the automatic premium loan (APL) will “kick in” to pay the premium and continue coverage. Eventually, if the cash value of the policy is not enough to pay the premium via the APL, then the grace period will begin. The policy owner will have 30 or 31 days to make the premium payment. If he
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does not do so, the policy will lapse. Again, reinstatement would be necessary if the policy owner wanted to continue with the same policy.
When death occurs during the grace period, the beneficiary of the policy receives the death benefit. It, of course, will be the face amount of the policy minus charges, including the outstanding amount of premium.
Advisor Remarks: 1. The grace period is a standard contract provision. 2. It is calculated as the premium due date + 30 or 31 days. 3. The grace period does not apply if the policy owner informs the insurance company that he will be terminating his insurance contract.
Related Terms: Automatic Premium Loan. Reinstatement.
Grandfathered Policies Life insurance policies purchased before December 2, 1982 are called grandfathered policies. To be “grandfathered” means to be exempt. And, true to that meaning, a grandfathered life insurance policy is exempt from tax reporting until the policy is disposed.
Policies issued since December 2, 1982 are tested against a theoretical policy that is set by the Income Tax Act. If the cash reserve of the policy has built up faster than the benchmark set in the theoretical policy, called the maximum tax actuarial reserve (MTAR), the policy becomes non- exempt and will be subject to annual taxation.
However, if the policy has a cash reserve build-up less than the theoretical policy, then the policy will be exempt.
The adjusted cost basis (ACB) for grandfathered policies is better from a tax viewpoint. It is calculated as the full amount of premiums paid, including riders. Also the net cost of pure insurance (NCPI) was not deducted from the adjusted cost basis as it is since Dec. 2, 1982. Therefore, the adjusted cost basis of a policy would be higher than a comparable non- grandfathered policy, and less tax would be paid.
If a policy change is made that causes the policy to lose its grandfathered status, the policy will be tested against the MTAR to determine if it is an exempt policy. Tax will be deferred on an
53 Fundamentals of Canadian Life Insurance exempt policy until the policy is disposed. If the test shows the policy to be non-exempt, it will be permanently non-exempt and therefore subject to taxation.
An advisor should seek assistance from a tax expert when issues such as changes to grandfathered policies arise.
Advisor Remarks: 1. An agent must be very cautious replacing a grandfathered policy because tax advantages may be lost. 2. Disposition occurs when an interest in the policy is transferred to another party. It includes (but is not restricted to) absolute assignment, a policy loan made since 1978, or a withdrawal. 3. The grandfathering issue applies to policies with a cash value --- that is whole life insurance --- and the investment account of universal life insurance.
Related Terms: Disposition. Taxation of Life Insurance. Adjusted Cost Basis. Maximum Tax Actuarial Reserve. Net Cost of Pure Insurance.
Group Disability Insurance Disability income insurance when provided to a group, such as by an employer to its employees, can also be called wage loss replacement.
The insurance is structured into short-term disability, and if disability (STD) is ongoing for a period of time (usually two years), it will be followed by long-term disability (LTD).
The benefit is paid if illness or an injury prevents the employee from working. The benefit is paid directly to the employee.
If the employer pays any part of the disability insurance premium on behalf of employees, then employees will have to declare the amount received during disability as taxable income. There will be a reduction in tax for any premiums paid by the employee.
But if the employee pays the premium, for instance, through payroll deduction, any money received during a period of disability will be tax-free.
Related Terms: Short-term Disability. Long-term Disability.
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Group Health Insurance Group health insurance is provided to the members of a group, usually employees, for health care above and beyond what is provided by provincial health insurance.
Group health insurance is provided in the form of: - Extended Health Care. It covers such services as prescription drugs, private hospital rooms, medical appliances like a knee brace, etc. - Dental Care. All plans will provide basic, also known as preventative, care. Additionally, orthodontics (braces), restorative, and prosthodontic procedures (bridges, dentures, or other devices) may be covered. - Vision Care. Pays for prescription glasses. - Accidental Death and Dismemberment. Pays a death benefit or benefit if there is dismemberment (a loss of limb, eyesight, hearing, etc). There are many circumstances that are excluded from coverage, such as if death occurs from the crash of a private airplane. - Critical Illness. Pays a lump sum within a limited period of time following diagnosis of a critical illness. - Long-term Care Insurance. Reimburses expenses associated with care needed as a person ages.
Payment for group health insurance claims is by reimbursement --- either to the group member who submitted a claim with the receipt, or directly to the professional, such as a dentist, who has submitted the claim to the insurer.
Claims for group health care insurance may have a deductible and co-insurance factor. Both reduce the amount of reimbursement paid by the insurer.
Premiums paid by the employer for group health insurance are not a taxable benefit for employees.
Related Terms: Group Insurance. Deductible. Co-insurance.
Group Insurance Group insurance is life, health, or disability insurance that is provided to a group of people under a master contract. Usually the policy owner is an employer that provides the insurance to its
55 Fundamentals of Canadian Life Insurance employees. The policy owner pays the premium but group members may be required to contribute to the cost if the plan is a contributory plan. In such a plan, the employer and employee share the cost, and usually the employer pays at least 50%. In a non-contributory plan, the employer pays 100%.
- Each member of a group receives a certificate as evidence of insurance. - The insurance company issues a standard group contract when there are 25 or more members of the group. Groups with fewer members will have to show medical evidence of insurability. - The amount of coverage is spelled out in the master contract. It will be the same for all the members of a class within the group. An example of a class might be “executives.” This is called the non-discriminatory benefits schedule. - All new group members will begin to enjoy group coverage when they have completed the probationary period. This is often 90 days. - Group plan members who belong to a contributory plan must then apply for the group benefit during the eligibility period following probation. This is usually 30 days’ long. If the application is not made during the 30 days, they will then need to provide medical evidence of insurability with their application. - To initiate coverage, group members must be actively at work on the day coverage is scheduled to begin.
Advisor Remarks: 1. Group life insurance is a taxable benefit to the employee but the death benefit is not taxed. 2. Extended health care, AD&D, vision care, dental plans, and critical illness insurance is not a taxable benefit to employees. 3. Employer contributions to disability income insurance will be taxable if a claim is made and the employee has not declared the premium contribution of the employer as a taxable benefit.
Related Terms: Group Disability Insurance. Group Health Insurance. Group Life Insurance.
Group Life Insurance Group life insurance is provided to the members of a group, usually employees, for life insurance coverage.
Group life insurance is provided to group plan members in the form of: - Basic Life. Covers the group plan member.
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- Optional Life. Extra coverage on top of basic life. - Dependent Life. Covers the dependents of the group plan member. - Survivor Income. Covers the group plan member and provides an on-going income to dependents.
The death benefit is paid to the beneficiary chosen by the group plan member. It is tax-free.
Group life insurance is also available to group policy owners as creditor life insurance. The policy owner enrolls its members, who are indebted to the policy owner, in the plan. The members pay the premium. This ensures the policy owner will be repaid the money owed to them if the member of the plan should die. For instance, a bank issues creditor life insurance in the form of mortgage insurance to people who have a mortgage with the bank. If the person dies, the bank is repaid the amount of mortgage, and any excess is paid to the beneficiary named in the policy.
Employer paid life insurance premiums are a taxable employee benefit.
Related Terms: Group Insurance. Creditor Protection.
Guaranteed Minimum Withdrawal Benefit Plans (GMWBs)
Guaranteed Minimum Withdrawal Benefit Plans (GMWBs) are a recent introduction to the Canadian life insurance market, but with a longer history in the US. These plans offer a guaranteed income with the potential for capital appreciation.
An investor deposits money into the plan. The investor has the option to defer withdrawals, after making the deposit, to a later date. If that occurs, he or she receives a credit for every year they do not make a withdrawal. The credit is granted as a percentage, such as 5%, of the initial deposit.
Whenever return of principal begins, it will be paid over a specified number of years. The payout is the higher of either a minimum guaranteed amount or the market value of the segregated fund in which the principal is invested. The payout value is reset annually or according to the promises of the insurer to the greater of the guaranteed minimum withdrawal balance or the market value of the seg fund, and therefore, income payments can increase over time.
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The plan provides a death benefit to beneficiaries that can be either a continuation of the income payment or a lump sum based on the cash value of the plan.
The growth of the capital in not taxed, and the portion of each income payment that is deemed return of principal is also not taxed. The portion representing investment growth is taxed as income.
Advisor Remarks: 1. There are many differences between this plan as offered by different insurers; this information is an overview of the fundamentals. 2. GMWBs can be held in registered plans, in which case the deposit maximum will be according to government regulations, and withdrawals are taxed as income. 3. An annual fee is charged by the insurance company providing the plan; these can range from 0.35% to 0.75% of assets.
Related Terms: Segregated Funds. Annuities. Reset.
Guarantees A guarantee is a promise. Life insurance offers a number of guarantees because it offers many different promises. Here are some examples of life insurance guarantees: - A life insurance policy sets out its promises in its face schedule: to provide, when the life insured dies, the death benefit of the policy to the beneficiary.
- A disability income insurance policy promises to provide a monthly income to someone who is totally disabled according to the definition of disability in the policy.
- A segregated fund guarantees to return either 100% or 75% of deposits when the ten- year period of the contract ends or if the contract holder dies within the ten years.
- An annuity promises to make a specified payment to the annuitant of the contract.
- A & S policies guarantee reimbursement of expenses.
- A long-term care insurance policy or critical illness insurance policy will pay its benefit if its conditions are met.
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- Reinstatement of a policy is guaranteed within two years after policy premiums stop if overdue premiums are paid, debts are repaid, and insurability is proven.
- The guaranteed insurability benefit is a rider that guarantees the amount of insurance coverage can be increased under specified conditions.
Advisor Remarks: 1. There are many forms of guarantees made by life insurance products. They are one reason underlying the strength of life insurance policies. Make sure you understand all guarantees. 2. Guarantees have value.
Related Terms: Annuities. Segregated Funds. Death Benefit.
Holding Out Holding out describes how a life agent presents himself or herself to the general public in regards to the services he or she can provide, and the authority and qualifications he or she has. It is, in other words, the public “face” of the agent.
- A person must not hold himself out as a licensed life agent unless he or she has been licensed. - Business must be transacted under the name that is stated on the license. - An agent must not mislead potential or existing clients in advertising or statements that are made in the process of soliciting or negotiating insurance policies. - An agent may include post-secondary educational attainment (such as B.A.) with their name on business cards, stationery or ads, but may not put “LLQP.” - An agent must not represent himself as having specific expertise in an area, or having designations, unless they have been earned and the agent has become suitably qualified as a result of experience, education, and/or training. This includes the broad area of “financial planning,” in which the only specific financial planning designation that exists is that of Certified Financial Planner® (CFP®).
Advisor Remarks: 1. Agents must not perform duties for which they are unqualified, such as advising on matters of law or income tax.
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2. Holding out is about transparency and honesty: you show yourself to be able to do what you have been licensed and authorized to do --- without embellishment. 3. When you are unable to perform a service for clients, provide a recommendation to another who can. Such networking can also build your client list from referrals by others.
Related Terms: Authority. Ethics. Fiduciary Duty.
Income Splitting Income splitting occurs when income is received and it is apportioned between spouses so that some of the income is moved to a spouse who pays tax at a lower rate than the other. By putting income into the hands of someone who pays less tax, money is saved.
In theory, income splitting could be used between any two spouses but it only makes sense when one person has a high tax rate and the other has a lower tax rate.
Some examples of effective income splitting include: - Opening a spousal Registered Retirement Savings Plan (RRSP). This is called a spousal plan. The higher-income spouse contributes to the plan for the other spouse. This works well for income splitting if the spouse receiving the contributions is in a low tax bracket when withdrawals begin.
- Splitting pension income for those 65 and older. Up to 50% of the annual income received from a lifetime annuity, registered pension plan, RRSP annuity, registered retirement income fund (RRIF), or deferred profit sharing plan annuity can be allocated to a spouse. The splitting for tax purposes is done via the tax return.
- Splitting Canada Pension Plan benefits. Both spouses must receive a CPP retirement pension. Their benefits are added together and then divided by two.
Advisor Remarks: 1. Income splitting must be handled very carefully so that tax rules are not broken. A client should always seek the advice of a tax specialist. 2. When the term “spouse” is used, it virtually always includes a common-law spouse or same-sex partner.
Related Terms: Registered Retirement Savings Plans. Registered Retirement Income Funds. Canada Pension Plan. Spousal Plan.
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Income Tax Individuals and companies in Canada pay income tax.
Individuals submit their tax return to the Canada Revenue Agency . The Agency collects tax on behalf of the federal government and the province in which the taxpayer lives, except for Quebec. It is a federal offense to try and evade tax, and any taxpayer caught in the act of tax evasion will be severely fined. However, residents of Canada may make full use of tax credits and tax deductions they have earned that will reduce the amount of tax they pay.
- A tax deduction occurs when contributions have been made to RRSPs, for union and professional dues, child care expenses, and business investment losses. Tax deductions reduce taxable income. - Tax payable before credits is calculated by applying the marginal tax rate of the taxpayer against his or her taxable income. - Non-refundable tax credits, such as charitable donations, are deducted from tax payable before credits. - Contributions made to the Canada Pension Plan/Quebec Pension Plan are also a non- refundable tax credit. - The dividend tax credit is a reduction in recognition of the income tax already paid by the corporation that has issued the dividend. An investor with a dividend tax credit pays less tax on the investment that has paid a dividend than if he or she had earned interest on the investment. - Those who have already paid tax to another country receive the foreign tax credit.
Agent Resources: Canada Revenue Agency : http://www.cra-arc.gc.ca/menu-eng.html Tax Planning for You and Your Family 2012, KPMG, Carswell: http://www.carswell.com/description.asp?docid=8187&promo=64155
Advisor Remarks: 1. A contribution to a Registered Education Savings Plan (RESP) is not a tax deduction. 2. Deposits made to a Tax-free Savings Account are not a tax deduction, but they are tax-free on withdrawal from the account. 3. Understand what constitutes a tax deduction, and what constitutes a tax credit.
Related Terms: Marginal Tax Rate. Canada Pension Plan.
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Incontestability This is a word that must be turned around to be easily understood. The real issue is contestability.
A policy is contestable up to two years after its date of issue if the insurer discovers a mistake was made on the application or there was a misrepresentation of facts. This means the insurer can “contest” the contract. It can dispute whether the benefit should be paid and may even deny payment.
However, after two years, the policy becomes incontestable. There can be no basis for argument between the insurer and either the beneficiary if the contract is a life insurance policy, or the policy owner if the contract is for disability insurance. The benefit must be paid except if there has been fraud involved in the application and/or policy. The presence of fraud always removes the onus of payment.
Advisor Remark: 1. Incontestability is a standard contract provision.
Related Terms: Contract. Fraud. Mistake. Misrepresentation.
Index-Linked Annuity The rate of return for this form of annuity is linked to the return of a market index, such as the TSX. Like payments from a variable annuity, the payments from an index-linked annuity are unpredictable and will change according to the higher or lower value of the index. An investor could benefit from an upward stock market trend with this type of annuity without having to invest in stocks directly.
Related Terms: Variable Annuity. Annuities.
Inflation Inflation is the factor by which the cost of living increases as measured in Canada by the Consumer Price Index (CPI). It is stated as a percentage. For instance, the inflation rate for December 2011 was about 2.3%.
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The CPI shows the change every month in the cost of a group of 600 household goods and services that includes food, transportation, clothing, etc. The CPI is measured against a base year in order to show how much prices have gone up since that time. In 2010, the CPI averaged 116.5, which means that what you could buy for $100 in 2002 cost $116.50 in 2010. In other words, over time, the same things cost more. Every consumer knows this.
