1 Life and Life Insurance Life insurance is aptly named. It is designed for the living. It benefits the living. Canadian life insurance companies consistently pay more money each year to living policyowners than to the estates or beneficiaries of those who die. For the Living Death claims are exclusively for the living. The benefit may be direct where there is a named beneficiary, or indirect where funds are paid to the estate or to assignees to cover debts. The beneficiaries may be family, business associates, employer corporations or charitable organizations. The money they receive helps living people. Essential Life insurance is a vital necessity. It meets life at the level of hard inescapable realities. It deals with death and aging, saving and borrowing, taxes and inflation, and with money management, the whole struggle to spend less than we earn. Most important, it deals with our interdependence, the reality of our need for each other in our families and in our businesses. Life insurance deals with our dreams and worries, our hopes and fears. In a world, without life insurance, tomorrow would be uncertain for everyone. Modern Life insurance in its present versatile form is a product of today's world. In North America the industry began in the late 18th century, but it has grown to the first rank among financial institutions only in the 20th century. The need for life insurance has increased greatly with the development of the modem and mobile family unit. The younger family often is isolated from parents, brothers, sisters and others who, in earlier days, could lend financial support when death or disability struck suddenly. Retiring couples typically face their old age more alone, their children have gone to form their own families. Government benefits have moved in to guarantee survival, but life insurance is needed more than ever to assure dignity and self-respect. In our modem economy credit is king, and the principle of living out of income - next year's as well as this - is firmly established. Life insurance helps support the tremendous burden of personal and business indebtedness, which otherwise would pose a dangerous threat to the financial stability of many families and businesses. In the few minutes it takes to fill out and sign applications and complete the medical information, life insurance can create contracts immediately binding - at least upon the insurance company - for long periods of time and for amounts of money as large as many people can earn in a lifetime. Well Established Life insurance is substantial and secure. In 1985 life insurance companies in Canada held assets of about $80.3 billion. Within ten years, to the end of 1995, those already impressive figures had grown to approximately $183.5 billions. By any standard, that is big business and rapid growth.
2 Popular Life insurance is popular. Four out of five families own life insurance, two out of three people are insured. In a recent study of consumer attitudes, more than 63% of those interviewed regarded life insurance as a necessity, and more than 78% thought it was the best protection against premature death. Communication A Problem Despite its popularity, the life insurance business is not free from problems. The study we've mentioned also revealed that "for most people the entire act of purchasing life insurance was fraught with anxiety: people are not confident about their ability to comprehend the pros and cons of alternative plans; they are unsure of how much influence the commission has on the agent's recommendations; they are unsure about what amount of coverage is adequate or desirable; they feel locked in to their policy choice once it is made; they have a suspicion of the 'fine print' in their life insurance contract; and their most basic anxieties are aroused by the subject of death and the need to provide for others in the event of death." This suggests a great deal about what agents could be doing better. It suggests a lot about simplicity of presentation and illustration, selling needs and not just policies, explaining the advantages of the life insurance policy both before the sale and at policy delivery, talking of death with sensitivity and tact as well as candour. It says more about communication than about life insurance itself. True, the "fine print" is in the policy, but who should be better equipped than the agent to explain that "fine print", to breathe life into legal terminology, turn non-forfeiture options into choice and flexibility and control, and settlement options into self-respect and peace of mind. Policy simplification, involving, wherever possible, the use of lay language rather than legal phraseology, is a high priority with most companies. The industry continues to make great strides in the area of product innovation. Variable annuities, variable life, adjustable life, non-smokers' premiums, universal life and term to age all reveal sensitivity to an evolving society and economy, and to a rapidly changing marketplace. Despite these changes, the basic challenge of communicating effectively with our prospects remains. We must learn to talk their language, not ours, identifying our products with their needs, relating the features of our policies to benefits that will help them achieve their goals. If we are to continue to grow, we will have to show our prospects and clients very clearly how our products and services can increase their happiness, satisfaction and peace of mind in words they can understand, images they can see, and in terms of goals about which they can get excited. It is not within the scope of this course to discuss all the communication problems of our business. We can, however, look at a few.
