Faceoff: Is costlier insurance cost-effective?

Canadian insurers have gone through two rounds of price increases since December 2010. Does pricier insurance still make sense for clients who want to leave legacies?

Rob Salvucci, CLU, RHU, FLMI, Director, insurance and estate planning, The Williamson Group.

Stance: Being uninsurable is a bigger problem than pricier insurance

The age factor

Declining interest rates are the fundamental reason insurance companies have raised premiums on Term-to-100 products. It’s a balancing act for insurance companies; they need to remain competitive yet financially viable.

The average increase in pricing is 10%, but that fluctuates based on age demographics. Over the last two years, younger age bands may have experienced up to a 20% increase in premiums, while for clients fifty and older—who make the bulk of estate planning purchases—the impact hasn’t been as dramatic. They may have experienced no increases, or nominal increases.

Term insurance is a more cost-efficient option for younger clients. But as age increases, so does the cost of insurance. People trying to wait out this period of rock-bottom interest rates need to be equally concerned about protecting their insurability.

Insurance isn’t a commodity clients can get in and out of at will. Clients must qualify medically to be insured. In most cases, the cost of waiting—even two or three years—might prove pricier than the price increase. Besides, even if interest rates start trending up, there’ll be a lag before current fixed-income investments mature and can be reinvested at higher interest rates.

Mortality trumps markets

If insurance is a suitable tool for a client, I wouldn’t recommend waiting for the market to turn. A greater risk than uncertain markets is a client experiencing poor health that makes him or her uninsurable. Worse still would be unexpected death or unforeseen critical illness or disability and no insurance proceeds or payments for dependants.

Many financial planners tend to focus too much on the accumulation side. They come up with great offensive strategies but don’t temper them with proper defence. Life can throw curves at us, in the form of critical illness, disability or premature death. It’s important to understand what the impact could be to your long-term plans.

Evolutionary insurance

I try to educate younger clients about the evolution in their needs — from temporary to permanent. In most cases, it might not be appropriate to jump into permanent options for clients who have competing interests and a tough time balancing budgets.

I’d advise them to start with short-term solutions that can ease into long-term estate needs. Term insurance could do the job of providing less expensive coverage and, most importantly, guaranteeing future insurability.

It’s important to confirm the term insurance product selected is convertible to permanent options without having to re-qualify medically. To get the best value on the client’s conversion privilege, you also need to determine whether the provider offers strong permanent solutions in addition to competitive term products.

Opportunities galore

Life insurance provides a whole realm of possibilities in estate planning. The basic approach is to provide liquidity at the time of death to pay debt, replace family income or provide cash to pay taxes that are triggered by death.

Even if you have the net worth to pay estate and probate taxes, it can still make sense to buy insurance. In a joint last-to-die policy, the death benefit can be delivered for pennies on the dollar.

Let’s assume a husband and wife are both 65, and have a tax liability of $1 million, which they want to pay in the most cost-efficient manner. For about $18,000 a year (on a joint life expectancy of 25 years), they can buy $1 million of joint last-to-die coverage. For a total projected outlay of $450,000, (25 years x $18,000) the couple’s estate will receive $1 million tax-free.

From an investment perspective, at life expectancy of 25 years, the internal rate of return on the premiums paid is 5.7%. Because it’s received tax-free, that’s the equivalent of earning 10% to 11% pre-tax in an outside investment, on a guaranteed basis (assuming the client is at the highest marginal tax rate). Compare that to today’s fixed-income markets, where it’s impossible to secure 9% or 10% rates of return on a guaranteed basis without taking on significant risks.

Cindy David , Vice-President, estate planning division, Dupuis Langen Financial Management Ltd.

Stance: Costlier insurance still cheaper than tax

To buy or not to buy?

When it comes to estate planning, quite often insurance is a choose-to-have, not have-to-have tool. Most people buy it to pay back tax liability so more of their estate gets into the hands of their beneficiaries.

In recent months, there has been a spike in level-cost permanent life insurance, but it remains a sound investment. The cost of life insurance is still lower than the cost of settling probate and paying taxes in cases where the insured shares a common liability that arises upon the death of the survivor.

It’s much cheaper to insure spouses or common-law partners under a joint last-to-die policy. Depending on age, you can get a 50% discount from your insurance provider if you insure two lives under one plan. That’s why insurance still works well for estate planning.

Let’s say you and your spouse are in your 50s and know that at 85 you’ll have an estate tax liability of $500,000. At the current rate insurance companies charge on a joint last-to-die basis for a $500,000 insurance plan, your estate will likely get almost twice as much back on the premium, than if you put $500,000 in a GIC with a 4% interest rate.

When buying insurance on an individual life, however, there comes a point where it can get too expensive.

Readjusting assumptions

In an economic environment where bond yields have plummeted and interest rates hit rock-bottom, insurance companies are struggling to fund guaranteed payouts promised in universal life policies. The first round of rate hikes in December 2010 responded to lowered revenues as a result of assumptions embedded in much higher rates of return.

While the spike in premium rates seems like fair pricing today, as interest rates recover, it might become a disincentive to buy insurance if insurance companies don’t reward clients for changes in interest rates.

To avoid that situation, some companies are considering building in clauses into the client contract that allow for the level guaranteed price to go down and adjust for increasing rates of return.

Greed or survival?

It’s important for consumers to understand the recent price hikes aren’t an attempt by insurance companies to gouge them and line their own pockets.

Before December’s rate hike, Canadian insurance companies were surveyed by Munich Re. The wholesale reinsurer asked retail companies two key questions:

• Of the products you have, do you feel you are priced for profitability?
• Do you feel your competitors are priced for profitability?

Most companies responded they were profitable on Term 10, Term 20, and yearly renewable term insurance plans. However, they unanimously agreed level-guaranteed universal life plans had zero profitability.

For most companies, level-cost universal life plans represent a majority of their market share, and they aren’t making any money on it. These companies hadn’t adjusted for fluctuating interest rates in decades, and it was time they adjusted to the current low-rate environment.

Given that we’re at a 50-year historical low for bonds and GICs, I’d be very surprised if prices went up by much more after this latest round of increases. If they do, it may remove the advantage that insurance has over paying taxes.

Not just for millionaires

Some people still believe estate planning is for millionaires. That notion is flawed. Estate planning is not just for the super wealthy. Nor is the purchase of insurance. Let’s say you’re a couple with a combined RRSP value of $500,000.

In B.C., 43.7% of that will go to the government—the primary beneficiary of all your savings. When people are told how much of their estate will go to the government, they are often shocked.

The fact that you have estate tax liability means you have assets. In fact, if you have fewer assets, you need to make your dollar stretch farther, and it’s even more important to establish a plan for paying the taxes.