The creeping-up of prices as shown by the CPI and reflected in the inflation rate is addressed by cost of living adjustments (COLA). For instance, many union contracts attempt to include a COLA clause to keep their members’ income in step with inflation. Pensions paid by both the Canada Pension Plan and Old Age Security keep pace with inflation by increasing their benefits annually.
Inflation especially hurts those who rely on fixed incomes, such as people who receive a non- indexed retirement pension, or a non-indexed disability benefit because their purchasing power is reduced over time (that is, the same amount of money buys less goods).
Agent Resources: Bank of Canada: http://www.bankofcanada.ca/
Advisor Remarks: 1. A life insurance policy needs an increasing death benefit to keep pace with inflation if the purpose of the policy is to pay estate taxes. This is especially true if the capital property of the life insured is expected to increase in value, such as might be expected of a cottage. Increasing coverage can be accomplished by an increasing term life policy, a participating whole life policy that reinvests dividends in more insurance, or a universal life policy. 2. Riders also address inflation. Life insurance riders that increase coverage include the guaranteed insurability benefit. Disability income insurance riders that provide inflation protection are the future purchase option, and the cost of living adjustment rider.
Related Terms: Time Value of Money. Present Value of Money.
Information Folder The Information Folder is a document that must be provided to every prospective segregated fund contract owner. It compiles all the information about the fund into one document identified on its cover as “Information Folder.”
The idea underlying the Information Folder is that the proposed contract owner can read all about the investment he or she is making, and make comparisons with other seg funds or other
63 Fundamentals of Canadian Life Insurance investments, such as mutual funds. In fact, the complexity and length of the Information Folder may suit regulatory requirements but is unlikely to be understood in full by most people.
The Information Folder will describe: - the sales charge - how withdrawals are calculated - how benefits are determined - the valuation of units - investment policy of the fund - management fees - the effects of switches and transfers - guaranteed and non-guaranteed benefits - many other factors
The prospective owner must sign a receipt confirming that he or she received the Information Folder for the fund before the sale is finalized.
Agent Resources: Fund Facts: http://www.fundfacts.com/Pages/Welcome.aspx Point of Sale Disclosure, CLHIA: http://www.clhia.ca/domino/html/clhia/CLHIA_LP4W_LND_Webstation.nsf/resources/Financial+A dvisors/$file/Advisor_fact_sheet.pdf
Advisor Remark: 1. Mutual fund investors receive an equivalent to the Information Folder when they buy units in a mutual fund. It is called a simplified prospectus. Regulators have recognized that even the simplified prospectus is too complicated for most people to understand and have permitted Fund Facts to be issued instead. Fund Facts are greatly shortened and easier to read versions of simplified prospectuses.
Related Terms: Segregated Funds, Mutual Funds
Insurable Interest When the application is made for a life insurance policy, the insurable interest must be named. This is the person on whose life the insurance is based and whose death will trigger the payment of the death benefit to the beneficiary.
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- The person named as insurable interest must agree in writing. In this way, no person can have their life insured without their knowledge and consent.
- If the death of a person would harm the policy owner, then that person can be an insurable interest.
- A person has an insurable interest in their own life, the life of his or her spouse, children, and grandchildren, and the life of a person who provides financial support, among others.
- A policy owner who is a business owner can also name an employee or business partner as an insurable interest.
Advisor Remarks: 1. A contract is void if there is not an insurable interest. 2. Insurable interest must be established in the application. 3. Insurable interest only exists in life insurance policies, not disability or A&S.
Related Terms: Contract. Business Life Insurance.
Insured The insured is one of the parties to the insurance contract. The insured is the owner of the policy and is responsible for making premium payments. The insured also has ownership rights to policy benefits such as taking a policy loan, so long as an irrevocable beneficiary has not been named. When an irrevocable beneficiary exists, he or she is in control of the policy but is not responsible for premium payments.
The parties to a life insurance contract are: - the insured (or policy owner); - the life insured (whose death triggers payment of the death benefit to the beneficiary); - the beneficiary; - the insurer (that has issued the policy).
The insured and the life insured may be the same person. When they are, this is a personal contract. When they are two different people, the contract is a third-party contract. When more than one person is named as a life insured, the contract is a joint contract.
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A disability insurance contract is always a personal contract between the insured and the insurer.
Advisor Remarks: 1. Often insurance for business uses is structured as a third-party contract and the business itself is the insured. 2. A joint contract will be one of two types: joint first to die or joint second (or last) to die. The death benefit of a joint first to die policy is paid to the other life insured. The death benefit of a joint second to die is paid to the policy beneficiary.
Related terms: Beneficiary. Irrevocable Beneficiary.
Insured Annuity An insured annuity is a combination of an annuity with a permanent insurance policy. It is not appropriate for use by those with less than $100,000 to invest in the annuity. How it works is that an annuity is taken out. Thus, the annuity forms an income stream for the annuitant. Part of the annuity payment is used to pay the premium on a life insurance policy that names the annuitant as life insured. The face amount of life insurance is the same amount as was invested in the annuity. On death of the life insured/annuitant, the face amount of the insurance is paid to beneficiaries tax-free. So, while it may appear that the annuity has diverted the capital from those who anticipated inheriting the amount invested in the annuity, the heirs end up receiving the same amount as if the annuity had not been purchased.
Related Term: Annuities.
Interest Interest has three meanings in a financial sense.
1. When an investment is made, it can grow as: - interest - stock dividends - a capital gain
Interest is an annual increase in the value of the principal sum by a percentage, such as 3%. For instance, $1,000 invested at 3% will be worth $1,030 at the end of the year. The interest rate is
66 Fundamentals of Canadian Life Insurance the number assigned a percentage that represents how much the investment will grow, such as 3%.
Investments that pay interest include savings accounts, Guaranteed Investment Certificates (GICs), Canada Savings Bonds (CSBs), government and corporate bonds, some mutual funds, and some segregated funds.
2. Interest is a charge paid by those who borrow money from a money lender. The rate paid by the borrower, also called the interest rate, is determined by many factors including the amount borrowed, the length of time for the loan, the financial institution providing the loan, and the credit rating of the borrower.
Interest charges apply on mortgages, loans and lines of credit, policy loans, unpaid credit card balances, unpaid income taxes, and many other forms of borrowing.
3. Interest is used to describe ownership of an asset. For instance, those who own real estate are said to have an interest in the property.
Advisor Remarks: 1. Interest can be earned and interest can be paid. 2. Interest earned on an investment must be declared annually for tax purposes unless the investment is held in an account that provides tax deferral, such as a Registered Retirement Savings Plan or Registered Education Savings Plan. 3. Interest is taxed at the same rate as earnings from working. 4. All withdrawals from a Registered Retirement Savings Account are taxed as if they were interest.
Related Terms: Capital Gains. Policy Loans. Sharia Law.
Irrevocable Beneficiary The policy owner of a life insurance policy will name either a revocable or irrevocable beneficiary to receive the death benefit when the life insured dies. Written notice must be filed with the insurer in order to establish a beneficiary as irrevocable after the policy is issued.
The policy owner must obtain the consent of the irrevocable beneficiary to:
- alter or revoke the beneficiary designation;
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- assign the policy; - withdraw funds; - transfer ownership; - change the policy coverage.
However, an irrevocable beneficiary does need not be informed if a policy is: - rescinded; - lapsed; - changed to a reduced paid-up policy; - or if the policy owner receives dividends.
Naming a beneficiary as irrevocable is appropriate if there may be problems with creditors and the beneficiary is not a person who would normally enjoy creditor protection, such as a spouse. Therefore, a person named in a business insurance policy as beneficiary for the purposes of buying the business from the estate of the company owner should be named irrevocable.
Also, it may be necessary to name an irrevocable beneficiary to comply with a separation agreement or family court order.
Advisor Remarks: 1. Revocable comes from the word “revoke.” It means to cancel or reverse; so, revocable means reversible. Irrevocable means irreversible. 2. An irrevocable beneficiary must give his or her permission to be replaced by another beneficiary, or to be named revocable.
Related Terms: Beneficiary. Assignment.
Joint and Last Survivor Annuity An annuity makes a regular payment, called the benefit, to a person who is called the annuitant. A life annuity pays that benefit for the entire life of the annuitant.
A joint and last survivor annuity is a form of life annuity that is based on the lives of two people. A married couple usually uses such an annuity, though it can be used by any two people who agree to the annuity contract. When used by a married couple, one spouse will receive the income until death and then the other spouse will receive the income until death. The same income is provided to one, and then the other.
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After death of the final annuitant, the annuity is terminated. No payment is made to an estate or beneficiary.
Advisor Remarks: 1. The annuity benefit paid to the annuitant may be a fixed amount or variable amount. A variable amount is received for a life annuity when the contract is a variable life annuity. 2. A life annuity can begin paying its benefit immediately post-application if the contract has been funded with a lump sum. If funding occurs over a period of time by a series of deposits, the annuity benefit begins after the final deposit. This is called a deferred annuity. 3. A life annuity is one of the options available for those with locked-in retirement funds.
Related terms: Life Annuities. Term Annuity.
Last Expenses Last, or final, expenses are those costs that must be paid after death. They are incurred once, not on a continuing basis.
Last expenses include: - the cost of a funeral; - legal costs; - accounting costs; - probate fees; - payment of debt in the name of the deceased, which can include personal loans, student loans, a mortgage, a line of credit, credit card balances, etc.; - income tax; - bequests to individuals or charities.
Advisor Remark: 1. Continuing expenses for survivors are the other form of expenses that must be paid after death of a primary income-earner.
Related topics: Continuing Expenses.
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Law of Agency The law of agency permits a life insurance agent to conduct business with clients on behalf of a life insurance company.
The concept is based on: 1. a principal (this is the life insurance company); 2. an agent (this is the life insurance agent); 3. a third party (this is the client).
The law of agency will be expressed in an agency contract. In that document, the principal establishes a relationship with the agent and gives the agent authority. The agent can then legally bind the principal to a third party.
Related term: Authority
Leveraging Leverage is a word that describes borrowing to invest. The borrowed money is added to the investor’s own funds to increase the total pool of money being invested, therefore: borrowed money + personal money = total to invest. For example, if a client has $5,000 to invest and then borrows $5,000, he has a total pool of $10,000 available for investing.
On the up side, when leveraging works as it is supposed to, the investment increases in value and the borrowed money plus interest is repaid. And, the total return belongs to the investor.
On the down side, leveraging carries a risk because if the leveraged investment declines in value, the borrowed money must still be repaid plus interest. This is why leverage is often described as having a magnifying effect on gains and losses.
Life insurance leverage uses a strategy known as 10-8. A client purchases an insurance policy with a guaranteed 8% rate of return. Meanwhile, that policy is used as collateral to borrow up to 100% of the cash surrender value of the policy at a 10% interest rate, often from the same insurance company.
CRA rules currently allow the interest payments to be deducted from tax if the proceeds of the loan are used to generate income. Deducting the interest reduces the after-tax cost of borrowing from 10% to approximately 5.5% if the taxpayer is in the highest marginal tax bracket.
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Related terms: Cash Surrender Value. Policy Loan. Marginal Tax Rate.
Life Annuities An annuity makes a regular payment, called the benefit, to a person who is called the annuitant. A life annuity pays that benefit for the entire life of the annuitant. Once payments begin, they cannot be stopped and withdrawals cannot be made.
- A life straight annuity guarantees the annuitant a benefit for life. When the annuitant dies, the contract terminates.
- A life annuity with guaranteed payments is provided as “life plus five-year guarantee” or “life plus ten-year guarantee.” If death occurs during the guarantee period, the beneficiary of the contract is guaranteed to receive the balance of what would have been paid during the period. For instance, an annuity that was paid annually for a “life plus ten- year” contract would guarantee ten payments would be made to the annuitant. If the annuitant died after two payments, the beneficiary would receive the equivalent of eight payments.
- A cash refund annuity guarantees the annuitant a benefit for life. If, at the time of death, the amount that has been received as the benefit does not equal the amount that was contributed to the annuity, the difference between amount received and amount contributed is paid to the beneficiary in a lump sum.
- An installment refund annuity is exactly the same as a cash refund annuity except the payment is made to the beneficiary in installments.
- A joint and last survivor annuity is used normally for a married couple. One spouse receives the income until death and then the other spouse receives the income until death. That ends the annuity.
Advisor Remarks: 1. The annuity benefit paid to the annuitant may be a fixed amount or variable amount. A variable amount is received for a life annuity when the contract is a variable life annuity or an index-linked annuity. 2. A life annuity can begin paying its benefit immediately post-application if the contract has been funded with a lump sum. If funding occurs over a period of time by a series of deposits, the annuity benefit begins after the final deposit. This is called a deferred annuity.
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3. A life annuity is one of the options available for those with locked-in retirement funds. 4. A life annuity is a transfer option for those with a Defined Contribution Plan as a company pension.
Related Terms: Term Annuity. Joint and Last Survivor Annuity. Locked-in Plans.
Life Income Funds (LIFs) At the end of the year when a person with a Registered Retirement Savings Plan (RRSP) turns 71, if he or she does not want to receive all the money in the plan as cash, he or she must transfer the money out of the RRSP. Most often, that money is moved into a Registered Retirement Income Fund (RRIF) so that tax deferral can continue.
Someone who has a Locked-in Retirement Account (LIRA) or a Locked-in RRSP must also transfer their money from these accounts by the end of the year when they turn 71. A Life Income Fund is one of the choices available to them.
There are many similarities between a Registered Retirement Income Fund and a Life Income Fund. Both plans have: - a minimum annual withdrawal requirement; - the same options available upon death of the plan owner, such as a tax-free roll-over to a spouse’s RRSP, RRIF, or life annuity; - a withholding tax applied on withdrawals above the minimum; - a choice of investment options.
A LIF can be opened at any age in Quebec, New Brunswick, and Manitoba. In other provinces, it cannot be opened before the age that the account owner would receive normal pension benefits. This can be as young as 50 in Alberta, or 55 in other provinces.
Only LIFs have a maximum that can be withdrawn each year. And LIFs require the spouse of a plan owner to waive their rights to a joint and last survivor annuity. Some provinces require conversion of the LIF to a life annuity by a certain age.
Advisor Remarks: 1. A variation on the Life Income Fund is available for those who worked in Ontario, Manitoba, or Newfoundland and Labrador. It is the Locked-in Retirement Income Fund (LRIF). It does not require conversion to an annuity at age 80, and is otherwise very similar to a LIF.
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Related Terms: Locked-in Plans. Life Annuities. Prescribed Retirement Income Funds (PRIFs). Locked-in Retirement Income Funds (LRIFs).
Locked-in Plans Locking-in of funds is required in two circumstances: 1. When a person with a registered pension plan through his employer has worked for that employer for more than two years, the contributions made during those two years are considered vested. That means the money will be in the control of the employee if he leaves that employer --- whether he is fired or quits. However, since the government makes the laws that govern registered pension plans, government rules dictate that the employee must use the vested money to provide a retirement pension. To ensure this happens, the money is locked-in (or inaccessible) until retirement age.
2. An employee with a defined contribution plan (DCP) is required to transfer his pension from his employer to a locked-in plan when he or she retires.
An employee with locked-in funds who continues to work can transfer the funds to the pension plan of the new employer. Those who have locked-in funds but are not retiring can use a Locked- in Retirement Account (LIRA) or Locked-in Retirement Savings Account (Locked-in RRSP) with a financial institution. Funds in both accounts grow on a tax-deferred basis. Those who are retiring can move their funds to a LIRA or Locked-in RRSP (until they turn 71). They also have the option of a Life Income Fund.
