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Insurance policies are designed to meet certain needs; the right policy for the
client will depend on his or her need and circumstances. Clients can make the
mistake of focussing on one need. In working through the answer to why
insurance is needed, you and your client may determine that more than one policy
is necessary.
Life Insurance
All life insurance policies are either term insurance or permanent insurance.
Term insurance is insurance for a period of time that ends on an expiry date. If
the life insured dies before the expiry date, then the insurer pays the death
benefit to the beneficiary whose name appears in the policy. If the life insured
does not die, there is no refund of premiums and no payment made by the insurer.
Permanent insurance is, for the most part, insurance for life. The policy expires on
the day the life insured dies. At that point, the insurer pays the death benefit to the
beneficiary.
“When I met with my agent I was already certain I needed life insurance, though I didn’t know what kind was best for me. I was really surprised to find out that I should also have a disability income policy, and travel insurance for the frequent business trips I make.”
Expiry date The day term insurance coverage ends. Death benefit The money that is paid to the beneficiary upon death of the insured.
Coverage for life insurance begins on the effective date of the policy. This date
is set out on the face page of the policy.
When a person dies with life insurance in force (between the effective date and
when it expires), the face amount of the policy (also called the death benefit), is
paid to the beneficiary according to the settlement option selected. Usually, the
death benefit is paid in a lump sum to the beneficiary. There is no requirement to
pay tax on the death benefit; it is tax-free.
Term Insurance
Term insurance is life insurance for a specific period of time, or up to a certain
age. The period of time is called the term. Terms are typically available for 1, 5,
10, 15, or 20 years or as a Term-to-65 policy. Term insurance is generally not
available for purchase after 70 years of age.
Term insurance can be purchased with a single premium or a series of premiums
paid monthly, quarterly, semi-annually, or annually.
Term insurance has great appeal, because a small amount of premium buys a lot of
coverage. A male in his mid-forties might only need to pay about $60 a month in
premiums for a five-year term policy that has a $500,000 death benefit. That
makes term insurance seem cheap, right?
The answer is yes — and no. The premiums are inexpensive for those who are
younger, because the chance of premature death is very low. Therefore, there is
very little risk that the insurer will have to pay the death benefit.
However, with advancing age, premiums become much more costly, because the
chance of death is much higher. As noted above, the risk for the insurer at age 70
becomes so great that term policies are not issued.
If a person does not die while a term policy is in force, there is no refund of
premiums to the policy owner or payment to the beneficiary. The money spent on
premiums has transferred the risk of death during the period of the policy from the
life insured to the insurer.
Term insurance is often an entry-level product. Younger clients and those without
the financial ability to acquire more costly insurance will find the low premiums
appealing. Some clients buy term because of the large amount of coverage that
can be acquired at the lowest cost of all types of policies. Still others may lack the
knowledge or ability to understand more complex forms of insurance.
Effective date The date the life insurance contract takes effect. Face page The face page or schedule of the contract contains many details relevant to the policy. Face amount The face amount is the amount of insurance that has been acquired and for which the premium pays. Settlement option
There are a number of ways the death benefit can be received by the beneficiary. A lump-sum cash payment is most typical.
What does term insurance provide for the policy owner?
A Refund of premiums on expiry date B Payment of the face amount if the life insured dies while the policy is in force C Coverage in the amount of the death benefit, payable to the beneficiary named
by the policy owner, if the life insured dies while the policy is in force
D Insurance for life
Term is the perfect insurance policy for needs that are temporary (think:
“termporary”). Clients will see term premiums quoted on the television or on
websites. Chances are the product that is sold this way is a level term policy.
Level term insurance provides the policy owner with:
Premiums that will stay the same (“level”) over the term;
A face amount specified in the policy that will stay the same (“level”)
over the term;
A death benefit paid to the beneficiary for the face amount of the policy if
the life insured dies during the term specified in the policy.
A person who buys level term insurance knows exactly how much it will cost,
how much it will pay out, who will receive the death benefit, and when the
insurance expires.
Other forms of term insurance that are less common are increasing term,
decreasing term, and renewable term.
“I have a two-year term policy that will expire next year. The premiums are $16.41 per month. My beneficiary, my bank, would receive $10,000 if I died before that date to repay the loan the bank gave me to start my own business.”
Increasing term insurance provides the policy owner with:
Premiums that will increase over the term;
An increase in the face amount specified in the policy over the term;
A death benefit paid to the beneficiary for the face amount in force at the
time of the death of the life insured during the term specified in the policy.
Increasing term insurance covers a life that is increasing in economic value. For
example, a lawyer who has just graduated and is just beginning to build a client
base.
Decreasing term insurance provides the policy owner with:
A level premium over a long term, such as 20 years or to age 65;
A decrease in the face amount each year;
A death benefit paid to the beneficiary for the face amount in force at the
time of the death of the life insured during the term specified in the policy.
Decreasing term insurance was once popular to insure decreasing financial
obligations, such as a mortgage. It is now used infrequently.
Renewal Option
Renewable term insurance policies give the policy owner the ability to renew
the policy. The policy owner can expect:
A higher premium on renewal. The new premium is called the guaranteed
renewal rate, and it is stated to the policy owner when the policy is taken
out.
Guaranteed renewability, because the life insured is guaranteed to be
insured, regardless of his or her health
The same face amount every time the policy renews; it is paid to the
beneficiary if the life insured dies
“I have increasing term insurance that grows every year to keep pace with my increased salary. I reckon that the beneficiaries of my policy — my family — will receive an amount that will suit their lifestyle.
Renewable term insurance allows the insured to renew the policy until a date — or
age — specified in the policy.
The most common renewal periods are 1, 5, 10, and 20 years. A 10-year
renewable policy, for example, will renew every 10 years without evidence of
insurability. The premiums for each renewable period will reflect the mortality
risk for that period, which increases due to the attained age of the life insured.
This is one reason the premiums at each renewal are higher than the premium of
the previous period.
Unless a policy purchased is a renewable policy, it is non-renewable. A non-
renewable policy terminates on its expiry date. A non-renewable policy owner
who wishes insurance after expiry of his or her policy must re-apply for a new
policy.
