HFI Financial

Contract & Company. Making the right choice:

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• Market Comparison:
  
  We recommend shifting the focus from computer projections, which are guaranteed not to come true, to an overall discussion regarding the design of the desired insurance contract and the choice ofthe insurance carrier. A Task Force Report from theSociety of Actuaries stressed that:
  
  "Sales illustrations should not be used for comparative policy performance purposes. Life insurance policies are complex financial instruments which generally contain both guaranteed and non-guaranteed elements. A sales illustration may be helpful in understanding how a particular policy performs under specified circumstances. It is generally not feasible, however, to use sales illustrations to determine whether one policy is a better buy than another… Policy illustrations should not be used for comparing the relative cost or performance of life insurance products."

• Deciding on Policy Contract & Company
  
  In our opinion, the best way to compare and decide, is to accept the fact that an insurance contract is a long-term agreement for the delivery of large sums of money in the distant future. It is important therefore, to base the selection of coverage on an assessment of the long-term prospects for a particular policy choice. The three major areas to be assessed are:
  
  The company’s financial strength
  Contractual guarantees in the policy
  Likelihood of superior performance over and above.minimum guarantees

• Company Solvency
  
  The first major area to consider is whether you believe that the company will be around when the claim occurs. To assess this, we look at:
  
  Its' history
  Current performance
  Treatment of policyholders
  Efficiency
  Financial strength
  Size and solvency
  Ownership
  Administrative competence
  
  
• Policy Guarantees
  
  It is essential to review the contract provisions which guarantee minimum performance. These contract provisions can be measured, quantified, and compared between different contracts. Some of the key clauses to be examined relate to:
  
  Definition of the manner in which minimum interest guarantees will function. ..Specifically, what rates are guaranteed and under what circumstances?
  Mortality guarantees - on what basis is mortality guaranteed, at what ratesand.for how long?
  Expenses - are expense charges guaranteed and on what basis?
  Exempt guarantee - it is imperative that the policy continue to be tax-exempt. In the event that the policy becomes non-exempt, the entire accumulated gain will become taxable. It is therefore, imperative to have a contract guarantee from the insurance company, agreeing to maintain the policy’s tax-exempt status.
  Future face amount increases - what is the company prepared to guarantee on a non-medical basis?
  Investment income tax - this represents 15% of the policy’s investment income and is factored into some companies’ calculation. It is important to establish whether or not a company has already included it. If taxes are refunded to the company in the event of cancellation, will they be refunded to the policy owner? Are there any other special advantages or disadvantages available in a particular policy form?
  
  
• Likelihood of Superior Performance
  
  Performing at the minimum guaranteed level would be inadequate since in most situations a significant segment is derived from the non - guaranteed portion of the contract. Differences in results will be determined by the same seven factors that determine solvency i.e.: history, current performance, final strength, treatment of policyholders, ownership and administrative competence. These factors will decide the overall company profitability and availability of excess earnings.The share of these profits that will find their way to any specific policy will be determined by clauses in the policy. Superior policy results will be a function of overall company performance. The specific clauses of each individual policy will determine how these results will be divided between shareholders and different groups of policyholders. Important clauses to examine include:
  
  Interest - definition of the manner in which excess interest or gains will be allocated to this policy. What interest spread is the company going to keep between its earned rate and the rate credited to the policyholder
  Mortality - specific wording relating to the allocation of better than guaranteed mortality experience to the specific policyholder.
  Expense - what is the potential for additional expense charges to be added or additional expense charge savings to be subtracted from the specific policy in question?
  Other - any other clauses that may be unique to an individual contract
  
  
• Consumer Accountability
  
  There are three basic factors that determine the premium of a life insurance policy - mortality risk charges, operating expenses (i.e. acquisition costs, premium taxes etc.) and earnings on policy reserves. A policy that does not disclose, define or guarantee these factors favours the insurance company over the policy holder.
  
  Mortality Risk Charges
  
  Are they guaranteed?
  Are they disclosed in the contract?
  If they are not disclosed in the contract can the agent get the company to state what the current mortality and guaranteed mortality factors are?
  
  Expense Charges
  
  Are these charges or the formulas for determining these charges guaranteed?
  Are they disclosed?
  
  Earnings
  
  Does the insurance company link the earnings to an outside independent index?
  If so, what is it?
  
  
• Tax Considerations
  
  In addition to consumer accountability, the insurance buyer should look at the policy’s design as it relates to tax rules. In 1982, Bill C-139 introduced new criteria for insurance companies to adhere to in designing products. If the buyer is a corporation, other aspects of the Income Tax Act need to be considered.
  
  Exempt or non-exempt?
  
  Is the policy designed to be exempt or non-exempt from accrual taxation under Section 12.2 of the Income Tax Act?
  If it is exempt does the policy contract state that it is guaranteed to maintain that exempt status?
  
  Capital dividend account
  
  Has the policy been designed to maximize the outflow of tax-free dividends through the capital dividend account?
  i.e. If a corporate owned policy only pays out on death the original basic sum insured, the credit to the C.D.A. will be less than that amount until the adjusted cost base of the policy is back to zero (usually between the 17th and 24th year). This type of design would create a shortfall of tax-free cash to satisfy the obligation for which the insurance was purchased such as satisfying a capital gains tax liability.
  
  Investment income tax
  
  Has the insurance company taken into consideration the impact that the investment income tax will have on the pricing of their policy?
  If the policy is surrendered for its cash value, will the insurance company pass on to the policyholder a refund of the investment income tax that the company receives as a tax credit from the government?
  
  
• Value Added Features
  
  The insurance buyers want to make sure that they are getting good value for the premium dollars being spent. They want flexibility in the product design to adapt to their situation as opposed to the buyer having to adapt to the rigidity of an insurance contract.
  
  Premium flexibility
  
  Is the premium fixed or does the policy allow the owners to decide year by year how much they should deposit?
  Can premiums be skipped from time to time?
  If premiums are skipped, is that considered to be a policy loan which either has to be repaid with interest or reduces the insurance proceeds on death?
  
  Additional Benefits
  
  Does the policy return all premiums (deposits) on death in addition to the original sum insured (to maximize tax-free dividends out through C.D.A.)?
  In an estate planning situation is there a substitute life provision in the event that the business assets are sold or transferred to other family members and the need for the insurance is required on other lives? (the advantage of this flexible feature is that the policy does not have to go through a disposition and possible accrual taxation that may be triggered.)
  
  Capital Benefits
  
  Does the policy provide for the payment of disability benefits from the tax-sheltered reserve?
  
  
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Last modified: December 14, 2008