I am pleased to introduce my guest-post today from Brian Poncelet from Right Insurance. Brian is a Certified Finance Planner who specializes in Life Insurance, Critical Illness Insurance and Disability Insurance. Brian takes his time today to write about common misconceptions and mistakes when buying term life insurance.

MISTAKE: Failing to buy enough insurance while you are still healthy.

Medical evidence is required when you buy life insurance.  This evidence usually consists of a list of questions to elicit your medical history, a brief exam by a nurse, a blood and urine specimen and possibly a report from your doctor.  If at a later date you decide that you really need more coverage, the process begins again.  If your health has changed you may have to pay higher premiums.

MISCONCEPTION: Cheapest is the best.

That term policy premium might be cheap in year one.  But most term policies renew at regular intervals (every 10,20 years) and the renewal premium rises at each interval because it reflects your new age.

In general, a 10 year term policy is the cheapest but by year 13 it is actually more expensive than buying Term 20. In other words, if you think you need coverage beyond 10 years, it is better to chose a 20 year term now.

MISTAKE: Failure to understand your options

So on each renewal the premium rises at each interval as stated above.  But you do have options.  Most term policies include a free option to convert your policy to permanent coverage before age 65.  Converting to permanent coverage make sense especially if you have had a change in health. Even better, you will not require a medical to convert.

The types of permanent coverage eligible for conversion usually include whole life and universal life but these also vary by company.  If you buy term coverage do so with a company that offers several options for the converted policy.

MISCONCEPTION: Buying through the internet is cheaper (no commissions to be paid)

Insurance comparison services on the internet say “buy direct and save money”. The fact is, you cannot receive a discount in the price of life insurance by avoiding a life insurance agent.  Sales charges and costs (such as commissions) are built into the premium that you pay for any life insurance policy that you buy. You will be paying those built-in charges regardless of where you buy the insurance.  Finding and using a local life insurance agent will not cost you more than dealing with someone in another city or province by telephone or mail.

MISCONCEPTION: Association insurance has cheaper rates.

Associations include organizations such as universities, credit card companies and consumer groups like CAA.  Sometimes association rates are cheaper but in many cases the rates go up every five years.  Associations are like groups where several insureds are lumped together and pay a premium relative to the group being covered.  Even where limited medical questions are asked, the premiums reflect the inability for the insurance company to fully assess individuals and the group like rates is charged.  Association groups also may offer very limited conversion opportunities.  Therefore if you cancel your credit card or if you are no longer a CAA member you coverage is cancelled.

As a smart consumer, obtain an individual insurance quote and compare the products for price, renewal options and conversion options.

MISTAKE: failure to understand that buying term is like renting life insurance.

Permanent (whole life) plans are more expensive in the early years but the premium stays the same for the duration of the contract.  Because you pay more in the early years, you have some equity (cash value) in the policy.  If you decide to cancel the contract you get the cash value back.  However, you have no equity in a term policy.  You pay premiums applicable to your age and this rate rises at every scheduled renewal.  Because you are paying the true cost of coverage, there is no equity in the policy.  If you cancel the coverage 10 years down the road because the renewal rate is too expensive, then you walk away.  Bottom line, you are renting coverage briefly and won’t have it when you need it or more importantly when your family needs it!

MISTAKE: paying your insurance premium on a monthly basis

The insurance company charges extra to those who pay monthly as they incur extra expenses to administer monthly payments.  If you are able to pay the yearly premium it can save you up to 10%.

MISTAKE: paying extra for benefits (the frills) that you may never use

Waiver of Premium Benefit: the insurance company will waive the premiums if you become disabled.  Few people understand that you must be totally disabled in order to be eligible.  Also if you have term insurance the insurance company will usually pay only to age 65 while for some types of permanent insurance they will pay the premiums beyond age 65.

Guaranteed Insurability Option: In a nut shell you pay more now just in case you want to buy more insurance in the future without having to provide proof of health.  It essentially insures your insurability.  However, your premium for the new policy will be at current age rates.  One more reason to buy all of the insurance that you need now and at your current age.

Accidental Death Benefit: This benefit guarantees that if you die in an accident, your beneficiary will receive an additional predetermined amount of money on top of the base policy amount Again, I’d say if you need accident coverage buy it rather than depending on an ADB rider hopefully supplementing the amount of coverage your family really needs now.

