INSURANCE 10 FORUM APRIL 2013

Transcription

1 INSURANCE 10 FORUM APRIL 2013

2 Change PHOTO: ERIC PEARLE / GETTY The winds of change are blowing through Canada s insurance industry in the form of a shrinking product lineup on the shelves of many insurance companies, substantial changes to the features and benefits of remaining products, and changes to accounting standards and legislation governing life insurance policies. What is the impact of these changes and what do they mean for advisors and their clients? Michael Callahan reports [ ] It is hard to believe that Canada s prime lending rate was per cent in August How times have changed. Currently at three per cent (January 2013), prime is near the record low of 2.25 per cent in April While ultra-low interest rates have fuelled a housing boom, they ve wreaked havoc on the Canadian life insurance market. At the root of the problem is the securing of the funds necessary to meet future obligations. In the current interest rate environment, many insurers are finding it difficult to invest in such a way that will cover their longer-term liabilities. But while low interest rates may be the most obvious issue, it s more than just interest rates alone. We re in something of a perfect storm right now, says Terry Zive, president of Zive Financial Inc. and chair of CALU s Policyholder Tax Task Force. Ultra-low interest rates, changes to International Financial Reporting Standards (IFRS), a review of the exempt test, regulatory APRIL 2013 FORUM 11

3 INSURANCE changes such as potential commission disclosure, steep declines and high volatility in global capital markets these are all contributing factors. As you can see, it s not just interest rates, but rather a combination of these factors that is placing significant stress on the insurance industry. Let s take a closer look at several key changes in the insurance industry, including a discontinuation of some products, significant changes to others, and changes to industry standards and government legislation. CHANGES TO EXISTING PRODUCTS The Canadian insurance industry has already undergone significant changes in recent years. Permanent life products, such as whole or universal life (UL) plans, are becoming more expensive as many insurers have substantially increased rates. Taking it a step further, several insurance companies have removed permanent life products from their shelves altogether. While changes to the exempt test rules may drive change in the future, low interest rates and changes in IFRS accounting standards are the driving forces behind the changes today. Insurance companies are now required to do mark-to-market accounting at the end of every quarter. This essentially means higher capital requirements for products with guarantees as companies are now required to hold larger capital reserves to ensure they will be able to meet those liabilities. As a result, we ve seen the cost of permanent products increase dramatically while some companies have discontinued permanent life insurance products entirely. Zive, who has over three decades of industry experience, says it s nothing new. There s a lot of pressure on the industry today. But our industry has been around for well over a century. It s very resilient. Of course, after a period of significant change it may not look the way it does today. But it will ultimately adapt and survive. Going forward, those changes will be reflected in the features, benefits and re-pricing of products. Although guaranteed pricing is common today, it may not be tomorrow. While we ve seen the product shelf shrinking in recent years, Zive sees it expanding in the future. [What s happening in the industry] is very interesting, he says. We expect to see new products on the shelves of all insurers, specifically on the UL side. Thirty years ago, adjustable pricing was common whereas UL was not. Going forward, I think we re going to see a return to adjustable pricing, within certain parameters of course, but ultimately dictated by the ongoing changes to the primary determinants of insurance pricing: interest rates, mortality rates and expenses. A shift from fixed to adjustable pricing will be a significant change in the mindsets of advisors and clients alike. As Canadians, we ve become used to guaranteed pricing. But a move away from guaranteed pricing could be quite attractive to clients. Guarantees are expensive, and lower guarantees mean lower capital requirements. This translates to lower costs for insurers, and subsequently cheaper products for consumers. Zive anticipates a strong market for these new products as there will likely be many clients willing to accept a lower guarantee in return for lower overall costs. However, clients must be aware that a lower guarantee also means more risk is being transferred away from 12 FORUM APRIL 2013 A move away from guaranteed pricing could be quite attractive to clients. Guarantees are expensive, and lower guarantees mean lower capital requirements. This translates to lower costs for insurers, and subsequently cheaper products for consumers. the insurance companies and placed on the clients. This is not unlike the shift we ve seen employers make in recent years from defined benefit to defined contribution plans, putting more responsibility on the shoulders of the individuals. These changes represent considerable challenges though, not only for the insurance companies and product design teams but also for advisors. There will no doubt be a steep learning curve for advisors who provide insurance solutions to their clients. Ultimately, it s our job to determine what level of risk is acceptable for our clients, adds Zive. We must ensure we re using products appropriately and effectively. MTAR AND THE EXEMPT TEST Permanent life insurance typically comes in three forms: term-to- 100 (T100), universal life (UL), and whole life insurance. Unlike T100, both UL and whole life policies allow the policyholder to accumulate investments inside the policy. The amount that can be accumulated inside a policy is governed by the maximum tax actuarial reserve (MTAR). ILLUSTRATION: AKINDO / ISTOCKPHOTO

