Life Insurance - E311 - 2020 Exam Preparation PDF

Life insurance Life Licence Qualification Program (LLQP) Exam Preparation Manual E-311 – 7th Edition, 2020  Life insurance 7th Edition, 2020 Revised by Roxanne Eszes, CFP® P...

Life insurance Life Licence Qualification Program (LLQP) Exam Preparation Manual E-311 – 7th Edition, 2020  Life insurance 7th Edition, 2020 Revised by Roxanne Eszes, CFP® Project management Sandra Ciccocioppo 1st Edition, 2015 and 2nd Edition, 2015 Written by Roxanne Eszes, CFP® Consultation committee Victor Lough B.A.CFP, Rocco Vetere and Eric Yeung, CFP®, CIM Project management Marie Achard, Emily Harrison and Lucie Regimbald French adaptation Normand Morasse French adaptation committee Me Jacqueline Bissonnette, Michelle Philibert-Charette, Serge Coudry, Hélène Doré and Martin Dupras © Autorité des marchés financiers, 2020 All translation and adaptation rights, in whole or in part, are reserved for all countries. No part of the material protected by this copyright may be reproduced or utilized in any form or by any means, electronic or mechanical, including microreproduction, photocopying, recording or any information storage or retrieval systems, without permission in writing from a duly authorized representative of the Autorité des marchés financiers. Despite the preceding paragraph, an authorized course provider may use copyright material as permitted under a licence agreement entered into with the Autorité des marchés financiers. Legal deposit – Bibliothèque et Archives nationales du Québec, 2020 ISBN 978-2-551-26582-4 (PDF)  Life insurance iii FOREWORD This manual is an exam preparation tool for future life insurance agents registered in the Life License Qualification Program (LLQP). Its contents will help candidates develop the competency targeted in the life insurance module of the LLQP Curriculum: Recommend individual and group life insurance products adapted to the client’s needs and situation. Chapter overview page The first page of every Chapter outlines the Curriculum module competency components and sub-components that will be covered. Highlighting which of the evaluation objectives are addressed in each of the manual’s Chapters serves to identify the contents that are essential to attain these objectives. It is thus recommended that candidates regularly review the competency components and subcomponents in order to contextualize and assimilate them as they read each Chapter. This will help develop an understanding of the nature and scope of the evaluated competency. Candidates must have fully understood the knowledge, strategies and skills covered in each Chapter in order to successfully pass the corresponding module of the LLQP licensing exam. In this text, the masculine form is used for both men and women.  Life insurance iv TABLE OF CONTENTS List of diagrams, documents and tables....................................................................................... xxiii List of abbreviations..................................................................................................................... xxv CHAPTER 1 INTRODUCTION TO LIFE INSURANCE MODULE 1.1 Risk of death........................................................................................................................ 2 1.2 Potential financial impact of death........................................................................................ 4 1.2.1 Loss of income.......................................................................................................... 4 1.2.2 Loss of caregiver....................................................................................................... 4 1.2.3 Debt repayment......................................................................................................... 5 1.2.4 Income taxes............................................................................................................. 5 1.2.5 Estate creation........................................................................................................... 6 1.2.5.1 Education funds........................................................................................... 6 1.2.5.2 Legacies...................................................................................................... 6 1.2.5.3 Charitable giving.......................................................................................... 6 1.2.6 Business impacts....................................................................................................... 7 1.3 Risk management strategies................................................................................................ 7 1.3.1 Risk avoidance.......................................................................................................... 8 1.3.2 Risk reduction............................................................................................................ 8 1.3.3 Risk retention............................................................................................................. 8 1.3.4 Risk transfer.............................................................................................................. 8 CHAPTER 2 TERM LIFE INSURANCE 2.1 What “term” means............................................................................................................... 11 2.1.1 Typical terms............................................................................................................. 11 2.1.2 Age limits................................................................................................................... 11 2.2 Policyholder vs. life/lives insured.......................................................................................... 11 2.2.1 Single life................................................................................................................... 12 2.2.2 Joint first-to-die.......................................................................................................... 12 2.2.3 Joint last-to-die.......................................................................................................... 14  Life insurance v 2.3 Death benefit........................................................................................................................ 14 2.3.1 Level term.................................................................................................................. 15 2.3.2 Decreasing term........................................................................................................ 15 2.3.3 Increasing term.......................................................................................................... 16 2.4 Term insurance premiums.................................................................................................... 17 2.4.1 How premiums are set............................................................................................... 17 2.4.1.1 Mortality costs.............................................................................................. 17 2.4.1.2 Expenses..................................................................................................... 18 2.4.2 Sample premiums...................................................................................................... 18 2.5 Renewable vs. non-renewable term insurance.................................................................... 19 2.5.1 Renewal provisions................................................................................................... 20 2.5.1.1 Renewable with guaranteed rates............................................................... 20 2.5.1.2 Re-entry term with adjustable rates............................................................. 21 2.6 Convertible term insurance.................................................................................................. 21 2.6.1 Incontestability and suicide provisions...................................................................... 22 2.6.2 Attained-age vs. original-age conversions................................................................. 23 2.7 Advantages and disadvantages of term life insurance......................................................... 24 2.8 Using term insurance........................................................................................................... 24 2.8.1 Short-term risks......................................................................................................... 24 2.8.2 Decreasing risks........................................................................................................ 25 2.8.3 Limited cash flow....................................................................................................... 25 CHAPTER 3 WHOLE LIFE AND TERM-100 INSURANCE 3.1 Concept of permanent insurance......................................................................................... 28 3.1.1 How permanent insurance differs from term insurance............................................. 28 3.1.2 Types of permanent insurance.................................................................................. 29 3.1.2.1 Whole life..................................................................................................... 30 3.1.2.2 Term-100 (T-100)......................................................................................... 30 3.1.2.3 Universal life (UL)........................................................................................ 30 3.2 Overview of whole life insurance.......................................................................................... 