MISTAKE: buying coverage because no medical evidence is required.

This might sound appealing but in actual fact you will pay more for this insurance and the amount of coverage available will be limited.  If you are healthy, take the time to prove it and pay premiums that truly reflect the good risk that you are.

MISCONCEPTION: the premium I see on the internet is what I get.

Insurance companies offer several classes of standard rates.  Those in the top physical condition and with no risk factors will get the best rate.  Premiums on the internet usually default to the top preferred category (the cheapest).  However, keep in mind, only a certain percentage of applicants will actually qualify for the best rates.

MISCONCEPTION: waiting until you lose weight or stop smoking in order to get the best rate.

This is just procrastination.  Yes, you may pay higher rates now but did you know that if you quit smoking or if you keep the pounds off  for one year, you can apply to have your rate reassessed.

I distinctly recall being given at the beginning of every elementary school year a brochure to take home to our parents offering insurance on our lives or in the event we experienced bodily injury.  It was always interesting to see how much you could get for a lost eye as opposed to a lost toe or disfigurement. My parents never ever bought insurance for me during my school years. But this was in a different time and place where peanut butter was freely eaten at lunch, there were no metal detectors at schools and no one thought twice about sending their kids on overnight trips.

With the world being, or seemingly being, a dangerous place, is life insurance an appropriate product for your child? According to a recent television commercial I watched, the answer should be yes; you never know when you need life insurance even for a child.

However, the general answer is no for two main reasons.

Firstly, statistically speaking, the child mortality rate is  low. According to the National Center for Health Statistics, there were 81,216,835 children between 0-19 years old living in the U.S.  in 2003. There were 53,539 child deaths that year or 65.9 deaths per 100,000 children. This is less than 1% of  children between 0-19. The leading cause of death in this age group was perinatal conditions (14,364 deaths) which the World Health Organization defines as deaths occurring under 5 years of age. In other words, if we assume 2003 was a typical year, the chances of an unfortunate and tragic death of a child are quite low and lower once a child survives past 5.

Thus, the probability of the risk of death for a child is low so paying an insurance premium to transfer risk of loss to an insurance company seems to be a waste of resources, considering there are more productive ways to spend money on a child.

Second, one of the primary reasons why people obtain life insurance is to mitigate against the financial consequences caused by the death of the insured. In the case of a minor, there generally is little to no lost income to be replaced. Obviously, there are funeral costs to consider if a child passes away but, given the low statistical chance this will happen, the financial risk of paying for a funeral is generally small enough to live without life insurance.

The exception to the general rule is if the child has a medical condition which is not severe but can affect their health (diabetes- to the extent diabetes can ever be thought to be minor- would be one example) or there is a genetic tendency towards certain type of disease in the family. In that case, assuming this is disclosed (to avoid a denial of claim based on pre-existing medical condition not disclosed), a term life insurance policy may be suitable in order to make it easier to obtain insurance later in life.

Having said that, one must weigh the cost of obtaining insurance with buying health insurance to supplement existing health care plans or investing in the child’s education. This type of balancing of priorities, obviously, involves contextual factors such as the medical condition at play, financial means, the number of children etc. etc.

The point being, if your child brings home a brochure offering life insurance after the first day of school, it may be an educational piece to read but perhaps not to act on.

No post tomorrow or Friday. I am on a mini-vacation. Enjoy the weekend.

Scotiabank became the second Canadian bank, after RBC, to begin selling insurance by building insurance retail operations next to their existing bank branches. The rather strange result of having adjoining retail frontage operated by the same business, but selling different products, is a means to circumvent rule not allowing banks to sell insurance out of existing bank branches.

Is this growing trend a good thing for the consumer, the shareholder and the economy as a whole?

THE CONSUMER

On the retail front, we have all heard about financial institutions wanting to capture all of our business as your “one stop” cradle to grave financial services shop. However, anecdotal evidence  suggests that customer loyalty at banks really does not pay and is there any evidence to show that the retail consumer benefits from pricing power from banking, borrowing, trading securities or buying insurance from one shop?

Granted, there are small discounts if you buy different types of product offerings under one umbrella (State Farm Insurance is known to give a discount but you have to move all your insurance to them) but why give up leverage of moving around from financial institution to financial institution if there is no corresponding monetary benefit to shopping under one roof?

