Clients want to know: What type of insurance should I have?

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1 Clients want to know: What type of insurance should I have? After reading this, you should understand: What types of insurance are available 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. 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. 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. Expiry date The day term insurance coverage ends. Death benefit The money that is paid to the beneficiary upon death of the insured. Copyright 2011 Oliver Publishing Inc. All rights reserved. 45

2 LLQP 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. 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. 46 Copyright 2011 Oliver Publishing Inc. All rights reserved.

3 Types of Insurance What does term insurance provide for the policy owner? A B C D Refund of premiums on expiry date Payment of the face amount if the life insured dies while the policy is in force 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 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. 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. Other forms of term insurance that are less common are increasing term, decreasing term, and renewable term. Copyright 2011 Oliver Publishing Inc. All rights reserved. 47

4 LLQP 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. 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. 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 48 Copyright 2011 Oliver Publishing Inc. All rights reserved.

5 Types of Insurance 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. 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. Having a renewable policy means that there is no requirement to show good health when the renewal periods end. Unless a policy purchased is a renewable policy, it is non-renewable. A nonrenewable 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 B C D Level Increasing Decreasing Renewable + FILE See file 4 for discussion on term insurance 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 Copyright 2011 Oliver Publishing Inc. All rights reserved. 49

6 LLQP 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. 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. + FILE See file 2 for understanding of suicide exclusion and incontestability clauses. 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 B C D 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. Renewable term provides an extension of the term policy; convertible term converts to permanent life insurance Premiums do not increase when renewable term is renewed but do increase on conversion of a policy to permanent life insurance Renewable term allows for the same face amount on renewal, but renewable and convertible term does not All of these answers 50 Copyright 2011 Oliver Publishing Inc. All rights reserved.

7 Types of Insurance Permanent Insurance 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 lumpsum 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. 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. 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. Which of the following types of policy does not provide permanent insurance coverage? A B C D Universal life insurance Whole life insurance Term-to-100 insurance Term insurance Copyright 2011 Oliver Publishing Inc. All rights reserved. 51

8 LLQP 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. 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 B C D To ensure needs of survivors are met in the event of premature death To pay final expenses To build cash value in a policy All of these answers Non-forfeiture options The three nonforfeiture 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. 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. 52 Copyright 2011 Oliver Publishing Inc. All rights reserved.

9 Types of Insurance There are three non-forfeiture options: Automatic premium loan (called APL); Extended term insurance (called ETI); Reduced paid-up insurance (called RPU). 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. + FILE 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-paylife 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. Copyright 2011 Oliver Publishing Inc. All rights reserved. 53

10 LLQP Paid-up Paid-up means there are no further premiums to be paid. 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. + FILE See file 6 for the distinction between ETI and RPU. 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. 54 Copyright 2011 Oliver Publishing Inc. All rights reserved.

11 Types of Insurance Policy Dividends 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. Dividends Dividends are paid to participating policy owners when a surplus in the reserves exists with the insurer. 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. Copyright 2011 Oliver Publishing Inc. All rights reserved. 55

12 LLQP 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 B C D A segregated fund Paid-up additions A special term addition 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 additions. 56 Copyright 2011 Oliver Publishing Inc. All rights reserved.

13 Types of Insurance 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. 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. 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.) Copyright 2011 Oliver Publishing Inc. All rights reserved. 57

14 LLQP The need for tax-deferred savings: Each premium adds value to the policy reserve, and will not be taxed annually provided the growth falls within limits set out in the Income Tax Act (ITA). The need to build collateral: The CSV is an asset that can be pledged as collateral for a secured loan at a lending institution. A secured loan is easier to obtain and carries a lower cost of borrowing. What is a benefit of whole life insurance that is not provided by term insurance? A B C D Every policy owner receives dividends Cash value A death benefit All of these answers Adjustable Premium Whole Life Insurance An adjustable premium whole life policy has, as its name suggests, premiums that change over the life of the policy. The premiums and death benefit will be guaranteed for a limited period, usually five years, and are then adjusted to keep pace with current investment yields. At the end of each guarantee period, a comparison will be made between the new investment yield and the yield at the beginning of the period. If the investment yield has increased: The sum insured stays the same and the premium is reduced. If the investment yield has decreased, either: The sum insured decreases and the premium stays the same; or The sum insured stays the same and the premium is increased. 58 Copyright 2011 Oliver Publishing Inc. All rights reserved.