Sam purchased a term-to-65 policy, whose death benefit increases at 5% per year. He purchased this policy so that his death benefit keeps pace with his increasing income of about 3% per year (and therefore his family’s lifestyle), as well as to compensate for inflation, which he figures will be around 2% per year. His premium will increase every year to reflect this increase in death benefit. What type of term policy did Sam purchase?
A Level B Increasing
C Decreasing D Renewable
Convertible Option
A term policy may be a convertible policy. If a policy is both renewable and
convertible, it is customarily called an R&C policy.
The convertible option on a renewable term insurance policy gives the policy
owner the right to convert the term policy to a permanent life insurance policy for
Having a renewable policy means that there is no requirement to show good health when the renewal periods end.
Mortality risk Mortality risk is a factor used in underwriting the policy by which the risk of death is rated. For instance, high mortality risk = high premium. Attained age The age of the life insured at the time of renewal.
the same or decreased face amount without evidence of insurability. In other
words, even if the life insured is in poor health and would be deemed uninsurable
if he were to apply for a policy, the policy owner can convert his policy to
permanent insurance. He continues to have the benefit of life insurance that will
be in place for the lifetime of the life insured, thanks to his conversion option.
It may be expected that a policy with a renewable and convertible option will be a
bit more expensive than a non-renewable policy.
The converted permanent insurance policy is considered an extension of the
original term-insurance policy as far as the contract provisions are concerned. For
this reason, the incontestability period and suicide clause do not begin anew.
The premium on conversion will be based on either the age of the insured when
the policy was first taken out, or on the attained age at the date of conversion.
Clearly, it is preferable to apply when younger, since premiums increase with age.
Conversion is usually not available after a certain age, typically age 70.
What distinguishes renewable term from convertible term insurance? A Renewable term provides an extension of the term policy; convertible term
converts to permanent life insurance
B Premiums do not increase when renewable term is renewed but do increase on conversion of a policy to permanent life insurance
C Renewable term allows for the same face amount on renewal, but renewable and convertible term does not
D All of these answers
“I was diagnosed with cancer two years ago. When my R&C policy comes up for renewal this year, I am going to convert it to a whole life policy and keep the same face amount. My
health will not affect my premiums.”
Incontestability A life insurance policy cannot be contested after it has been in force for two years. Suicide clause A death benefit will not be paid to the beneficiary of a policy if the life insured dies as a result of suicide within two years of the effective date of the policy.
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See file 2 for understanding of suicide exclusion and incontestability clauses.
Permanent insurance is in force for the lifetime of the life insured. The beneficiary
of the policy receives the amount of the death benefit when the life insured dies.
Premiums for permanent insurance are considerably more expensive than for an
equivalent face amount of term insurance, because, unlike term, the insurer knows
with absolute certainty that the death benefit will have to be paid at some point.
Like term insurance, permanent insurance can be purchased with a single lump-
sum premium or premiums paid monthly, quarterly, semi-annually, or annually.
Permanent insurance is available as:
Whole life insurance;
Adjustable premium whole life insurance;
Term-to-100 insurance;
Universal life insurance.
Whole Life Insurance
Whole life insurance is available as: whole life, in which the premiums are paid
until the life insured dies, and limited payment life, which requires premiums to
be paid over a specified period of time or to a specified age. For instance, a 20-pay
life policy requires premiums to be paid for 20 years. The coverage, however, is
life-long. A payments-to-age-65 policy requires premiums to be paid until the life
insured is 65. Again, the coverage is permanent.
Which of the following types of policy does not provide permanent insurance coverage?
A Universal life insurance B Whole life insurance C Term-to-100 insurance D Term insurance
“I have a whole life policy, because I know my pension will always be able to pay my premiums. But the policy for my wife was a 10-pay policy. I paid these premiums while I was still working and had the finances to make the payments easily. Her coverage is permanent, even though the premiums were not.”
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See file 7 for limited payment non-par whole life insurance. Whole life A whole life policy sees the same premium paid for life.
Limited payment life Limited payment life sees the premium limited to a number of payments over a specified time or to a specified age.
When an agent proposes whole life insurance to a client, the agent can emphasize
features that benefit the policy owner during his or her lifetime. They include:
The policy reserve;
Policy dividends.
The Policy Reserve
During the early years of a whole life policy, the policy owner pays more in
premiums than coverage requires. This creates a “policy reserve.” The policy
reserve, or cash reserve, increases with every premium payment and by compound
growth on the savings within the reserve.
If a policy owner no longer wants insurance coverage, then part of the value of the
policy reserve can be received by the policy owner via the policy’s cash
surrender value (CSV). Cash surrender value is exactly what it says: cash paid to
the policy owner in return for the surrender of the policy. Thus, unlike the case
with term insurance, the policy owner receives “money back” if the policy is
discontinued.
Since the greatest personal risk is that of becoming disabled, why would someone want to buy whole life insurance?
A To ensure needs of survivors are met in the event of premature death B To pay final expenses C To build cash value in a policy D All of these answers
The policy reserve also provides the policy owner with the ability to:
Borrow from the CSV with a policy loan;
Use a non-forfeiture option.
Taking a Policy Loan: Up to 90% of the cash surrender value (CSV) of a policy
can be borrowed from the insurer by the policy owner in a policy loan. Interest on
the loan is charged at the rate set by the insurer, which is usually competitive with
rates offered by banks or other lending institutions.
If the policy owner dies before the loan is repaid, the outstanding amount of the
loan, plus interest, is deducted from the death benefit. It is possible, therefore, to
seriously erode the value of the death benefit with a large loan.
Converting the CSV into non-forfeiture options: Non-forfeiture options give
the policy owner some alternatives to surrendering his or her policy. Thus, the
policy owner continues to enjoy insurance coverage.
Dividends A whole life policy is available as a participating, or par, policy, in which dividends may be received. If dividends are not received from the policy, it is called a non-par policy. Dividends are not
guaranteed; you will learn more about them later in this chapter. Non-forfeiture options The three non-forfeiture options are the automatic premium loan, extended term insurance, and reduced paid-up insurance. Each option provides the policy owner with a way of maintaining insurance coverage. Cash surrender value forfeits insurance coverage.