3 The Sunset Years Obsession Most people under 40 find it difficult to get excited about their retirement years. Yet we often talk so much about "life after retirement age," overlooking the fact that our prospect is far more interested in the intervening years. Why not talk to our prospect in terms of planning today for family security and peace of mind for all the todays that are left to live? Why not show what life insurance can do at age 30, 35 or 45 as well as at retirement age? Show how our products can help buy that country retreat sooner, get into one's own business faster, or perhaps retire earlier? Poverty Prevention? It's been claimed in the past that "life insurance will not make you rich, but it will prevent your ever being poor." To Canadians of this generation, who take prosperity for granted, assume success as their birthright, and can't or won't visualize poverty, this will not be good enough. Shouldn't we be talking about systematic financial planning through properly selected life insurance and other products as an antidote to the anxiety bred by endless instalment payments, and the frustration of lost financial opportunities? Talk about life insurance not just as a defence against failing, but as an effective weapon in a person's battle for success? Why not portray it as the source of estate liquidity that success itself will necessitate? Portray it as the solid basis which will permit its owner to be all the more aggressive in the pursuit of business and investment success? Why Exaggerate? More harm than good is done to our industry by those agents, who are fortunately in the minority, who tend to lavish one grandiose adjective on top of another when describing their company's policies. Even some forms of permanent insurance have been portrayed on occasion as a "terrific investment", in apparent reference to the cash surrender values. Agents, and their prospects, should clearly understand those values are the policy reserves built up within the contract to supplement what, at the later ages, is an inadequate premium for the policy's face value. It is this policy reserve that enables permanent insurance to pay off in full, regardless of the life insured's age at death. Selling permanent cash value insurance as an investment would not be unlike recommending an annuity for its life protection values. Let's become less dramatic and more correct and specific when describing our products. Versatility Financial planning and investment are usually tied in with long-term objectives, covering periods through which considerable changes in situation and lifestyle can be expected. Should we not give greater emphasis to the extraordinary flexibility that can be built into a life insurance and retirement program? Would it not be more effective to say that life insurance is a uniquely versatile financial instrument, relatively easy to acquire and maintain and which can be adapted to suit changed circumstances in the future? Would it not be more correct and credible if, when discussing the need to provide for future retirement income and other financial goals, we confine our recommendations to the most appropriate contracts: those which are designed for retirement and sufficiently versatile to adapt to future changed needs.
4 Us and Them There is the old argument whether it is more intelligent to buy term insurance with a relatively small initial premium outlay or permanent insurance with a higher initial premium outlay. In practically no other area is there such a frustrating gap between the reality of the situation (at least as we perceive it) and what our prospects perceive as reality. Let us re-examine the problem as a study in communications. Before we do, however, let us establish a few ground rules. A new age has dawned in the life insurance business - the age of investment type products, an extraordinarily wide product range, volatile interest rates and of balanced financial planning. In the past when we argued permanent versus term or guarantees versus equities, we were arguing "us" versus "them". This need no longer be true. Now we can avoid all arguments and engage in constructive discussion of "us" plus "them"; in other words, what particular combination of our life and disability income products, what mix of our guarantees and our equities best suits the prospect's needs. Let's assume we have available both long and short-term guarantees and equities and that we are going to get the entire sale, regardless of what the prospect may decide. Hopefully, this approach will allow us to examine the whole question more objectively. The Contract All life insurance policies are contracts binding in law. Usually there are two parties to the contract, the insurance company and the life insured who is also owner of the policy. Where one person wishes to arrange life insurance on another person's life, we have a third party, the owner-applicant as well as the life insured and the insurance company. Partnership insurance, where one partner insures the life of the other, key person insurance, where a corporation insures one of its key employees, juvenile insurance, where a parent insures a child - all are examples of third party arrangements. It is worth noting that the contract is unilateral. Once the contract is in force, only the insured can terminate it - prior to any expiry or maturity date written into the policy. Permanent cash value insurance - whole life, or some modification of it, has no expiry date. (Endowment contracts have an expiry date which is also the maturity date.) With permanent insurance there is the absolute assurance that a claim must be paid at some time. The question is "when," not "if'. Term insurance by definition has an expiry date, beyond which the contract cannot be extended -unless it is converted. Any convertible term policy is potentially permanent, but the longer conversion is delayed, the more costly the premium may be. The Need For Both A keen advocate of term insurance may argue that term alone is adequate, providing it is renewable and convertible. Eventually, the term enthusiast will say, people outlive their needs for life insurance. Children grow up and are no longer dependants, mortgages are paid off, group and personally owned pension plans mature and, of course, investment portfolios have grown to the point where they represent estates of impressive proportions, well able to provide essential liquidity.
