Aging insurance

It seems we’re overdue for a reality check. According to various statistical studies, life expectancies of both men and women are increasing. In 1996, there were 3,125 centenarians in Canada; in 2001 the number grew to 3,795; and this segment of the population is steadily increasing.

Undoubtedly, an aging population has huge economic ramifications for our country. The healthcare system, Canada Pension Plan, and the workforce will all be affected by the changing demographics.

In all likelihood, we’ll see a surge in retirement homes, bifocals, hearing aids, Viagra prescriptions, mobility scooters and electric wheelchairs. But has anyone thought about how this shift in demographics will affect the insurance industry?

At a glance, it seems aging should be beneficial for companies—people living longer, more premiums, and more time to invest premium dollars. While all that’s true, there may be some snags the industry, and we advisors, need to consider.

Case in point is a situation we ran into recently with a client and a Term to Age 100 policy, which endows at age 100. Mr. Smith applied at the age of 85 and was approved for a $100,000 life insurance policy. The level premium of $11,600 was payable up to age 100, a total of $174,000. According to the terms of the contract, at age 100 the policy endows and the face amount is paid out to the lucky survivor. Well, Mr. Smith turned 100 this year, and received a $100,000 cheque, to be followed in December with a T5 for $100,000 to be included in income.

Had our client not reached his 100th birthday, his beneficiary would have received $100,000 taxfree. However, because he did survive, the $100,000 is deemed a disposition and is taxable. Something seems amiss.

Most of the current life insurance taxation rules are a result of amendments made to the Income Tax Act in December 1982. Calculations that determine the value of disposition of a life insurance policy have to do with the method of determining the adjusted cost basis (ACB) of a policy. An amount up to the ACB is received by the policy owner, tax free on disposition; and any amount above the ACB is taxable. Regulation 308 provides a guideline to the insurers on how to arrive at the ACB by calculating the Net Cost of Pure Insurance (NCPI). The ACB is then calculated by totalling all the premiums paid and deducting from it the sum of the NCPI.

Simply stated, the NCPI grinds down the ACB; so the longer the policy is in force the lower the ACB. The table used for calculations is the 1969-1975 mortality table of the Canadian Institute of Actuaries (CIA), published in Volume XVI of the Proceedings of the CIA. There are some quirks in this table that create a few problems. One major issue is that the last row on the table ends at age 70. And the insurer is instructed to determine NCPI from the table.

The approach, however, is not uniform because there are variations among insurance companies in determining the Net Amount at Risk (NAAR). The figures can vary from company to company. However, in many similar situations the insurers’ calculations lead to a very high NCPI, usually in excess of the ACB.

Now in some planning cases, such as a corporate-owned policy that is held to death, this could be a good thing. That’s because if the corporation receives the death benefit and there is a low ACB, a larger amount will go to the Capital Dividend Account. However, in the case of a disposition it can be problematic. Let’s look at the scenario for Mr. Smith. Over his lifetime he has paid $174,000 in premiums, his NCPI is $190,000 and his ACB is negative $16,000, or zero. Thus, on disposition the entire $100,000 is taxable as income. It doesn’t seem fair or equitable—except maybe for the CRA.

The Department of Finance and the insurance industry will have to review the calculation methodology and modernize it. At very least, the tables should be updated and there should be some uniformity in the approach. Let’s hope they get to it before we all turn 100.