Automatic Premium Loan (APL): When a policy owner forgets to pay the
premium or is short of money when the premium is due, the policy will remain in
force by using an automatic premium loan.
The APL automatically — without the necessity of the policy owner taking any
action — charges premiums as a policy loan against the cash surrender value of
the policy to continue insurance coverage. It can be used until the policy owner
recommences premium payments or until the amount of the loan plus interest
equals the cash surrender value of the policy. Coverage will end when the grace
period following the final premium payment ends. So, if the final policy premium
date is January 1, the grace period will keep the policy in force for another 30 or
31 days. The death benefit (less loan amount) will be paid if the life insured dies
during the grace period. The policy will lapse as of January 31. Death after that
date will not be covered.
Extended Term Insurance (ETI): This option allows the policy owner who stops
paying premiums to keep coverage in force by using the cash surrender value of
the policy as a lump-sum premium to buy term insurance. The face amount of the
term policy that is acquired will be the same as the whole life policy; however, its
term will be based on the attained age of the life insured when this option is
selected. Riders and other benefits from the original policy will be cancelled.
Grace period The grace period is 30 or 31 days after the premium due date.
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See file 5 for information on the grace period. Riders A rider is a benefit or extra coverage
that is attached to the main policy. Riders help to customize the policy to more closely match the needs of the customer.
“My husband and I could no longer afford the premiums on my 20-pay-life policy with a $250,000 face amount. I used the extended term insurance option to change my coverage to term insurance with $250,000 in coverage.
Reduced Paid-up Insurance (RPU): Whereas ETI uses cash surrender value to
switch permanent coverage to term coverage — much like the reverse of the
convertible term option — reduced paid-up insurance uses the cash surrender
value of the whole life policy as a lump-sum premium for a whole-life policy that
is paid-up. The policy owner sacrifices the amount of coverage that he or she had
previously for a lesser face amount, but the policy continues as a permanent
policy.
The new face amount will be based on the attained age of the life insured and the
cash surrender value in the policy.
RPU provides many of the features of the original whole-life policy, including a
cash surrender value and insurance coverage for the lifetime of the insured. Riders
and other benefits are cancelled.
“I decided I couldn’t keep up with my whole life premiums, but permanent insurance is important to me. I need to know that I will pay all my final expenses, not my kids. I converted my policy to reduced paid-up insurance: it’s permanent insurance ─
not as much coverage as I had, but enough to give me peace of mind.”
Paid-up Paid-up means there are no further premiums to be paid.
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See file 6 for the distinction between ETI and RPU.
Whole life policies may be non-participating policies, in which case the policy
owner is not entitled to a dividend. Whole life policies may be participating
whole-life policies, in which case the policy owner is entitled to receive dividends
from any surplus in the reserves of the insurer. Obviously, participating policies
are a bit more expensive than a corresponding non-participating policy.
Policy dividends paid by an insurer are different from the dividends that are paid
if you own stocks of a company. Policy dividends are a distribution of surplus
earnings held in the participating account established by the insurer that receives
premiums from participating policies.
A surplus is created when the insurer incorrectly overestimates mortality rates and
expenses, and/or underestimates its investment earnings. It is mandatory for the
insurer to keep reserves to meet its insurance obligations, but once those reserves
are exceeded, the excess is distributed to the par-policy owners as a dividend.
Dividends are not guaranteed, and their amount can vary year to year. They begin
at the end of the first year of a policy and are paid after the first premium in the
second year has been received by the insurer.
When the policy owner completes the application for a participating policy, he or
she must indicate how the policy dividends will be received. There are three basic
purposes to which policy dividends can be put:
As savings;
To acquire more life insurance;
To reduce premiums.
Dividends as Savings: The savings option will see policy dividends:
Paid by cheque once a year to the policy owner;
Left on deposit with the insurer to accumulate interest;
Invested in a segregated fund, mutual funds.
Segregated fund A segregated fund is a type of investment available through insurers that provides a guarantee to the investor that either 75% or 100% (depending on the contract) of their deposits will be retuned on the death of the policy owner or on the maturity of the contract. More information on segregated funds will be provided in the Investment module.
Dividends Dividends are paid to participating policy owners when a surplus in the reserves exists with the insurer.
Dividends Used for More Life Insurance: The policy owner can select:
Paid-up additions (PUAs);
Special term additions (also known as the fifth-dividend option);
Term additions.
Paid-up addition: A paid-up addition (PUA) uses the policy dividends to buy
additional insurance. As its name suggests, this insurance is paid-up — it needs no
premiums. It is usually a participating policy (par policy) in its own right, with its
own cash surrender value. Paid-up additions add to the face value, cash surrender
value, and loan value of the original policy.
A medical exam is not required in order to purchase paid-up additions. Also, they
can be surrendered individually any year without affecting the actual policy and
received as cash or used to pay premiums.
Special term addition: A special term addition is a one-year non-renewable term
policy that is typically equal to the cash surrender value of the policy at the end of
that policy year. The difference between the cost of term insurance and the policy
dividend is paid in cash. A medical exam is not required in order to purchase
special term addition.
Term addition: A term addition uses the whole dividend to buy a non-renewable
one-year term addition that will be paid if the life insured dies during that year. A
medical exam is not required in order to purchase term addition.
If a participating whole life insurance policy was being used in a business, which form of dividend payment will help the face amount of the insurance policy keep pace with the cost of living?
A A segregated fund B Paid-up additions
C A special term addition D A term addition
Dividends Used to Reduce Premiums: The use of dividends to reduce the policy
owner’s outlay for premiums is called premium offset. The simplest method for a
policy owner to use to reduce premiums using dividends from a participating
policy is to apply the cash received towards the premium payment. There is a
benefit and a disadvantage to choosing this course of action. The benefit is that the
policy owner reduces his or her outlay towards the premium. For instance, when
the annual premium is $3,200 and the policy owner receives $200 in dividends,
the premium is reduced by the dividends to $3,000 ($3,200 – $200). The
disadvantage is that the policy owner is not acquiring more life insurance via
Paid-up additions (PUAs) can be used towards premiums by using the dividends
of the PUAs or cashing in individual PUAs. Thus, if the annual premium is
$3,200, and the policy owner has reinvested dividends each year in a PUA, he or
she might receive $100 in dividends from PUAs. The policy owner could then use
the $100 against the $3,200 premium to reduce the premium to $3,100 ($3,200 –
$100). The policy owner could also sacrifice a single PUA, receive its cash
surrender value ($200), and use the $200 towards the premium, so that the
premium is then reduced to $3,000 ($3,200 – $200). The premium can also be
reduced by a combination of PUA dividends and PUA cash surrender value.