5 By way of counterbalance, here are reasons why permanent insurance makes good financial sense for many people. 1. Cash, usually in large amounts, is needed whenever death occurs. Some examples are: terminal illness and funeral bills, unpaid taxes including particularly the income tax on capital gains, probate, legal and executor/executrix fees and debt repayment. 2. Just as continuing inflationary trends increase the costs of dying with each passing year, so does the cost of providing for dependants. Even if children have become self-supporting, the widowed spouse who has not been employed outside the home is at an age where remarriage becomes unlikely and employment improbable. Whatever income earnings skills this person once possessed will have rusted or become useless because of new procedures and technology. Even if she or he could anticipate being self-supporting, that should be a matter of choice rather than necessity. 3. If investments have to be sold to raise the cash for items 1 and 2 above, executors/executrixes often have to accept sacrifice prices. This is especially true of a business interest and real estate holdings, depending on the urgency of the sale and prevailing market conditions. 4. Cash from other sources form part of a decedent's estate for probate and administration purposes. They are therefore subject both to the delays of passing of an estate and to legal and probate fees. Life insurance payable to a named beneficiary bypasses this estate-probate bottleneck as well as being protected from the claims of creditors. Its value is not included in determining probate costs, and proceeds can be paid immediately in useful amounts, even without releases from tax authorities. 5. Without continued life insurance after retirement, the pensioner would probably feel compelled to elect the joint and last survivor annuity option to protect the surviving spouse. Assuming both are in normal health and the male two or three years the senior, then he is likely to be outlived by seven or eight years, during which time continued income will be needed. The joint life option may help solve the problem but it creates another by reducing the potential income by, usually, about 15-20%. With an adequate amount of insurance still in force, ideally on a paid-up basis, the annuitant can better afford to take the maximum or near-maximum retirement income, knowing the insurance proceeds will replace that income should the annuitant die too soon. 6. The future costs and benefits of permanent insurance are known in advance whereas with term insurance (other than term to age 100) these factors may be unknown quantities. 7. Term insurance to age 100 is another form of permanent insurance. However, this plan of insurance may or may not have cash values, non-forfeiture values such as reduced paidup insurance and automatic premium loan, etc.. Term to 100 is normally non-participating and with level, step premiums, or interest rate sensitive premiums being payable to the insured's age 100. It is obvious to most unbiased, rational thinkers that people generally have a mixture of insurance needs -some of a permanent nature and some more limited or temporary. To attempt to solve those varying needs with a single type of life protection is unintelligent. It is similarly somewhat illogical to say that the one type is good and the other is bad. However, it is agreed that one kind can be less appropriate to covering a specific need. You have the responsibility of recommending policies that will best meet the need or solve the problem. Most of your proposals will be for a balance of both. It is not perm VERSUS term it-is perm AND term, and you, as a trained financial advisor, who has the ability to provide the essential balance between the two.
6 The Promise All life insurance contracts promise to pay to the beneficiary the face value of the policy immediately upon due proof of death. This is surely the miracle of life insurance. New value is generated - a relatively small monthly premium can create an estate - by the stroke of a pen. Life insurance is time insurance. Financial success requires talent, experience, knowledge, hard work - and time. Life insurance can replace time by creating capital immediately to replace the income a person could have earned - in time. The promises of life insurance are impressive in their simplicity and directness. Implicit in them, however, is a potentially serious problem - "If I can just wait until I die I know a claim will be paid. But what happens if I want to or have to stop paying premiums before I die and before the maturity date? Can I salvage any value for my premium dollars?" The answer is "no" and "yes". It is "no" for most forms of term insurance because they are essentially pay as you go propositions. The premiums are just sufficient to pay administrative expenses and the anticipated cost of mortality claims. For one year renewable term insurance providing a level amount of coverage, the premium increases every year. For five year renewable term the premium increases every five years. In reducing term insurance, the premium remains level, but the unit cost of the insurance increases as the same premium buys successively smaller amounts of coverage each year. Because the premium is just sufficient to cover expenses and mortality no reserve large enough to create non-forfeiture values usually develops. Which brings us to the essential difference between most term insurance and permanent insurance. Term's Unique Values Term insurance is highly valuable and totally appropriate where needs are temporary; for example, the need to insure partners in a joint business venture of a definitely limited duration; or to cover the outstanding balance of a debt, perhaps a mortgage, perhaps a loan from a friend or family member. Term insurance is also a useful expedient when problems are permanent but where the insured s capacity to pay premiums is limited; for example a medical student, married and with a family, the proprietor of a new business who has invested all available resources in the development of, business. Subject to certain conditions, premiums for the net cost of pure term insurance, required by a lender as collateral on the life of a business owner to insure the amount of a loan, are deductible from the taxable income of the business. Life Insurance Defined The late Ben Feldman of New York Life said: "The basic purpose of life insurance is to create cash... nothing more... and nothing less. Everything else confuses and complicates. "Insurance is the only tool that take pennies and guarantees dollars. "Life insurance is time. The time a man might not have. If he needs time, he needs life insurance."