More concerning, the dirty little secret of insurance sold by banks is that banks are actually selling other insurer’s products or white-labeled products. Scotiabank will be selling Sunlife products. My insurance broker once told me that, at that time, RBC insurance products were white-labeled Manulife policies. If the banks are acting as distribution channels for insurers, obviously, there are costs of sales and their margins to consider. For a business with such large over-heads as banks, the cost could be great and they will be downloaded to the consumer.

But, to defend the banks for a minute, this may also be a good move if, and only if, this starts a price war. Banks have been selling insurance for years but if they move in scale, this may trigger price movement downwards. The key, as a smart consumer, is to obtain multiple insurance quotes from the banks, insurance brokers, on-line insurance quotes using the same assumptions and determine if different distribution channels have different price structures. If they don’t, I would still purchase insurance from someone other than the banks to avoid giving up all your leverage as a consumer; rarely is the lazy consumer, the smart one.

THE SHAREHOLDER

Increasing revenue sources means increasing revenue which, hopefully, means increased earnings. However, if the banks engage in a pricing war with the insurance companies (assuming the banks underwrite their own products) and vice versa (remember that some insurance companies are beginning to build out their banking divisions as well), what’s good for the consumer is bad for the shareholder. The recent supermarket price wars are a good example of happy consumers and unhappy shareholders.

On the downside, insurance is also a tricky risk management product. Actuarial calculations on probability of payout are really educated guesses into the future. Already juggling fallout from the credit crisis, if a bank dramatically increases its insurance exposure, it may have to build greater capital ratios (both for deposits and insurance exposure) which is a drag on earnings. Once again, the question becomes how well can a bank manage risk?

THE ECONOMY

There’s a rather deafening silence in the dialogue about financial services reform- the reinstitution of the Glass-Steagall Act. This Act, passed at the height of the Great Depression in the U.S., separated banks, investment banks and insurance companies from owning one another. One justification was that traders should be barred from using bank deposits to trade; banks are supposed to limit risk on deposits and they should not allow traders to have access to deposits given their relatively riskier functionality.

The act was repealed in 1999 under intense lobbying by financial institutions. Citigroup was the most well-known institution to consolidate deposit-taking, trading and insurance functions under one financial services holding company after the repeal of the act. Citigroup also became the poster-child for the credit crisis as its large derivatives exposure and imprudent trading practices put depositers’ money at risk.

Many countries continue to prohibit the consolidation of banking and investment trading functions. The U.S. sits on the other extreme of non-regulation. Canada occupies the grey zone. A financial institution can do a bit of everything- as long as its not under the same roof (a rule only a bureaucrat could convincedly think would work in real life).

If banks become insurance juggernauts, are we exposing our deposits and insurance premiums again to traders with much higher risk tolerance than the retail consumer? Perhaps the practical regulatory solution is to mandate higher capital ratio levels on both the deposit taking and insurance side once exposures reach certain levels and limit the use of revenue derived from safer divisions by riskier functions. Certainly,  risk-taking and innovation are opposite  sides of the same coin but one wonders if such risk taking should be done with grandma’s money.

Insurance is the transfer of risk from one party to another. In consideration of  monetary payment by the insured, the insurer promises to pay compensation based on some future risk/loss, such as disability or death, to a designated party. In and of itself, the concept of insurance is great. Who does not want a risk management tool that shifts your risk to someone else?

However, the devil is in the details and there are two larger and worrying trends in the insurance industry. The first is that insurance companies don’t want to be boring old insurers anymore but asset managers. The second is a general consolidation of the industry. In Canada, three insurers- Manulife, Great-West Life and Sun Life- now control approximately 65% of the market. In the United States, companies dominant insurance niches. While the public opposes big banks, the insurers quietly reached a scale the banks would die for.

The result is that most insurance companies need to pay out as little as possible to maintain or grow their assets under management (in fact, many insurers sell policies as loss leaders while making money on asset management) and a consolidated industry means pricing power. Neither is particularly  good for the consumer.

On a more specific level, what are 5 warning signs that you may have an improper insurance policy?

1. No medical required before obtaining an insurance policy

Four Pillars and I  have written before about post-claim underwriting. While illegal in many jurisdictions, there are many ways to re-characterize a policy to be potentially within the scope of the legislation (and require expensive litigation to resolve).