Needs Answered by Whole Life Insurance
Estate planning: If it is necessary for the policy owner to have life insurance in
force at the time of death in order to provide for beneficiaries or to pay capital
gains tax on property willed to beneficiaries, or to cover final expenses, then
whole life insurance provides the security of knowing the death benefit will be
available for these uses.
Creditor protection: A small business owner, someone who is self-employed, or
someone who otherwise has significant debt, can be protected from the claims of
creditors by a whole life insurance policy:
During the lifetime of the policy owner, the CSV of the policy cannot be
claimed by a creditor if the beneficiary is an irrevocable beneficiary (that
is, a beneficiary who cannot be altered without his or her permission) or a
revocable beneficiary who is a spouse, child, grandchild, or parent. These
beneficiaries are called preferred beneficiaries.
On death, proceeds of the policy are protected from creditors, because the
proceeds become an asset of the beneficiary, providing the beneficiary is
not the estate of the policy owner. Therefore, creditors of the insured have
no claim. (This is also true of the proceeds from term insurance.)
“A policy owner is not guaranteed to be able to buy paid-up additions, because the dividends needed to buy PUAs are themselves not guaranteed. However, my par policy has paid dividends for the last two years. I used the dividends to buy PUAs.”
The policy owner must also choose how premiums will be structured and the
death-benefit options of the policy. Together, these choices allow an insured to
tailor the policy to meet his or her needs.
As mentioned, one of the key features of universal life is its flexibility. The policy
owner can increase or decrease the face amount of the insurance with satisfactory
evidence of insurability, add more lives to be insured under the policy and
substitute one life insured for another. The amount and duration of the premiums
and how the savings are invested are also highly flexible.
Flexibility also extends to the death benefit. A whole life policy owner receives
the cash value of their policy if it is surrendered or borrowed against. On death,
the beneficiary receives the sum insured less an amount that may be reduced if a
policy loan has been taken. Therefore, they receive the cash value or the sum
insured. Universal life policy owners can choose to receive the cash value of their
policy in addition to the sum insured on death.
What are the decisions that must be made by a universal life insurance policy owner?
A The face amount, the investment of funds, how the premiums will be charged, and death benefits
B The investment of funds, how the insurance will be costed, and death benefits C The face amount, the life insured, the beneficiary, the investment of funds, how
the premiums will be charged, and the form of death benefit
D The face amount, the beneficiary, and the investment of funds
There are three separate parts to a universal policy — insurance, investment, and
expenses. Unlike other types of policies where the factors that determine the price
of the policy are not revealed to the policy owner, a universal life policy lists
separately the cost of insurance (the mortality charge applied to the policy), the
growth rate applied to the account value of the policy, and the expense charges of
the insurer (for administration, expenses, and sales costs) as they apply to the
policy. The term used to describe this separation is unbundling.
Unbundling these costs is considered to be a very important feature of universal
life, because of the benefit to the policy owner. He or she can see exactly how
much growth is occurring in the account, the rate of growth, and the costs of
insurance and expenses. Thus, each of the premium pricing factors can be
monitored separately from the others; amongst other information, this reveals a
true picture of investment performance. By being able to monitor investments, the
policy owner is better aware of whether changes to the investments are warranted.
Unbundling Unbundling makes all the cost aspects of the universal life policy transparent.
The cost for insurance protection in a universal life policy is called the mortality
charge. It is based on:
The age of the life insured;
The risk classification of the life insured, which is determined by gender,
smoking status, health factors, etc.;
The cost of insurance based on the net amount at risk (NAAR).
The policy owner must choose whether the life insurance premium will be based
on a yearly renewable term (YRT) rate (that increases annually) or a level cost
of insurance (LCOI) rate (that remains constant, or level, for life and is based on
term-to-100 rates). The cost for insurance is deducted from the policy owner’s
account monthly.
The choice between the two rates should be made with care, because each has
special considerations. YRT premiums will be low initially, but as the insured
ages, premiums will escalate. LCOI premiums may be higher initially, but will
remain constant over time. The cash values in each policy also accumulate at
different rates.
“I took out my universal life policy three years ago to cover my wife and me. I’ve had a lot of changes in my life since then, and my policy has changed as my circumstances have changed. I divorced last year, for instance, so I discontinued the coverage for my wife. My medical practice has grown by 220%, so I have increased my coverage to keep pace with my growing income. Plus, I have a more positive view now of the investment potential of Asian markets. I switched my universal life investments into this market in time to enjoy a 18% surge in value. No other insurance policy can give me this flexibility.”
Yearly renewable term(YRT) Yearly renewable term increases in cost upon every renewal. Level cost of
insurance (LCOI) premiums stay level for the duration of the policy.
Expense charges against the U.L. policy include administration, expenses, and
sales costs. They are deducted from the account monthly.
The Investment Component of Universal Life
Deposits made in addition to the premium for the universal life policy build a pool
of savings in the account, called the account value, or the accumulation fund. As
long as the account value can pay the mortality charge and policy expenses, there
is no need for premium payments by the policy owner.
If the account value is used for premium payments, its value is reduced.
The Structure of a Universal Life Policy
optional deposits mortality charge Premiums Account Value
investment
expenses some expenses may be deducted before premium is deposited
Premiums and deposits made to the account are invested by the policy owner in
investment products offered by the insurer. There are many products from which
to choose, including savings accounts, guaranteed term deposits, investment
funds.
The investment earnings grow within the account. The income within a tax-
exempt universal life policy does not have to be declared each year. This means
that taxes are not paid until the policy is disposed. Thus, the policy owner
benefits from compounding (earning growth on growth).
What factor might indicate changes to investments should be made in a universal life policy?