30 3.2.1 Coverage term........................................................................................................... 30  Life insurance vi 3.2.2 Policy reserve............................................................................................................ 30 3.2.3 How premiums are set............................................................................................... 31 3.2.3.1 Mortality costs.............................................................................................. 31 3.2.3.2 Expenses..................................................................................................... 31 3.2.3.3 Investment returns....................................................................................... 32 3.2.3.4 Impact of modal factor................................................................................. 32 3.2.4 Premium options........................................................................................................ 33 3.2.4.1 Ongoing premiums...................................................................................... 33 3.2.4.2 Single premium............................................................................................ 33 3.2.4.3 Limited payment.......................................................................................... 34 3.2.5 Death benefit options................................................................................................. 34 3.2.5.1 Guaranteed whole life.................................................................................. 34 3.2.5.2 Adjustable whole life.................................................................................... 34 3.3 Non-participating vs. participating whole life policies........................................................... 35 3.3.1 How shortfalls or surpluses occur.............................................................................. 35 3.3.2 Non-participating policies.......................................................................................... 35 3.3.3 Participating policies.................................................................................................. 36 3.3.3.1 Identifying the difference.............................................................................. 36 3.4 Dividend payment options for participating policies............................................................. 36 3.4.1 Cash.......................................................................................................................... 37 3.4.2 Premium reduction.................................................................................................... 37 3.4.3 Accumulation............................................................................................................. 37 3.4.3.1 Investment options....................................................................................... 37 3.4.3.2 Upon death.................................................................................................. 37 3.4.4 Paid-up additions (PUA)............................................................................................ 38 3.4.5 Term insurance.......................................................................................................... 38 3.4.6 Impact on death benefits and cash values................................................................ 38 3.4.6.1 Dividend illustrations.................................................................................... 38 3.5 Non-forfeiture benefits.......................................................................................................... 39 3.5.1 Cash surrender value (CSV)..................................................................................... 39 3.5.1.1 Surrender charges....................................................................................... 40 3.5.1.2 Policy loans.................................................................................................. 40 3.5.2 Automatic premium loans (APL)................................................................................ 40  Life insurance vii 3.5.3 Reduced paid-up insurance....................................................................................... 41 3.5.4 Extended term insurance........................................................................................... 42 3.6 Limited payment whole life................................................................................................... 42 3.7 Premium offset policies........................................................................................................ 43 3.7.1 Illustrations and disclosure........................................................................................ 43 3.8 Advantages and disadvantages of whole life insurance....................................................... 45 3.9 Comparing term and whole life insurance............................................................................ 46 3.10 Using whole life insurance.................................................................................................... 47 3.10.1 Taxes upon death................................................................................................ 47 3.10.2 Future insurability................................................................................................ 48 3.10.3 Increasing coverage............................................................................................ 48 3.11 Term-100 (T-100) life insurance........................................................................................... 49 3.11.1 Duration of coverage........................................................................................... 49 3.11.2 Premiums............................................................................................................ 49 3.11.2.1 Level cost of insurance (LCOI).................................................................... 50 3.11.2.2 Limited payment T-100................................................................................ 50 3.11.3 Death benefit....................................................................................................... 50 3.11.4 Upon age 100...................................................................................................... 51 3.11.5 Availability from insurers...................................................................................... 51 3.11.6 Using Term-100................................................................................................... 51 CHAPTER 4 UNIVERSAL LIFE INSURANCE 4.1 Transparency through unbundling........................................................................................ 53 4.1.1 Premium tax.............................................................................................................. 54 4.1.2 Mortality charges....................................................................................................... 55 4.1.3 Administrative expenses............................................................................................ 55 4.1.4 Investment income................................................................................................... 55 4.2 Flexibility for the policyholder............................................................................................... 55 4.2.1 Timing and amount of premiums............................................................................... 56  Life insurance viii 4.2.1.1 Insufficient account value............................................................................ 56 4.2.1.2 Modal factors for UL policies........................................................................ 57 4.2.2 Face amount.............................................................................................................. 57 4.2.3 Life/lives insured........................................................................................................ 58 4.3 Pricing the insurance component......................................................................................... 59 4.3.1 Net amount at risk (NAAR)........................................................................................ 59 4.3.2 Yearly renewable term (YRT).................................................................................... 60 4.3.3 Level cost of insurance (LCOI).................................................................................. 60 4.3.4 Choosing between yearly renewable term (YRT) and level cost of insurance (LCOI) costing....................................................................................... 61 4.3.5 Guaranteed vs. adjustable mortality deductions........................................................ 62 4.3.5.1 Open-ended or restricted increases............................................................ 62 4.4 Death benefit options........................................................................................................... 62 4.4.1 Level death benefit.................................................................................................... 63 4.4.2 Level death benefit plus account value..................................................................... 64 4.4.3 Level death benefit plus cumulative premiums.......................................................... 65 4.4.4 Indexed death benefit................................................................................................ 66 4.5 Investment components....................................................................................................... 66 4.5.1 Net premiums............................................................................................................ 