A “no medical required” insurance underwriting process may not indicate per se that you are subject to post-claim underwriting but it could be a warning sign you could be sold a policy subject to post-claim underwriting. It may make the process of obtaining insurance easier but the potential future-risk is greater.

2. The purpose of insurance is not being used for risk management

As reported by Riscario Insider, the 10/8 program, which involves using insurance policies as collateral towards a loan to the policy-holder to be used for business or investing purpose (thus making the interest tax deductible), is being reviewed by CRA.

Depending on the specifics, some insurance policies were designed more as tax shelters than insurance. In such cases, the insured could run audit risk for what is supposed to be a risk management tool.

While no one knows what will happen to the 10/8 program (and you know there is too much money at stake not to have the insurance company fight this out), the larger point to consider is why you are entering into an insurance contract. If you are being sold something who’s primary purpose is not risk management then think twice since you have opened yourself to other risk factors.

3. Watch the exclusions

Insurance policies are drafted to set out what it does not cover rather than what it does. Just because it is called critical illness insurance, does not mean all type of critical illness are covered and if you have a family history of certain critical illness, the insurer could deny you on the grounds you failed to disclose a pre-existing condition.

The point is to ask your insurance broker what the policy does NOT cover as well as covers so you understand the limitations of your policy. If you may possibly fall under an exclusion, then the policy is not right for you.

4. Unnecessary insurance

Life insurance for minor children. Mortgage insurance. Credit balance insurance. Flood insurance for someone living in North Dakota. There are a lot of insurance products that are ideal for a small subset of the population but sold to everyone. The fundamental question to be asked is always: (i) am I actually at risk (chances of a minor child dying are slim; and (ii) does the risk of occurrence actually require transfer of such risk (a minor child has no dependents so who really needs the money on death?)?

5. Too much insurance

This one is always tricky but insurance brokers tend to start high on their coverage (for their commission). The question to be asked is always: how much money do I really need in case something happens to me? This requires some cash flow projections based on your own life-style rather than what the insurance company tells you.

Government deficits are sometimes called deferred taxation. At some point, you have to pay for them somehow usually though increased taxes. The question is not “if” but “when” the taxation will occur. It appears that the private company equivalent of deferred taxation occurs, in part, by simply underfunding pension plans and employee benefit obligations. For some Nortel employees, they are finding the hard, and sad, way that their “insurance plan” actually wasn’t an insurance plan.

As the story indicates, Nortel’s long term disability benefits was funded by the company itself, through what are known in the insurance industry as health and welfare trusts. On a very simplistic basis, the company creates the trust with the named employees as beneficiaries of the trust. The employers and employees can contribute to the trust.  The administration of the trust is out-sourced to insurance companies who administer the payouts and report to the trustee (who, realistically, report to management of the company) the financial position of the trust.  A trust is used since it is creditor proof. In other words, it is self-insurance with a benefit to the company of the contributions being tax deductible.

But the trust is not an insurance company. It is administered by an insurance company as self-insurance. What is the difference? Primarily, insurance companies are regulated to maintain some minimum capital requirement to adequately fund payment to the policy-holders. Self-insurance has no such requirements. Additionally, a person holding a policy from a bankrupt insurer can typically apply to a government insurance program to maintain coverage for some set period of time. No such insurance exists for self-insurance program.

In other words, it has the sheen of being insurance without being insurance. In and of itself, it is a good struture- PROVIDED it is adequately funded. If the company cannot continue to fund the health and welfare trust fund adequately, the company ceases to fund, there’s a large run on claims or any combination of the three, the self-insurance tends to collapse eventually on to itself. As the recent past has showed us, companies run the same way as governments in that they are deferring their current costs by underfunding pension or employee benefits to make the books look good.

What are the practical implications for you and I? A Nortel situation is not common-place so most of us would not be denied coverage tomorrow by our employers. Instead, I would check to see whether your health benefits are actually insured by an insurance company or self-insured by the employer with the insurance company as administrator.

If it is self-insurance, it is, frankly, hard to tell whether there is adequate funding since you would have to know both the claims history of all the named employees in the trust plus the company’s funding history. This type of information is difficult to obtain unless you are in senior management. But at least you know the risk factors involved in claiming on your employee benefits.