A The desire for a higher face amount B The need to change the life insured C Growth that is not fulfilling the expectation of the policy owner
D The need to add a life insured
Disposed A policy is disposed in many ways, including surrender of the policy, its absolute assignment, or its lapsation. Disposition is a taxable event. Compounding Compounding is when investment growth earns growth, hence returns are said to be “compounded.”
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See file 12
regarding the danger of leveraging a universal life policy.
Fundamentally, universal life policies offer two basic investment options: one
investment option guarantees the rate of return, such as would be received in a
daily interest account, in Guaranteed Investment Certificates, or with Treasury
bills; the other investment option provides no guarantees. Instead, investments
fluctuate in relation to market performance by linking to market indexes or a vast
array of mutual funds or mutual-fund portfolios. An account need not be entirely
guaranteed (safely invested) or entirely non-guaranteed (risky investments); a
balanced portfolio holds both types of investments.
What type of return does the universal life policy owner receive when the investments in the policy are linked to a mutual fund?
A Non-guaranteed return
B Guaranteed return C Balanced return D The return depends on the type of mutual fund
The challenge to the agent who is selling a universal life policy is to guide the
policy owner to the type of investment best suited to his or her needs and risk
tolerance. To do so, the agent and policy owner must understand the relationship
between risk and return. It is very simple: investments that are very safe (i.e., are
guaranteed) produce the lowest returns. Conversely, non-guaranteed investments
may deliver higher returns and the highest potential for losses.
Features of Universal Life Similar to Whole Life
Like whole life insurance, universal life offers:
A cash surrender value (CSV);
Policy loans;
Premium offset.
Cash Surrender Value: The cash surrender value of the policy is determined by its
total account value. The total account value is the total of all the investments in
the investment account, less deductions for the current month’s expenses.
The CSV is the total account value, minus outstanding loans, minus surrender
charges. Many policies have a surrender charge that applies if the policy is
surrendered. These may apply up to 20 years after the policy was issued.
Policy Loans: A policy loan cannot exceed the cash surrender value of the
account. There will be a tax implication if a loan exceeds the adjusted cost
basis (ACB) of the policy. If the life insured dies with an outstanding policy loan,
death benefits will be reduced by the amount remaining on the loan, plus interest.
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See file 13 for
guidelines on how to select the best investment.
Adjusted cost basis (ACB) The adjusted cost basis of a life insurance policy is a number used to determine whether a policy might be taxable if it is disposed. The amount paid in premiums is typically the largest cost contributor to the ACB.
You will learn more about ACB later in this module.
Premium Offset: The need for future premiums can be eliminated by paying
larger-than-required premiums in the early years of the policy. The premiums are
then paid by the accumulated tax-sheltered investments in the account.
What is a benefit of universal life insurance that is not provided by whole life insurance?
A Policy loans B Cash surrender value C The flexibility of the policy
D Guaranteed returns
Unique Features of Universal Life
The ability to make a cash withdrawal from a policy without forfeiting the policy
is available only to those who own universal life policies. Also, death-benefit
choices are provided to the policy owner that are not available to the owners of
other types of policies, because they reflect the investment aspect of the universal
life policy.
Cash Withdrawal: A cash withdrawal can be made from a universal life policy. If
not repaid, it may reduce the amount of the death benefit. The tax implications of
withdrawals are addressed in the chapter “How Do I Get My Money?”
Death Benefit Choices: Universal life provides a variety of death benefits to
reflect the nature of the policy as both insurance and as an investment. The policy
owner selects his or her preference when the application is made. Usually the
policy owner considers the needs of the beneficiary first. Other facts to be
weighed include the investment objectives of the policy owner, his or her ability
to pay premiums, and personal preferences. You will learn about these settlement
options in the section on applying for insurance.
What could reduce the amount of death benefit in a universal life policy?
A Cash withdrawals B Policy loans C Policy expenses D A and B
“I’m a confident and experienced investor. The ability to get back the amount my premiums earned as a result of my investment decisions, in addition to the death benefit, was a key reason for me to buy a UL policy.”
+ FILE
See file 14
for a comparison of term, whole life, and universal life insurance.
This benefit provides exactly what its name says: guaranteed insurability. It
guarantees the policy owner the right to increase the amount of life insurance at
certain times, over periods of time, or if certain events occur — usually up until
the age of 40 and generally not past age 50 without evidence of insurability. These
dates, events, and the amounts by which the insurance can be increased are
established when the rider is purchased.
The extra insurance is usually limited to the face amount of the policy or to an
amount specified in the rider.
A new home may mean a larger mortgage, and consequently a bigger financial obligation than was contemplated when a policy is first taken out. The Guaranteed Insurability Benefit rider can allow policy coverage to increase in such an event.
Also called the disability income benefit, this rider can be added to a policy only
when the policy owner and the life insured are the same person (a two-party
contract). It provides a monthly income, after a three- to six-month waiting
period, to age 60 or 65 or as long as the policy is in force, during which time the
life insured is totally disabled. Total disability is defined as the insured’s inability
to perform the essential acts of his or her occupation or any occupation for which
he or she is reasonably suited by education, training, or experience.
The amount of the benefit is linked to the face amount, usually as a fixed-dollar
amount per $1,000 of life coverage.
This rider may also include a waiver of premium benefit that will waive
premiums during a period of total disability.
Waiver of Premium Benefit (WP)
Disability income insurance will not compensate you fully for the amount you
were earning when working, but will go a long way towards “paying the bills.”
Most living expenses continue during a period of disability: mortgage or rent,
food, utilities, car payments, and insurance premiums will all need to be paid, just
as if you were still earning a salary. However, if you have included a waiver of
premium with your individual policy, your disability income insurance premiums
will be one less bill you have to pay.
The waiver of premium rider pays the premiums on a policy if the life insured is
disabled. There is a three- to six-month waiting period after the start of a
qualifying total disability, during which time premium payments continue. From
that point onward, the premiums are paid by the insurer. Some waivers pay the
premium retroactively from the beginning of the disability if the disability
continues after the waiting period, and any premiums that were paid are refunded.