By the end of the year the locked-in account owner turns 71, the funds in the LIRA or Locked-in RRSP must be transferred to another account --- similar to the transfer of an RRSP to a RRIF, or to a life annuity. Such accounts are the: - Life Income Fund - Prescribed Retirement Income Fund (PRIF) - Locked-in Retirement Income Fund (LRIF) Advisor Remarks: 1. Locked-in funds are protected from creditor claims. 2. A LIRA is also known as a Locked-in RRSP depending on the province that administers the plan. 3. Contributions cannot be made to locked-in plans by their account owner. They are funded completely by the transferred contributions from a former registered pension plan.
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Related Terms: Registered Pension Plans (RPPs). Locked-in Retirement Accounts (LIRAs). Life Income Funds (LIFs). Prescribed Retirement Income Funds (PRIFs). Locked-in Retirement Income Funds. (LRIFs).
LLQP (Life Licence Qualification Program) The LLQP is the study program that must be completed in order to obtain a life insurance sales licence in all provinces except Quebec.
The content of the program is specified in the Design Document available through the Canadian Council of Insurance Regulators. The program covers insurance, investments, and retirement. Providers of the program are certified once they have met requirements that their study program satisfies all learning objectives in the Design Document. There are about 10 active providers of the program, but some of those only provide the program to their own “hires,” such as London Life, or Primerica. Provider pass rates vary; those with the highest pass rate do not necessarily offer the best study program since a high pass rate can be the result of who enrolls with that provider.
Study programs are, for the most part, self-study. The student then must pass a Certification Exam or be otherwise “certified” by the provider that he or she has successfully attained the knowledge needed in order to take the provincial exam. The student takes his or her Certificate to an exam centre with acceptable ID. Durham College administers the exam through exam centres across Canada (with the exception of Quebec which has its own licensing system). The 140- question four-hour provincial exam can be taken online or in print; the pass mark is 60%. The exam is an endurance test: there are no breaks allowed for any reason (without a doctor’s note). A student who has passed the provincial exam may then be sponsored by an insurer to acquire his or her provincial sales licence. It is not necessary to write the provincial exam for each province in which the agent wants to work since the program is nationally recognized; once a student passes one provincial exam, that is sufficient in all other LLQP jurisdictions.
A student who has passed the LLQP receives no designation and may not advertise that he or she has completed the LLQP.
Advisor Resources: Canadian Council of Insurance Regulators, LLQP Design Document: http://ccir- ccrra.org/en/init/LLQP/LLQP_Des_Doc_changed_Jan_12_2009.pdf CLIFE, Which training company is best? http://clifece.com/index.php/component/content/article/36/65- become-an-insurance-agent#best%20company
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CLIFE, The LLQP Dictionary, http://www.llqpdictionary.com Durham College: http://www.durhamcollege.ca/llqp/main.php?lang=eng
Related Terms: Chartered Life Underwriter, Certified Financial Planner
Locked-in Retirement Accounts (LIRAs) Most employer-provided pensions are either a defined benefit plan (DBP) or defined contribution plan (DCP). When a member of either of these plans quits or is fired from the company, he or she can take with them all contributions made after the first two years of employment. One option for the transfer of that money is a Locked-in Retirement Account (LIRA).
And, when a member of a defined contribution plan retires, he or she must transfer out the value of his or her plan and a LIRA is a choice available to them.
A LIRA is also known as a Locked-in RRSP. The Pension Benefits Act of the province that regulates the plan chooses the term it will use.
The funds in a LIRA can be invested in many different ways, and investments can be changed as the account owner desires. There is no annual taxation of the value of the LIRA.
Withdrawals cannot be made from the LIRA unless the account owner faces extreme financial hardship, a shortened life expectancy, is no longer a resident of Canada, or the value of the fund falls below a specified amount.
The funds in a LIRA must be transferred out of the LIRA by the end of the year in which the account owner turns 71. Transfer options include a: - life annuity - Life Income Fund (LIF) - Prescribed Retirement Income Fund (PRIF) - Locked-in Retirement Income Fund (LRIF)
Advisor Remarks: 1. It is not where the pension member lives that determines pension plan rules; it is the province where the plan is registered that determines the rules. This is true of all pension plans. 2. Those who receive a pension governed by the Employment Pension Plans Act in Alberta can unlock up to 50% of a LIRA under certain circumstances.
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Related Terms: Locked-in Plans. Life Annuities. Life Income Fund (LIF). Prescribed Retirement Income Fund (PRIF). Locked-in Retirement Income Fund (LRIF).
Long-term Care Insurance (LTC) Long-term care (LTC) insurance addresses the need to pay for care as a person ages and is no longer able to live completely independently.
Care may come in many forms: at home, in a nursing home, at an adult day care centre, or in a hospice.
LTC is an important insurance product because people are living longer at advanced ages, and it can be very expensive to buy care that is needed in later life. Therefore, an LTC policy saves an insured from paying for care, and this leaves more money in the person’s estate.
An application can be made for LTC between the ages of 21 and 80.
The benefit can be received as reimbursement of expenses or as income. It is not a lump sum. The benefit will be received when there is an impairment in thinking, or the insured cannot perform two of the activities of daily living (called ADLs). The ADLs are: eating, dressing, bathing, toileting, maintaining continence and moving the position of the body. The benefit of the policy will be paid after a waiting period. - Reimbursement claims must be supported with evidence of expenses paid.
Premiums paid for a personal policy are not tax deductible and benefits are not taxed.
LTC Insurance is also available through a group plan. Premiums may then be considered a medical expenses; the group plan administer will make this determination.
Advisor Resources: Canada’s Long-term Care Crisis and Its Insurance Solution, CLIFE, www.CLIFEce.ca The Long-term Care Planning Network: http://www.ltcplanningcentral.com
Advisor Remarks: 1. An impairment in thinking is called cognitive impairment. Cognitive impairment generally refers to a loss of mental capacity, as demonstrated by a loss of short or long-term memory, orientation (to people, place or time), deductive or abstract reasoning, or judgment relating to safety awareness.
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2. Riders are available on the policy including a return of premium rider that will refund premiums is a claim is not made within a specified time. 3. LTCI is a living benefit insurance product.
Related Terms: Estate. Accident and Sickness Insurance.
Long-term Disability (LTD) Long-term disability is a form of disability insurance coverage in a group plan.
Benefits will be paid: - after a four-month to 52-week qualifying period (or qualification period). During this period, the employee will receive a benefit from a short-term disability plan, or employment insurance (EI); - when the definition of disability is satisfied; - as a percentage of pre-disability income; - to age 65.
LTD uses two definitions of disability. 1. Own occupation. This is often used for the first 24 months of LTD. Disability exists when the physical or mental impairment of the employee, due to injury or illness, prevents them from performing the regular duties of their occupation.
2. Any occupation. This definition is used if the physical or mental impairment of the employee, due to injury or illness, continues after 24 months of inability to perform his or her own occupation. Essentially, it broadens the type of work a disabled person could perform by expecting the person to assume the regular duties of any occupation for which they are suited, or may reasonably become suited to perform based on education, training and experience.
The tax on the benefit depends on who has paid the premium. If the employee paid the LTD premium, the LTD benefit is tax-free. If the employer paid the premium, the benefit is taxable to the employee.
Advisor Remarks: 1. The definitions of disability for LTD are different from the definitions used in a personal policy.
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2. LTD benefits paid under a group plan can be reduced by “offsets”. See the term Offset for a full description. 3. This is a form of insurance that provides a “living benefit.”
Related Terms: Group Disability Insurance. Short-term Disability. Offset.
Marginal Tax Rate In its most simple explanation, perfectly suitable for everyday use, the marginal tax rate (MTR) is the rate at which a Canadian taxpayer pays income tax.
The taxable income of the taxpayer is determined for income tax and then the relevant marginal tax rate is applied. The rates as of 2012 are 15%, 22%, 26%, and 29%. The rates have been known to change (usually increase) and every year the amount of income on which the rates are based is adjusted upwards. This means: - if income stays the same or decreases, the taxpayer may end up in with a lower MTR, or - if income increases, more tax may have to paid if the new income moves the taxpayer up to the next rate level.
The marginal tax rate of the taxpayer is key to determining estate taxes. MTR can be lowered by tax deductions, such as those received by RRSP contributions, and to a lesser extent by tax credits.
The marginal tax rate is also used when determining related taxes, such as capital gains tax (which is 50% of the capital gain multiplied by the MTR of the investor).
Advisor Resources: Canada Revenue Agency : http://www.cra-arc.gc.ca/menu-eng.html Tax Planning for You and Your Family 2012, KPMG, Carswell: http://www.carswell.com/description.asp?docid=8187&promo=64155
Advisor Remark: 1. A life agent should not advise on tax issues or calculate taxes for a client; this should only be done be a tax expert, such as an accountant.
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Related Terms: Income Tax. Capital Gains.
Maturity Guarantee A maturity guarantee applies to a segregated fund (seg fund) contract. It is one of two seg fund guarantees: the other one is the death benefit guarantee. Together, they are called the principal guarantee.
The maturity guarantee means that when the 10-year seg fund contract ends, the contract owner (note, not the beneficiary) receives either 75% or 100% of the deposits he has made. The seg fund contract specifies 75% or it specifies 100%; the contract owner gets the guarantee offered for the fund selected.
At the end of 10 years, if the value of the contract is more than what would be received as the guarantee, then the investor receives that (greater) value.
In other words, the maturity guarantee is a minimum that will be received after 10 years regardless of the actual account value.
The amount received as a maturity guarantee can be: - increased by contract reset; - increased by ongoing deposits - decreased by making withdrawals from the contract.
Example: Single deposit to seg fund: $10,000 with a 75% guarantee 1. Account value at end of 10 years = $6,200 Amount received at end of 10 years = $7,500 2. Account value at end of 10 years = $8,500 Amount received at end of 10 years = $8,500
Advisor Remarks: 1. All segregated fund contracts provide a maturity guarantee. 2. Very few insurers now offer a 100% maturity guarantee; 75% is the norm. 3. The maturity guarantee benefit is the sum paid by the insurer if the contract at maturity is worth less than the 75% or 100% guarantee.
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4. The maturity guarantee only applies if the contract is kept for the full 10 years. Early termination negates the guarantee. 5. If a withdrawal is made from the contract during its 10-year term, the maturity guarantee is adjusted based on the amount remaining in the contract.
Related Terms: Segregated Funds. Policy-based Guarantee. Deposit-based Guarantee. Reset.
Maximum Tax Actuarial Reserve (MTAR) The maximum tax actuarial reserve (MTAR) is a limit that separates a tax-exempt life insurance policy from a taxable policy.
The MTAR limit is defined by Revenue Canada. It is the maximum amount of growth permitted in the policy as weighed against actual life insurance costs.
In order to correctly identify the MTAR for a policy, the insurer that has issued the policy creates a hypothetical policy based on all the parameters of the real policy. This “test” policy is used as a benchmark. Then the real policy is compared against the benchmark. If policy growth is less than the identified MTAR limit, the policy is tax-exempt.
Only policies with cash values are tested; universal life policies are of most interest because of their investment account within the policy and therefore, the most potential for gains.
The policy test is done annually before the anniversary of the policy. Insurers warrant policies will remain tax-exempt; only exceptional circumstances could cause the MTAR limit to be exceeded. If it is, action will be promptly taken to bring the policy back in line so that it continues to be tax- exempt.
Advisor Remarks: 1. A life agent should not advise on tax issues such as the MTAR. 2. It is important to understand that the MTAR exists so that a policy owner can be made to understand that growth within a policy is limited, and this distinguishes a policy from pure investment. Related Terms: Grandfathered Policies. Universal Life Insurance. Taxation of Life Insurance.
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Misrepresentation Misrepresentation occurs when a person makes a statement that is not supported by fact. Misrepresentation is willful, intentional, and performed with the full knowledge of the person making the statement that the information is not true.
For instance, a life insurance applicant who declares no health problems on the application when he knows he has terminal cancer has made a misrepresentation.
If a misrepresentation occurs that is material to the risk being insured against (such as cancer being a material risk to life insurance), and the true information would have influenced the insurer issuing the policy, the insurer has the right to cancel the policy or deny a claim.
It is essential that neither a prospective policy owner nor a life insurance agent misrepresent information to an insurer.
Advisor Remarks: 1. A material fact is significant information that influences a course of action. 2. Ensure you understand the difference between a mistake and misrepresentation.
Related Term: Mistake.
Mistake A mistake occurs when a person makes a statement that is unintentionally wrong, an omission, or an error.
For instance, a life insurance applicant who declares no health problems on the application even though he has terminal cancer, of which he is unaware, has made a mistake.
If the insurance company then proceeds to issue the policy, a mutual mistake would have been made.
A life insurance policy may be made invalid by a mistake.
If the mistake is minor, and would not have affected the decision of the insurer to issue the policy, the policy may be amended.
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Advisor Remarks: 1. A mistake is based on unintentionally providing wrong information or unintentionally failing to provide information. 2. Ensure you understand the difference between a mistake and misrepresentation.
Related Term: Misrepresentation.
Money Laundering Life insurance agents are required by law to be aware of their obligations under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act. This is the legislation created by the federal government to address money laundering and terrorist financing.
The agency charged with developing operational guidelines around the Act in addition to many other activities is called the Financial Transactions Reports Analysis Centre of Canada or FINTRAC for short.
All life agents should read the FINTRAC guidelines and keep themselves up to date on changes to the Act and guidelines.
Money laundering “red flags” are those activities that an agent must learn to recognize as being behaviour that causes suspicion of possible money laundering. Such red flags would be cited if a client attempted a cash purchase of a product, or there was a question about the legitimacy of identification being used by a possible client.
Agents must be able to prove that they are compliant with all the requirements of the Act.
Agent Resources: FINTRAC: http://www.fintrac.gc.ca The Requirements for a FINTRAC Compliant Practice, CLIFE, www.CLIFEce.ca Establishing a FINTRAC Compliant Practice, CLIFE, www.CLIFEce.ca How to Survive a FINTRAC Audit, www.CLIFEce.ca
Morbidity Disability income is based on the morbidity rate for the insured --- in other words, what is the likelihood that the insured is going to make a disability claim?
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Life insurance is based on the mortality rate for the life insured --- in other words, when is the life insured likely to die?
The morbidity rate for the insured in large part determines the premium for the policy.
Morbidity is determined as the result of analyzing many factors for a proposed insured including: - his or her age with older prospects facing higher rates than younger prospects; - if the insured is a man or woman. Women have a greater chance of being disabled and therefore have a higher morbidity rate. - Whether the insured smokes, because smokers have a higher morbidity rate than non- smokers. - The job of the insured. This is called his or her occupational classification. Basically this classification assigns a higher risk to those who work at unskilled jobs. On the other end of the scale, professionals who can satisfy certain criteria are considered the lowest risk for disability.
Advisor Remark: 1. Other factors in addition to morbidity that will be used to assess the premium for a disability policy include the claims history of the proposed insured, and what is determined to be his or her stability and motivation.
Related Terms: Occupational Classification. Mortality.
Mortality A life insurance premium is largely based on the mortality rate for the life insured --- in other words, when is the life insured likely to die?
Mortality rates are determined by mortality tables. These tables show, by age, the probability that a person of that age will die before their next birthday.
Many mortality tables are created based on factors such as gender, health, and whether the life insured smokes.
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This is why detailed information is taken on the application. The underwriting department of the life insurer will want to be certain that the correct mortality rate is being used for the proposed life insured.
Advisor Remark: 1. Disability income is based on the morbidity rate for the insured --- in other words, what is the likelihood that the insured is going to make a disability claim?