15 Types of Insurance How Interest Rates Affect Adjustable Premium Whole Life When interest rates have increased over guarantee period When interest rates have decreased over guarantee period Sum Insured Stays the same. Decreases, and premium stays the same. Premium Decreases, and sum insured stays the same. Increases to prevent sum insured from decreasing. + FILE See file 8 for a case study on the use of adjustable whole life. This plan is popular in an economy in which interest rates are rising. However, it will fall from favour when interest rates decrease and policy owners are confronted with paying more premiums for the same coverage or reducing coverage for the same premium. Term-to-100 Insurance Term-to-100 (also called T-100) insurance is a hybrid of term insurance and permanent insurance. It is in force for a term (to age 100) and premiums are paid over the same period. + FILE See file 9 for a comparison between T-100 and Whole Life insurance. When the life insured reaches 100 years of age, this policy either pays out the face amount or is considered paid-up, which means that future premiums are not required to keep the policy in force. Like term insurance, T-100 generally has no cash value or dividends. Because the T-100 policy always pays if death occurs before age 100, or, if, the person lives beyond age 100, pays out a death benefit whenever the person does die, T-100 polices are in fact permanent policies. Term-to-100 offers the distinct advantage of lower premiums relative to premiums for other permanent policies. Term-to-100 insurance has given me one of the key benefits of term insurance lower premiums with one of the key benefits of permanent insurance life insurance coverage I can count on until I turn 100. Copyright 2011 Oliver Publishing Inc. All rights reserved. 59

16 LLQP Who Benefits Most from Term-to-100 Insurance T-100 insurance will appeal to those who find the insurance-for-life aspect of permanent insurance important, and yet do not need the frills associated with other forms of permanent policies (such as dividends, policy loans, or cash surrender value). Correspondingly, the policy owner should not pay for features he or she does not need. + FILE See file 10 for a case study on the use of T-100. T-100 is every bit as useful for estate-planning purposes for individuals and businesses as other forms of permanent insurance. Why would a customer choose T-100 over whole life? A Premiums are lower B She wants dividends C She wants life insurance without additional benefits D A and C Universal life insurance An interest-ratesensitive policy that is a unique combination of insurance and investment. Universal Life Insurance Universal life insurance is a unique combination of insurance and investment that offers flexibility that is not available with any other type of life insurance. The universal life policy is often referred to as an account; this reflects the investment nature of the policy. Universal life is an effective tool for tax planning and estate planning, because it is a permanent policy. We have already discussed how a whole life policy builds up a policy reserve from overpayment of premiums in the early years of the policy. Universal life may also build a reserve from the investment account or accounts that comprise a part of the policy. The management of the investment account is in the hands of the policy owner. The account value of the universal life policy is the total of all the investments in the investment account, less deductions for the current month s expenses. The universal life policy owner must make the decisions about how to invest the account value. The policy owner takes on the investment risk that is borne by the insurer when the policy is whole life. The agent will provide valuable information and guidance to assist with investment decisions, but, ultimately, the responsibility for those decisions rests with the policy owner. 60 Copyright 2011 Oliver Publishing Inc. All rights reserved.

17 Types of Insurance 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 B C D The face amount, the investment of funds, how the premiums will be charged, and death benefits The investment of funds, how the insurance will be costed, and death benefits The face amount, the life insured, the beneficiary, the investment of funds, how the premiums will be charged, and the form of death benefit 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. Copyright 2011 Oliver Publishing Inc. All rights reserved. 61

18 LLQP The Insurance Component of Universal Life 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 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. 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. 62 Copyright 2011 Oliver Publishing Inc. All rights reserved.

