Archive for category: Insurance

Given the problems encountered by some large financial institutions in the United States, how concerned should we be about the state of the life insurance industry in Canada?

Insurance is one of the most closely regulated industries in Canada. Unlike the United States, in Canada, there is a government organization that supervises all of the federally incorporated and foreign insurers to ensure that these companies operate in a prudent manner. This organization is the Office of the Superintendent of Financial Institutions (OSFI). The major life insurance companies are federally regulated by OSFI (For those companies that are provincially chartered their oversight is provided by the province in which they do business).

Life Insurance companies are decreasing in number

It is a fact that over the past decade the number of life insurance companies operating in Canada has decreased dramatically. This decrease is mainly due to the mergers and acquisitions of the existing companies. For example, those individuals who maintained policies issued by Maritime Life, Commercial Union, North American Life, or Aetna Life, now find themselves insured by Manulife Financial.

The good news? No insured individual has ever lost any contractual benefits due to their insurance company being acquired by another.

Adequate reserves are the key to stability

• OSFI oversees the stability of life insurance companies by enforcing the requirement that adequate reserves be maintained in order for the companies to meet their future contractual obligations.

• Reserves are known as “actuarial liabilities” and each company is required to put money aside and to invest that money prudently so that they may pay future benefits on policies that they have sold in the past.

• These reserves are generated from premiums paid to the insurer and the investment income earned on those premiums. Under the Insurance Companies Act, insurers are required to invest in a “reasonable and prudent manner in order to avoid undue risk of loss.”

• Also, OSFI requires an amount over and above these reserves, known as the Minimum Continuing Capital and Surplus Requirement (MCCSR) to be maintained by the insurer. OSFI expects that the life insurers maintain an amount equal to 150% of the MCCSR requirement. The MCCSR ratio maintained by member companies of the Canadian Health and Life insurance Association has consistently been significantly higher than the minimum requirement.

More protection for Canadian policyholders

As additional protection afforded a life or health insurance policyholder there are benefits provided to all policyholders through a not-for-profit organization known as Assuris. This organization in a manner similar to the Canadian Deposit Insurance Corporation protects policyholders should their insurance company fail. Assuris guarantees the following:

• Death benefits – Up to $200,000 or 85% of the promised face value, whichever is higher;

• Critical Illness – Up to $200,000 or 85% of the promised benefit, whichever is higher;

• Health expenses (including travel insurance) – $ 60,000 or 85% of the promised benefit, whichever is higher;

• Monthly income (disability, annuity etc). – $2,000 or up to 85% of the promised benefit whichever is higher;

• Insurance companies TFSA’s – Up to $100,000;

• Segregated Funds – $60,000 or up to 85% of the promised guaranteed amount whichever is higher.

So how strong is the Canadian Life Insurance industry?

• The combination of strong effective oversight and regulation of prudently invested actuarial liabilities have resulted in a robust financial industry enjoying assets of more than $514 billion in Canada, making the industry one of the largest investors in Canada.

• 10% of all Canadian and Provincial Government bonds and 15% of all Canadian corporate bonds are held by the insurance industry.

• Canadian insurers also hold $650 billion in assets abroad. The industry in Canada employs over 150,000 people.

Even though the life insurance industry in Canada has gone through significant changes in the past decade or two, the industry remains stable and capable of meeting its contractual obligations in the future.

The planning considerations of where and how to own your life insurance can be varied and sometimes complicated. It is important to remember that who owns the policy, controls the policy. The owner has the right to name a beneficiary, assign the policy, take cash value loans or even cancel or surrender the policy. The insured does not have to consent to these transactions although there are steps available to require his or her permission when necessary. This article focuses on the main, but not all, issues in determining the ownership of a life insurance policy.

When considering the ownership of a life insurance policy on your life, generally there are three options:

1. Personal or individual ownership

2. A company that you own or control

3. A trust

For many Canadians, option #1 is an obvious choice as most do not own a company and wouldn’t have any complex planning considerations to warrant trust ownership. For those, however, that do have a choice, it is important to review the advantages or disadvantages of each. The beneficiary arrangements should be appropriate for the ownership type selected. This is especially true for corporate ownership as the Canadian Revenue Agency may look closely at the ownership/beneficiary structure.