The definition of disability will be provided in the policy, but most policies
exclude disabilities caused by an injury that is intentionally self-inflicted, an
injury caused while committing an illegal act, a condition that existed before the
rider was issued, and an injury sustained by military personnel during an act of
war.
Disabilities sustained after age 60 are usually not covered.
If the life insured dies, the face amount will not be reduced by the premiums paid
on behalf of the policy owner by the insurance company.
Two-party contract When an insurance contract is a two-party contract between the policy owner and the insurer, it is also called a personal policy. Waive To waive means to temporarily put aside or give up.
A variation on this rider, called the waiver of premium for payor benefit covers
the policy owner if the contract is a three-party life insurance contract (the policy
owner and the life insured are two separate people). In this case, the policy owner
who is responsible for payment of the premiums is protected from having to make
premium payments if he or she is disabled. The same exclusions will apply as
when the contract is a two-party contract. However, the policy owner will have to
provide evidence of insurability when acquiring the policy containing this benefit.
Accelerated Death Benefit
The accelerated death benefit is also known as a living benefit rider.
This rider pays some of the face amount of the policy to the life insured during his
or her lifetime. Therefore, it reduces the amount of death benefit the beneficiary
will ultimately receive.
The maximum that can be received is usually a percentage of the face amount
(often 50%), and there can be a dollar limit, too.
The life insured must meet certain requirements before receiving this benefit, such
as suffering from a specific or terminal disease.
The accelerated death benefit is available as a:
Terminal illness benefit: when death of the life insured is expected to
occur within twelve months, as declared in a doctor’s certificate;
Dread disease benefit: if the life insured is diagnosed with one of a
number of specified diseases, such as cancer, heart disease, etc.;
Long-term care benefit: when the life insured cannot perform two or more
of the Activities of Daily Living (ADL), the life insured would qualify
for this benefit. More details on long-term care insurance as a stand-
alone product follow later in this book. Since death is not imminent, the
benefit is paid monthly as a small percentage of the face amount.
During a period of disability, the waiver of premium rider transfers responsibility for premium payments from the disabled policy owner to the insurance company. In essence, the company pays itself.
Long-term care
insurance Long-term care is one type of insurance that provides a “living benefit,” in other words, it provides a benefit during the lifetime of the insured. Other living benefits include disability income insurance and critical illness insurance.
In practice, even when a policy does not contain this rider, insurers have been
known to provide the policy owner with an “advance” against the death benefit of
the policy when the life insured has a terminal illness, especially in cases of
financial hardship.
Parent Waiver
When life insurance is placed by a parent on the life of a child, until the child is a
certain age. A parent waiver waives future premiums if the parent dies.
Term Insurance Rider
A term rider may be added to a permanent life policy that will increase the amount
of death benefit during a period covered by the rider. The death benefit is the total
of the permanent policy and term rider. A term rider on a permanent policy allows
a policy owner to take a lesser amount of permanent life insurance, and save the
expense accordingly.
John wants a $500,000 permanent policy for payment of last expenses. He is 47 and has a mortgage of $40,000, with four years left to pay. What would be an effective way of structuring a policy for John?
A $500,000 in term insurance B $540,000 in term insurance C $540,000 in permanent insurance D $500,000 in permanent insurance with a $40,000 term rider
Riders can also be added that cover lives in addition to that of the life insured.
Most commonly, these riders are used for a spouse and/or children. There is a
special child term rider, which covers children of the family for small amounts,
ranging from $1,000 to about $25,000. The premium for the child’s coverage is a
flat amount, unrelated to the number of children in the family, and so does not
require a change if the number of children changes. Coverage for the child usually
ends when the child turns 21 or 25, although an option is often provided that
permits the child to convert coverage into an individual life insurance policy
Disability insurance replaces the policy owner’s income in the event that he or
she becomes physically unable to work due to an accident or illness. Although
disability income insurance is perhaps less well-known than life insurance,
experts agree that disability coverage is essential — especially when statistics
reveal that the probability of being disabled is much greater than the chance of
premature death.
While many people are covered for the medical costs of injury or sickness
through provincial or private health insurance, without disability insurance they
are not prepared for the loss of wages that accompanies such an event. In general,
if a person counts on his or her job to pay the costs of daily living for themselves
or their family, that person needs disability coverage.
Disability income insurance is provided through:
Individual insurance policies;
Group insurance policies;
Federal government programs;
Provincial government programs;
Individual life insurance contracts as a rider.
What is the difference between life insurance and disability income insurance? A Disability income insurance is income protection insurance
B Disability income insurance is a way to transfer risk C Disability income insurance provides an income to a beneficiary D Disability income insurance provides life insurance to disabled people
Fundamental to the concept of disability insurance is that benefits received from
any or all sources — private or public — will not pay more to the sick or injured
person than that person received as earned income while working. Thus, a
person is compensated for their misfortune, but not rewarded. Limiting insurance
in this way prevents overinsurance.
Which of the following statements is true about the disability income benefit and disability income insurance?
A The disability income replaces earned income lost due to disability. B Coverage for disability income insurance is based on earned income. C Coverage for the disability income benefit is based on the total income of the insured. D A and B
Earned income Earned income for disability insurance purposes is the amount of income that would be lost due to disability. Overinsurance When disability insurance is based on earned income, the insurance benefit compensates the insured for their loss of income. It prevents overinsurance, by which the insured would earn more from insurance than by working.
Personal Disability Income Insurance Disability is the inability to work because of injury or illness. For insurance
purposes, it exists when:
An accident or sickness has occurred or becomes known while the policy
is in force, thereby ruling out pre-existing conditions;
A condition requires medical attention and the individual is under the care
of a doctor; and
The individual is unable to perform the essential duties of his or her
regular occupation.
Types of Disability Income Policies
There are three types of policies to cover personal disability insurance needs:
Cancellable, also called commercial policies;
Guaranteed renewable policies;
Non-cancellable and guaranteed renewable policies.
A Cancellable Policy
This policy, also called a Commercial Policy, is issued on a “class” basis. A class
is formed when people are grouped together by age, gender, occupation, or type of
plan. A cancellable policy can be cancelled, and the premiums increased, benefits
reduced, or restrictions imposed by the insurer at renewal when the claims for the
class are higher than anticipated.