19 Types of Insurance As the following diagram illustrates, at some point the two rates will be equal. As a general rule although this will vary depending on the age of the insured at onset, and on interest rates this point will be between eight and twelve years into the contract, and the cash values may be equal in about the twentieth year of the contract. Mortality Charges and a Universal Life Policy Premium cost T Years N.B. Universal life policies are usually non-participating; that is, they do not receive policy dividends. The minimum premium is designed to keep the policy in force to age 100. There is a maximum premium allowable; it is defined by a formula in the Income Tax Act (ITA). If the maximum is exceeded, the policy loses its tax status as an insurance policy and is classified as a non-exempt policy subject to tax as an investment that must be reported annually. The policy owner has the option of having premiums increased or decreased, based on minimum requirements and maximums allowed, or they can be stopped and restarted, if the account value can pay the cost of insurance and expenses. This is unique to universal life. + FILE See file 11 on how a U.L. policy can be presented. If the policy owner fails to maintain enough funds in the account to pay the mortality charge and expenses, the insurer gives the policy owner a period at least 30 days to make a premium payment to cover the shortfall. If the policy owner fails to pay these charges, the policy will lapse. What is true of premiums paid for a universal life policy regardless of which premium pricing method is used? A B C D It is never necessary to pay a premium When premiums are not paid, the account value is reduced Premiums are paid into the investment account The policy owner can always choose how much premium to pay Copyright 2011 Oliver Publishing Inc. All rights reserved. 63

20 LLQP The Expense Component of Universal Life Expense charges against the U.L. policy include administration, expenses, and sales costs. They are deducted from the account monthly. + FILE See file 12 regarding the danger of leveraging a universal life policy. 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 Premiums optional deposits Account Value some expenses may be deducted before premium is deposited mortality charge investment expenses 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. Disposed A policy is disposed in many ways, including surrender of the policy, its absolute assignment, or its lapsation. Disposition is a taxable event. The investment earnings grow within the account. The income within a taxexempt 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? Compounding Compounding is when investment growth earns growth, hence returns are said to be compounded. A B C D The desire for a higher face amount The need to change the life insured Growth that is not fulfilling the expectation of the policy owner The need to add a life insured 64 Copyright 2011 Oliver Publishing Inc. All rights reserved.

21 Types of Insurance 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. + FILE See file 13 for guidelines on how to select the best investment. What type of return does the universal life policy owner receive when the investments in the policy are linked to a mutual fund? A B C D Non-guaranteed return Guaranteed return Balanced return 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. 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. Copyright 2011 Oliver Publishing Inc. All rights reserved. 65

22 LLQP 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 B C D Policy loans Cash surrender value The flexibility of the policy 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. + FILE See file 14 for a comparison of term, whole life, and universal life insurance. 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 B C D Cash withdrawals Policy loans Policy expenses 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. 66 Copyright 2011 Oliver Publishing Inc. All rights reserved.

23 Types of Insurance The Market for Universal Life Due to its focus on investments and investment performance, universal life will appeal to those who are: Younger and more willing to make their own decisions and take risks on investments. Also, they have the time to allow the investment component of the policy to grow. Planning their estates: The need for permanent insurance and the deathbenefit options available fulfil the requirement for life insurance paid on death. Looking for flexibility: Some people will find the flexibility in a universal life product appealing. Cost-oriented: People who want to monitor insurance expenses separately from investments will appreciate the unbundled aspect of universal life. + FILE See file 15 for a case study on the use of a universal life policy. Investment-oriented: Many people think they can time the markets or otherwise make better decisions about their investments than the insurer would make on their behalf. Seeking creditor protection: Just as other types of insurance provide creditor protection when a beneficiary other than the estate has been named, so too does universal life. Topped-up on Registered Retirement Savings Plan (RRSP) contributions and seeking other methods of tax-deferred growth. RRSPs Registered Retirement Savings Plans (RRSPs) are taxassisted retirement savings plans in which contributions grow on a taxdeferred basis. Summary of Universal Life Universal life is the most complicated life insurance product. To understand it fully, it is essential to consider that: It is insurance-for-life, with premiums charged according to whether the policy owner has selected a yearly renewable term or T-100 rate; The unbundling aspect has particular appeal to investors eager to monitor investment performance; Investments are controlled by the policy owner to suit his or her needs and preferences; the policy owner faces all the investment risks including losses, if any; Its flexibility allows life insureds to be added and the amount of coverage to be changed over the duration of the policy; Copyright 2011 Oliver Publishing Inc. All rights reserved. 67