67 4.5.1.1 Exemption test............................................................................................. 67 4.5.2 Tax deferral................................................................................................................ 67 4.5.3 Investment choices.................................................................................................... 67 4.5.3.1 Daily interest accounts................................................................................. 68 4.5.3.2 Guaranteed investment accounts................................................................ 68 4.5.3.3 Index fund investments................................................................................ 68 4.5.3.4 Mutual fund investments.............................................................................. 68 4.5.4 Impact of investment returns on policy viability......................................................... 69 4.5.4.1 Policy illustrations........................................................................................ 69 4.6 Accumulating fund................................................................................................................ 69 4.6.1 Surrendering the policy.............................................................................................. 70 4.6.2 Policy withdrawals (partial surrender)........................................................................ 71 4.6.3 Premium offsets......................................................................................................... 71 4.6.4 Policy loans............................................................................................................... 72  Life insurance ix 4.6.5 Collateral for third-party loans................................................................................... 73 4.6.6 Leveraging................................................................................................................. 73 4.6.7 Distribution upon death.............................................................................................. 74 4.7 Advantages and disadvantages of universal life (UL) insurance.......................................... 75 4.8 Comparing universal life (UL) and whole life........................................................................ 76 4.9 Using universal life (UL) insurance....................................................................................... 77 4.9.1 Maxed out registered retirement savings plan (RRSP) and tax-free savings account (TFSA)......................................................................................................... 77 4.9.2 Tax-free retirement income........................................................................................ 77 CHAPTER 5 RIDERS AND SUPPLEMENTARY BENEFITS 5.1 Riders that provide additional benefits upon death.............................................................. 79 5.1.1 Paid-up additions (PUA) rider.................................................................................... 79 5.1.2 Term insurance riders................................................................................................ 80 5.1.2.1 On a term policy........................................................................................... 81 5.1.2.2 On a permanent policy................................................................................. 81 5.1.2.3 Family coverage rider.................................................................................. 81 5.1.2.4 Child coverage rider..................................................................................... 82 5.1.2.5 Converting child or family coverage riders................................................... 82 5.1.3 Accidental death (AD) rider....................................................................................... 83 5.1.4 Guaranteed insurability benefit (GIB) rider................................................................ 84 5.2 Supplementary benefits (benefits in addition to the deathbenefit)....................................... 85 5.2.1 Accelerated death benefits........................................................................................ 85 5.2.1.1 Terminal illness (TI) benefit.......................................................................... 85 5.2.1.2 Dread disease (DD) benefit (a.k.a. critical illness or CI benefit).................. 86 5.2.2 Accidental dismemberment benefit........................................................................... 87 5.2.3 Waiver of premium for total disability benefit............................................................. 89 5.2.3.1 Waiting period.............................................................................................. 89 5.2.3.2 Renewable or convertible term policies....................................................... 89 5.2.4 Parent/payor waiver benefit....................................................................................... 89 5.3 Using riders and supplementary benefits to customize coverage........................................ 90 5.3.1 Cost of coverage....................................................................................................... 90  Life insurance x 5.3.2 Value of coverage...................................................................................................... 90 5.3.2.1 Limitations.................................................................................................... 91 5.3.2.2 Exclusions.................................................................................................... 91 5.3.3 Differences between companies............................................................................... 91 5.4 Advantages and disadvantages of riders and supplementarybenefits................................. 92 CHAPTER 6 GROUP LIFE INSURANCE 6.1 How group life insurance works........................................................................................... 94 6.1.1 What constitutes a group........................................................................................... 94 6.1.2 Policyholder............................................................................................................... 95 6.1.3 Master contract.......................................................................................................... 95 6.1.4 Group membership.................................................................................................... 95 6.1.4.1 Actively-at-work requirement....................................................................... 96 6.1.4.2 Membership classes.................................................................................... 96 6.1.5 Premiums.................................................................................................................. 96 6.1.5.1 Tax treatment for employer.......................................................................... 97 6.1.5.2 Tax treatment for employee......................................................................... 97 6.1.5.3 Sales tax on premiums................................................................................ 97 6.2 Group term insurance coverage........................................................................................... 98 6.2.1 Schedule of benefits.................................................................................................. 98 6.2.1.1 Earnings multiple......................................................................................... 99 6.2.1.2 Flat rate........................................................................................................ 99 6.2.1.3 Length of service......................................................................................... 99 6.2.1.4 Combination................................................................................................. 99 6.2.2 Coverage maximums................................................................................................. 100 6.2.3 Reductions for older or retired group members......................................................... 100 6.2.4 Optional additional coverage..................................................................................... 100 6.2.4.1 Term coverage............................................................................................. 101 6.2.4.2 Permanent coverage................................................................................... 101 6.3 Dependant life coverage...................................................................................................... 101 6.3.1 Definition of dependant.............................................................................................. 102  Life insurance xi 6.3.2 Death benefit amount................................................................................................ 102 6.3.3 Premiums.................................................................................................................. 103 6.4 Survivor income benefits...................................................................................................... 103 6.4.1 Beneficiaries.............................................................................................................. 103 6.4.2 Benefit amount.......................................................................................................... 103 6.5 Accidental death and dismemberment (AD&D).................................................................... 104 6.5.1 Basic vs. voluntary AD&D.......................................................................................... 104 6.5.1.1 Coverage for dependants............................................................................ 