On a more sober note, one tends to learn a lot about people and structures when times are bad. What we are seeing is that the concept of security is self-made rather than given by third parties who ultimately live in self-perservation rather than for your benefit. If there is one lesson reinforced by this recession, it is that the only person who you can rely on for your own security is yourself.

There has been a lot of focus lately about insurance. Particularly, there has been  focus on post-claim underwriting (Ellen Roseman addresses the post-claims underwriting and the banks, Canadian Capitalist’s guest writer addressed post-claims underwriting in discussing mortgage vs. life insurance, and Four Pillars wrote  an editorial about post-claims underwriting). This raises a much larger issue of when and why do insurance companies deny coverage and what you, as a smart consumer, can do to attempt to avoid this.

First, let’s take a step back. An insurance company actually does not make money selling insurance. It is a loss leader.  Instead, insurance companies make money by investing your policy money and the more they keep, the more likely an insurance company will keep Wall Street happy. Thus, its business model relies on keeping your money.

To this end, there are two primary ways that an insurance company can deny you coverage on policies that are not in default for non-payment. The first is fraud by the policy-holder. This is pretty self-explanatory.

The other, murky, way to deny insurance coverage, subject to countless lawsuits, is the intersection between pre-existing conditions and post-claims underwriting.

PRE-EXISTING CONDITION

Under the “limitations, exclusions and non-waivers” section of a typical policy, there are paragraphs of exclusions if you suffered from a pre-existing condition which was not disclosed in your insurance application and which you were aware of or should have been aware of before the commencement of the policy.

In plain English, was there some condition that the insurance company you did not disclosure which would have either resulted in them increasing your premiums or denying you coverage altogether?

What happens if you have a pre-existing condition and you make a claim? If you disclosed your pre-existing condition, you may be denied coverage on that particular condition for a period of time. If you did not disclose the pre-existing condition and the insurance company believes you should have reasonably known or disclosed the pre-existing condition then your coverage may be denied.

Of course, pre-existing condition has been abused by certain members of the industry as a blanket means of denying coverage.

How do you attempt to avoid being caught in pre-existing condition trap? Some pre-existing condition denials occur simply because the policy-holder has not seen the doctor for a while and the insurance company is reviewing older documentation. The gap between the last medical visit and the commencement date of the policy could have incumbated a lot of medical conditions not disclosed. For policy holders who are more high risk, insurance companies do require a physical now as part of its due diligence.

But for what appears on paper to be less risky policy-holders, the insurance company may forgo this altogether (this was the case during good times but this may have changed) and by doing this really placed the risk onto you that you have a clean bill of health since your last visit. The moral of the story being get a physical as part of the process of obtaining insurance (if you are not required to already).

The second practical step is be honest and forthcoming and do it in writing. If an insurance company has on file a medical disclosure which may or may not be part of your medical records, it is more difficult to deny coverage.

POST-CLAIM UNDERWRITING

Post-claim underwriting is a denial of coverage based on a pre-existing condition on steroids. In essence, the insurance company does little to no due diligence before offering you coverage and, at the time of a claim, begins to determine whether you are actually eligible to be covered at all according to the risk the policy-holder provides, giving it, with 20/20 hindsight, potential carte blanche to deny coverage.

If you live in the United States, some good news. In 2007 and 2008, 38 States and the District of Columbia passed laws limiting post-claim underwriting. In an important 2008 decision of Hailey v. the California Physicians’ Services, the California Court of Appeal ruled that it is the insurance companies duty: “to make reasonable efforts to ensure the subscriber’s application is accurate and complete as part of the Pre-contract Underwriting Process.” (emphasis is my own).

In other words, unless you make reasonable investigation before the policy is signed, barring fraudulent misrepresentation, it will be more difficult for insurance companies to use post-claim underwriting as a means to deny coverage.

If you live in Canada (land of the lumbering consumer protection laws- see the laughable do not call list as Exhibit A), I understand that only the Province of Alberta has taken some legislative action on this front (anyone care to help?). So, the one thing you can do as a pro-active consumer, is lobby for a change in the laws to prohibit or restrict post-claim underwriting. Insurance is a provincial jurisdiction so write your elected representative provincially.