24 LLQP An added expense component reflects the costs the insurer incurs maintaining this type of complex policy. Supplementary Benefits and Riders to Personal Life Insurance Supplementary benefits and riders are policy extras. They are optional additions to a policy that benefit either the beneficiary or the policy owner. Riders are issued with the policy, and they add an extra cost to the premium. The additional expense does not increase the cash surrender value, non-forfeiture values, or paid-up additions of the policy. A key feature of benefits and riders is the flexibility they offer the policy owner. Short-term needs can be met by adding a rider, and when it is no longer needed, it can be allowed to expire or can be cancelled. In this way, a policy owner can customize a standard policy to meet his or her exact needs as those needs change. Riders can be very affordable insurance solutions: an accidental-death-benefit rider, for instance, is a low-cost way of increasing coverage. Riders stay in force until they expire. If a rider expires, its additional cost ceases. If the policy type changes such as when a term policy is converted to whole life riders attached to the original policy will no longer exist. Fundamentally, riders have been designed to address specific risks in order to provide additional coverage for disability, accident, illness, prolonged care, and for additional insureds (other family members who are added to the policy). Accidents happen every day. If an accident causes death within 365 days, the Accidental Death Benefit increases the amount of the death benefit. 68 Copyright 2011 Oliver Publishing Inc. All rights reserved.

25 Types of Insurance Riders include: Guaranteed insurability benefit (GIB); Accidental death benefit (ADB); Accidental death and dismemberment (AD&D); Monthly disability income benefit; Waiver of premium benefit (WP); Accelerated death benefit; Parent waiver; Term insurance. Guaranteed Insurability Benefit (GIB) 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. + FILE See file 16 for a case study on the use of the GIB rider. 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. Copyright 2011 Oliver Publishing Inc. All rights reserved. 69

26 LLQP The GIB is useful to add more insurance if the circumstances of the life insured have changed since the policy was first acquired. The events may be specified within the policy, or, if not specified, they may include: increased income, increased debts, marriage, divorce, and the need to guarantee obligations to an exspouse and children, having a child or another child, or acquiring debt as a sole proprietor or partner of a business. Accidental Death Benefit (ADB) The focus in an accidental death benefit is on the word accident. If the life insured dies by accidental means, an amount, in addition to the face amount, will be paid to the beneficiary. Since this amount is usually the same as the face amount, the beneficiary receives a death benefit twice as large as that provided by the original policy. The types of accidents covered are defined in the rider, and death must occur within a specified number of days following the accident, usually 365 days. When a policy pays out twice the face amount it is called double indemnity. Accidents not covered include: suicide, war, riot, an unlawful act, or aviation accidents in which the insured was not flying on a commercial airline as a farepaying customer. The premium for the ADB depends on the age of the life insured and the premium payment period. An ADB is usually not available to those over 55 and ends at age 60. Accidental Death and Dismemberment (AD&D) When an accidental death benefit also provides coverage for dismemberment (that is the loss of a limb, an eye, or other body part), the rider becomes known as an accidental death and dismemberment (AD&D) rider. The benefit of an AD&D rider is usually paid out in a lump sum, specified in the rider and paid according to a schedule in the policy. The rider will stipulate the amount that will be paid for dismemberment and specific losses, such as an arm, caused by an accident. As with the ADB rider, death must be attributed solely to an accident and must occur within 365 days of the accident. Coverage is usually limited to those under age 60 or Copyright 2011 Oliver Publishing Inc. All rights reserved.

27 Types of Insurance Monthly Disability Income Benefit 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. Two-party contract When an insurance contract is a twoparty contract between the policy owner and the insurer, it is also called a personal policy. 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. Waive To waive means to temporarily put aside or give up. 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. Copyright 2011 Oliver Publishing Inc. All rights reserved. 71

28 LLQP 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. 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. 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. 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 standalone product follow later in this book. Since death is not imminent, the benefit is paid monthly as a small percentage of the face amount. 72 Copyright 2011 Oliver Publishing Inc. All rights reserved.

29 Types of 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 B C D $500,000 in term insurance $540,000 in term insurance $540,000 in permanent insurance $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 without providing evidence of insurability. Copyright 2011 Oliver Publishing Inc. All rights reserved. 73

30 LLQP Disability Income Insurance 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? 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. A B C D Disability income insurance is income protection insurance Disability income insurance is a way to transfer risk Disability income insurance provides an income to a beneficiary 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 B C D The disability income replaces earned income lost due to disability. Coverage for disability income insurance is based on earned income. Coverage for the disability income benefit is based on the total income of the insured. A and B 74 Copyright 2011 Oliver Publishing Inc. All rights reserved.