Related Terms: Morbidity. Underwriting.
Mortgage Insurance Mortgage insurance is a form of life and disability insurance made available by a financial institution to a person taking out a mortgage with that institution. It cannot be a requirement for the person acquiring the mortgage although it may appear so for the inexperienced or first-time mortgagee. The amount of coverage declines in step with the mortgage. Rates are significantly higher than for an equivalent amount of term life insurance. Also, if the mortgagee changes mortgage-providers, a new mortgage policy will need to be acquired.
Personnel at financial institutions who sell mortgage insurance are not insurance licenced.
Related Term: Term Insurance.
Mutual Funds A mutual fund is an investment. It is created by a mutual fund management company. The company, called the manager, designs types of mutual funds based on how the money in each fund will be invested. If the money will be invested in real estate, for example, then the fund will be a real estate fund. If the money will be invested in the stocks of public companies, the fund will be an equity fund.
Funds are further characterized by where in the world the money will be invested. For instance, if the equity fund will be buying stocks of companies located in China, Korea, or Japan, then it will be called an Asia-Pacific Equity Fund (or similar geographical description). Fund details are contained in the simplified prospectus and fund fact sheets; segregated funds provide disclosure in their Information Folder.
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Investors deposit their money with the management company. These deposits create a pool of money. It is used by the management company to acquire investments according to the type of mutual fund, such as equity or real estate, and the investment objective and risk tolerance of the investors.
Each investor receives a number of units in the fund proportionate to their investment. The fund manager determines the value of each unit. As the pool of investments held in the fund increase in value, the investor receives more units. Or, if value decreases, the number of units decreases. In comparison, the value of “notional” units of a segregated fund increase and decrease while the number of units owned by the investor stays the same. There are no guarantees about the future value of a mutual fund.
The investor pays a sales fee, or load, to buy into the fund and an annual management fee to the fund manager for their professional services in overseeing the fund. It is usually expressed as a percentage of their total unit value – such as 2%.
Advisor Remarks: 1. Investment objectives for mutual funds include safety, growth, and income. Balanced funds strive to deliver all three objectives. 2. Mutual funds are available across the spectrum of risk: from extremely risky to very safe. 3. Life insurance agents cannot sell mutual funds to their clients. However, they may obtain a mutual fund sales license and they are then permitted to sell mutual funds. 4. Mutual funds can be purchased inside a registered account, such as an RRSP or RESP, where tax will be deferred until money is withdrawn. 5. The management fee is called the management expense ratio, or MER.
Advisor Resources: Mutual fund self-regulatory organization: http://www.mfda.ca; Association of independent dealers: http://www.fmfd.ca Licensing: IFSE, https://www.ifse.ca/Site/ProcessPage.aspx?SID=879BAE7D-1F85-4A98-B2AF- CE80C130B198&ID=CC8B8319-4C20-4A4F-9095-411512807740&SID=879BAE7D-1F85-4A98-B2AF- CE80C130B198&P=1a and The Canadian Securities Institute, https://www.csi.ca/student/en_ca/courses/csi/ifc.xhtml?cid=ga- ifc5&gclid=CKCckq29xq4CFSQCQAod3D9vXw
Related Terms: Segregated Funds. Risk Tolerance. Notional Units.
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Needs-Based Sales Approach Fundamental to life insurance sales is the ability of the sales agent to determine correctly both the most suitable product based on the client’s needs, and the amount of coverage. It is important that all is disclosed to the client, that the client understands what he or she is purchasing, and the amount of coverage is neither too little nor too much.
Failure to recommend an appropriate product or an appropriate amount of insurance coverage can lead to liability claims by dissatisfied clients. Documentation of advisor recommendations is essential in case a client asserts unsuitability.
Needs are determined in the fact finding interview conducted by the agent. The agent will record the information provided by the client and use it as a basis for recommendations.
Although proprietary software programs will determine “how much” insurance is needed, LLQP students have learned two approaches to determining need: - Capitalization of income is based on the concept that the death benefit of a life insurance policy will be invested at a set interest rate and the annual interest paid on that sum will equal the income lost with the life insured dies. It is calculated as: income of life insured divided by today’s interest rate. - Capital Retention Approach is based on the concept of dividing ongoing expenses by today’s interest rate, adding final expenses and subtracting from that sum the cash that is immediately available to meet expenses. This sum becomes the investable amount; interest it earns pays the ongoing expenses of survivors.
Advisor Resources: The Approach, CLHIA: http://www.clhia.ca/domino/html/clhia/CLHIA_LP4W_LND_Webstation.nsf/resources/Financial+Ad visors/$file/The_Approach_RefDoc_EN.pdf
Net Cost of Pure Insurance The net cost of pure insurance (NCPI) is the mortality charge for the insurance portion of a life insurance policy. It applies to policies issued since December 1, 1982.
The NCPI in a policy will increase every year in step with the increasing age of the life insured.
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NCPI enters into the calculation of the adjusted cost basis (ACB) of a policy: ACB = premiums NCPI
Therefore, NCPI affects taxable gain of a policy loan and the taxable portion of a withdrawal, since ACB is used in both these calculations.
The NCPI does not affect the death benefit.
Advisor Remarks: 1. An agent will never be required to determine NCPI.
Related Terms: Mortality. Adjusted Cost Basis. Grandfathered Policies.
Non-forfeiture Options When the owner of a whole life insurance policy pays his or her premiums, a portion of the premiums are set aside by the insurance company in a cash reserve. An owner who is no longer able or willing to pay premiums has the option of terminating the policy by taking the cash surrender value (CSV), or has three choices to continue the policy. The money in the cash reserve provides these choices. They are called non-forfeiture options.
1. So that insurance coverage is not immediately terminated as it is with taking the CSV, the policy owner can stop paying premiums and the automatic premium loan (APL) continues premium payments on his behalf. The APL uses the cash surrender value of the policy to pay premiums. Once the CSV is used by the final premium, there is a 30 or 31-day grace period. If the life insured dies during the grace period, the death benefit (minus amount taken from the CSV and interest) will be paid to the beneficiary. But, if the premium is not paid during the grace period, the policy is finished and the policy owner receives no money because no CSV exists.
2. To permanently eliminate the whole life premium, a policy owner can use the CSV of the policy as a lump-sum premium to buy term life insurance. This is called extended term insurance or ETI. The face amount of the ETI policy is the same as the original whole life policy. However, the term of the ETI policy will be based on the age of the life insured (called attained age) when this option is used.
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3. Another permanent measure to eliminate premium payments is to use the CSV of the policy as a lump-sum premium to buy a whole life insurance policy. This is called reduced paid-up insurance or RPU. The face amount will be less than the original policy but coverage is lifelong. This “miniature” policy has its own CSV but does not pay dividends.
Advisor Remarks: 1. Non-forfeiture options means the policy is not immediately forfeited (given up) as it is when the cash surrender value is taken. 2. Reduced paid-up insurance (RPU) continues to provide permanent insurance coverage of the life insured. 3. Neither the extended term insurance option nor the reduced paid-up insurance option requires ongoing premium payments. This may be a solution for those who either took out too much insurance coverage when the application was made or for those whose financial circumstances have changed since application. 4. Taking the CSV, a policy loan, or using non-forfeiture options may mean the policy owner must pay tax.
Related Terms: Whole Life Insurance. Cash Surrender Value. Term Life Insurance.
Notional Units A notional unit is a representation of ownership in a segregated fund. Unlike mutual funds that carve their pool of assets into units owned by investors, the assets of a segregated fund are owned by the insurance company that has issued the fund.
The notional units are created to give seg fund investors: - a way to monitor growth; - a way to compare growth of the notional units of one fund against other notional units of seg funds or mutual funds units.
The notional units are also the means by which growth is allocated, or distributed, by the insurer. An investor, therefore, receives growth on each notional unit based on investment performance. He or she receives the growth based on the period of time during the year that notional units were held. This is described as time-weighting. A full year would see 100% of growth allocated; six months would see 50% of growth allocated.
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Advisor Remark: 1. When a distribution of investment growth is made, the value of each notional unit increases. In a mutual fund, unit prices are fixed so when a distribution of growth occurs, the investor receives more units in the fund.
Related Terms: Segregated Fund. Mutual Funds.
Occupational Classification Although occupation of a life insured---in other words, how the life insured is employed---is a factor considered by life insurance underwriters, occupational classification is a key consideration of disability income insurance underwriters.
In Canada, The National Occupational Classification (NOC) is the nationally accepted reference on occupations. It organizes over 30,000 job titles into 520 occupational group descriptions. Underwriters use the NOC to create five classifications that are the basis for disability insurance premiums.
- Those who work outdoors as manual labourers using heavy machinery or equipment are considered the greatest risk for claims. They are most likely to be disabled due to their work and working conditions, and have the highest rate of morbidity. The morbidity rate is the likelihood that the insured is going to make a disability claim. These workers are classified as “level one” on the scale of occupational classification. - Select professionals are at the other end of the scale, such as lawyers, doctors, and dentists. They are considered very unlikely to make a claim. They are classified as “level five.” - In between, the scale classifies workers according to the risk they represent in terms of making claims.
Advisor Remark: 1. Some occupations are too risky and the insurance company will turn down an applicant with such an occupation.
Related Terms: Morbidity. Disability Income Insurance.
Offset Offset describes the use of other disability benefits to reduce the long-term disability (LTD) benefit that would be paid to a disabled group insured.
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In effect, these other providers of benefits become the first payors. The LTD plan pays second, and is known as the second payor.
The group insured receives the benefit from the first payor. The amount contributed by the first payor(s) is subtracted from the LTD benefit entitlement. The balance of the LTD benefit is then paid.
Example: LTD benefit entitlement: $1,000/mo. Payment by first payor: $400/mo Payment by LTD: $600/mo
First payors include: - The Canada Pension Plan/Quebec Pension Plan - Workers’ Compensation (if the injury or illness was caused at work) - Auto insurance (in some cases)
Offset may also be created by benefits received from sources such as a retirement pension.
Offsets contribute to what is called the all sources maximum. The all sources maximum accounts for all income earned during long-term disability. It is a dollar limit to how much an insured can receive. If an insured receives more than the maximum, insurers believe a disabled person loses the incentive to return to work.
Advisor Remarks: 1. The definitions of disability for LTD are different from the definitions used in a personal policy.
Related Term: Long-term Disability Plans.
Old Age Security (OAS)
Old Age Security is the retirement pension received by every Canadian (Excluding those who are serving time in a jail or prison for a sentence longer than two years) at age 65 who meets the criteria for residency. As of 2012, the federal government proposes to raise the age to 67.
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The pension is paid as either a full pension or partial pension.
The pension is paid monthly. The pension keeps pace with inflation as measured by the Consumer Price Index (CPI), and is adjusted in step with the CPI every January, April, July, and October.
The amount received as the pension is taxed as if it had been earned as income.
It is possible that a person receiving the pension has an income that is higher than what is called the OAS threshold amount. This could happen because, for instance, they continue to work, or make large withdrawals from their RRSP or RRIF. If a person’s income is greater than the threshold amount, then he or she must repay part of the OAS that was received. The threshold amount increases every year. The repayment is calculated as: (Income minus threshold) multiplied by 15% This used to be called the OAS clawback, but is now called repayment.
If repayment is required when income tax is calculated for the year, the OAS pension in the following year will be reduced. This is called a Recovery Tax.
Advisor Resource: Service Canada: http://www.servicecanada.gc.ca/eng/sc/oas/pension/oldagesecurity.shtml
Related Term: Canada Pension Plan.
Participating Whole Life Insurance The policy owner of participating, or “par,” whole life insurance has a life insurance policy that may pay dividends. The choice to make the policy a “par policy” and receive dividends is made on the application. Premiums are higher for a par policy.
The dividends are not paid in the first year of the policy. They begin after the first premium has been paid in the second year. They are not guaranteed!
Dividends can be paid by cheque annually to the policy owner, left on deposit with the insurer where they receive interest just like a savings account, or invested with the insurer in segregated funds that the insurer offers.
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Dividends can also be reinvested with the insurer to increase insurance coverage on the life insured. This occurs via: - Paid-up additions (PUAs). A PUA is an addition to the base policy. It increases the amount of life insurance coverage but doesn’t need premiums because the premium has been paid by the dividend. PUAs can be surrendered individually without affecting the base policy, and received as cash or used to make premium payments.
- Term additions. A one-year term policy whose premium is paid by the dividend; its face value is received by the beneficiary if the life insured dies during the year in addition to the face value of the base policy. - Special term addition. A one-year term policy equal to the cash surrender value at year- end.
Advisor Remarks: 1. A participating whole life insurance policy owner may receive dividends. A non-par whole life policy owner does not receive dividends. 2. When dividends are reinvested with the insurer to buy more life insurance, life insurance coverage then can, for instance, keep pace with inflation and rising needs. 3. Premiums are more expensive for participating whole life than for non-participating whole life. 4. Dividends are often associated with premium offset or “vanishing premiums.” Such strategy must be handled judiciously so as not to create an expectation by the client that premiums will not be required.
Related Terms: Whole Life Insurance. Term Life Insurance.
Permanent Life Insurance Permanent life insurance is life insurance in force for the entire life of the life insured. It does not end according to a date, age, or any factor other than death.
There are basically three types of permanent life insurance: - Whole life insurance. Provides benefits to the policy owner in addition to life insurance. Whole life insurance creates a cash reserve from a portion of the premium payments. The cash reserve makes a cash surrender value available to the policy owner that is received if the policy is sacrificed. It also creates non-forfeiture values or benefits (the automatic premium loan provision, extended term insurance option, or the reduced paid- up insurance option). Whole life insurance is also available in a form in which dividends
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may be received from the life insurance company. This is called a participating or “par” policy.
- Universal life (UL) insurance. Like whole life insurance, UL has a cash reserve. However, only UL policies direct a portion of each premium to an investment account. Numerous investment options are available to the policy owner. UL policies offer flexible premiums and insurance options.
- Term-to-100 (T-100) life insurance. A permanent policy that requires no additional premiums after age 100. T-100 often does not provide any benefits beyond life insurance coverage, such as cash surrender value.
Advisor Remarks: 1. T-100 is the most basic form of permanent insurance. It does not provide the benefits of other forms of permanent life insurance. 2. Universal life insurance is the most complex of the three forms of insurance. The policy owner must understand fully his obligations to monitor investments and insurance. 3. Whole life insurance provides security without ongoing policy owner decision-making (other than to pay premiums). 4. Riders are available on all three types of permanent insurance.
Related Terms: Whole Life Insurance. Universal Life Insurance. Term-to-100 Life Insurance. Non-forfeiture Options.
Personal Contract A personal contract exists in life insurance policies when the policy owner and the life insured are the same person.
A disability insurance policy only allows the insured to be the policy owner; there is no possibility of one person insuring the health of another.
Contrast a personal policy with a third-party life insurance contract, in which the policy owner and life insured are two separate people. A third-party contract bases the premium on the life insured, and his or her mortality rate. Separate underwriting may be performed on the financial ability of the policy owner to pay premiums. If it appears that overinsurance is indicated on an application
93 Fundamentals of Canadian Life Insurance for a life insured, and the requested amount of insurance cannot be supported by the need for such insurance, it may be denied.
By a similar measure, the amount of life insurance a person puts on their own life must be supported by facts of need. It is not possible for a person to insure himself or herself for a vast sum of money if nothing supports that assertion. Insurers assess coverage, and any limitations manage their risk.
Advisor Remark: 1. When life insurance is associated with a registered account, such as an RRSP, then the policy must be a personal contract.
Related Term: Contract.
