Life insurance
Life insurance is a contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary (or the estate) a sum of money (the "benefits" or "face value") upon the death of the insured person.[1] The death benefit is usually paid tax-free.[1] Depending on the contract, other events such as terminal illness or critical illness may also trigger payment. The policy holder typically pays a premium, either regularly or as a lump sum. Other expenses (such as funeral expenses) are also sometimes included in the benefits. The advantage for the policy owner is "peace of mind", in knowing that the death of the insured person will not result in financial hardship for loved ones and lenders.
Life policies are legal contracts and the terms of the contract describe the limitations of the insured events. Specific exclusions are often written into the contract to limit the liability of the insurer; common examples are claims relating to suicide, fraud, war, riot and civil commotion.
Life insurance can be divided into two basic categories: term and permanent.[2] Term insurance is meant for a specific period. For example, an investor might take a 10-year policy to insure against early death, thus providing a legacy for a spouse and/or children. Permanent insurance is intended as an investment to leave a tax-free legacy upon death.
As of 2022, 22 million Canadians are covered by life insurance[2], including group benefits. In 2022, 83% of life insurance premiums paid were for individual coverage, and 17% of premiums were related to group benefits.[2]
Individually owned life insurance is typically purchased through an agent, broker or advisor.[2] A medical questionnaire is normally required. Factors that influence premiums may include "age, sex, condition of health, medical history, family medical history, financial situation, occupation and dangerous activities".[1] Older people pay more, smokers pay more, and men pay more than women. Some 96% of people who apply for coverage are approved.[1]
Definitions
- Insured
- the owner of the policy, responsible for the premiums, and who must have an insurable interest[3]
- Life insured
- the person whose death will cause payment under the policy
- Beneficiary
- the person(s) paid upon the death of the life insured
Types of life insurance
Term insurance
Term insurance can be offered as part of group benefits, or be purchased by individuals.
Many people will be well served by term insurance because it is much cheaper than other types, and will only be in place while the policy holder needs it. It will eventually expire worthless (if the policy holder does not die within the coverage period), but then retirement savings should have replaced it.
Suppose you are a 25 yrs old male (we’ll use males because their insurance costs more than that of females), you are planning to get a mortgage soon and you just had your first child. Clearly, your sudden disappearance would be a problem for the surviving members of your family, because your salary would be gone. You need to get enough life insurance to replace your salary, or at least part of it, probably at least until the kids leave the home. There is a an “Income Replacement Calculator” here that says that is you want to provide $50k of annual indexed income over 30 yrs, using 3% inflation and 5% nominal return on investments (the capital would be invested), the amount of insurance needed is $1.15M. This is a big number, and it is likely that the only affordable way to insure yourself for this amount would be term insurance. For a 25 year old non-smoker living in Quebec for example, with “regular health”, the cheapest 30 year term policy (with a coverage of $1.1M) from a company with an “A.M. Best” rating of A- or better would cost approximately $875 a year in November 2023 (source). In contrast, the equivalent “whole life guaranteed” policy would cost about $5300 per year.
The same figures for a female are $580 a year for term, and about $4900 for whole life.
Permanent insurance
Permanent life insurance comes in two main types: universal and whole life. However, Term to 100 policies blur the lines somewhat between term and permanent policies, offering lifetime coverage without, however, building a cash surrender value.
Cash surrender value is the moving part that distinguishes traditional permanent policies. If you surrender the policy, you can get some money back, but it is taxed somewhat like a capital gain.
According to one source, "using a permanent insurance policy as a tax shelter makes sense only when your RRSPs and TFSAs are maxed out, you have a significant amount invested in bonds or other fully taxable investments, and you are virtually certain you won’t need the money in your lifetime."[4]
Term versus perm
The following table compares some features of term versus permanent insurance:[5][6][7][8]
| Term insurance | Permanent insurance | |
|---|---|---|
| Possible uses | * Income replacement for dependants (insure human capital) * Cover debts such as a mortgage1 * Cover future educational expenses1 * Key person insurance (for a business) * Spousal and child support replacement (in divorce/separation cases) * All other temporary life insurance needs |
* Pay for your funeral * Leave an estate tax-free * All other lifelong insurance needs |
| Cost | * Much lower premiums than permanent insurance when you are young and healthy * Becomes very expensive with age (mortality risk increases), but then the need for temporary insurance should be smaller or inexistent |
* Premiums can be constant for life (and initially much higher than term) |
| Competitive market | Yes. Price is the main differentiator between companies |
Less so (products are more complex, more variable between companies, and more difficult to compare) |
| Examples | * 1 year term (used mostly for group benefits) * 5 year term * 10 year term * 20 year term * 30 year term * Term to 65 |
* Term to 100 * Whole life * Universal life |
1 If you have insured the full present value of your future employment earnings (human capital), there is no need to add more coverage for your mortgage or for your kids' education.
Buying life insurance
Selecting an agent or broker
Life insurance agents may represent only one lifeco, whereas brokers are supposed to spread their business to several companies.[1] The Canadian Life and Health Insurance Association Inc (CLHIA) recommends that you phone two or three agents/brokers for a preliminary interview. CLHIA suggests asking the following questions:[1]
- How long has the agent been in business and what company or companies does he/she represent?
- Does the agent belong to a professional association?
- Has the agent qualified for professional accreditations?
- Is the agent licensed in your province?