7 The Essential Difference This is not a course in actuarial science. It is for sales people, not mathematicians. Therefore, it is enough to state here that policy reserves of permanent insurance are a mathematical means to an end. They develop where ultimate policy commitments require their creation. Total Flexibility The non-forfeiture options are available as alternatives to forfeiting all rights under a contract of life insurance. The basic option is for the policy owner to surrender all rights under the policy for cash; the other options derive from it. They are: 1. Reduced paid-up insurance. The cash surrender value is used as a single premium payment on a permanent cash value policy with the face amount reduced below the face amount of the original policy. The amount of reduced paid-up insurance will vary with the amount of the cash surrender value and the age of the insured at the time the option is elected. 2. Extended Term Insurance. The cash surrender value is used as a single premium payment, in this case on a term insurance policy for an amount equal to the original face amount of the policy, but for a limited period of time. Duration of the term insurance will vary with the amount of the cash surrender value and the age of the insured at the time the option is elected. 3. Premium Loan. This option combines use of the cash surrender value and the cash loan privilege in the contract. It is the usual automatic non-forfeiture option. Premiums are automatically borrowed from the insurance company on the security of the cash reserve. The policy remains fully in force (including all additional benefits and riders - an important advantage over extended term insurance) subject to a lien against the death benefit or cash surrender value, equal to the amount of the premiums borrowed plus interest on them. The non-forfeiture options allow great flexibility in responding to changed circumstances. Adversity may dictate use of the premium loan privilege; reduction of need for insurance may indicate the paid-up provision. Investment or business opportunities requiring cash investment may suggest surrender, or better still, use of the cash loan privilege to borrow an amount equal to the cash surrender value while keeping the policy in force. Painless Refinancing To appreciate better the property aspects of permanent life insurance, let us compare ownership of life insurance to ownership of a home. There is an immediate and vital difference between buying a home and buying a life insurance policy. It's called a down payment. Need we say more? A second point is worth noting. People buying a home tend to think of its cost as the nominal purchase price of the home; what it would have cost if they had paid all cash. They ignore the tremendous amount of money that interest on their mortgage, or mortgages, contributes to the ultimate cost of the home. On the other hand, people instinctively calculate the cost of life insurance in terms of the total payments. Why? Well, it's our fault, isn't it? When was the last time you quoted a single premium, just to show your prospect the true cost of the life insurance, as opposed to the carrying charge levied for the privilege of paying in annual instalments?
8 Let's carry the comparison of home purchase and life insurance purchase a step further by comparing the non-forfeiture options in the life insurance contract to methods of refinancing purchase of a home. 1. Cash Surrender of a life insurance policy is the equivalent of the sale of a home. When you decide to "sell" your life insurance you are guaranteed a buyer (the insurance company), a fixed minimum price (the cash surrender value -plus the accumulated dividends, if there are any), and there are no selling expenses to pay. This is not to say that residential real estate is a bad investment. Indeed, for thousands of Canadians it has proved a superb investment. Yet it remains an equity investment where sale price is always determined by current market conditions, not by contractual guarantees. 2. Paid-Up Insurance. Imagine this conversation: "Hello, A Developer, it's J. Homeowner. Do you have a minute? Fine... Look, I called about my daughter's wedding last week. You see, she's the last of the children to go out on her own, and we don't need nearly the room we did when we bought the house. So I've decided to stop making the mortgage payment and send you the deed to the property. You just arrange to find me a smaller house that we can buy free and clear with the equity we have built up in this one. Okay? Wonderful! Bye!" Wonderful! Yes! Impossible? Absolutely! But isn't that, in effect, what the paid-up option allows us to do? - Stop paying premiums for all time on a policy and trade it in, expense free, for a smaller one fully paid for? 3. Extended Term Insurance. "Hello, M. Developer, it's J. Homeowner again. My spouse and I have been talking this matter over. We know the house is too big for us, but we've invested a great deal in it, and we think it will be a good place to entertain our grandchildren. We'd still like to stop making those mortgage payments and, if I read our Mortgage Agreement correctly, it states very clearly that we can discontinue mortgage payments any time we wish and still remain in the house, using the equity we've already built up to pay rent for the house as long as the money lasts. I am sure there are a few details to take care of, M. Developer, but I know your office can prepare the necessary documents. Thanks a lot! 'bye." Ridiculous? Maybe, but isn't that exactly what the extended term option allows us to do? - Quit paying premiums and use our cash surrender value to rent a term policy of equal size for as long a period as it will buy. All this, with no legal or administrative charges. 4 Automatic Premium Loan. "Hello, M. Developer? You guessed it - it's me again. My spouse and I have been reviewing the situation further and neither of us is too happy about renting. Now, if I read this Mortgage Agreement correctly, it says if I ever want to discontinue first mortgage payments, all I have to do is stop paying and your office will automatically, at no expense to me, arrange an open-ended second mortgage account, at a competitive interest rate, from which account you will borrow just enough each month to meet the first mortgage payment. It says too, if I understand it correctly, that I can resume regular payments on the first mortgage any time I want, or make payments intermittently, or just pay off the interest on this second mortgage account or just forget about it altogether - and let you subtract whatever I owe from the repurchase price you have guaranteed me, whenever I want to sell the house outright. "M. Developer, I know what you are thinking - but this is really my final decision. Start one of those open-end second mortgage accounts for me and we can review the situation next year." An incredible dialogue? Certainly - but it should point up a fact we often overlook - that permanent life insurance is not only uniquely flexible but also, in this age of consumerism, it is a totally consumer-oriented product.
