There was a sign in a variety store near my old home. “We have a deal with the bank. We don’t cash checks or give credit and they don’t sell groceries” That seems a fair division of duties.
However, unlike groceries, banks will get involved with any financial service. Sadly, many people find out that banks are not much better at these extra services than they would have been selling groceries.
Take, for instance, life insurance.
It is unlikely that you can get a business loan without the loans officer suggesting that you add life insurance. “Just in case. Besides its group insurance, so there is no messy paperwork and it’s cheap, right?” I suppose they mean well, but you would be better off buying broccoli from them.
There are important differences between coverages issued to you personally and to you as a member of the bank’s creditor group plan.
- You do not own the coverage. If the bank stops offering it, you are without. If the insurance company decides they do not want it anymore, you are without. If you change banks you are without. No problem with personally owned insurance.
- You do not control the coverage. Group coverage can be re-priced, the terms of the contract can change and it can be cancelled. None of these are possible with an individual policy.
- If you are not in perfect health, the group plan may not be available. With group coverages, you are healthy or you are not. With individually owned insurance, there are intermediate prices. Even if you are not “standard” you can get coverage. Better a somewhat higher price than no coverage.
- At the bank, coverage will expire at 65 or maybe 70. Well before you will expire.
- You cannot be sure the insurer will pay. Most of these coverages have a pre-existing condition clause that could make it possible for the insurer to avoid payment. There have been cases where the bank did not forward the paperwork to the insurer. Not surprising that they refused to pay when that happens. With individual coverages, the insurer does their serious underwriting when they get the application. With group coverages, some of them do it when they get a claim.
Given these differences, you would think bank insurance would be cheap. You would, of course, be wrong.
For business loans, bank creditor insurance is frequently more than twice as much as individual insurance. For a 40-year-old male non-smoker life insurance to cover a $1,000,000 loan would cost $115 per month, including the provincial sales tax with the cheapest of the major banks. It would increase by 85% at age 45. Over 10 years you would pay about $20,000.
Individual life insurance for a standard risk, would cost $8,100 over the same 10 years. The coverage is renewable until 85 and no element of it can be changed by the insurer. It could be changed to another form of coverage if you wished to do so.
There is no technical problem regarding pledging the policy as security for the loan. You merely assign the death benefit to the bank to the extent their interest may appear. Under current tax law in Canada, if the insurance is a requirement of making the loan, the interest is deductible in the same way as it would be if the bank provided the insurance.
Despite the high price and unattractive terms of bank insurance, the worst could be yet to come.
Suppose you die and the bank’s group insurer actually pays. The bank loan of $1,000,000 would disappear and the assets of your debt free business could be distributed to your family.
There is a catch if you use the bank insurance. The distribution of the $1,000,000 gain from the insurance could be taxable. About $310,000 of tax. There is presently some doubt about this because of a case that appears flawed but nonetheless may be the law. It might get out of the corporation tax free but I don’t know anyone who would guarantee that.
If you had owned the individual life insurance instead of being a member of a group, the bank would have used the pledged insurance money to pay the loan and your business would still be debt free. In this case, the $1,000,000 distribution to your family will be tax free. Ask your accountant how the “Capital Dividend Account” works.
So, we have this result. Using bank insurance, you pay more to get less and end up owing the government 31% of what you collect on your insurance.
Nice deal! Better to buy the groceries from them. At least you can recognize a damaged tomato.
If a bank is supplying you with creditor group insurance call an adviser and explore the advantages of individually owned insurance.
All numerical examples are based on bank offered insurance rates, individual insurance rates and tax treatment in Ontario, Canada as I understand them at the date of publication. Specific individual results may be different.
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. email@example.com