- Will the agent provide references from other clients?
Provincial regulators
The sale of life insurance is regulated by provinces and territories. Check that your agent is licenced.
| Province/territory | Regulator |
|---|---|
| Alberta | Alberta Insurance Council |
| British Columbia | Insurance Council of British Columbia |
| Manitoba | Insurance Council of Manitoba |
| New Brunswick | Financial and Consumer Services Commission |
| Newfoundland & Labrador | Superintendent of Insurance |
| Northwest Territories | Superintendent of Insurance |
| Nova Scotia | Superintendent of Insurance |
| Nunavut | Superintendent of Insurance |
| Ontario | Financial Services Regulatory Authority of Ontario |
| Prince Edward Island | Superintendent of Insurance |
| Québec | Autorité des marchés financiers |
| Saskatchewan | Insurance Councils of Saskatchewan |
| Yukon | Superintendent of Insurance |
Getting ready for the meeting
Once an agent/broker has been selected, the prospective buyer should get ready for the meeting, i.e. become armed with as much information as possible. The prospective buyer should have a very clear idea of what type of life insurance to purchase (typically, term), for how long, what face value, what is the minimum acceptable lifeco rating, and approximately how much the premiums will cost. You should 'buy' the life insurance policy you actually need, not be 'sold' what the agent/broker might want to sell you.
Commissions paid to agents
Buyers of life insurance should be aware that agents make significantly larger commissions by selling permanent insurance, relative to term insurance. Barney gave the following example in 2011:[9]
- A $500,000, 10-year term policy for a 40-year-old, male non-smoker in preferred health is $370 per year. The basic commission rate for that policy is 40% with typical bonuses of 190% added to that. The total commission for the sale of that policy is $429.
- The minimum premium for a UL (Universal Life) policy from the same company is $2,878. Basic commission for that policy is 60% (half again as much as for the term product) with the 190% bonus generating a payday for the agent of about $5,007.
The example above is dramatic because the premiums between term and UL are very different when the death benefit is equal (here, $500k). But even comparing a term and an permanent product with the same yearly premiums (but different death benefits), the agent will get a bigger commission from the sale of permanent insurance. On the other hand, the purchaser of the permanent insurance product with an "affordable premium", equal to what term insurance would have cost (for a much larger death benefit), is left with a product having a death benefit that may be way too low relative to his or her needs.[8]
Consumer protection
Founded in 1990, Assuris is the not for profit organization that protects Canadian policyholders in the event that their life insurance company should fail.[10]
Four lifecos have failed in Canada since Assuris was established, as shown in the following table:[11]
| Year | Company | Number of life policies | Group insurance holders |
|---|---|---|---|
| 1992 | Les Coopérants | 222,000 | 600,000 |
| 1993 | Sovereign Life | 249,000 | ? |
| 1994 | Confederation Life | 260,000 | 1.5 million |
| 2012 | Union of Canada Life | 22,000 | ? |
According to Assuris, all the Canadian policies were transferred to solvent life insurance companies.[11]
See also
References
- ^ a b c d e f Canadian Life and Health Insurance Association Inc (CLHIA), A guide to life insurance, viewed June 11, 2019
- ^ a b c d Canadian Life and Health Insurance Association Inc (CLHIA), Canadian life and health insurance facts 2023, viewed November 17, 2023
- ^ Wikipedia, "Insurable Interest", viewed February 23, 2009.
- ^ Dan Bortolotti, Life insurance: Is term life always enough?, MoneySense, January 27, 2012, viewed January 29, 2017
- ^ Colin Ritchie, The Perm/Term Squirm: Deciding Between Permanent And Term Life Insurance Policies – Part 1 – Term Life Insurance, Canadian MoneySaver, January 2014 issue, viewed January 28, 2017
- ^ Bob Barney, The Mistake Many Will Never Know They Made, Canadian MoneySaver, September 2014 issue(subscription required), viewed January 28, 2017
- ^ Moshe Milevsky (March 30, 2010). "The lowdown on insurance salesmen and warranty peddlers". The Globe and Mail. Retrieved January 21, 2017.
- ^ a b Robert Barney, Pushing Whole Life, Canadian MoneySaver, January 2002 issue(subscription required), viewed January 29, 2017
- ^ Bob Barney, Casting Blame In The Wrong Direction, Canadian MoneySaver, February 2011 issue, viewed January 28, 2017.
- ^ Assuris - Protection for your life insurance products, viewed November 20, 2012.
- ^ a b Assuris, Past Insolvencies, viewed January 18, 2017
Further reading
- Financial Wisdom Forum topic: "Life Insurance"
- Financial Wisdom Forum topic: "Wills, Estate Planning, Life Insurance"
- Financial Wisdom Forum topic: "Life insurance" - a much older discussion
External links
- Canadian Life and Health Insurance Association Inc (CLHIA), A guide to life insurance
- Life insurance: Is term life always enough? | MoneySense
- M.A. Milevsky, Your Life's Worth: If you have children, you need life insurance. But how much is enough?, National Post Business magazine, October 2002
- Grant Robertson and Tara Perkins, What your insurance broker doesn't want you to know, The Globe and Mail, December 21, 2010
- Moneysense, Finding the right cover -- Retirement planning? Decide which insurance is right for you, June 2016 (with input from M.A. Milevsky)
- Data tracking life insurance policy could come back to bite you