105 6.5.2 Exclusions................................................................................................................. 105 6.5.3 Overall limits.............................................................................................................. 105 6.6 Conversion privileges........................................................................................................... 106 6.6.1 In Québec.................................................................................................................. 106 6.6.1.1 Leaving the plan.......................................................................................... 106 6.6.1.2 Master contract terminates.......................................................................... 107 6.6.2 In the rest of Canada................................................................................................. 107 6.6.3 Premiums upon conversion....................................................................................... 108 6.7 Replacement contracts......................................................................................................... 108 6.7.1 Benefit amounts......................................................................................................... 108 6.8 Disabled members............................................................................................................... 108 6.9 Group creditor insurance...................................................................................................... 109 6.9.1 Death benefit............................................................................................................. 109 6.9.2 Beneficiary................................................................................................................. 110 6.9.3 Premiums.................................................................................................................. 110 6.9.4 Additional coverage................................................................................................... 110 6.9.4.1 Disability...................................................................................................... 110 6.9.4.2 Critical illness............................................................................................... 110 6.9.4.3 Unemployment............................................................................................. 110 6.10 Group life insurance vs. individual life insurance................................................................. 111 6.11 Advantages and disadvantages of group life insurance....................................................... 112  Life insurance xii CHAPTER 7 TAXATION OF LIFE INSURANCE AND TAX STRATEGIES 7.1 Key concepts........................................................................................................................ 114 7.1.1 Tax-free death benefit................................................................................................ 114 7.1.2 Policy dispositions..................................................................................................... 115 7.1.3 Policy gains............................................................................................................... 116 7.1.4 Adjusted cost basis (ACB)......................................................................................... 116 7.1.4.1 Last acquired date....................................................................................... 116 7.1.4.2 G1 policies.................................................................................................. 117 7.1.4.3 G2 and G3 policies..................................................................................... 118 7.2 Taxation of policy dividends.................................................................................................. 120 7.3 Taxation of a full surrender................................................................................................... 120 7.3.1 Policy gain calculation............................................................................................... 120 7.4 Taxation of a partial surrender.............................................................................................. 121 7.4.1 Reducing coverage.................................................................................................... 121 7.4.2 Policy withdrawals..................................................................................................... 122 7.5 Taxation of policy loans........................................................................................................ 123 7.5.1 Repaying a policy loan.............................................................................................. 124 7.5.2 Policy loan interest.................................................................................................... 124 7.6 Taxation of exempt vs. non-exempt policies......................................................................... 124 7.6.1 Purpose of exempt test - insurance or investment?.................................................. 125 7.6.2 Maximum Tax Actuarial Reserve (MTAR) rule........................................................... 125 7.6.2.1 8-Pay endowment at age 90 for G3 policies................................................ 125 7.6.2.2 20-Pay endowment at age 85 for G2 policies.............................................. 126 7.6.3 Maximum Tax Actuarial Reserve (MTAR) remedies.................................................. 127 7.6.3.1 Increasing the face amount......................................................................... 127 7.6.3.2 Withdrawing premiums................................................................................ 127 7.6.3.3 Side funds.................................................................................................... 128 7.6.4 Anti-dump-in rule....................................................................................................... 128 7.6.4.1 Applying the 250% rule................................................................................ 128 7.6.4.2 Implications for minimum-funded policies.................................................... 129  Life insurance xiii 7.6.5 If a policy becomes non-exempt................................................................................ 129 7.6.5.1 Deemed disposition..................................................................................... 129 7.6.5.2 Annual accrual rules.................................................................................... 130 7.7 Tax implications of replacing an existing policy.................................................................... 130 7.7.1 Policy disposition....................................................................................................... 130 7.7.2 Tax advantages of older policies............................................................................... 130 7.8 Absolute assignments.......................................................................................................... 130 7.8.1 General rule............................................................................................................... 131 7.8.2 To a non-arm’s length party....................................................................................... 131 7.8.3 Assigning a policy to a spouse.................................................................................. 132 7.8.3.1 Opting out of the spousal rollover................................................................ 132 7.8.3.2 Income attribution rules............................................................................... 133 7.8.4 Assigning a policy to a child...................................................................................... 133 7.8.4.1 Defining “child”............................................................................................. 134 7.8.4.2 Direct transfers only..................................................................................... 134 7.8.4.3 Education funding or other intergenerational transfers................................ 135 7.9 Death of the policyholder...................................................................................................... 136 7.9.1 Rollover to spouse..................................................................................................... 136 7.9.2 Contingent policyholder............................................................................................. 137 7.9.2.1 Rollover to a child........................................................................................ 137 7.10 Taxation of life insurance strategies..................................................................................... 137 7.10.1 Using the policy as collateral............................................................................... 138 7.10.1.1 Borrowing for business use......................................................................... 138 7.10.1.2 Deducting premiums.................................................................................... 138 7.10.2 Annuitizing the cash surrender value (CSV)........................................................ 139 7.10.2.1 If the policyholder is disabled....................................................................... 139 7.10.2.2 Partial surrender.......................................................................................... 140 7.10.3 Leveraging a life insurance policy....................................................................... 