31 Types of Insurance 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. 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. 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. Copyright 2011 Oliver Publishing Inc. All rights reserved. 75

32 LLQP 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. Which type of disability income insurance would a person select who wants to be absolutely certain that their coverage would not be cancelled? A B C D A guaranteed renewable policy A non-cancellable and guaranteed renewable policy A conditionally renewable policy A and B + 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. 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. 76 Copyright 2011 Oliver Publishing Inc. All rights reserved.

33 Types of Insurance There are four definitions of disability: Total disability; Residual disability; Partial disability; Presumptive disability. Total Disability Total disability is classified by the ability of the policy owner to work at: Any occupation (any occ); or His or her regular occupation; or His or her own occupation (own occ). When any occupation is chosen, the policy owner would receive a disability benefit when he or she is unable to work at any job. The policy owner cannot receive any other income. Therefore, if the policy owner claims he or she cannot work at his or her job, but the policy is written to include any occupation, the claim may be turned down, because the policy owner could work at another job, regardless of its suitability. The regular occupation clause will provide a disability benefit to an insured who is unable to perform the essential duties of his or her regular occupation. If the insured earns a salary or wage from other employment, the policy benefit will be reduced or eliminated by those employment earnings. When own occupation is selected, the policy owner can claim his or her disability benefit when he or she is unable to perform the essential duties of his or her own regular or previous occupation. Full benefits are paid, even if the person is working at another occupation, as long as the insured cannot work at his or her regular occupation. This definition is available only to the top occupational classifications. Residual Disability When a policy covers residual disability or provides residual disability as a rider, a benefit is received when the insured is able to earn between 20% and 80% of his or her salary by working. This definition of disability is also known as the proportional disability definition, because the benefit is in proportion to wages lost and supplements what is being earned as income. Copyright 2011 Oliver Publishing Inc. All rights reserved. 77

34 LLQP Which definition of total disability allows the insured to earn employment income, plus 100% of his or her disability income benefit? A B C D Residual benefit Any occupation Regular occupation 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). 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. 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. 78 Copyright 2011 Oliver Publishing Inc. All rights reserved.

35 Types of Insurance Elimination Period 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. 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. 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. Copyright 2011 Oliver Publishing Inc. All rights reserved. 79

36 LLQP 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 FILE See file 18 for examples of how these riders are used. 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. 80 Copyright 2011 Oliver Publishing Inc. All rights reserved.

37 Types of Insurance Cost of Living Adjustment (COLA) 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. 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. 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 Copyright 2011 Oliver Publishing Inc. All rights reserved. 81

38 LLQP purpose is to provide the disabled with a new occupation on a full-time or parttime basis. Other Common Riders Return of Premium: Some or all of the premiums are returned if claims are less than 20% of premiums paid and waived. Lifetime Injury: Extends injury benefits beyond 65 for life. Lifetime Sickness and Injury: Extends total benefits for life. Zero-Day Qualifying: Removes the requirement for total disability to occur before residual benefits can be paid. First-Day Hospital Coverage: Pays benefits from the first day of disability, when the insured is confined to hospital. Accidental Death and Dismemberment (AD&D): Just like the AD&D rider to a life policy, the AD&D rider to a disability income policy pays a lump sum for accidental death and all or part of that sum for dismemberment (loss of limb, sight, etc.), depending on the loss. Summary of Life Insurance Riders Guaranteed Insurability Benefit Accidental Death Benefit Accidental Death and Dismemberment Waiver of Premium Accelerated Death Benefit Parent Waiver Term Rider Best for people who are younger wish to guarantee future insurability are anticipating increases in their future insurance needs are concerned about the chance of dying in an accident work in an occupation in which there is a chance of accidental death are concerned about the chance of dying in an accident work in a dangerous occupation participate in dangerous hobbies would enjoy the security of having the insurer continue to pay their premiums in the event of a disability wish to obtain benefits similar to a critical illness policy and/or a long-term care policy without acquiring an additional policy are purchasing insurance for dependent children are purchasing permanent insurance, but cannot afford the full amount of insurance necessary to meet their needs are purchasing permanent insurance, but would like the flexibility to reduce the amount of coverage at a later date (i.e., when the mortgage is paid off) 82 Copyright 2011 Oliver Publishing Inc. All rights reserved.