In the meantime, how do you know if you are part of a post-claim underwriting insurance policy? A few things to watch for:

1. Medical portion of your application is vague to non-existent;
2. No medical exam no matter how much risk you may pose; and
3. Very quick turn-around between application and when policy is issued.

Ask about the process and if all three pop up, you may want to walk away.

The truth is that an  insurance companies, if it wanted to, could employ a phanlax of claims adjusters and lawyers to help deny coverage. However, if you believe in third part insurance, this should not mean you should not take pro-active steps to help ensure you are covered when you need it. Good luck.

CBC recently ran a story on hidden charges on credit cards and highlighted a new insurance product on the market called credit balance insurance. As the story indicates, part of the issue with this insurance is the dubious sales techniques engaged by the credit card companies; specifically, credit card holders are being charged for this insurance without their consent worldwide. Assuming you actually have a choice on purchasing this insurance, what is it and is it for you?

For brevity, I only highlight some main points. Here is an example of an informational pieces on credit balance insurance circulated by one of its carriers (I am not supporting or not supporting this institution; they just happened to have thorough sales literature on the topic).

Credit balance insurance is a type of insurance that covers the insured’s outstanding balance on their credit cards in the event death, disability, critical illness and involuntary loss of employment. The CBC article is incomplete in addressing what happens in one of these occurrences.

It is correct in stating that in the event of involuntary job loss the insurance ONLY covers the minimum payments and not the balance outstanding. In other words, the insurance only pays enough to keep your credit cards in good standing. Like any other insurance, there is a maximum monthly benefit and a maximum payout benefit (the link I cited indicated $750 maximum monthly benefit and $25,000 total benefit in the event of job loss; I noticed other policies only had maximum payout benefits as low as $15,000).

In events of death and critical illness, it will pay the balance on the credit credit UP TO the maximum benefit and NOT necessarily the balance on your credit card. In other words, if your credit card balance is quite high and you either pass away or have a critical illness, the insurance may not cover the entire balance.

In looking at any insurance policy, you look at what it does not cover more than what it covers and here are some of the weaknesses of most credit balance insurance policies:

• If you already have sufficient life insurance, disability insurance or critical illness insurance coverage, credit balance insurance is most likely redundant given those policies may cover what credit balance insurance covers and more;
• There is no coverage if you are not in good standing with your credit card (i.e. you did not make your minimum payments), if you have a pre-existing medical condition, you resign from your job or you were an employee with a fixed term contract;
• In some policies, coverage ends for involuntary job loss when you return to school or enter retraining; and
• I could not find a return of premium rider anywhere so you are not getting your money back if you never claim on the policy.

For those subject to involuntary job loss, the more practical solution may be to use a line of credit to wipe out the balance than to rely on credit balance insurance. Remember that in these instances, the insurance only pays the minimum balance so interest continues to accrue at very high interest rates. You may be better financing your debt by applying the line of credit, with lower interest rates, to credit card debt and carrying the line of credit with more favorable terms.

What about costs of the policy? The formula is based on how much your outstanding balance is every month. For example, one carrier had a formula of 94 cents for every $100 of outstanding credit card balance.

This product seems ideal if you have no insurance coverage and carry very little balance month to month. Otherwise its coverage seems limited. But, as usual, it pays to read the terms and conditions before you buy since each insurance provider has slightly different terms.

Equally important, please make sure to check your credit card statement to see if this premium is being charged against your will.

When we are younger, we worry whether we have enough life insurance coverage to provide for our dependants in the event of a premature death. As we get older that threat seems to subside somewhat as children cease to become minors, debt gets paid off and our net worth increases. But does that necessarily mean that we should allow our insurance policies to lapse?

Not necessarily. What happens when we get older is that the role of insurance changes from providing financial support on premature death to insurance being used as a financial hedge against taxes on our death. After all, all our RSP’s, 401(k)’s and analogous structures are government sponsored tax deferral strategies. At some point, you can’t defer these taxes anymore and you would rather have the insurance company pay than your estate. Let me explain.

At death, there is a deemed disposition (a disposition is a fancy word for a sale) of all your assets at market value (there are provisions which allow some assets, such as a principal residence, to be subject to a roll-over to your spouse on a tax deferred basis). If you purchased the assets a long time ago, and assume natural price appreciation based on inflation alone, the estate’s tax bill is generally equal to the profit on the deemed disposition. This can be quite a  significant tax hit.