4 The MTAR calculation is a critical component of the exempt test, which is actually a collection of tests administered by an insurance company when a whole or universal life policy is first issued, and subsequently on an annual basis on every policy anniversary. Insurance companies administer their policies to ensure the investment accumulation inside whole and universal life policies does not exceed the MTAR limit (thereby retaining tax-exempt status). The exempt test compares the savings component of a life insurance policy to the savings component of a hypothetical benchmark policy. In order for a policy to be classified as exempt, its savings component must not exceed the savings component of this benchmark policy. Currently, the benchmark policy is described as a 20- pay endowment at age 85 policy where the savings component is determined using the mortality and interest rate assumptions that were used in determining the premiums of the actual policy (for non-par policies) or that were used in setting the cash values of the policy (for par policies). PROPOSED CHANGES TO THE EXEMPT TEST In the federal budget delivered on March 29, 2012, Finance Minister Jim Flaherty announced preliminary changes to the exempt test. We have a high-level overview, but we don t yet have the details, says Steve Krupicz, FSA, FCIA, AVP, Special Case Markets, with Manulife Financial. The industry is still waiting for the Department of Finance to communicate the details of those changes. One can still get a general sense of the potential impact from the higher-level details that have been communicated. As Krupicz explains, the changes include modifications to both the benchmark policy and the determination of the savings component of the actual policy. Benchmark policy. The budget changes the benchmark policy from a 20-pay endowment at age 85 to an 8-pay endowment at age 90, measured using a 3.5 per cent interest rate and the Canadian is it time to examine what client portfolios are missing? TIME TO TAKE STOCK In recent years, market volatility has caused some Canadian investors to shy away from equities. While this approach may feel safe, it might be putting their long-term financial goals at risk. To help advisors educate their clients, we ve created the Time to Take Stock program. Time to Take Stock examines the current situation facing investors, the factors that influence financial decision making, and how investors might rebuild portfolios with a prudent equity allocation designed for the long term. It also provides three practical strategies for re-entering the market. To download our client-use Time to Take Stock brochure, visit franklintempleton.ca/takestock. For Dealer Use Only, Not for Distribution to the Public Franklin Templeton Investments Corp. All rights reserved.

5 INSURANCE Institute of Actuaries (CIA) mortality table. This change will likely result in the following modifications: Shortening the assumed payment duration to eight years will increase the savings component of the benchmark policy, thereby increasing the maximum deposit to an exempt policy in the early years of that policy. Lengthening the assumed endowment age to 90 will decrease the savings component of the benchmark policy, thereby reducing the maximum deposit permitted. Changing the mortality and interest assumptions that were used in determining the premium or cash value of the actual policy may have varying effects, but will likely lower the savings component of the benchmark policy which, again, will subsequently reduce maximum allowable deposits. Savings component. The budget also announced that surrender charges would no longer be deducted in determining the cash value of the policy. Furthermore, the savings component would be calculated using the same 3.5 per cent interest assumption and CIA mortality table as is being prescribed for the benchmark policy. It is expected that these changes will affect policies as follows: Disallowing the deduction of surrender charges will increase the value of the actual policy, thereby reducing the permissible maximum deposit to an exempt policy. Changing the mortality and interest assumptions used in determining the premium or cash value of the actual policy will have a varying effect depending on the levels of the current assumptions relative to the newly prescribed assumptions. The new reserve method, referred to as net premium reserve in the budget, has only been described in very generic terms. As such, it is not possible to state definitively the exact impact of this change. However, from the generic terms used, it is expected that the new reserve method would generally produce a higher value for the actual policy, thereby reducing the permissible maximum deposit to an exempt policy. Keep in mind that these changes are just an overview at this point. Since the exact details haven t been fleshed out yet, it s hard to accurately determine the full impact of the proposed changes, adds Krupicz. Essentially, we have an idea of the general direction of the changes, but it s too early for providers to make product adjustments, or for advisors to fully understand the subsequent effects. INDUSTRY PERSPECTIVE We ve seen considerable evolution in the insurance marketplace over time. Much of this evolution predates the financial crisis, the economic downturn and the period of record low interest rates. Financial institutions have [had to] become more innovative in the way they run their business and in the products they offer consumers, says Joanne Abram, chief executive office of the Alberta Insurance Council. This has also impacted the way advisors conduct their business and provide advice to their clients. The growth of the managing general agency (MGA) system of product distribution is a prime example of how the industry has reacted and adapted to a changing landscape. The Alberta Insurance Council makes sure that the insurance industry in their province is held to the highest standard. As Abram This is a very exciting time in our industry. Times are changing and companies, products and advisors must evolve and adapt to the coming changes, whatever they may be. But make no mistake the glass is half full, and it can fill up very quickly. Terry Zive, financial advisor points out, The value of financial advice provided by a licensed, educated agent or broker has never been more important. Consumers are being bombarded with insurance options from all directions, and a generation has grown up with the internet and social networking sites that offer opinions and suggestions on all aspects of their lives. And yet, despite the vast of array of resources available to Canadians, basic financial literacy is still noticeably lacking. It is difficult for one to make a purchase these days without being offered insurance to offset a debt in the case of a disability, death or loss of employment. Unfortunately, these purchases are often impulse decisions that are not made within the context of an individual s overall financial plan. It is important to remember that when purchasing insurance a client is purchasing a promise that they will be indemnified against loss in the event of a specified peril. It s not a product that clients can test-drive, Abram explains. If they realize after the fact that it wasn t the right product or plan, it s too late. It is therefore essential that advisors provide comprehensive, sound advice. So what does this sea change mean for advisors? Well, it s safe to say that many current strategies will have to be revisited on numerous levels. Furthermore, new products, terms and conditions will no doubt present a learning curve for both advisors who sell insurance and insurance companies alike. However, it is often said that where there is challenge, there is opportunity. As Terry Zive puts it, This is a very exciting time in our industry. Times are changing and companies, products and advisors must evolve and adapt to the coming changes, whatever they may be. But make no mistake the glass is half full, and it can fill up very quickly. MICHAEL CALLAHAN, CFP, is a financial planner at RBC Investments in Ottawa and can be reached at callahan_michael@yahoo.com. If you would like a PDF of this article, please contact the editor at kdoucet@advocis.ca. 14 FORUM APRIL 2013