39 Types of Insurance Accident and Sickness (A&S) Insurance 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. 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. 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. Copyright 2011 Oliver Publishing Inc. All rights reserved. 83

40 LLQP Travel Assistance In case of emergencies, when a person is travelling outside Canada, this policy pays for health-care services required outside Canada that are not paid for by provincial plans. A basic travel assistance policy will cover hospital and medical costs incurred while travelling outside Canada, repatriation (the cost of moving back to Canada if the insured is totally disabled or returning his or her remains if death occurs abroad), transfers to hospitals, any required travel by family members or companions accompanying the insured, and assistance, such as translation services. An enhanced policy can include almost all qualified costs of accident or sickness. + FILE See file 19 for a case study on the use of an A&S policy. Prescription Drugs This policy can pay some or all of the costs of prescription drugs via: A reimbursement plan in which the insured pays for the drugs and is reimbursed by the insurer; A pay direct plan in which the insured is provided with a drug insurance plan card to pay for the drugs, and the pharmacy bills the insurer directly. Dental Plans Dental plans most commonly provide coverage for: Basic preventative service: Examinations, consultations, X-rays, diagnostic procedures, polishing, fillings, and anesthesia for any preventative service; Endodontics: Root-canal work, gum-disease treatment, and major surgery; Restorative services: Crowns and inlays, fixed bridgework, and maintenance and replacement of appliances; Orthodontics: Braces, usually for dependent children only; Periodontic service: Dealing with teeth, bones, and gums; major surgeries Prosthodontic service: To replace missing teeth with dentures, bridges, crowns, caps, or veneers. All dental-insurance plans start by providing preventative services, such as semi-annual check-ups, before providing any other type of service. 84 Copyright 2011 Oliver Publishing Inc. All rights reserved.

41 Types of Insurance Accidental Death and Dismemberment (AD&D) You have already been introduced to AD&D as a rider; this form of AD&D insurance is a stand-alone policy. Like the rider, a lump sum benefit is paid if the insured dies from an accident or suffers a qualifying multiple dismemberment. A partial benefit is paid for a single dismemberment. This is the only type of A&S policy in which a beneficiary will be designated. The beneficiary will receive the lump-sum payment on the death of the insured. What kind of protection does A&S insurance provide? A B C D Protection from unanticipated qualified medical or dental expenses Income protection Protection from the cost of all medical expenses All of these answers Critical Illness Insurance (CI) Critical illness insurance is a relatively new type of health insurance designed to manage the risk associated with contracting certain dreaded diseases. Even though mortality rates are falling, the number of people with critical illnesses, such as cancer, heart disease, and stroke, is increasing. + FILE See file 20 for a case study on CI. A CI policy pays a lump-sum benefit to the insured if the insured is diagnosed with any critical illness covered in the policy and, for most conditions covered, is still living 30 days after the diagnosis. The benefit may be used in whatever way the insured wishes. It can be used to fulfil dreams (that always-wished-for trip or holiday) or for more practical uses (retrofitting a vehicle or the home) or to buy health services through a private health-care system, such as that available in the United States. Critical illness policies are most commonly used to remove the financial burden once the insured becomes critically ill and is unable to work. In this context, it will be used to provide the necessities of life, not to fulfil an item on the dream list. The policy differs from life insurance in that the benefit is paid directly to the insured. Unlike disability insurance, there is no requirement for earned income. Critical illness insurance can be acquired as a limited-payment policy, in which premiums are payable for 20 years, or as a level-premium plan, in which premiums are paid until the policy expires. Copyright 2011 Oliver Publishing Inc. All rights reserved. 85

42 LLQP The types of CI policies are: Renewable (e.g., 10-year renewable; 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. 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. 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 86 Copyright 2011 Oliver Publishing Inc. All rights reserved.

