Life Insurance products can be confusing to most of us. What is term insurance? What is Whole Life or Universal Life? What is the best product?
There are different products available to allow the Insurance Planning Professional provide a proper solution for a particular planning objective. In other words, there is no ‘best product’. Our planning needs and objectives are different. And our overall financial situation may not allow us to fully implement an ideal solution today, but we may find it prudent to provide for our current needs while maintaining flexibility for the future.
It is important to keep in mind that in order to purchase life insurance we must qualify. The factors affecting our ability to qualify include our own health history, occupation, age and even family health history. Our sex and smoking status will affect our ‘standard’ rates. (Females have a longer life expectancy so their Life Insurance rates are lower than males and Smokers have a much shorter life expectancy so their rates are higher than non-smokers. Smoker rates may be 25% to 100%+ higher depending on the age and type of product).
An underlying theme in any planning strategy should be the retention of future flexibility. As we go through life our needs, our objectives and even our values may change. So it is important to build flexibility into any planning we put into place today.
So, what about the different types of products? In simple terms, there are two types of products—Term Insurance and Permanent Insurance. And, there are various product variations within these two general categories.
Term insurance typically provides coverage for a specified ‘term’ (such as 10 or 20 years), and can often be ‘renewed’ at higher premiums for another ‘term’ up to a specified maximum age such as 75. Typically the premiums payable at the time of renewal are guaranteed but are much higher than the original premiums. Term insurance provides maximum coverage for minimal cost but only for a specified term. Eventually the renewal rates become very expensive. Coverage ceases totally at the maximum specified age.
Term insurance is, therefore, an excellent product to protect for ‘short term’ needs such as mortgages or business debts. It is, however, a very poor or totally inadequate vehicle for long term planning objectives.
Term insurance typically does not have any cash values.
Many Term insurance products are ‘Convertible’ to a permanent life insurance plan. This ‘convertibility’ allows the insured to change the plan from a Term Plan with increasing premiums and a termination date to a plan providing coverage for life at a guaranteed cost (permanent insurance). This ‘conversion’ option is only available to a specified age (such as 65 or 75). When a person ‘converts’ his Term policy to a Permanent Policy, he is able to do so without having to qualify medically and the rates payable will be based on the rates then available at the then current age. To illustrate, if a 35 year old purchased Term Insurance 30 years ago and was converting it to Permanent Insurance today, he would pay the rates currently available for a 65 year old.
Permanent Insurance provides insurance for life. Typically the premiums payable are guaranteed to stay level for life as well.
Compared to Term Insurance, Permanent Insurance is initially more costly but over the long run it is much less expensive and remains level in cost and affordability.
So Permanent Insurance is not as effective for short term planning needs, but it is much superior for long-term estate and financial planning objectives.
There are different product types providing permanent insurance.
Whole Life Insurance
Whole Life insurance is the traditional policy with level premium payments designed to remain in force over the entire lifetime of the insured. The way the policies work, early premiums tend to be higher than required to cover the probability of death. By doing this, the policy has a base reserve. This reserve, along with accumulated interest and the premiums that continue to be paid, cover the years later in life when the insured is more likely to die. Paying the initial higher premium enables the premium to remain level in later years.
Many Whole Life Policies earn ‘dividends’ from the insurance company and these dividends can be used in a variety of ways to enhance the overall value of the plan. Whole Life is generally the more expensive of the various permanent plans but can provide excellent long-term values and enhanced security.
Some Whole Life plans are available to be guaranteed fully paid up (no future premiums required) after a specified period such as 20 years.
Term to 100
Term to 100 is really a ‘stripped down’ version of Whole Life. It typically provides guaranteed coverage for a guaranteed level premium for life. There are no cash values or dividends provided in basic Term to 100 products.
Some insurance companies have Term to 100 products available with guaranteed cash values and, in some cases; the client has the option of stopping his premium payments in the future in exchange for a reduced fully paid up policy.
Some Term to 100 products can also be structured to be fully paid up after a specified period such as 20 years.
Universal Life Insurance
Universal Life Insurance ‘unbundles’ the various elements of a life insurance policy and provides the client with a wide range of investment options within the life insurance policy and a considerable level of flexibility, which can be used in a wide range of financial, and estate planning strategies.
The various elements of the product, which are ‘unbundled’, are the cost of insurance (either term insurance or Term to 100), policy administration costs, Provincial Premium tax, and the investment options (and performance). For most Universal Life plans the cost of insurance and the administration costs are guaranteed for life. So the only variables are the deposits, investment returns and any possible change in future Provincial Premium Tax rates. Most insurance companies have a wide range of quality investment funds and options available as well as ‘GIC’ type of accounts for investment allocations.
A Universal Life policy is a flexible premium, adjustable benefit policy with a current interest or investment rate applied to most of its benefits. In one contract it blends term insurance and a savings account earning current rates of return. Unlike a whole life policy, its premiums can be increased or decreased, paid when due or at unscheduled dates or stopped entirely and restarted at the owner’s will, provided the policy value is adequate to maintain the cost of the insurance.
A very attractive feature of Universal Life is that any ‘investment deposits’ made (within limits prescribed by the Income Tax Act and Regulations) earn their returns on a fully tax sheltered basis. This fully sheltered growth helps to maximize future investment account values within the policy. Typically the death benefit for the Universal Life policy will be the amount of insurance PLUS the full value of the investment account and, as a death benefit, this is paid out Tax-Free under the Income Tax Act. This is sometimes referred to as the ‘Ultimate Tax Shelter’.
There are a number of personal and corporate tax and estate planning strategies that can be implemented using Universal Life policies and there are a number of product variations made available to help maximize the benefits with these various planning strategies.