A Guaranteed Renewable Policy
This policy is guaranteed to be renewed until age 55, and usually to 65. The terms
and conditions of the policy remain the same with each renewal; however,
premiums can be increased on a class basis if the class of the insured shows a
higher claims experience.
A Non-Cancellable and Guaranteed Renewable Policy
This policy provides the highest level of protection to the insured and,
consequently, has the highest premiums. The policy is guaranteed to be renewed
until the insured reaches 65. The insurer cannot cancel the policy, increase the
premiums, add restrictive riders, or reduce benefits.
Pre-existing conditions These are existing health conditions that would negatively affect the premiums charged for the policy, or perhaps even jeopardize the issue of the policy itself.
Which type of disability income insurance would a person select who wants to be absolutely certain that their coverage would not be cancelled?
A A guaranteed renewable policy B A non-cancellable and guaranteed renewable policy C A conditionally renewable policy D A and B
Personal Disability Income Insurance Policy Benefits
The benefits of a disability income policy are based on:
The definition of disability in the policy: coverage based on whether the
insured can perform any job or wishes to restrict employment to his or her
regular or own occupation;
Benefit payments: how much will be paid;
Elimination period: how long to wait before payments begin;
Qualification period: how long total disability must exist before residual
benefits will be paid;
Benefit period: how long payments are received.
Definition of Disability
Though different levels of coverage are available, only those in the top
occupational classifications can choose freely from among all levels. Those
employed in lower occupational classifications will have fewer choices. For
instance, a person who is not in a top classification may be forced to take coverage
that provides a benefit if he or she is unable to work at any job or he or she is
unable to perform the essential duties of his or her regular occupation. Thus, they
are not able to cover themselves to ensure eventual return to the job they were
performing pre-disability.
“I’ve been working as a chiropractor for the past 12 years. Since I run my own practice, I took out a guaranteed renewable disability income insurance policy to give me income protection. Recently, a number of my colleagues have hurt their backs on the job trying to move and manipulate patients who are seriously overweight. I didn’t think this affected me, but now my insurer says my premiums are increasing because claims for my “class” have been higher than expected.”
+ FILE
See file 17 for
a case study on disability income insurance.
Occupational classifications Occupations are classified for the purpose of disability income insurance by how likely a claim may be and the severity that the claim may present for the insurer. The highest classification is reserved for professional occupations, such as doctors or dentists, who meet specified criteria. The lowest classification is unskilled workers and labourers.
Which definition of total disability allows the insured to earn employment income, plus 100% of his or her disability income benefit?
A Residual benefit B Any occupation C Regular occupation D Own occupation
Partial Disability
A partial disability definition provides coverage that is simply a percentage of the
total disability benefit. There is no formula used; it is simply a straight percentage
(usually 50%). For example, after a period of total disability, if an insured could
only perform some of the tasks of his or her occupation or can only work for part
of the time the insured normally works, the partial disability benefit is paid. The
benefit is paid only to a maximum number of months (usually 3 or 4 months).
Presumptive Disability
A presumptive disability claim will be honoured when the insured suffers the loss
of limbs, sight, hearing or speech, paraplegia or paralysis. Full benefits are
payable until the end of the benefit period or for life, regardless whether or not the
person can return to work.
Benefit Payments
The income or payment received by the policy owner is called the benefit. The
amount of benefit that will be received will be determined by reviewing all the
sources of income of the applicant. Income that is directly attributed to being
actively at work is the basis for the calculation. You will learn more about the
amount of benefit in the next chapter, as you determine how much insurance a
client should carry.
“I’m educated as a mechanical engineer. When I started work 13 years ago, I took out a disability policy with an “own occupation” definition to ensure my family always has my income to count on. The stresses at my job became intolerable and I took disability leave. Because I have an own occ definition when I want to pick up occasional work at a building site, my benefits are not reduced, plus I receive an hourly wage for the work I do.”
The elimination period is a waiting period between disability and benefits. It is a
period of self-insurance, in which the insured retains the risk of disability.
The longer the elimination period, the lower the premium.
Qualification Period
A disability income policy with a residual definition may specify a period of time
after the accident or illness during which the insured must be totally disabled. This
period of time is called the qualification period. On completion of this period,
residual (or partial) benefits will then be available.
Usually policies issued to the top occupational classes do not have a qualification
period. The requirement for total disability to precede residual benefits may be
eliminated by a zero-day qualifying period rider. This is a rider attached to the
policy that reduces the qualification period to zero days of total disability before
partial benefits begin.
The qualification period is not the same as the elimination period or waiting
period. The elimination period is the period between disability and benefits; the
qualification period is the period between total disability and residual benefits.
Benefit Period
The benefit period is the length of time an income will be received; the longer the
benefit period, the higher the premiums. The most common benefit periods are
one year, two years, five years, or to age 65.
The top occupational classifications have the longest benefit periods (e.g., up to
age 65) while those at the bottom of the scale will have benefit periods restricted
to years or months.
“I eliminated coverage for the first two months of disability to help reduce premiums. My first benefit cheque will be received at the end of month three, because disability benefits are always paid a month in arrears.”
An individual short-term disability policy has a benefit period of two years or less.
Some policies may have a benefit period of five years. An individual long-term
disability policy is one with a benefit period of five years or longer that begins
after the short-term disability or government benefits end, and traditionally
continues until age 65.
Personal Disability Income Insurance Policy Riders
Just as riders can be added to a life policy, so too can they be added to a disability
policy to customize the policy and better match the needs of the client. Riders to a
disability income insurance policy include:
Future purchase option;
Cost of living adjustment;
Waiver of premium;
Rehabilitation benefit.
Future Purchase Option (FPO)
The future purchase option (FPO), also called the future income option (FIO),
allows the policy owner to increase the amount of monthly income benefit to keep
pace with his or her growing income, with no evidence of medical insurability.
The premium will be increased in step with the increase in coverage. Income will
have to be proven when this option is used.
The premium may also be adjusted if the occupational classification of the insured
changes. The benefit period of the additional income will be the same as the
original policy.
The future purchase option is available only as a rider to a policy and must be
exercised before the insured is 50 years of age.