Since taxes and debt are paid out of the estate before any distributions to beneficiaries can take place, one has a large issue of how to maximize the distribution. This is where insurance plays a large role.

The estate is actually not using the insurance to pay the beneficiaries but using it to pay taxes the estate is owing to the government so that it can distribute as much of the estate as possible having used the insurance company to settle the tax bill. The analysis starts at different points but gets you to the same place.

Thus, as you get older, your analysis is moving from: (a) how much money do my dependents need if I were to prematurely die to (b) what is my tax bill if I die. You most likely get to (b) if your dependents are no longer dependents.

The calculation, therefore, goes from income replacement to: (proceeds of disposition of estate at fair market value) – (acquisition value) = taxable gain. Now take your tax gain and multiple by applicable tax rate = amount of desired insurance. Your accountant can help you come up with the numbers.

The amount of desired insurance can be more or less than your current coverage but adjustments to the insurance policy should be made on that above formula and not on what your insurance broker thinks you need. If you are a saver and buy and hold people, you may have to adjust your policy upwards since your gain may be significant and your tax hit high.

You may actually end up in a strange situation where your life insurance coverage was adequate as income replacement for your dependents but not as a tax hedge upon death if you invested wisely over the years (talk about the law of unintended consequences!).

If you want to read a good insurance based blog, please visit Riscario Insider who is an actuary in the insurance industry and a frequent commentator.

…please don’t forget to thank a war veteran today for their sacrifice and please wear a poppy.

(excuse the appearance, we are under construction)

Last week, I received a notice from my potential disability insurance company that I had not completed all the pre-requisites for obtaining disability insurance and my pre-approval had expired. I would once again have to apply for insurance. What happened was that my doctor did not complete the insurance company’s paperwork in time (it turns out that he has a notorious reputation among the insurance companies for being extremely tardy in his paperwork). Although I am a little perplexed by my doctor’s actions, I have decided not to reapply for disability insurance for the very simple reason that I am now eligible for these benefits under a group plan.

However, this did get me thinking about who really needs insurance and why we should obtain it. At the end of the day, insurance shifts the financial risk of certain events from yourself to the insurance company. Thus, in the event of death, it is the insurance company who will pay out the debts of your estate. In the event of critical illness (cancer, blindness etc.), the insurance company will pay you monies to treat the illness and maintain a certain lifestyle and, in the event of a disability, disability insurance replace your wages.

But’s here’s the catch when you really think about insurance; its not the risk of a certain event happening, its the risk of what happens after the event occurs. For example, I am not insuring against a disability; I am insuring against my lost income if I cannot work due to a disability. If I insured against a non-existent risk after an event has occurred, I am over-insured. For example, I have no dependents so what monetary risk is there in me passing away (assuming that my assets are more than my debts)?

Having said that, I will be obtaining life insurance even though I have no dependents given that it is cheaper to obtain insurance when I am younger and for tax reasons. Life insurance is a great vehicle to pay taxes in the event of death.

Everyone gets taxed when they die- either in the form of estate taxes, probate or the deemed disposition of the deceased’s assets on the date of death triggering capital gains (in plain English, the tax authorities rule that the deceased sold everything on the day of death and any gains on those assets are taxed accordingly). The taxes can be quite onerous and can take up to 40% off the value of your estate. It is not unusual for an estate to declare bankruptcy if there isn’t enough insurance to fund tax liabilities arising from death (yes, the tax authorities even get you after death).
I have every intention of contributing my maximum allowable contributions to my RSP; I also intent to have a large portfolio of stock outside my RSP. This means that I will have a large tax bill on death. I intend to leave a legacy to loved ones and to educational institutions to fund scholarship for worthy but needy applicants. I do not want an unreasonable portion of my estate being used to pay taxes before it gets to the beneficiaries. Thus, life insurance to me is to insure against the risk of not leaving enough for my beneficiaries and various educational institutions; the insurance proceeds can pay my taxes and my estate can be used for the purpose it was intended for.

If there is a morale to this post it is this- ask yourself what risks will occur after a traumatic event and have you insured yourself against this? Or, to look at is another way, is it really necessary to insure yourself against the risk arising from certain events? Your comments are always appreciated.