Life Insurance

After determining approximately how much coverage is needed, the next step is to decide on the type of policy to purchase. Rates can vary a great deal based on coverage type, so it is often best to obtain quotes on several types as well as from several companies.

The major categories of life insurance available to Canadians are:

• Term
• Whole life and
• Universal life

Term life insurance policies are intended to meet coverage needs for a fixed length of time. Premiums and benefits remain unchanged for the policy term, which can be as little as five years or as long as 100 years, depending on the company offering the policy. Term policies are also available that expire when the insured reaches a certain age, such as age 65, 70, 75 or even 100.

Once the stated term has expired, most individuals are eligible to renew their policies for an additional term. Because the covered party is now older and his or her health may have worsened, premiums for new coverage are always higher (up to 7-10 times the premium) Therefore, it is best to select the appropriate term for which coverage is needed so that the premium can be locked in for the longest feasible period. Most companies offer the option to convert a term policy to a whole life or universal policy without requiring additional proof of good health or evidence of insurability.

Most insurance companies set an age at which they will no longer renew a term policy. The usual standard is 75 years of age. This means that even if a 20-year policy is purchased at age 56, it cannot be renewed. Conversely, a 20-year policy purchased when the insured is 36 years of age can be renewed.

Some people mistakenly believe that term policies offered until a certain age are an adequate substitute for permanent coverage. However, these policies provide no coverage beyond the stated age and are not renewable, although most companies will allow the insured to convert to a different plan such as a 10-year term policy. With the increased average life expectancy, losing insurance coverage at age 65 or even 75 can mean a substantial gap in many families' financial plan.

Whole life coverage is available in two types, par and non-par policies. The primary difference between the two is that par policies generate dividends, which provide a partial refund of premiums plus earnings, if any, from investments. The companies do not guarantee dividends, and dividends can vary a great deal from one year to the next. Non-par policies do not pay dividends, but the future value of the policy is guaranteed, not projected as is the case with par policies.

When comparing quotes, only non-par whole life plans provide an accurate picture of what the premiums will truly be. This is because dividends on par policies can fluctuate widely, which has a direct impact on the net cost of the premium. Although it is possible to obtain quotes on par policies, the information is a statistical projection rather than an iron-clad guarantee.

Non-par policies usually have fixed premiums over a long period -typically to age 100- and then no additional premiums are due beyond that point regardless of how long the insured remains covered. However, it is also possible to "back-load" the cost of the policy by choosing lower premiums during the first few years of the policy's life; the premiums increase each year to a set point and then remain consistent for the duration of the policy. Non-par policies are also available that allow level premiums for a set period, such as 10 or 20 years, or until a certain age is attained, such as 65 years of age. Naturally, when the total policy cost is compressed into a briefer time span, the premiums will be more expensive.

Universal life is a popular choice for many who seek not only investment growth but also relief from taxes. The cost of a universal life policy may be paid with pre-tax money and can be an attractive non-RRSP investment growth. Essentially, payments toward a universal policy are placed in a holding account, which the insurance company then invests. The purchaser of the policy directs the choice of investments. Earnings are deposited into the holding account, where they are sheltered from taxes.

The insurance company withdraws funds from the holding account to pay for the covered individual's life insurance and to pay administrative fees associated with the account's management. Typically, the policy guarantees a minimum growth rate, currently around 3 per cent in most cases. Growth in excess of the insurance and administrative costs is allowed to accumulate as savings, which the insured may withdraw at a future time to fund retirement, education or similar costs. Current tax laws also allow the possibility of assigning the policy to a bank and then taking out a loan, tax-free, against the insurance policy.

People who benefit the most from universal life policies usually share six qualities. First, the individual actually needs life insurance. His or her marginal tax bracket is a high one, and he or she has already maximized pension and RRSP contributions. He or she should have the desire or need to generate additional income for the future. The investment horizon should be a minimum of 10 years. Finally, the purchaser is typically seeking to reduce his or her taxes on investment income.

Because universal life is a complicated affair, due in large part to the Canadian income tax laws related to this type of insurance, it is advisable for anyone considering such a purchase to consult a trained professional for advice. For example, contributions from the tenth year forward cannot exceed 2.5 times the value of the fund 3 years before. This provision may prove an unpleasant surprise to those who do not make substantial deposits during the policy's early years.

Rate comparisons for universal life policies are difficult due to the number of variables possible. Only certain factors remain relatively constant. These are the actual cost of the life insurance; whether insurance costs increase periodically or remain level for the duration; initial benefit amount; amount and duration of deposits; and the assumed rate of growth.

Mortgage reducing term or declining benefit coverage is often purchased to cover the pay-off on a home loan. For example, if the mortgage term is 20 years, the insurance benefit will decline each year for 20 years, after which no coverage remains. When such policies are sold by an insurance company, the named beneficiary, typically the spouse, receives the death benefit tax-free. When purchased through the lender, the lender receives the death benefit to offset the balance due on the mortgage. For most people, term life is a better option as the premiums are typically less and the insurance is not lost if the home is sold.

Critical illness insurance is a type of hybrid policy. As a rule, should the covered party suffer a stroke, kidney failure, heart attack or certain coronary surgeries, be diagnosed with a potentially fatal cancer or become deaf and blind, he or she receives a lump-sum benefit tax-free. Other conditions, such as paralysis and multiple sclerosis, may also be qualifying events. Should the covered individual die prior to making a claim, many policies provide for a full refund of the premiums already paid. This coverage is normally available only to those who are in good health and whose immediate family has a good health history.