Policy-based Guarantee
A segregated fund contract is funded by a lump sum or on-going deposits, and the money is invested for a ten-year term. When on-going deposits are made, the contract offers two ways to apply the ten-year term. One way is on the basis of deposits made (called a deposit-based guarantee) and the other is on the basis of the policy (called a policy-based guarantee).
A policy-based guarantee is also known as a contract-based guarantee. The maturity date is established by the initial deposit. Subsequent deposits do not change the maturity date but the guarantees will increase during the 10-year period due to deposits.
A deposit-based guarantee means that each deposit will have its own ten-year period to maturity. The initial deposit establishes the first maturity date. Every subsequent deposit matures ten years from the date of that deposit. Therefore, if the initial deposit is made May 2, the maturity period for that deposit is ten years later, on May 2. If the next deposit is made May 5, that deposit matures on May 5 in ten years’ time.
Both guarantees increase the value of the maturity and death benefits since those benefits (75% or 100%) are recalculated on a higher amount due to the deposit(s).
Advisor Remark: 1. Guarantees provide security to contract owners.
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Related Terms: Segregated Fund. Deposit-based Guarantee. Maturity Guarantees.
Policy Dividends A policy owner who has a participating, or “par,” whole life insurance policy may receive policy dividends.
Dividends are not paid in the first year of the policy. They begin after the first premium has been paid in the second year. Dividends are never guaranteed to be paid.
Dividends can be: - paid by cheque annually to the policy owner, or - left on deposit with the insurer where they receive interest just like a savings account, or - invested with the insurer in segregated funds that the insurer offers, or - reinvested with the insurer to increase life insurance coverage on the life insured.
When dividends are reinvested in order to increase life insurance coverage, they are used to buy: - Paid-up additions (PUAs). - Term additions: a one-year term policy whose premium is paid by the dividend; its face value is received by the beneficiary if the life insured dies during the year in addition to the face value of the base policy. - Special term additions: a one-year term policy equal to the cash surrender value of the base policy at the end of the policy year.
Advisor Remarks: 1. The policy owner pays a higher premium for a par policy for the right to receive dividends. 2. Life insurance dividends are not the same as dividends received from investing in stocks. Dividends paid to the owners of stocks are a distribution of a portion of company profits. 3. Stock dividends are only paid when the board of directors of the company declares a dividend. They are not guaranteed and that is their only similarity to life insurance dividends.
Related Term: Participating Whole Life Insurance.
Policy Loan A policy loan is like a bank loan, except it is a loan taken by the policy owner from a life insurance company. The cash surrender value of a whole life policy or universal life policy is used as collateral for the loan.
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The maximum amount that can be taken as a policy loan is 90% of the policy’s cash surrender value. The life insurance company charges interest on the loan at rates competitive to other lending institutions.
If a loan is greater than the adjusted cost basis (ACB) of the policy, then the amount that exceeds the ACB will be taxed unless the loan is repaid in the same calendar year.
The adjusted cost basis is the sum of money that represents: the amount of premiums that have been paid minus a charge that represents the cost of life insurance (This cost is called the net cost of pure insurance.) minus dividends that have been received
Therefore, if a loan is taken for $10,000 and the ACB is $12,000, no tax will be owed. However, if a loan is taken for $10,000 and the ACB is $8,000, then $2,000 will be taxable if not repaid in the first year of the loan.
Advisor Remarks: 1. Only whole life insurance and universal life insurance policy owners are able to take policy loans. A term life policy owner could take his or her policy to a bank for a bank loan and use the term policy as collateral. This is called a collateral assignment. 2. A policy owner who has named an irrevocable beneficiary must have the permission of the beneficiary to take a loan.
Related Terms: Face Page. Adjusted Cost Basis.
Pooled Registered Pension Plans (PRRPs) The Pooled Registered Pension Plan is the newest form of retirement pension arrangement to be introduced by government.
PRPPs are designed for smaller companies, and the self-employed. Since contributions are pooled, plan members will benefit from the lower investment management costs associated with the scale of these funds.
There will be two classes of members eligible to participate:
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- Employed Members will include employees of an employer that offers a PRPP; - Individual Members will include the self-employed and employees of an employer that does not offer a PRPP.
While investments will be common across all members, there will be certain administrative and regulatory differences between the two classes. When an employer offers a PRPP, its employees may be enrolled in the plan and contributions will be made at a default level set by the employer. Individual Members will have to make a choice on their own on whether to join. Employer contributions will be locked-in under PRPPs. Contributions will also be made by employees.
Advisor Resource: Department of Finance Canada: http://www.fin.gc.ca/n11/data/11-119_2-eng.asp
Advisor Remark: 1. PRRPs are a defined contribution plan. This means contributions are deducted from RRSP contribution limits and that the retirement pension will be a result of contributions and investment performance.
Pre-existing Condition A pre-existing condition is a health ailment that existed before the application for insurance was made, or is in existence at the time the application is made.
The applicant may no longer have symptoms from the ailment but if a full health history is being taken, then he or she must disclose any and all pre-existing conditions since they may be considered material to the policy.
A pre-existing condition can be handled by: - denying the policy; - temporarily or permanently exclude claims that arise from the condition.
An applicant who fails to reveal a pre-existing condition could have made a mistake or a misrepresentation.
Advisor Remarks: 1. If an agent learns of a pre-existing condition at the time of application or policy delivery, he or she must disclose the information to the insurer. If the policy has not been delivered, it should be returned to the insurer.
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2. The Medical Insurance Bureau or MIB would be a source of information about health conditions that would affect the policy.
Related Terms: Exclusions. Mistake. Misrepresentation.
Premium The premium is the payment made by the policy owner (also called the insured) to the life insurance company.
The payment may be made monthly, every three months (called quarterly), every six months (called semi-annually), or once a year (called annually).
The premium can be paid in a lump sum when a life insurance policy, segregated fund contract, or annuity contract is taken out. When this occurs: - the life insurance policy is pre-paid. - the segregated fund guarantees will be based on the full amount received. - the annuity contract can offer an immediate benefit to the annuitant, or the benefit can be deferred to a future date.
If the premium payment for a life insurance policy is not received by its due date, the grace period for the policy goes into effect immediately. The grace period is 30 or 31 days’ long. If the life insured dies during the grace period, the beneficiary will receive the death benefit (determined as face amount of the policy minus unpaid premium minus interest charged on the unpaid premium). If the premium is not paid before the end of the grace period, the policy terminates (called the lapse of the policy). Any cash surrender value will be paid in cash to the whole life policy owner. A universal life policy owner will receive cash surrender value and the value of their investment account.
A policy that has lapsed because premiums were not paid may be reinstated. The policy owner must apply for reinstatement within two years, pass the medical exam, and repay any amounts owed to the insurance company.
Advisor Remarks: 1. The premium is the consideration in the contract formed when a life insurance policy is taken out. It makes the life insurance policy a binding contract.
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2. Pre-authorized account withdrawals are often used for premium payments to ensure the policy owner’s policy does not fall into arrears.
Related Terms: Grace Period. Reinstatement.
Prescribed Annuity A life annuity or term certain annuity can be a prescribed annuity. Prescribed annuities have tax advantages over those that are non-prescribed.
There are many requirements that must be satisfied for an annuity to qualify as prescribed. Key among them is the need for the owner of the annuity contract and the annuitant to be the same person.
For prescribed annuities, each annuity payment is comprised of a capital portion and an interest portion. The interest portion is subject to tax. The capital portion is not. Because the ratio between the capital portions and taxable portions is fixed throughout the benefit period, there is an element of tax deferral.
In comparison, the taxable portion of a non-prescribed annuity will vary each year. It will be highest in the early years of benefits because a greater portion of the benefit is comprised of interest. The taxable portion declines over time as more and more capital is being returned to the annuitant, and less capital is earning interest.
Advisor Remarks: 1. The annuitant of a prescribed annuity knows exactly how much tax will be owed on the annuity every year, so long as his or her tax rate does not change.
Related Terms: Life Annuities. Term Annuities.
Prescribed Retirement Income Funds (PRIFs) A Prescribed Retirement Income Fund (PRIF) is also known as a Prescribed RRIF (Registered Retirement Income Fund). It is available only to registered pension plan members whose plans are subject to the Pension Benefits Act in Saskatchewan and Manitoba.
In other words, the members of a company pension plan registered in Saskatchewan or Manitoba are governed by the pension laws of the province regardless of whether they live in the province.
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A PRIF is one of the options available to those who: - have a defined contribution plan that must be transferred from the employer at retirement, or - have a Locked-in Retirement Account (LIRA) or Locked-in Retirement Savings Plan (Locked-in RRSP), and who need to close down their locked-in plans at age 71.
A minimum amount must be withdrawn annually from the PRIF, but there is no maximum withdrawal limit. There is no requirement to ever transfer funds from the PRIF to a life annuity.
Advisor Remark: 1. It is not where the pension member lives that determines pension plan rules; it is the province where the plan is registered that determines the rules. This is true of all pension plans.
Related Term: Locked-in Plans.
Present Value of Money The present value of money is a concept used in investing. Present value of money says if you have an option between paying a sum in the future or paying the exact same sum now, it is better to pay in the future.
There are many practical, everyday applications to this concept. For instance, if given the choice to buy furniture now at $1,000 or in 36 months at $1,000, the payment should be made in 36 months.
It is possible to calculate backwards from the future date to find what that same amount of money is in today’s dollars. For instance, $1,000 in three years might be $900 today. It is less than the future amount because the future amount represents the end game: returns and compounding have worked their magic on the smaller amount to make it bigger.
Contrast present value of money with time value of money.
The time value of money says if you have the option between receiving the same sum of money now or in the future, take it now. This is because if a person has the money “now,” it can be invested, earn interest or other forms of return, and those returns can compound over time. So, the money taken “now” has earnings potential.
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For instance, if given the choice between using $50 in shopping points now or in three months, the $50 should be taken now.
Advisor Remark: 1. Time value is about taking money now. Present value is about paying money later. It will help you to remember if you associate time with taking and present with paying.
Related Term: Time Value of Money.
Privacy and Confidentiality The need to keep customer information private and confidential is a requirement for life agents, and all those who work in the financial services industry.
Government legislation, commonly called PIPEDA (the Personal Information Protection and Electronic Documents Act), specifies how information can be collected, used, and disclosed.
The agent or a third party that takes personal information for processing must safeguard that information and it must not be shared with another person unless: - the person has given written permission for the information to be released to a third party; - there is a legal need to release the information (This would be true if, for instance, it appeared that a person obtained funds as a result of a crime and police had to be notified.)
Information an agent has about a client must not be used to disadvantage that client.
Advisor Remarks: 1. An agent will collect very sensitive health and financial details in the application process. These must not be shared or used to benefit the agent in any way. 2. A good business practice is to develop a personal privacy policy, and make it available to potential or existing clients.
Related Terms: Ethics. Fiduciary Duty.
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Probate When a person with assets dies, the value of assets in his or her estate is subjected to a charge that is known as probate, probate fees, letters probate, or in Ontario as an estate administration tax.
Probate fees are charged in every province except Quebec and are measured as a percentage of the value of the estate. Not all assets will be charged a probate fee. For instance, if property is held in joint tenancy with right of survivorship it will pass to the surviving owner and will not be subject to probate. Life insurance policies with a beneficiary that is not the estate will not be subject to probate. Trusts can be used as a means to avoid probate.
Advisor Resources: List of Probate Fees by Province: http://www.scotiabank.com/ca/en/0,,869,00.html
Rated Contract Premiums for a life insurance policy are based largely on when the life insured is expected to die. Those who are at a lower risk of premature death are considered by insurers to be “preferred”; some insurers even have a class that is better than preferred. Life insureds that fall within expectations of death as shown in the mortality tables are considered a standard risk, and those whose medical history or other factors show them to be a greater risk may be offered a rated contract. The contract is called a rated contract because it is rated according to a table and the extra premium is sometimes called a “Table rating.”
Tables start at 1 (or “A”) and go up from there to about Table 16 (this varies between insurers). Each table can be as much as a 25% increase in the term insurance rate, so a Table 2 or B would add as much as 50% to the standard rate, Table 4 would add 100%, etc.
Table ratings are higher for term life insurance than whole life insurance. This is because whole life policies are a combination of cash and life insurance so only the cost of the life insurance is affected by the extra rating and therefore the extra premium for the policy is less.
Advisor Remarks: 1. Insurers vary in their table ratings so if you work in the broker environment it will be wise to compare policies to get the customer the best premium based on an equivalent amount of coverage. 2. The more risk represented by the life insured, the higher the table rating and the more expensive premiums will be.
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Recurring Disability A disability is considered to be recurring when the illness or injury that was the initial cause of total disability recurs within a certain period of time after the person returns to work. It applies only to long-term disability.
If the disability recurs 14 to 30 days into the qualification period after returning to work, the disabled person is again considered to be totally disabled. He or she does not need to satisfy the qualification period again.
If the same, or a related, cause of disability recurs within six months after a new qualification period has been satisfied, the person will considered to have been continuously disabled. Again the need for a new qualification period is waived.
Advisor Remark: 1. The qualification period for long-term disability is, at the least, four months to 52 weeks, at the most.
Related Term: Long-term Disability Insurance.
Registered Disability Savings Plans (RDSPs) A Registered Disability Savings Plan (RDSP) is a type of savings account that helps Canadians with disabilities and their families save for the future.
The beneficiary of the plan is the person who will eventually receive the funds that have been deposited.
Contributions can be made by anyone to an RDSP, providing the RDSP holder gives written permission. There is no annual contribution limit. The lifetime contribution limit is $200,000.
The Government of Canada contributes to every RDSP through the Canada Disability Savings Grant. The beneficiary may apply for a Canada Disability Savings Grant once he or she is 18, or the family of the beneficiary can apply before age 18. The amount of grant received will be based on the amount contributed to the plan and the family income of the beneficiary’s family. The annual maximum of the Grant is $3,500. The lifetime maximum is $70,000.
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Low and modest income contributors may receive the Canada Disability Savings Bond from the Government. The amount of the bond is based on income, not contributions.
Unused grant and bond entitlements can be claimed for up to 10 years.
Advisor Resource: Human Resources and Skills Development Canada, Registered Disability Savings Plans: http://www.hrsdc.gc.ca/eng/disability_issues/disability_savings/index.shtml
Advisor Remark: 1. Funds from a deceased person who has an RRSP, RRIF, or registered pension plan can be rolled- over to an RDSP.
Related Terms: Registered Plans. Disability Income Insurance.
Registered Education Savings Plans (RESPs)
A Registered Education Savings Plan or RESP is a type of savings account that can pay towards the costs of a college or university education for a child.
There are four parties to an RESP: 1. the student, who is called the beneficiary; 2. the financial contributor to the plan, who is called the subscriber; 3. the financial institution or group plan provider that holds the deposits in the RESP account; 4. the Government of Canada that makes deposits to the RESP account through its Canada Education Savings Grant (CESG) and Canada Learning Bond (CLB).
- the student can withdraw the funds from the RESP when he or she enrolls in a post- secondary college, or university program; - on withdrawal, the RESP money students receive is taxed according to their income. Since their income tends to be lower, their tax rate is lower and often they pay no tax; - the subscriber does not receive a tax deduction or tax credit on his or her contributions to the plan; - the RESP account can be invested in many savings or investment options, such as GICs or mutual funds;
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- the savings in the account grow due to interest, stock dividends, or capital gains. Tax is not paid annually; - the CESG pays money into every RESP account: more is paid to low and medium-income contributors; - the CLB pays money only into the accounts of low and medium-income contributors.