“Some years ago I took out a disability income policy based on the salary I earned as a plant foreman. Last year I was promoted to plant supervisor. The only way I could increase my disability coverage to keep pace with my new salary was to apply for a new policy. Unfortunately, since I applied for my first policy I have been diagnosed with rheumatoid arthritis. Because of this, I can’t get a new policy. I wish now I had added the future purchase option to my first policy. It would have allowed my coverage to keep pace with my increasing salary.”
+ FILE
See file 18 for examples of how these riders are used.
The cost of living adjustment (COLA) option addresses the impact inflation has
on the purchasing power of a fixed income. Fundamentally, a person who lives on
a fixed income — that is, receives the same amount of money for a prolonged
period of time — is able to buy less and less because inflation continually causes
prices to increase.
The Cost of Living Adjustment rider is selected by the policy owner to increase
benefits based upon the Consumer Price Index (CPI). If increases are compounded
monthly, a more generous benefit will be received. The policy owner may find a
“cap” on how much benefits can increase; once the cap is reached, there are no
further COLA adjustments.
This rider is essential for a young policy owner; if the policy owner is disabled for
life at a young age, the purchasing power of the benefit would be greatly
diminished as the years progressed in the absence of a COLA rider.
Waiver of Premium (WP)
The waiver of premium rider on a disability income policy transfers the payment
of the policy premium to the insurer, while the insured receives disability benefits
— exactly the way it works when this rider supplements a life insurance policy.
The waiver of premium benefit with a disability income policy usually begins
within one to six months of disability; in other words, if the waiting period is three
months, premiums will be paid by the insured for three months and no longer.
Also, the premiums paid during this time may be returned, if the rider is structured
do so.
Rehabilitation Benefit
The rehabilitation benefit will cover the cost of any retraining or rehabilitation that
is not covered by other programs, such as those provided by the government. Its
“I have a disability income policy to ensure there will be an income available for my family if I become sick or injured. My COLA option means that, even if I make a claim in ten years, the benefit will have kept pace with inflation.”
Accident and sickness (A&S) insurance is provided to all Canadians by their
provincial health plans. However, individual accident and sickness policies are
available from insurers to make up for the limitations of government-provided
insurance.
A&S insurance is completely separate and distinct from disability income
policies, because it does not provide income to the insured; A&S protects against
loss and provides partial or entire repayment of qualifying medical and dental
expenses incurred by the insured.
Personal Accident and Sickness Insurance The most common types of accident and sickness policies are:
Extended health care;
Travel assistance;
Prescription drug plans;
Dental plans;
Accidental death and dismemberment.
Extended Health Care
Extended health care “extends” health-care benefits beyond what is provided by
government plans. This can cover:
Semi-private or private hospital rooms;
Ambulance services;
Prescription drugs;
Private-duty nursing;
Medical appliances, such as splints, braces, and artificial limbs;
Diagnostic services.
The need to transfer test results such as X-rays may not be covered by the provincial plan. This is where extended health care can save an expense for an insured.
Renewable and convertible, in which the policy can be converted to
lifetime coverage;
Level term (e.g., term to age 65 or 75);
Lifetime.
A CI policy is available for purchase up to age 65. Children may be covered, and
typically are added as a rider to the parent’s CI policy. Children are most often
insured for conditions associated with the young, such as cystic fibrosis.
Pre-existing conditions are excluded, as are people with HIV/AIDS. To protect
themselves, insurers usually state that, if conditions such as cancer are diagnosed
within 90 days of the issue of the policy, they will consider it a pre-existing
condition and no benefit will be paid in such cases.
Premiums are based on:
Age of the insured;
Amount of coverage;
Gender;
Smoking status;
Renewability of the policy;
Definitions used within the policy.
All policies cover the top four health conditions: heart attack, cancer, stroke, and
heart bypass surgery. Thereafter, up to 23 other illnesses and conditions can be
covered. However, there will be differences between insurers on the definitions of
the illness covered, and the definition must be satisfied or the insured will be
unable to make a successful claim.
Cancer is an excellent case in point. Many people diagnosed with many types of
cancer recover, yet there are others that are terminal. Therefore, the coverage for
cancer in the policy must list the types of cancer covered, and the impact the
“The stroke I suffered two years ago left me almost an invalid. I used the funds from my critical illness insurance to put ramps into my home, to install grips in the bathroom, and to customize a van with a mechanism to lift my wheelchair in and out.”
After an elimination period (ranging from zero days to 180 days), benefits for
long-term care insurance are paid weekly or monthly. Benefits are payable if there
is:
Cognitive impairment: an inability to think, perceive, reason, or
remember;
Inability to perform, unaided, two of the five activities of daily living
(called ADLs): bathing, eating, dressing, toileting, or transferring
positions of the body. Some policies include a sixth condition which is
incontinence (lack of bladder control), in which case they have to have
two of the six conditions.
The length of the benefit period ranges from three years to life.
Terms
The policy is guaranteed renewable and premiums are level for the duration of the
policy, including renewal periods. The insured must be between the ages of 31 and
80 (depending on the insurer); premiums become expensive with age, so the
policy should be taken out well before it may be needed. There is a 10-day
rescission period.
Riders are available for inflation protection, waiver of premium, and return of
premium.
Limitations
Benefits will not be paid when there is a pre-existing condition, unless care begins
at least six months after the policy’s effective date.
What is the primary advantage of long-term care insurance?
A To provide an income to the elderly B To preserve the value of the estate of the individual needing long-term care
C To provide care for the disabled D To alleviate the guilt of long-term caregivers
Impairment does not need to be physical for the benefit to be received from a long-term care policy. Cognitive impairment, such as a loss of memory, would be reason enough for a benefit to be paid.
ADLs Activities of Daily Living or ADLs include bathing,
eating, dressing, toileting, and transferring positions of the body. The inability to perform any two of these activities qualifies the insured for the long-term care benefit.
Rescission period Insurance policies provide a 10-day period after the policy is delivered, in which the policyholder can change his or her mind, cancel the policy, and receive back any money that has been paid. After the rescission period ends, the policy can be discontinued at any time by not paying the premiums, in other words the policy will lapse, but money will not be refunded.