140 7.10.3.1 Collateralizing the cash surrender value (CSV)........................................... 140 7.10.3.2 Interest paid or capitalized........................................................................... 141 7.10.4 Charitable giving.................................................................................................. 141 7.10.4.1 Charitable donations tax credit.................................................................... 141 7.10.4.2 Assigning a new insurance policy to a charity............................................. 143  Life insurance xiv 7.10.4.3 Assigning an existing insurance policy to a charity...................................... 143 7.10.4.4 Naming a charity as the beneficiary............................................................. 145 CHAPTER 8 BUSINESS LIFE INSURANCE 8.1 Potential impacts of death on a business............................................................................. 147 8.1.1 Loss of skills.............................................................................................................. 147 8.1.2 Creditor demands...................................................................................................... 148 8.1.3 Family member interference...................................................................................... 149 8.1.4 Equality for family members...................................................................................... 149 8.1.5 Capital gains tax........................................................................................................ 150 8.2 Business types..................................................................................................................... 150 8.2.1 Sole proprietorship.................................................................................................... 151 8.2.2 Partnerships.............................................................................................................. 151 8.2.3 Corporations.............................................................................................................. 151 8.2.3.1 Public vs. private corporations..................................................................... 152 8.2.3.2 Capital gains exemption.............................................................................. 152 8.3 “Key person” life insurance................................................................................................... 153 8.3.1 Split-dollar arrangements.......................................................................................... 153 8.3.1.1 Taxation of key person split-dollar arrangements........................................ 154 8.3.2 As a requirement for borrowing................................................................................. 155 8.4 Buy-sell agreements............................................................................................................. 155 8.4.1 Cross-purchase agreements..................................................................................... 155 8.4.2 Why buy-sell agreements are important.................................................................... 156 8.4.2.1 Guaranteed buyer........................................................................................ 157 8.4.2.2 Guaranteed value........................................................................................ 157 8.4.2.3 Mandatory sale............................................................................................ 157 8.4.2.4 Guaranteed funding through life insurance.................................................. 157 8.4.3 Criss-cross insurance................................................................................................ 157 8.4.4 Business-owned insurance........................................................................................ 159 8.4.4.1 Role of the capital dividend account (CDA)................................................. 160 8.4.4.2 Funding cross-purchase buy-sell agreements............................................. 161 8.4.4.3 Funding share-redemption buy-sell agreements......................................... 162  Life insurance xv CHAPTER 9 APPLICATION AND UNDERWRITING 9.1 Process overview................................................................................................................. 165 9.1.1 Agent’s role................................................................................................................ 165 9.1.2 Completing the application........................................................................................ 165 9.1.3 Underwriting.............................................................................................................. 166 9.1.4 Issuing and delivering the policy................................................................................ 166 9.2 Application............................................................................................................................ 166 9.2.1 Policy details.............................................................................................................. 166 9.2.1.1 Applicant/policyholder.................................................................................. 167 9.2.1.2 Life insured.................................................................................................. 167 9.2.1.3 Beneficiary................................................................................................... 167 9.2.1.4 Type of policy............................................................................................... 167 9.2.1.5 Riders and supplementary benefits............................................................. 168 9.2.1.6 Premium options.......................................................................................... 168 9.2.1.7 Dividend options.......................................................................................... 168 9.2.2 About the applicant.................................................................................................... 168 9.2.2.1 Financial ability............................................................................................ 169 9.2.2.2 Insurable interest......................................................................................... 169 9.2.2.3 Justification of amount of coverage............................................................. 170 9.2.2.4 Insurance application history....................................................................... 171 9.2.3 About the life insured................................................................................................. 171 9.2.3.1 Personal information.................................................................................... 171 9.2.3.2 Medical information...................................................................................... 172 9.2.4 Incomplete or erroneous information......................................................................... 173 9.2.4.1 Mistake........................................................................................................ 173 9.2.4.2 Fraudulent misrepresentation...................................................................... 174 9.2.4.3 Incomplete information................................................................................ 175 9.2.5 Agent’s comments..................................................................................................... 175 9.3 Temporary insurance agreement (TIA)................................................................................. 175 9.3.1 Requirements for coverage....................................................................................... 175 9.3.2 Coverage limits.......................................................................................................... 176  Life insurance xvi 9.3.3 Coverage duration..................................................................................................... 176 9.3.4 Agent’s responsibilities.............................................................................................. 176 9.4 Underwriting by the insurance company.............................................................................. 177 9.4.1 Underwriting guidelines............................................................................................. 177 9.4.2 Attending physician’s statement (APS)..................................................................... 178 9.4.3 Medical exam............................................................................................................ 178 9.4.4 Medical Information Bureau (MIB)............................................................................. 179 9.4.5 Motor vehicle record (MVR)....................................................................................... 180 9.4.6 Inspection report........................................................................................................ 180 9.4.7 Requests for clarification or more information........................................................... 181 9.4.8 Financial underwriting................................................................................................ 181 9.4.9 People who are not Canadian citizens...................................................................... 181 9.4.9.1 Permanent residents.................................................................................... 182 9.4.9.2 Awaiting permanent residency..................................................................... 