43 Types of Insurance cancer must have on the insured before a benefit is paid. It would be tragic for an insured to suffer a type of cancer not covered in the policy and find that his or her CI policy would not make the anticipated payment. Thus, very specific definitions of the nature and scope of conditions covered will demand a higher premium than definitions that are vague and less likely to be satisfied when a condition occurs. Here are some examples of how the top four conditions will have to be satisfied: Heart Attack: An acute episode of heart disease due to insufficient blood supply to the heart muscle, especially when caused by a coronary thrombosis or coronary occlusion. Therefore, it is clear that the heart muscle must be affected for a claim to be successful. Cancer: A malignant tumour of potentially unlimited growth that expands locally by invasion and systematically by metastasis. However, some cancers are readily treatable and even cancers such as breast cancer or prostate cancer, are not necessarily fatal. There could be a delay before payment is made while the severity of the cancer and the prognosis for the patient is determined. Stroke: A sudden diminution or loss of consciousness, sensation, and voluntary motion, caused by a rupture or an obstruction of an artery of the brain by a blood clot. Strokes have many degrees of severity; and critical illness would have to be established for a claim. Heart Bypass Surgery: A surgical procedure to bypass blocked heart arteries with a graft. Since surgery is specified in the definition, less invasive procedures, such as balloon angioplasty would not qualify for a claim. Other Conditions: Policies can be structured to provide benefits for the following conditions: Blindness; Deafness; Kidney failure; Major organ transplants; Multiple sclerosis;; Copyright 2011 Oliver Publishing Inc. All rights reserved. 87

44 LLQP Paralysis Coma; Others particular to each insurer. A return-of-premiums rider to this policy will refund premiums if a claim is not made within a specified period of time. All CI policies cover specific health conditions with the exception of: A B C D Cancer Heart attack Stroke HIV/AIDS + FILE See file 21 for a case study on LTC. Long-Term Care Insurance (LTC) If your client is a member of the baby-boom generation, chances are good that one or both of his or her parents will live a long life. After living independently, it is reasonable to anticipate the need for care. The parents will perhaps first need care while continuing to live at home, then in a retirement home or seniors residence, and eventually in a nursing home. Has your client explored the cost of such living arrangements? Have the parents planned for the expense of such assisted living? It can easily cost thousands of dollars every month. A long-term care policy can provide peace of mind by assuring that necessary care can be afforded and will be provided. A policy can be structured to provide benefits for: Home health care, also called attendance care, for those expenses that would be incurred by someone who continues to live independently; Chronic care for the expense of care in a chronic-care facility, such as a nursing home; Medical equipment; Respite care; Hospice care; Adult day care. Remember, long-term care is also available as a rider to a life policy. 88 Copyright 2011 Oliver Publishing Inc. All rights reserved.

45 Types of Insurance Benefits 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. Impairment does not need to be physical for the benefit to be received from a longterm 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. 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 Copyright 2011 Oliver Publishing Inc. All rights reserved. 89

46 LLQP Summary of Insurance Products Best for people who Term life want lower premiums would have survivors with financial needs (i.e. a spouse and children) are younger than 50 have financial commitments of a known amount and period of time (such as a mortgage) Whole life have better incomes would have survivors with financial needs (i.e. a spouse and children) have estate planning goals (i.e. the desire to leave an inheritance to their children) can appreciate the value of policy loans and other policy features need the discipline of an insurance contract to save T-100 do not require a cash value within their life insurance policy wish to be insured for life have an estate planning need Universal life are focused toward investments and investment performance desire and/or require flexibility in an insurance contract need the simplification of insurance and investments together would have survivors with financial needs (i.e. a spouse and children) Disability are working full-time are self-employed, especially with dependents are not covered or not completely covered by other plans (i.e. by workers compensation) Accident & are self-employed, especially with dependents Sickness are not covered by an employer-sponsored plan want the enhanced provisions of care guaranteed, such as a private hospital room travel frequently Critical illness believe their employment or another factor in their life (i.e. where they live) puts them at risk of developing a disease or illness are single and lack family members to provide care if a disease or illness strikes do not work full-time and are, therefore, unable to acquire disability insurance Long-term care have a family history of disease or illness have ancestors in which longevity is indicated do not want to place a financial burden on others for care have been and wish to remain independent for as long as 90 Copyright 2011 Oliver Publishing Inc. All rights reserved.