Advisor Resource: Human Resource and Skills Development Canada, Registered Education Savings Plans: http://www.hrsdc.gc.ca/eng/learning/education_savings/index.shtml
Advisor Remarks: 1. An RRSP contributor receives a tax deduction for the money paid into an RRSP account. An RESP contributor does not receive a tax deduction. 2. If the child does not continue his or her studies beyond high school, the money in the RESP can be transferred to the RESP of his brother or sister, transferred to the contributor’s RRSP, or withdrawn unless the plan is a group plan. Group plans have different rules. 3. An RESP is used to pay higher education costs of a child. An RRSP can pay higher education costs of an adult learner through its Lifelong Learning Program. 4. There is a maximum amount that can be contributed to an RESP.
Related Terms: Registered Retirement Savings Plan (RRSPs). Registered Plans.
Registered Pension Plans
A Registered Pension Plan (RPP) is created when a company puts a pension plan in place for its employees. The pension plan will be registered with the agency or commission that administers the Pension Benefits Act in the province where the company is based.
For instance, when you hear a company pension plan being discussed on the news (such as the GM pension plan), it is a registered pension plan that is being discussed.
Registered pension plans are provided as: - defined benefit plans - defined contribution plans - group retirement savings plans - deferred profit-sharing plans - pooled registered pension plans
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Related Terms: Defined Benefit Plans. Defined Contribution Plans. Locked-in Plans. Pooled Registered Pension Plans.
Registered Plans An individual who has a plan that is called “registered” has a form of savings account that is registered with Canada Revenue Agency (CRA).
A person does not register his or her plan with the CRA. When he or she opens an appropriate savings account with a financial institution, that institution registers the account with CRA. This is done to ensure that the person receives the tax benefits that are associated with registered plans.
There are four broad categories of registered plans for individuals: 1. retirement plans through RRSPs and RRIFs 2. education through RESPs 3. disability through RDSPs 4. investment through TFSAs
Advisor Remarks: 1. Registration ensures the account owner receives tax advantages. 2. Canada Revenue Agency administers tax laws and various programs related to tax for the Government of Canada.
Related Terms: Registered Retirement Savings Plans. Registered Retirement Income Funds. Registered Education Savings Plan. Registered Disability Savings Plan. Tax-free Savings Account. Defined Benefit Plans. Defined Contribution Plans.
Registered Retirement Income Funds (RRIFs)
A Registered Retirement Savings Plan (RRSP) account must be closed at the end of the year the plan owner turns 71. To continue the tax deferral provided to the plan owner with an RRSP, he or she could transfer the money to an annuity or Registered Retirement Income Fund (RRIF) account.
Every year, a minimum amount must be withdrawn from the RRIF. Withdrawals above the minimum will have a withholding tax applied by the financial institution that is home to the account.
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The funds received from the RRIF must be declared annually for tax purposes. They are taxed the same as if they were earnings from employment.
When a RRIF plan owner dies, the funds in the RRIF can be cashed out and tax paid accordingly.
To continue tax deferral on the money in the account after death of the plan owner: - The money can be transferred to the RRIF of a spouse, an annuity for a spouse, or the RRSP of a spouse who is younger than 71. - If the deceased plan owner has a financially dependent child, the money can be transferred to a term annuity to age 18. - A child or grandchild who is dependent on the RRIF plan owner due to mental or physical disability can receive the money from the RRIF into his or her RRSP, RRIF, annuity, or Registered Disability Savings Plan (RDSP).
Advisor Remarks: 1. Canada Revenue Agency determines what the minimum annual withdrawal amount will be for a RRIF. 2. There is no maximum that can be withdrawn. 3. A RRIF provides more flexibility in the amount of money that can be withdrawn than an annuity.
Related Terms: Registered Retirement Savings Plans (RRSPs)
Registered Retirement Savings Plans (RRSPs) A Registered Retirement Savings Plan or RRSP is a type of savings account that allows contributors to save for retirement.
There are two parties to an RRSP: the contributor and the financial institution that holds the contributions in the RRSP account. - contributions are limited to the lesser of an annual dollar amount or 18% of income earned in the previous year; - contributions are tax deductible; - contributions may be invested in many ways. The investment growth is not taxed annually in the RRSP; - an RRSP account can only stay open until the end of the year when the contributor turns 71;
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- if the contributor has a company pension plan, the amount he or she can contribute to their RRSP is reduced. This is called a pension adjustment; - if a contributor doesn’t contribute the maximum amount each year, they can carry forward the difference between their contribution and the maximum; - a person can use some of their personal contribution room towards an RRSP for their husband or wife. This is called a spousal plan; - withdrawals prior to age 71 are permitted. Part of the withdrawal is withheld for tax and the rest of the withdrawal is treated like income for tax purposes; - when the plan ends at age 71, the RRSP value can be received as cash, transferred to a Registered Retirement Income Fund (RRIF), or transferred to an annuity. If cash is taken, it will be taxed. If the money is transferred to either of the two options, tax will be delayed until the contributor withdraws the money.
Advisor Resources: Canada Revenue Agency, Registered Retirement Savings Plans: http://www.cra- arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/rrsps-eng.html
Advisor Remarks: 1. Anyone can be named as a beneficiary of a RRSP. But when a spouse, financially dependent child or grandchild, or child or grandchild dependent due to mental or physical infirmity is named as a beneficiary, the beneficiary will receive the value of the account if the contributor dies. If the spouse receives the money, it is called a spousal roll-over when the funds are transferred into the spouse’s own RRSP, RRIF, or to a term annuity. A financially dependent child/grandchild can defer tax by using the money for a term annuity paid to age 18. A dependent child/grandchild can transfer the funds to a personal RRSP, RRIF, annuity, or Registered Disability Savings Plan (RDSP). 2. Withdrawals can be made from the RRSP to assist with home ownership (Home Buyer’s Plan) or adult education (the Lifelong Learning Program).
Related Term: Spousal Plans.
Reinstatement A policy owner is not required to pay premiums. When a policy owner fails to pay the premium and the grace period expires, the policy will be rescinded by the insurance company. It will no longer be in force and a claim can’t be made.
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However, the policy owner has up to two years following rescission to reinstate the policy. Medical proof of insurability will be required, and the policy owner must pay the premiums for the period of time the policy was rescinded, plus interest.
The two-year period prohibiting a claim due to suicide will start again after reinstatement.
A reinstatement is preferable to a new policy because premiums will be based on the age of the life insured when the policy was first taken out, and so will be less than the attained age of the life insured at the time of reinstatement. Reinstatement would be especially beneficial if the policy had been issued prior to December 2, 1982 and had the tax advantages accorded to policies before that date.
Advisor Remark: 1. Reinstatement and renewal are two completely separate actions; do not get them confused.
Related Terms: Grace Period. Suicide Exclusion Clause.
Reinsurance Life insurance companies must limit the amount of risk they are exposed to. One way they do this is by having a maximum amount of life insurance that they will put on any one person. This maximum is called their retention limit, or the limit to what they will retain.
If there is a need for insurance greater than the retention limit, the additional amount of insurance can be assumed by another insurer. This is reinsurance.
The insurer that issues the policy and passes along the risk is called the direct writer. The company assuming the risk is called the assuming company.
This process can be repeated again so that a third insurer assumes risk from the second insurer. This is called retrocession and the third insurer is called the retrocessionaire.
Both an assuming company and retrocessionaire will charge a premium for the risk they take on.
Advisor Remark: 1. Reinsurance is a form of risk management by insurance companies.
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Renewable Term Life Insurance Term life insurance is life insurance that provides a death benefit during a period of time, such as 10 years, or up to an age, such as age 65. The death benefit will be paid to the beneficiary if the life insured dies during the term.
Policy owners who choose a renewable term life policy have the option at the end of their first term to simply renew the policy. In other words, the policy continues with the same face amount over the new term. The renewal may be for another period of time or to another age. If the life insured dies during the new period of time, the death benefit is paid to the beneficiary. There is no premium refund if death does not occur.
Policy renewal is guaranteed in a renewable term life insurance policy.
For example, if a policy owner has a five-year renewable policy, the policy can be renewed for another five years at the end of the first five years. The health of the policy owner is not a consideration because the renewal is guaranteed. The same face amount applies to the new policy as the original policy, but premiums will increase.
Advisor Remarks: 1. Renewable term insurance is combined with convertible life insurance to make renewable and convertible term (R&C term). 2. A policy can be renewed more than once. 3. The face amount does not increase over each term so renewable term insurance is not appropriate for increasing needs. 4. Renewal is guaranteed. Therefore, deteriorating health is not a consideration. 5. There are no tax implications with term life insurance. Like all life insurance, its face value will be paid to the beneficiary tax-free when the life insured dies.
Related Terms: Term Life Insurance. Universal Life Insurance.
Replacement
Replacement is the act of replacing an existing life insurance policy with a new policy.
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Replacement of policies is carefully monitored for evidence that the agent is replacing the policy only to generate a sales commission. Replacement is valid so long as it is in the client’s best interest.
Replacement rules are enforced to prevent unnecessary or wrong replacement. The Life Insurance Replacement Declaration (LIRD) sets out 11 questions that must be answered. These questions are intended to assist the client in gathering sufficient information to understand the implications and risks of replacing an existing policy with a new one. There is no need to answer each question expressly in writing but agents can use the questions to guide them in preparing the explanation.
If an agent chooses to answer each question separately, care should be taken to ensure the answers relate specifically to the client’s needs and the product’s features. Simple “yes” or “no” answers to the questions will not generally be sufficient. The written explanation should relate to the client’s needs. It should explain how the existing policy fails to address those needs and it should explain how the new policy is better suited to address them.
The written explanation should also identify any risks associated with replacing the existing policy.
When a client proceeds with replacing a policy, the new policy will again have a two-year period during which a death benefit will not be paid to the beneficiary if death occurs as a result of suicide. The policy also becomes contestable during these two years, and its benefits may be denied if a mistake is found on the application.
Advisor Resource: Life Insurance Replacement Declaration (LIRD), CLHIA: http://www.clhia.ca/domino/html/clhia/CLHIA_LP4W_LND_Webstation.nsf/resources/Content_PD Fs/$file/Replacement_Disclosure_Guide_to_Preparing_the_Written.pdf
Advisor Remarks: 1. New policies may have different tax rules. The client must be made aware of any disadvantages of replacement. 2. The cost of premiums will be higher on a new policy if the same life is insured in both the old and new policies, because that person will be older than when the original policy was taken out.
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3. A life insurance agent must ensure there is no gap in coverage between a policy that is being replaced, and the new policy.
Related Term: Churning and Twisting.
Rescission Rescission is considered a right of the policy owner and is usually called “the right of rescission.”
It is a term in the insurance contract that allows the policy owner to change his or her mind about the policy within 10 days of signing the policy receipt and get his or her money back. The policy receipt is signed when the policy is sent from the insurance company to the policy owner.
If the policy owner decides he or she doesn’t want the policy, the premium that he or she paid that accompanied the application will be repaid by the insurance company. The policy is terminated.
A person who has rescinded a policy, and then decides to proceed with obtaining a policy will need to re-apply.
Of course, a policy can be terminated at any time by not paying premiums or by informing the insurance company in writing. Premiums that have been paid will not be refunded.
Advisor Remarks: 1. Rescission is expensive for the life insurance company that has prepared the policy because of the expense of underwriting the policy. 2. Rescission is also expensive for the agent who may have spent considerable time and energy preparing the application and working with underwriters.
Related Terms: Policy. Application. Premiums. Underwriting.
Reset Reset applies to a segregated fund (seg fund) contract. It describes the step taken by the contract owner when the value of the seg fund has increased, and he or she wishes to lock in that new value.
The contract owner simply asks the insurance company to reset the fund. At the end of the day the request is received, the seg fund value is determined at the new amount.
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Once reset is used, the maturity and death benefit guarantees are based on the new (higher) value of the contract.
The maturity date of the contract is changed on the date of reset and a new 10-year period begins from that date.
Example: Account value at start of day = $10,000 75% maturity guarantee = $7,500 75% death benefit guarantee = $7,500
Reset account value at end of day = $12,000 75% maturity guarantee = $9,000 75% death benefit guarantee = $9,000
As always, if the actual value in the account at the time of maturity or death is greater than the guaranteed amount, the actual value (the greater amount, also called the market value) is what is paid out.
Advisor Remarks: 1. Using reset is an option, not a requirement. 2. Not all seg funds offer reset. 3. The number of resets per year will be limited according to what is stated in the Information Folder for the fund. 4. Use of reset is inappropriate for a contract owner who wants to limit the length of the seg fund investment to 10 years.
Related Terms: Segregated Funds. Maturity Guarantee. Death Benefit Guarantee.
Residual and Partial Disability Benefits
Residual and partial disability benefits are available to an employee who is a member of a long- term disability plan and has qualified as being totally disabled, but is able to work part-time. The employee will receive the disability benefit in addition to salary from his or her employer.
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To receive the partial disability benefit, the employee must experience a loss of earnings above a specified amount. For instance, he or she must lose 20% of earnings to qualify.
The percentage of income lost forms the percentage of benefit received. So: 20% loss of income
= 20% benefit.
Residual disability benefits are available when the employee can earn between 20% and 80% of their pre-disability income. Often, residual disability is not available until the two-year own occupation period has been completed.
The benefit is calculated according to a specific percentage. It is calculated as: pre-disability income minus income earned divided by pre-disability income equals the percentage of the disability benefit that will be received.
This % is applied against the total disability benefit to give the residual benefit. If the total disability benefit is $10,000 but the % is 90, 90% of $10,000 ($9,000) will be received.
Advisor Remark: 1. Since the disability benefit amount is less than full salary, neither of these benefits restores 100% of income because they both provide a percentage of disability benefit, not a percentage of salary.
Related Term: Long-term Disability Insurance.
Riders A rider is an insurance benefit added on to the base policy. Common life insurance riders include: - term insurance rider: term insurance is provided on top of a permanent insurance policy. - accelerated death benefit rider (also known as a terminal illness benefit or living benefit): pays some of the face amount during the lifetime of the life insured. - waiver of premium (WP) rider: eliminates the need for the policy owner to pay premiums if he or she is unemployed or disabled. - disability income benefit rider: provides a monthly income if the policy owner is disabled.
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- accidental death benefit rider: increases the face amount paid if the life insured dies in an accident. - accidental death and dismemberment rider: increases the face amount paid if the life insured dies in an accident or suffers dismemberment. - guaranteed insurability benefit rider: guarantees that the policy owner can increase the amount of insurance at certain times.
Common disability riders include: - waiver of premium (WP) rider: same as above - future purchase option (FPO; also called future income option or FIO): allows the amount of disability insurance coverage to be increased. - cost of living adjustment (COLA): increases the amount of disability benefit in keeping with inflation; - rehabilitation benefit: covers rehabilitation by paying for retraining for a new job or occupation.
Advisor Remarks: 1. Riders increase the premium cost. 2. Riders create a customized policy to suit particular client needs. 3. Riders are an option to a policy, not a requirement. 4. A return of premium rider that pays back some or the entire premium to the policy owner is available for term life, disability, critical illness, and long-term care insurance.
Related Terms: Term Life Insurance. Disability Income Insurance.
Risk Tolerance Risk tolerance is the amount of investment risk than an investor feels comfortable taking on, and keeping. It is linked to the possibility of short-term loss in return for future higher gains. For instance, an investor who loses money on an investment and then maintains that losing proposition while waiting for the investment to increase in value is risk tolerant.
Investment risk is absolutely linked to investment returns. The higher the risk associated with an investment, the better the chance of a higher return. Therefore, the risk tolerance of a person will be an indicator of the amount of return he or she will receive.
