Life Insurance Options
There are hundreds of life insurance products available in the Canadian market place, and they fall into one of two categories: term or permanent.
Term plans have a set expiry date; permanent plans expire at death.
Think of term as coverage that is rented and permanent as one that is purchased. Both options have unique features and applications, making them both indispensable.
You can choose within each of those categories from many types of specific plans. For example, there are 10-year term plans and terms of other durations…some expire at the end of a specific number of years, while others expire at a certain age. In the permanent group, you will find more complex policies like Universal Life, Hybrid Insurance, or Participating Whole Life. Each is unique in how they are structured and have many options for customizing death benefits or funding levels. Permanent plans can develop cash values and can be paid up so that they stay in force for the life of the insured.
Although there are numerous plans to choose from, the process of choosing the right term plan is relatively simple. Choosing a permanent insurance plan, on the other hand, is a completely different story, often fraught with confusion because of jargon and complexities.
(What’s that you say? Insurance plans with jargon? When was the last time you went to a social event and stood in rapt attention listening to a financial planner talk about Paid Up Additions (PUA), Level Cost Insurance Charges (LCOI), Net Cost of Pure Insurance (NCPI), and Lapse Subsidies? Probably never and for good reason! It’s not all that exciting, is it? We don’t live in a bubble, here at Cove…we know that insurance lingo can be difficult to understand, and we will always explain your options in an easy-to-understand way.)
When someone with insurance dies, the beneficiary doesn’t typically care what kind of special features the insurance had. It just doesn’t really matter as long the insurance money shows up when it is supposed to. This shouldn’t mean that choosing the right permanent product with confidence is impossible—it just means it is easier when you have knowledge and experience on your side.
That’s where we come in.
We have developed tools to boil down the complexity into simple fundamentals we are confident you will understand.
With over 30 years of experience analyzing and testing products and applications, working with insurance company actuaries on product development and seeing firsthand what does and doesn’t work, we can guide you through the decision-making process, so you feel confident about your decisions.
We know what plans to recommend and what ones to avoid.
We have developed rules that, in some cases, have become absolutes in terms of how we view certain products and their use. These rules are based on many hours of research and years of experience that have proven to us, beyond all doubt, that some products stand head and shoulders above the rest, while others should be avoided.
Our go-to product is term insurance if cash is needed during a specific period of time to meet a financial obligation that will eventually diminish.
Here are some examples of situations where creating capital with term insurance makes the most sense:
- to produce survivor income prior to retirement
- to buy out a shareholder prior to retirement
- to repay a loan of a limited term
- to replace a key employee or shareholder
- to provide collateral for creditors to secure a loan
But when it comes to covering liabilities that can last a lifetime, permanent insurance is the best choice.
Examples of life-long liabilities include:
- tax liabilities payable at death
- buy-sell plans that stay in force for life
- the desire to create capital to pay cash to a child in lieu of a business interest
- the desire to create capital at death to enhance your estate or make a philanthropic gift
The type of insurance we recommend is also contingent on whether the insurance proceeds are needed at the death of one person or at the second death of two people. The reasons for buying the insurance dictates which of these two options is best.
Cove’s Hierarchy of Value for insurance products in the market place:
We will not promote, sell, or use participating Whole Life products issued by any carrier.
Rule #1: We do not recommend Participating Whole Life under any circumstance because we believe it does not provide good value to our clients.
This is in spite of the fact that it is a widely distributed and popular product among insurance advisors.
We believe participating Whole Life insurance products are inefficient and expensive and that the way they are sold is misleading and unreliable. This speaks to both the nature of the products and to how they are sold. Within the insurance industry, they are referred to as the “black box” of insurance products because the math that goes into their administration cannot be traced to an individual policy, and you have to be an actuary with inside information to reconcile the values.
They are the ultimate “trust me” in the insurance world. We do not believe in blind faith—we believe in accountability and logic in making important financial decisions.
You can read more about our reasoning behind our stance against Whole Life insurance products in our report The Great Canadian Whole Life Face Plant.
Rule #2: We do not recommend insurance products for the purposes of tax sheltered cash accumulation for retirement.
While this is a popular marketing strategy with other insurance advisors, our recommendations are made in order to provide cash at death. All policy options, including cash value insurance policies, are measured for performance for the return they will generate on death (based on the premiums paid).
We believe that a reputable, experienced portfolio manager can provide better returns on investment than a high cash value life insurance policy. The typical approach that most other insurance advisors take when comparing life insurance cash value accumulation to that of an alternative investment is biased against the alternative investment. The normal approach is to compare the tax sheltered insurance policy to a fully taxable investment, such as an interest bearing fixed income investment (which significantly reduces the net return).
Our experience has found that most investors earn their returns as a blend of interest, dividends, and capital gains, significantly reducing the tax rate that is applied to the return. Additionally, the investment returns illustrated in the life insurance policy are not reasonable or sustainable based on the investment options available and the related policy fees.
We believe that when the comparison is done correctly, an alternative investment portfolio will outperform a life insurance policy from a cash accumulation perspective.
You can read more about our position in our report Measuring Plan Performance.