Personal Ownership

Most life insurance policies are owned by the life insured with a named beneficiary, usually a spouse. A major advantage of naming a beneficiary is that the proceeds at death may be protected against the claims of creditors or litigants. A named beneficiary of the “preferred” class (spouse, parent, child, grandchild) also protects any cash values of the policy from similar claims during the lifetime of the insured. Unless there are compelling reasons for it, do not name your estate as your primary beneficiary. Doing so could expose the insurance proceeds to probate fees as well as potential creditor and legal claims.

There are situations where the ownership of the policy may rest with someone other than the insured. This would include an ex-spouse on a policy to fund matrimonial agreements upon death. It could also be for a blended family situation that a spouse would own coverage on the other spouse to protect his or her children from a previous relationship. Naming a successor owner in these situations is recommended.

Company Ownership

If you own a company, you have the choice of having your insurance coverage held in your company. For example, if you are an incorporated professional, you could have your professional corporation own your policy. The same is true if you have a holding company that you own and control. The benefit of doing so is that the dollars used to pay the premiums are “cheaper” for the company than they are for you personally. Life insurance premiums are generally not tax-deductible and are paid with after-tax dollars. If you are paying the premiums out of corporate earned income, dollars taxed corporately at a low rate (11% in B.C. for example) are cheaper than personal dollars taxed at an average rate of 35% or more.

The after-tax cost of the earnings used to pay for the life insurance is a primary reason why corporate ownership is considered for life insurance that otherwise would be required personally. The ability to pay out the death benefit up to the full amount received by the corporation to the surviving spouse or family on a tax-free basis makes this a very attractive option.

There are, however, a few downsides to corporate ownership. The first of these has to do with the calculation of how much of the death benefit received by the corporation can be paid out tax-free out of the Capital Dividend Account (CDA) to the spouse or family member as beneficiaries or surviving shareholders. Depending on when the death occurs, there may be a portion of the death benefit trapped in the corporation and not eligible for CDA payment. In order to pay this amount (which represents the remaining adjusted cost basis of the policy) out of the corporation, an ordinary taxable dividend would have to be declared. This may be considered a small price to pay, however, based on the after-tax cost savings over the years preceding death. Also, if death occurs at normal life expectancy or a short time thereafter, usually all the proceeds are available for a tax-free CDA payment.

Another disadvantage is that, unlike personal ownership with a named preferred beneficiary, the proceeds are not protected from the creditors of the corporation. There are often other factors to consider when considering corporate ownership of life insurance, so it is important to ensure that you receive competent advice in this regard.

Aside from making sure the proceeds of the insurance end up where they are needed the most, if current and future premiums are being paid from personal funds that have already had the taxes paid, then personal ownership may be preferable.

Trust Ownership

A trust arrangement is often used in more complicated situations. For example, if there are multiple beneficiaries who need to be treated differently, or if there are multiple policies, it may be less complicated to use a trust to allow control over the policies and the distribution of the proceeds by the trustee(s).

Another scenario is where the policy is owned by someone other than the life insured who wishes a successor owner to be named if he or she predeceases the insured. An example of this would be a single parent who purchases a Whole Life policy on his or her child and needs to have a successor owner until the child reaches the age of 18. Should the owner name a sibling, a subsequent transfer of the policy to the aunt or uncle could create a taxable policy gain. It would also not be creditor proof as a sibling is not a preferred beneficiary. Use of a Trust to hold the policy until the appropriate time for the child to become owner is a way to avoid this.

An important use of a trust, specifically an Irrevocable Life Insurance Trust is for holding life insurance on the life of a U.S. citizen living in Canada. Since the trust is resident in Canada, the life insured should not be subject to any potential U.S. estate taxes upon death.

Shared Ownership

A planning opportunity exists with a life insurance policy that contains a cash value. The concept behind Shared Ownership is that the individual insured would own and pay for the cash value portion of the policy while the company would own and pay a reasonable cost for the life insurance component. Under this arrangement, the insured would be investing in a tax-deferred life insurance policy while the cost of the insurance is borne by another entity. This increases the internal rate of return on the cash value growth and would be received tax-free by his or her named beneficiary upon death.

Ownership and beneficiary arrangements are very important aspects of life insurance planning. Make sure that you receive the best advice possible in order to achieve the optimum result.

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