182 9.4.9.3 International students.................................................................................. 182 9.4.10 Frequent travellers............................................................................................... 183 9.4.11 Avocations........................................................................................................... 183 9.5 Risk classes and their impact on premiums......................................................................... 183 9.5.1 Standard.................................................................................................................... 184 9.5.2 Preferred.................................................................................................................... 184 9.5.3 Rated......................................................................................................................... 184 9.5.4 Exclusions................................................................................................................. 184 9.5.5 Upgrading risk class.................................................................................................. 185 9.5.6 Declined..................................................................................................................... 185 9.6 Client factors that may affect premiums............................................................................... 185 9.6.1 Age............................................................................................................................ 186 9.6.1.1 Attained age................................................................................................. 186 9.6.2 Gender....................................................................................................................... 187 9.6.3 Health status or risk class.......................................................................................... 187 9.6.4 Hazardous occupation............................................................................................... 188 9.6.5 Hazardous lifestyle.................................................................................................... 188 9.7 Company factors that may affect premiums......................................................................... 189 9.7.1 Mortality costs............................................................................................................ 189  Life insurance xvii 9.7.2 Administration costs and expenses........................................................................... 189 9.7.3 Investment returns..................................................................................................... 189 9.8 Reinsurance......................................................................................................................... 189 9.9 Issuing the policy.................................................................................................................. 190 9.9.1 Delivery...................................................................................................................... 190 9.10 Acceptance........................................................................................................................... 191 9.11 Group life insurance............................................................................................................. 191 9.11.1 Basic group life insurance................................................................................... 191 9.11.2 Additional coverage............................................................................................. 192 9.11.3 Creditor life insurance.......................................................................................... 192 9.11.3.1 Post-claim underwriting............................................................................... 192 CHAPTER 10 ASSESSING THE CLIENT’S SITUATION 10.1 Assess the family dynamics.............................................................................................. 194 10.1.1 Current spouse.................................................................................................... 195 10.1.1.1 Dependent vs. self-sufficient...................................................................... 195 10.1.2 Support obligations to ex-spouse(s).................................................................... 195 10.1.2.1 Court-ordered insurance............................................................................ 196 10.1.3 Minor children...................................................................................................... 196 10.1.3.1 Current care arrangements........................................................................ 196 10.1.3.2 Child support to ex-spouse........................................................................ 197 10.1.3.3 Court-ordered insurance............................................................................ 197 10.1.4 Other dependents................................................................................................ 197 10.1.4.1 Disabled family members........................................................................... 197 10.1.4.2 Aging parents............................................................................................. 198 10.2 Assess the employment situation...................................................................................... 198 10.2.1 Employee............................................................................................................. 198 10.2.1.1 Current income........................................................................................... 198 10.2.1.2 Future income potential.............................................................................. 199 10.2.1.3 Job stability................................................................................................. 199 10.2.1.4 Group benefits............................................................................................ 199  Life insurance xviii 10.2.2 Business owner................................................................................................... 200 10.2.2.1 Sole proprietorship..................................................................................... 200 10.2.2.2 Corporation................................................................................................ 201 10.2.2.3 Partnership................................................................................................. 201 10.2.2.4 Existing buy-sell agreement....................................................................... 202 10.2.2.5 Business income stability and amounts..................................................... 202 10.2.3 Retirement........................................................................................................... 203 10.2.3.1 Time to retirement...................................................................................... 203 10.2.3.2 Retirement income sources....................................................................... 203 10.3 Assess current financial situation...................................................................................... 204 10.3.1 Assets.................................................................................................................. 204 10.3.1.1 Liquid assets.............................................................................................. 204 10.3.1.2 Fixed assets............................................................................................... 205 10.3.1.3 Investment assets...................................................................................... 205 10.3.1.4 Pension entitlements.................................................................................. 206 10.3.1.5 Case study summary of assets.................................................................. 206 10.3.2 Debts................................................................................................................... 207 10.3.2.1 Mortgage.................................................................................................... 208 10.3.2.2 Credit cards and lines of credit................................................................... 208 10.3.2.3 Other loans................................................................................................. 208 10.3.2.4 Case study summary of liabilities............................................................... 209 10.3.3 Tax liability upon death........................................................................................ 209 10.3.4 Current expenses................................................................................................ 210 10.3.5 Available cash flow.............................................................................................. 211 10.4 Assess existing insurance................................................................................................. 212 10.4.1 Individual insurance............................................................................................. 212 10.4.2 Business insurance............................................................................................. 214 10.4.2.1 Relationship to buy-sell agreement............................................................ 214 10.4.2.2 Type of policy............................................................................................. 214 10.4.2.3 Ownership of policy and payment of premiums......................................... 215 10.4.3 Group insurance.................................................................................................. 