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Low risk tolerance is characteristic among investors who want guaranteed returns, such as from a Guaranteed Investment Certificate.
The degrees of risk tolerance are: - risk averse: there is no tolerance for losses; - risk tolerant: there is some acceptance of losses; - risk seeker (speculative investor): the investor seeks high-risk opportunities and is ready, able and willing to lose.
Risk tolerance is related to factors such as: - the investor’s age: those who are younger have a higher risk tolerance than those who are older; - gender: women are less risk tolerant on the whole than men; - the time horizon: this is the length of time before invested money is needed. Less time = less risk tolerance; - financial goals: the more important the need, the lower the risk tolerance. For instance, there would be a very low risk tolerance for an investment destined to fund a child’s university education; - previous investing experience: a positive experience can help to increase risk tolerance. The opposite is also true.
Advisor Remarks: 1. An investment is called “risky” when the risk exists that the investor may lose some, or all, of his or her money. There are degrees of risk, based on what the potential for loss is. 2. Some investments have zero risk. A Canada Savings Bond is such an investment. 3. Risk tolerance must be taken into consideration in insurance sales and service when seg funds are being contemplated, when investment funds are being chosen for the investment account of a universal life policy, or a person is considering a variable annuity.
Related Terms: Capital Gains. Equity. Fixed-income Investments. Time Horizon.
Rule of 72 The Rule of 72 is an easy calculation to demonstrate to a client a rate of return that is needed to double an investment or how long it takes for an investment to double in value, when its annual income is reinvested. Reinvesting income allows the returns to compound, and therefore growth is greater than if returns were not reinvested.
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The rule can be used two ways: 1. to find the rate of return that is needed to double the investment, if the number of years is known: The calculation is: rate of return = 72 ÷ years Example: if the time period is 12 years: 72 ÷ 12 = 6; therefore, a 6% rate of return is required for the investment to double in value in 12 years.
2. to find the amount of time that is needed to double the investment, if the rate of return is known: The calculation is: number of years = 72 ÷ average annual rate of return Example: if the rate of return is 3%: 72 ÷ 3 = 24; therefore, it will take 24 years for the investment to double in value at a rate of return of 3%.
Advisor Remark: 1. Compounding is achieved when the return from each period is reinvested in the invested amount. In this way, the invested amount increases in value, and returns are based on this higher value.
Related Terms: Risk Tolerance. Equities.
Sales Charge A sales charge is paid by segregated fund and mutual fund investors. It is a percentage charge, such as 2%, not a dollar fee.
The sales charge can be applied one of three ways: 1. Sales charge applied to deposit(s). This charge is known as a front-end load. It reduces the total amount of investment going into the fund. 2. Sales charges applied to withdrawals or surrender of the contract. There are two loads that can be applied when a withdrawal or surrender is made: the back-end load or the deferred sales charge.
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- The back-end load will see a charge against the total value of the fund at the time of the withdrawal or surrender. - The deferred sales charge applies a charge that declines over a period of years. If a withdrawal or surrender is made during this time, the scheduled charge is applied. After a period of time, usually six years, the charge is waived, so for a segregated fund it will have vanished at the time of maturity. 3. Sales charge applied on maturity. An investor with a back-end load will pay the load when a withdrawal is made, the contract is surrendered, or seg fund contract matures.
Advisor Remarks: 1. A no-load fund is another type of fund that is offered. It compensates for the absence of a fee by charging a higher annual management fee. 2. The management fee is an annual charge. It is charged independently of the sales charge. 3. The investor chooses the sales charge when the contract is taken out.
Related Terms: Segregated Funds. Mutual Funds.
Segregated Funds Segregated funds are also called seg funds or Individual Variable Insurance Contracts (IVICs). They are an investment offered by insurers with a 10-year term-to-maturity.
Seg funds guarantee that, on maturity, at least 75% of the deposits made by the contract owner will be returned. Some contracts guarantee 100% of deposits will be repaid. Seg funds also guarantee that if the contract owner dies during the 10-year term, the beneficiary of the contract will receive 75% or 100% of the deposits made by the contract owner (depending on the contract). However, in both instances --- on maturity and death --- the market value of the contract will be received if it is greater than the guaranteed amounts.
Deposits to a segregated fund are invested in funds similar to mutual funds. There are a vast number available based on the investment objective and risk tolerance of the contract owner.
Unique to segregated funds is the ability to lock-in returns in a process called reset. This increases the value of the contract and its guarantees. Reset also begins the 10-year term of the contract again.
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Withdrawals can be made from a seg fund contract, though there are financial penalties for doing so. Withdrawals adjust the guarantees downwards.
Like mutual funds, seg fund contract owners pay a sales charge when they first invest and management fees every year. Both are charged as a percentage of deposits. Management fees are higher for seg funds than mutual funds.
Advisor Resource: Point of Sale Disclosure, CLHIA, http://www.clhia.ca/domino/html/clhia/CLHIA_LP4W_LND_Webstation.nsf/resources/Financial+Ad visors/$file/Advisor_fact_sheet.pdf
Advisor Remarks: 1. The details of the seg fund are outlined in an Information Folder. It must be provided to potential investors. 2. Management fees for seg funds are higher than mutual funds because of the potential cost to the insurer of fulfilling the guarantees.
Related Terms: Sales Charge. Reset. Maturity Guarantee. Death Benefit Guarantee.
Self-directed RRSP A self-directed RRSP (Registered Retirement Savings Plan) is one of two types of RRSP accounts. The other is a managed RRSP.
- A self-directed account can only be provided by investment dealers since only investment dealers can offer products suitable for the self-directed RRSP that other financial institutions cannot. - A self-directed RRSP gives the account owner more investment choices for his or her account. For instance, shares can be traded within a self-directed RRSP. - A self-directed account requires the account owner to make investment decisions, and to take a more active role in managing the account --- if best results are to be achieved. - A managed account relieves the account owner from active management. He or she must decide among a portfolio of mutual funds, or Guaranteed Investment Certificates offered by the account provider, and the decision-making is restricted to changing between the limited scope of investments.
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Advisor Remark: 1. Less confident and knowledgeable investors are better served by a managed account.
Related Terms: Registered Retirement Savings Plans. Mutual Funds.
Settlement Options A settlement option is one of the four ways the death benefit is paid after the life insured has died. Most often, it is selected on the application but if not, it can be chosen by the beneficiary.
1. As a lump sum paid by cheque to the beneficiary. 2. As interest. The insurer invests the death benefit and pays the interest earned on the death benefit to the beneficiary. Payments are made on a regular basis. 3. As installments. A portion of the death benefit plus interest is paid to the beneficiary. A fixed period option pays the installments over a period of time. A fixed amount option pays the installments in equal payments.. 4. As a life annuity. The death benefit forms a single premium to buy a life annuity for the beneficiary.
Advisor Remark: 1. None of these options are the “best.” The best choice is determined by the needs of the beneficiary and the ability of the beneficiary to manage a potentially large sum of cash.
Related Terms: Life Annuities. Interest. Death Benefit.
Short-term Disability (STD) Short-term disability is a form of disability insurance coverage in a group plan. It is also known as weekly indemnity (WI).
Benefits will be paid: - after a three-day to seven-day qualifying period (or qualification period) if the cause of the disability is illness; - starting on the first day if the cause of the disability is an accident; - up to four months and as long as 52 weeks. Then the employee is transferred to long-term disability.
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The benefit amount is not linked to a definition of disability. The benefit is simply linked to the inability of the employee to perform his or her job.
The amount received as a benefit will be a percentage of the employee’s weekly income. It is common for an employee to receive 60% of weekly income, or 66-2/3% of weekly income.
The tax on the benefit depends on who has paid the premium. If the employee paid the STD premium, the STD benefit is tax-free. It will also be tax-free if the employee declared the premium the employer paid on behalf of the employee as taxable income.
Advisor Remark: 1. A disabled employee receives a benefit first from a STD plan. If disability continues beyond the end of the STD benefit period, then the employee receives an LTD benefit.
Related Terms: Group Disability Insurance. Long-term Disability (LTD).
Sole Proprietorship A sole proprietorship is a company owned by one person. All assets and all liabilities are the responsibility of the owner. Most small businesses start as sole proprietorships and then transition to incorporation.
A sole proprietor must be very cautious when it comes to those with whom there is a business relationship and creditor situations arise. In other words, any business debt should be borne by the sole proprietor, and not become a family responsibility if the sole proprietor dies.
For this reason, if a sole proprietor takes out life insurance that names a key employee as the beneficiary in order to buy the business from the surviving family, the beneficiary designation should be irrevocable. In that way, creditors cannot pursue the death benefit.
Advisor Remark: 1. Sole proprietorships give a business owner a freedom from certain reporting obligations.
Related Terms: Corporation. Business Life Insurance.
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Spousal Plan A spousal plan is also known as a spousal Registered Retirement Savings Account (RRSP). It is one way to “split income” in retirement if one spouse is expected to pay less tax than the other.
It is also useful for the tax deduction a contributor will receive if he or she is older than age 71 and can no longer contribute to his or her own RRSP, but whose spouse is younger and still has an RRSP.
A spousal plan is created when both spouses (legal or common-law) have their own RRSP accounts and one spouse contributes to the RRSP of the other. The amount that can be contributed is determined each year as: contributor’s maximum RRSP contribution amount minus sum he or she contributed to his or her own RRSP for the year equals spousal plan contribution
The contributor receives the tax deduction.
Withdrawals are taxable to the contributor if they do not remain in the plan for three calendar years. After three years, if funds are withdrawn, they are taxable to the owner of the spousal RRSP.
Advisor Remarks: 1. An RRSP account owner who contributes the maximum annual amount to his or her plan will not be able to contribute to a spousal plan. 2. The person who receives the contributions for a spousal plan is called the recipient spouse.
Related Terms: Registered Retirement Savings Plans (RRSPs). Income Splitting.
Spousal Rollover A spousal rollover describes tax deferral of assets. It occurs when a spouse dies, and instead of assets then becoming taxable, the assets roll-over to the surviving spouse and tax deferral continues until the death of that spouse. In this way, a married or common-law couple, either
122 Fundamentals of Canadian Life Insurance opposite-sex or same-sex, is treated as a unit of two people instead of two people, each with separate and distinct interests.
Examples of a spousal rollover are: - when an RRSP or RRIF account owner dies and the funds in his or her account rollover into the RRSP or RRIF of the surviving spouse; - capital property, such as a stock portfolio, will roll-over to the surviving spouse at its adjusted cost base; - when assets are transferred to a spousal trust.
Advisor Remarks: 1. A spousal rollover ensures that the death of one spouse does not create a taxable event. 2. Note that a Tax-free Savings Account does not have a roll-over provision because withdrawals are tax- free.
Related Terms: Registered Retirement Savings Plans. Registered Retirement Income Funds.
Stocks Stock in a company is also known as company shares. Terms such as “the stock market” refer to the buying and selling of shares of companies that are listed for trading on the stock market. The two words – stocks and shares – are pretty much interchangeable.
Stocks, or shares, represent ownership in an incorporated company. - Private companies buy and sell their shares privately. - Public companies buy and sell their shares on stock markets. The Toronto Stock Market (TSX) is the leading stock market in Canada.
Stock is issued as common and preferred shares.
When stocks increase in value, and an investor sells at a higher price than he or she paid for the stock, the investor will receive a capital gain on the sale. When stocks decrease, a capital loss will be received. Capital gains are taxed at a lower rate than interest or stock dividends. Capital losses are deductible from capital gains.
Stocks of companies comprise the bulk of investment in investment funds (that is, mutual funds) that include the word “Equity” in their name. A Canadian Equity Fund will hold shares of Canadian
123 Fundamentals of Canadian Life Insurance public companies. It is therefore important to recognize that an investor in such a fund is, in fact, investing in stocks and he or she must be tolerant of the risk values associated with stock investing.
Owners of stock receive certain rights, including that to receive dividends, if the company is sufficiently profitable and they are declared by the Board of Directors.
Advisor Remark: 1. Do not advise on the buying or selling of stocks; this is beyond the limit of your life licence. You must not hold yourself out by appearing to have this knowledge.
Related Terms: Risk Tolerance. Equities.
Subrogation Subrogation is a legal right of an insurer to pursue a third party for economic losses the insurer has sustained by paying a claim of one of its policy owners.
In other words, if someone else is at fault for the reason for a claim, then the insurer can pursue that party to shoulder the expense of the claim.
For instance, if John is disabled because of Mary, John’s insurer will pay his disability benefit and then subrogate the claim to Mary. If subrogation is successful, Mary (or her insurer) will have to reimburse John’s insurer for the cost of the disability payments John received.
The insured who makes the claim will not be aware of subrogation; it occurs between the insurer and the third party. Subrogation reduces expenses of the insurer, and therefore can contribute to the profitability of the insurer.
Advisor Remark: 1. An agent does not participate in the subrogation process.
Suicide Exclusion Clause The suicide exclusion clause is a standard part of every life insurance policy.
This clause states that the death benefit will not be paid if death of the life insured occurs by suicide within the two-year period following the issue date of the policy. However, the life
124 Fundamentals of Canadian Life Insurance insurance company must return premiums that were paid by the policy owner, but without interest.
If death by suicide occurs after two years, the death benefit is paid in full to the beneficiary of the policy.
Advisor Remark: 1. The suicide exclusion clause is a standard contract provision.
Related Term: Contract
Tax-free Savings Accounts (TFSAs) A Tax-free Savings Account (TFSA) is a registered investment account designed to encourage savings. A TFSA has two chief benefits: 1. investment growth that occurs within the account is not taxed; 2. withdrawals are not taxed.
To open a TFSA, a Canadian must be at least 18 years’ old. There is a maximum dollar amount of contribution that can be made in a year. If the maximum contribution is not made in any one year, it can be carried forward to a future year or years. Contributions are not tax deductible.
Money deposited to a TFSA can be invested in any of the options provided by the financial institution where the account is held. These can include Guaranteed Investment Certificates (GICs), mutual funds, and bonds.
If a withdrawal is made in one year, it can be redeposited – even in the same year. If that occurs, there will be a tax penalty, but there is no penalty if the deposit is made in future years.
Withdrawals are not included as income, and therefore do not affect benefits such as Old Age Security.
If a person with a TFSA dies, the assets in the account can be transferred to a spouse or common-law spouse.
Advisor Resource: Government of Canada: http://www.tfsa.gc.ca
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Advisor Remarks: 1. TFSAs are unique due to their tax-free withdrawals. 2. Unlike an RRSP, a TFSA does not need to be closed at age 71. 3. Unlike a RRIF, there is no need to make a minimum withdrawal from a TFSA.
Related Terms: Registered Plans. Registered Retirement Savings Plans (RRSPs). Old Age Security.
Taxation of Life Insurance When a life insured dies, the death benefit of the policy is paid to the beneficiary tax free. This is true of all life policies.
Taxation of a life insurance policy occurs when a policy owner uses the cash benefit from a whole life insurance policy or universal life insurance policy. The benefits that may be taxed are: - taking the cash surrender value of the policy. - taking a policy loan from the life insurance company. - making a withdrawal from the universal life insurance account. - converting the cash surrender value of the policy into an annuity, except if the policy owner is totally and permanently disabled. This is called annuitization.
There will also be tax consequences for a universal life policy owner who experiences growth in the investment account of his policy that is greater than the amount allowed by the Income Tax Act. This amount is called the maximum tax actuarial reserve or MTAR. However, all insurers warrant that their policies will be kept below the MTAR limit so this is not a concern for the policy owner.