9 Dividend Options Participating insurance forms a vital part of our business. Reference should be made, therefore, to the various ways in which dividends, usually credited annually, may be used. Today there are as many as nine different dividend options available. 1. Accumulation - Each dividend is left on deposit to accumulate at interest compounded annually. 2. Premium Reduction -Each dividend is applied toward payment of the next premium due on the policy. 3. Cash - Each dividend is paid in cash to the applicant. 4. Paid-Up Additions - Each dividend is applied to purchase additional participating paid-up insurance for a level amount payable at the same time as the benefit on the basic policy. These additions have cash value and may be surrendered at any time or used to provide non-forfeiture options or cash loans under the normal terms of the contract. 5. Special Term Addition - Under this option, often referred to as "the Fifth Dividend Option", each dividend is applied to purchase an amount of one year term insurance equal to the cash surrender value at the end of the policy year. Dividends in excess of what is required to purchase the term insurance are left to accumulate, used to reduce premium payments or to purchase paid-up additions. This is the option which is often used in Split-Dollar Funding arrangements and in certain business life insurance situations where it is desirable that the death benefit be supplemented by a reimbursement, partly, or in full, of the total of premiums paid. 6. Term Addition - Each dividend is used to purchase a one year term addition payable on the death of the insured. Under this option, the whole dividend is used to create as much additional term insurance as it will buy. 7. Investment Fund - Each dividend is used to purchase units in a segregated fund which is usually oriented strongly toward common stocks. Use of this option allows an insured to combine guarantees and equities automatically under one plan. 8. Enhanced Coverage - Each new cash dividend is used to purchase the required amount of additional insurance called the Enhancement. The Enhancement may include the paid-up additions previously credited, if any, plus the amount of one year term insurance needed to meet the required Enhancement for that year. Any cash dividend in excess of the amount necessary to purchase one year term is used to purchase paid-up additions or is put into an Enhancement Reserve account. 9 Premium Offset or Abridged Premium -This is a method of paying premiums. It is not a dividend option, though it does involve the use of Paid-up Additions. Under this method, future premiums are paid, or "offset" by using current and future dividends and a portion of the previously accumulated Paid-up Additions. After premiums have been paid for a number of years, say about years (depending on age), the current dividend may be used to pay part of the premium. In the case where that dividend is insufficient by itself to cover the whole premium, an amount of the Paidup Additions is surrendered to release the cash values needed to pay the balance.
10 Smoothing Out the Lumps For various reasons, people may wish to receive proceeds of a policy in the form of an income rather than in a lump sum. This can be accomplished through settlement options, both for death benefits to beneficiaries and cash surrender or endowment values to insureds. Settlement Options 1. interest only with the right to withdraw principal at any time. 2. fixed amount of income for as long as it can be paid. 3. fixed period of income for whatever amount can be paid. 4. lifetime income, with or without minimum guaranteed periods of income to survivors of the person originally receiving the income. Through blending of capital and interest, much larger incomes can be generated than through interest only; but with the complete assurance that income will last for the period chosen. 5. joint and last survivor income, where income is guaranteed as long as one or the other of two people (often husband and wife) is still living. Perm plus term & guarantees plus equities = balanced financial planning The life insurance agent should combine the qualities of various products to obtain the best possible financial program for the client. Perm and term have contrasting characteristics but they work well together, just as equity based products can successfully complement the guaranteed values of traditional annuity contracts.