215 10.4.3.1 Face amount.............................................................................................. 215 10.4.3.2 Policyholder and conditions of membership............................................... 215  Life insurance xix 10.4.3.3 End date and convertibility......................................................................... 216 10.4.3.4 Vulnerabilities............................................................................................. 217 10.4.4 Government benefits........................................................................................... 217 10.4.4.1 Canada Pension Plan (CPP) survivor benefits.......................................... 217 10.4.4.2 Québec Pension Plan benefits (QPP)........................................................ 218 10.4.4.3 Old Age Security (OAS) allowance for surviving spouse........................... 219 10.4.4.4 Workers’ Compensation benefits............................................................... 219 10.5 Identify client’s priorities in the event of death................................................................... 220 10.5.1 Family lifestyle..................................................................................................... 220 10.5.2 Final expenses.................................................................................................... 222 10.5.3 Plans for future.................................................................................................... 222 10.6 Next steps............................................................................................................................ 223 CHAPTER 11 RECOMMENDING AN INSURANCE POLICY 11.1 Evaluate the probability, severity and duration of risks...................................................... 225 11.1.1 Probability of death.............................................................................................. 226 11.1.1.1 Current age and gender............................................................................. 226 11.1.1.2 Personal and family health history............................................................. 227 11.1.1.3 Lifestyle risks.............................................................................................. 228 11.1.2 Financial impacts of death................................................................................... 228 11.1.3 Duration of risk.................................................................................................... 229 11.1.4 Other risks........................................................................................................... 229 11.1.4.1 Risk of illness or disability.......................................................................... 229 11.1.4.2 Risk of unemployment................................................................................ 230 11.2 Insurance needs analysis – Income replacement approach....................................... 230 11.2.1 Capitalization of lost income................................................................................ 231 11.2.2 Impact of investment returns, inflation and income tax....................................... 231 11.2.2.1 Accounting for income taxes...................................................................... 231 11.2.2.2 Accounting for inflation............................................................................... 232 11.2.2.3 Accounting for income taxes and inflation simultaneously......................... 233 11.2.3 Weaknesses of the income replacement approach............................................. 234  Life insurance xx 11.3 Insurance needs analysis – Capital needs approach........................................................ 234 11.3.1 Income earned by survivors................................................................................ 234 11.3.2 Ongoing expenses............................................................................................... 235 11.3.3 Income shortfall................................................................................................... 236 11.3.3.1 Capitalization of income shortfall............................................................... 237 11.3.4 Capital needs analysis......................................................................................... 238 11.3.4.1 Final expenses........................................................................................... 238 11.3.4.2 Tax liabilities............................................................................................... 238 11.3.4.3 Debt elimination......................................................................................... 239 11.3.4.4 Estate expenses......................................................................................... 239 11.3.4.5 Emergency fund......................................................................................... 240 11.3.4.6 Education fund........................................................................................... 240 11.3.4.7 Estate equalization..................................................................................... 241 11.3.4.8 Charitable bequests and legacies.............................................................. 241 11.3.4.9 Total capital needs..................................................................................... 241 11.3.4.10 Assets available upon death...................................................................... 242 11.3.4.11 Existing insurance...................................................................................... 244 11.3.4.12 Shortfall...................................................................................................... 244 11.4 Bringing it all together........................................................................................................ 245 11.4.1 Duration of risk.................................................................................................... 245 11.4.2 Investment needs................................................................................................ 246 11.4.3 Cash flow vs. premiums...................................................................................... 246 11.4.4 Coverage for spouse or dependents................................................................... 247 11.5 Making the recommendation............................................................................................. 247 11.5.1 Type of coverage................................................................................................. 247 11.5.2 Death benefits..................................................................................................... 248 11.5.3 Premiums............................................................................................................ 249 11.5.4 Beneficiaries........................................................................................................ 255 11.5.4.1 Primary and contingent.............................................................................. 255 11.5.4.2 Revocable or irrevocable........................................................................... 256 11.5.4.3 Probate implications................................................................................... 256 11.5.5 Highlighting important clauses............................................................................. 256 11.5.5.1 Exclusions.................................................................................................. 256 11.5.5.2 Incontestability........................................................................................... 257  Life insurance xxi 11.5.5.3 Grace period.............................................................................................. 257 11.5.5.4 Reinstatement............................................................................................ 258 11.5.5.5 Right of rescission...................................................................................... 258 11.5.5.6 Expiry......................................................................................................... 258 11.5.5.7 Surrender charges..................................................................................... 259 11.6 Using illustrations.............................................................................................................. 259 CHAPTER 12 ONGOING SERVICE 12.1 Monitoring changing client needs...................................................................................... 261 12.1.1 New dependants.................................................................................................. 261 12.1.2 Marriage.............................................................................................................. 262 12.1.3 Divorce............................................................................................................... 262 12.1.4 Employment changes.......................................................................................... 262 12.1.5 New mortgage..................................................................................................... 263 12.1.6 Acquiring a business........................................................................................... 263 12.1.7 Leaving Canada.................................................................................................. 263 12.1.8 Updated needs analysis and recommendations.................................................. 263 12.2 Amending a policy............................................................................................................. 