The amount of tax that will have to be paid will be related to the adjusted cost basis (ACB) of the policy. As of Dec. 2, 1982, the method for calculating the ACB changed. Policies issued prior to this date are called grandfathered. These policies have preferential tax treatment compared to those issued after that date.
The ACB is a figure that represents the cost of the policy. It is a base value from which policy gains are calculated.
Advisor Remarks: 1. Term life insurance has no tax implications.
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2. The role of the agent in regards to taxation is to ensure that a policy owner with tax issues seeks professional tax expertise.
Related Terms: Cash Surrender Value. Policy Loan. Grandfathered Policies. Adjusted Cost Basis.
Temporary Insurance Agreement (TIA) The Temporary Insurance Agreement (TIA) is a stop-gap between an application for life or A&S insurance coverage and the effective date of the actual policy.
The agent issues the TIA. It is a binding contract between the applicant and the insurance company.
A TIA for a life policy requires the policy owner and life insured to answer a set of questions. If all questions are answered “no” and if an amount equal to a monthly premium has been provided, the TIA will provide a specified amount of life insurance while it is in effect. For a life policy, the TIA expires after 90 days. The actual policy also invalidates the TIA. The TIA will also be invalid if misrepresentation occurs on the application, or the application is fraudulent.
For a death benefit to be paid, death of the life insured cannot be the result of suicide. The death benefit of a TIA is paid to the beneficiary.
Advisor Remarks: 1. The Temporary Insurance Agreement (TIA) is also called a conditional insurance agreement or temporary life insurance. 2. A policy owner who receives a TIA is not guaranteed that he will receive a policy. Also, if health conditions change during the period the TIA is in force, they will be taken into consideration before the policy is finalized.
Related Terms: Application. Policy. Contract.
Term Annuity An annuity makes a regular payment, called the benefit, to a person who is called the annuitant. A term annuity, also called a term certain annuity, pays that benefit over the term of the contract. The term may be a period of years, or to a selected age.
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Uses for term annuities: - One of the options available to continue tax deferral when the owner of a Registered Retirement Income Fund (RRIF) dies is for the spouse to use the funds in the RRIF to buy a term annuity to age 90. - A term annuity to age 90 may be used if the funds in the RRIF are to be used by a child or grandchild who was dependent on the RRIF owner due to physical or mental infirmity. - RRIF funds can also roll-over on a tax-deferred basis to a financially dependent child. A term annuity can be used for this purpose and its term will be the number of years remaining until the child turns 18.
Advisor Remarks: 1. A term annuity can provide a bridge income between retiring and receiving a retirement income, for instance if a person retired at age 60 but did not begin CPP benefits until age 65. 2. A term annuity can begin paying its benefit immediately post-application if the contract has been funded with a lump sum. If funding occurs over a period of time by a series of deposits, the annuity benefit begins after the final deposit. This is called a deferred annuity.
Related Term: Life Annuities.
Term Life Insurance Term life insurance is life insurance that provides a death benefit for a period of time, such as 10 years, or up to an age, such as age 65. The death benefit will be paid to the beneficiary if the life insured dies during the term.
The shortest period of time for a term life policy is one year. The maximum age for term insurance is increasing because people are living longer and term policies are now available to age 85.
Like all life insurance, the premium for term life will be based on underwriting factors for the life insured such as age, health, and family medical history. However, term insurance always has lower premiums for an equivalent amount of life insurance coverage in comparison to other types of life insurance.
Term life insurance is the most easily understood form of life insurance by clients: it has a start date and an end date. There is no uncertainty about how long premiums have to be paid. If the life insured does not die during the term, there is no refund of premiums.
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Term insurance may be issued where it can be renewed, term after term, or converted, from term to whole life.
Term life insurance may be issued as: - level term life in which the amount of insurance and premium stays over the term, or - increasing term life in which the amount of insurance and premium increase over the term, or - decreasing term life in which the amount of insurance and premium decrease over the term.
Advisor Remarks: 1. Term life insurance is not permanent insurance. 2. Term life insurance is best for temporary needs, like ensuring coverage would be sufficient to pay off the balance on a mortgage. 3. Term life insurance has the least expensive premiums for equivalent amounts of coverage (all underwriting factors being equal). 4. There are no tax implications with term life insurance. Like all life insurance, its death benefit will be paid to the beneficiary tax-free when the life insured dies. 5. Term life insurance is available as a rider on a permanent life insurance policy.
Related Terms: Renewable Life Insurance. Whole Life Insurance. Universal Life Insurance. Riders.
Term-to-100 Life Insurance Term-to-100 (also called T-100) life insurance is a permanent life insurance policy that lasts to age 100, or the anniversary date of the policy that is closest to the 100th birthday of the life insured.
If T-100 offers cash value, it will be lower than other forms of permanent insurance, and for this reason the premiums for a life insured will be less. Many T-100 policies do not offer any cash value.
The premiums over the entire duration of a T-100 policy are the same amount. At age 100, the policy is considered paid up so no further premium payments are required.
Riders can be added.
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Advisor Remarks: 1. T-100 is the most basic form of permanent insurance, and does not provide the benefits of other forms of permanent life insurance. 2. Because it does not provide any method of increasing the death benefit over time, T-100 is not suitable for needs that may increase due to inflation or other factors, such as capital gains tax.
Related Terms: Permanent Life Insurance. Term Life Insurance.
Time Horizon Time horizon is a term related to investment needs. It describes when money that is being saved will be needed.
A long time horizon can add a degree of safety to investing because if losses occur in the early years, a long period of time remains in which to recoup the losses. The opposite is also true: a very close time horizon will mean an investor usually does not want additional risk because there won’t be enough time left to gain back what has been lost before the money is needed.
Events that have time horizons include: - retirement; - retirement of spouse; - marriage; - post-secondary education for a child; - purchase of a second home; - vacation; - vehicle purchase. 1. Time horizon and risk tolerance can be closely related.
Related Term: Risk Tolerance.
Time Value of Money The time value of money is a concept used in investing. It says if you have the option between receiving the same sum of money now or in the future, take it now. This is because if a person has the money “now,” it can be invested, earn interest or other forms of return, and those returns can compound over time. So, the money taken “now” has earnings potential.
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There are many practical, everyday applications to this concept. For instance, if given the choice between using $50 in shopping points now or in three months, the $50 should be taken now.
Contrast time value of money with present value of money. Present value of money is a concept that says if you have an option between paying a sum in the future or paying the exact same sum now, it is better to pay in the future.
Therefore, if given the choice to buy furniture now at $1,000 or in 36 months at $1,000, the payment should be made in 36 months.
It is possible to calculate backwards from the future date to find what that same amount of money is in today’s dollars. For instance, $1,000 in three years might be $900 today. It is less than the future amount because the future amount represents the end game: returns and compounding have worked their magic on the smaller amount to make it larger.
Advisor Remark: 1. Time value is about taking money now. Present value is about paying money later. It will help you to remember if you associate time with taking and present with paying.
Related Term: Present Value of Money.
Trusts A trust is created when the assets of a donor are placed into a trust for the benefit of a beneficiary. The donor, in effect, loses control of the assets placed into the trust since the dispersal of trust assets and/or income is the responsibility of the trustee.
There are two broad categories of trusts: - inter vivos trusts used when the donor is alive. The donor may become a trustee of his or her trust and still maintain control of the trust. - testamentary trusts used when the donor is deceased.
Two forms of inter vivos trust are: - An alter-ego trust when the beneficiary is the same person as the donor. - A joint partner trust when the beneficiaries are the donor and his or her spouse or partner.
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A popular testatmentary trust is the spousal trust which is used for the benefit of a surviving spouse and trust beneficiaries.
Trusts are very costly to set up and administer, and therefore require significant asset contribution to be worthwhile. Clients who express interest in a trust must be referred to a lawyer.
Unbundling This term describes how universal life policies separate the elements of life insurance, investment, and policy expenses.
By keeping each element separate from the others, and reporting them separately to the policy owner, the policy owner can better track investment performance.
He or she can then decide whether investment performance is meeting expectations or whether changes are needed.
Advisor Remarks: 1. Only universal life insurance provides unbundling. 2. Unbundling reflects the importance of the investment aspect of universal life insurance. 3. Unbundling benefits the universal life policy owner because it provides a clear picture of investment performance.
Related Term: Universal Life Insurance.
Underwriting When the life insurance company receives an application for insurance, it goes to the underwriting department.
In the underwriting department, the underwriters review: - The details including health, family health history, occupation, gender and smoking status about the person making the application and about the person whose life will be covered by the policy. (The policy owner and life insured are not always the same person.) - Information from the Medical Insurance Bureau databank (also called the MIB) about the person whose life will be insured. - Information provided in reports the agent has prepared.
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- An Attending Physician’s Statement (also called the APS) from the family doctor about the life insured.
Based on the information gathered, the underwriters decide how risky it is to insure the person whose death would trigger the payment of the death benefit. That risk then determines how much the policy owner will pay as a premium. - when risk meets accepted criteria for standard coverage, they offer a standard premium to the policy owner; - when risk is greater than standard criteria (in other words, there is a higher probability of death), a rated contract will be offered with higher premiums; - when risk is associated with a certain risk, that risk may be excluded in an exclusion rider. For instance, car racing would be excluded from a policy and the death benefit would not be paid when death resulted from car racing; - when risk is unacceptable, they can reject the application.
Advisor Remarks: 1. The agent is required to pass along all relevant information to underwriters about a person applying for a life insurance policy. This is called constructive notice. 2. Agent reports will include reporting on the use of drugs or alcohol by the applicant, an inspection report, and/or a hazardous sports and occupations questionnaire. 3. If the premium for a policy is higher than the standard premium it is called a rated premium. 4. The policy owner will be informed of the higher premium required before the policy is completed. He or she can accept the offer of the insurance company, or reject it. There is no negotiation permitted.
Related Terms: Mortality. Morbidity. Rated Contract.
Unfair Trade Practices Unfair trade practices include a number of unsavoury activities by agents and insurers that are at the basis of unfair —or even, unlawful -- competition and treatment of customers. They include: - misrepresentations by life agents about the benefits, advantages, or terms of a policy that are not true; - misrepresentations by life agents about guaranteed benefits; - false or deceptive advertising; - undisclosed replacement; - policy twisting or churning for the purpose of generating a commission;
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- tied selling in which the purchase of one product is conditional based on the purchase of another product; - coercion in which a customer is taken advantage of, or pressured to buy; - inducements, such as offering to make a payment or provide a gift that is unsuitable because of its expense; - premium rebating, by paying a part of all of a premium or offering another service or item of value in return.
All activities must meet the minimum ethical standards of the industry. These standards are written as codes of conduct by associations such as Advocis (http://www.advocis.ca).
Advisor Remark: 1. One of an agent’s greatest assets is his or her reputation. A good reputation is attained and maintained by avoiding unfair trade practices.
Related Terms: Churning. Ethics. Misrepresentation.
Uniform Life Insurance Act Every Canadian province has an Insurance Act. They are all very similar, except for Quebec, and for that reason, they are considered uniform across the country. There is no actual Uniform Life Insurance Act; there are life insurance acts that happen to be uniform (or standard) in their details.
Accident and sickness provisions are contained within each Insurance Act.
Advisor Remark: 1. Contract provisions are the contract details of the policy as required by each Insurance Act.
Universal Life Insurance Universal life insurance (also called UL) was developed to address the need to provide insurance with investment opportunity.
A universal life policy allows deposits to be made by the policy owner beyond the basic need for life insurance. The deposits are invested in the products offered by the insurance company, such as a mutual fund or Guaranteed Investment Certificate (GIC).
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The policy owner can monitor investment growth because the cost of life insurance in the policy, investment performance, and policy expenses are unbundled. This means each item is reported to the policy owner separately.
Investment growth in the UL policy is tax deferred unless growth exceeds the limit specified by Canada Revenue Agency. This limit is called the maximum tax actuarial reserve or MTAR.
Universal life insurance is highly flexible. Investments can be changed. The amount deposited to the policy can be changed. The face amount of insurance can be changed and the life or lives insured by the policy can also be changed. Withdrawals can be made that do not need to be repaid, plus policy loans can be taken. There is also a choice of death benefits provided by universal life insurance: the only type of life insurance that gives such an option.
The universal life policy requires the policy owner to choose between two forms of insurance cost. One is the level cost of insurance or LCOI. The other is yearly renewable term insurance or YRT. A policy based on LCOI will have the same sum paid as a premium over the entire policy. A policy based on YRT will see the premium cost increase each year.
Advisor Remarks: 1. The death benefit choice is made with the policy application. The choice affects premiums with the lowest premium associated with the life insurance death benefit, and the highest with the life insurance death benefit plus total account value. 2. Only universal life policy owners have to make this type of choice about their death benefit because only universal life policy owners have life insurance and an investment account.
Related Terms: Adjusted Cost Basis. Policy Loan. Unbundling.
Waiver of Premium Rider A waiver of premium (WP) rider, like all riders, is an addition to a base policy. It is available to be added to life insurance, disability insurance, critical illness insurance, and long-term care insurance policies.
The WP rider is available to cover: - up to six months’ unemployment of the policy owner during which time the policy owner is receiving Employment Insurance benefits;
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- disability of the policy owner when the disability is longer than three to six months’ duration. Any premiums paid during this period are then returned to the policy owner if disability persists.
In both instances, the objective of the rider is to eliminate the responsibility of the policy owner to pay premiums, when he or she will have incurred a loss of income due to unemployment or disability.
Advisor Remark: 1. Become familiar with the leading riders on life insurance and disability insurance and their terms and conditions.
Related Term: Riders.
Whole Life Insurance Whole life insurance is a policy that covers the entire life of the life insured --- whether that life is 9 years or 90 years’ long. Whole life insurance provides benefits in addition to life insurance due to the cash reserve created by a portion of the premium payments. The cash reserve is also called the policy reserve.
- Whole life is permanent insurance. This means premiums are paid by the owner of the policy for the lifetime of the person insured by the policy. - Whole life insurance is alternatively called limited payment life when the premiums are paid: o for a period of time (such as 25 years) o to a certain age (such as age 70) - A portion of each whole life insurance premium paid to the insurance company creates what is called a cash reserve. The cash reserve is a pool of money that is available for use by the owner of the policy. - If a policy owner no longer wants life insurance, he or she can withdraw the cash surrender value (known as the CSV) from the cash reserve. - When the policy owner takes the CSV, insurance coverage is terminated and no death benefit will ever be paid. - The policy owner can also use the cash reserve to take a policy loan for up to 90% of the amount available as the CSV.
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- The cash reserve also provides three non-forfeiture values or options to continue insurance coverage.
Advisor Remarks: 1. Whole life is one form of permanent insurance. The others are adjustable premium whole life, term-to- 100, and universal life. 2. Because whole life insurance is permanent insurance it is best for permanent needs, like estate planning. No matter when the life insured dies, the insurance will be in force. 3. Premiums are more expensive for whole life than for term insurance. 4. Taking the CSV, a policy loan, or using non-forfeiture options may mean the policy owner must pay tax. 5. A whole life insurance policy that pays dividends to its owner is called a participating or par policy.
Related Terms: Cash Surrender Value. Policy Loans. Non-forfeiture Values. Participating Whole Life Insurance.
Yield to Maturity Yield to maturity (YTM) is the amount an investor receives when he or she has bought a fixed- income investment, such as a bond, and holds the investment until its maturity date.
The maturity date is the day when the investment is due for repayment to the investor.
The YTM takes into consideration the interest rate paid on the coupons attached to the bond, its face value (called par value), current market price, and time to maturity. It is a complex calculation and, for this reason, usually provided in bond yield tables.
Advisor Remark: 1. This is an investment term that you should be familiar with but it will not apply to life insurance products
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