264 12.2.1 Administrative changes....................................................................................... 264 12.2.2 Changes requiring underwriting........................................................................... 264 12.3 Renewing a policy............................................................................................................. 265 12.4 Replacing a policy............................................................................................................. 266 12.4.1 Churning and twisting.......................................................................................... 266 12.4.2 Disclosure requirements...................................................................................... 266 12.4.3 Cancelling the contract being replaced............................................................... 268 12.5 Cancelling a policy............................................................................................................. 268 12.6 Surrendering a policy......................................................................................................... 269 12.7 Policy assignments............................................................................................................ 269 12.7.1 Absolute policy assignment................................................................................. 269 12.7.2 Partial policy assignment..................................................................................... 270  Life insurance xxii 12.8 Claims process.................................................................................................................. 270 12.8.1 Agent’s role.......................................................................................................... 270 12.8.2 Completed claim form.......................................................................................... 271 12.8.3 Policy status........................................................................................................ 271 12.8.4 Proof of death...................................................................................................... 271 12.8.5 Letters probate.................................................................................................... 271 12.8.6 Attending physician’s statement (APS)............................................................... 272 12.8.7 Proof of age and gender...................................................................................... 272 12.8.8 Confirmation of beneficiary.................................................................................. 272 12.9 Group life insurance claims............................................................................................... 273 12.10 Factors that could vary the payment upon death.............................................................. 273 12.10.1 Participating whole life policies............................................................................ 273 12.10.2 Adjustable whole life policies............................................................................... 273 12.10.3 Universal life policies........................................................................................... 273 12.10.4 Misstatement of age............................................................................................ 274 12.10.5 Misstatement of gender....................................................................................... 275 12.10.6 Policy assigned as collateral............................................................................... 276 12.10.7 Outstanding policy loan....................................................................................... 276 12.10.8 Unpaid premiums................................................................................................ 277 12.11 Settlement options............................................................................................................. 277 12.12 Time requirements............................................................................................................. 277 12.13 Tax treatment of death benefits......................................................................................... 278 CONCLUSION............................................................................................................................. 279 BIBLIOGRAPHY.......................................................................................................................... 280  Life insurance xxiii LIST OF DIAGRAMS, DOCUMENTS AND TABLES CHAPTER 1 Table 1.1 Probability of death and life expectancy vs. age......................................... 3 CHAPTER 2 Diagram 2.1 Death benefit for level, decreasing or increasing term insurance............... 15 Table 2.1 Sample annual premiums, $100,000 term life insurance, male non-smoker......................................................................................... 18 Diagram 2.2 Annual term insurance premiums based on term and age of issue............ 19 Table 2.2 Advantages and disadvantages of term life insurance................................ 24 CHAPTER 3 Diagram 3.1 Comparing 10-year renewable term and whole life premiums for coverage of $250,000............................................................................ 29 Table 3.1 Sample modal factors.................................................................................. 32 Table 3.2 Advantages and disadvantages of whole life insurance.............................. 45 Table 3.3 Term life insurance vs. whole life insurance................................................ 46 CHAPTER 4 Diagram 4.1 Flow of money through a universal life (UL) policy...................................... 54 Table 4.1 Cost of insurance (COI) per $1,000 using yearly renewable term (YRT) vs. level cost of insurance (LCOI) costing................................................... 61 Diagram 4.2 Level death benefit option.......................................................................... 63 Diagram 4.3 Level death benefit plus account value...................................................... 64 Diagram 4.4 Death benefit plus cumulative premiums................................................... 65 Diagram 4.5 Indexed death benefit................................................................................. 66 Table 4.2 Advantages and disadvantages of universal life (UL) insurance................ 75 Table 4.3 Whole life insurance vs. universal life (UL) insurance................................ 76 CHAPTER 5 Table 5.1 Sample accidental death and dismemberment (AD&D) Schedule of loss..... 88 Table 5.2 Advantages and disadvantages of riders and supplementary benefits...... 92  Life insurance xxiv CHAPTER 6 Table 6.1 Group life insurance vs. individual life insurance........................................ 111 Table 6.2 Advantages and disadvantages of group life insurance.............................. 112 CHAPTER 7 Table 7.1 Factors affecting a policy’s adjusted cost basis (ACB)................................ 119 Diagram 7.1 Maximum Tax Actuarial Reserve (MTAR).................................................... 126 CHAPTER 9 Diagram 9.1 Impact of age at issue on premiums........................................................... 186 Diagram 9.2 Impact of gender on premiums.................................................................... 187 Diagram 9.3 Impact of health class on premiums............................................................ 188 CHAPTER 10 Table 10.1 Summary of assets of Derek and Becky’s family........................................ 207 Table 10.2 Summary of debts of Derek and Becky’s family.......................................... 209 Table 10.3 Summary of CPP and QPP survivor benefits in 2020................................. 219 CHAPTER 11 Table 11.1 Risk assessment matrix............................................................................... 225 Table 11.2 Odds of dying for males and females.......................................................... 226 CHAPTER 12 Document 12.1 Standard Life Insurance Replacement Declaration (LIRD)......................... 267  Life insurance xxv LIST OF ABBREVIATIONS ACB Adjusted cost basis AD Accidental death AD&D Accidental death and dismemberment APL Automatic premium loans APS Attending physician’s statement AWCBC Association of Workers’ Compensation Boards of Canada CCPC Canadian-Controlled Private Corporations CDA Capital dividend account CI Critical illness CLHIA Canadian Life and Health Insurance Association COI Cost of insurance COO Chief operating officer CPI Consumer price index CPP Canada Pension Plan CRA Canada Revenue Agency CSV Cash surrender value CV Cash value DBPP Defined benefit pension plan DCPP Defined contribution pension plan DD Dread disease DI Disability benefit DIA Daily interest account DUI Driving under the influence EI Employment Insurance ETF Exchange traded funds ETP Exempt test policy FMV Fair market value GIA Guaranteed investment account GIB Guaranteed insurability benefit GIC Guaranteed investment certificates LCGE Lifetime capital gains exemption  Life insurance xxvi LCOI Level cost of insurance LIRD Life insurance replacement declaration LOC Line of credit MIB Medical Information Bureau MTAR Maximum Tax Actuarial Reserve MVR Motor vehicle record NAAR Net amount at risk NCPI Net cost of pure insurance Non-par Non-participating OAS Old Age Security Par Participating PUA Paid-up additions QPP Québec Pension Plan QSBC Qualified small business corporation RESP Registered education savings plan RRIF Registered retirement income fund RRSP Registered retirement savings plan T-100 Term-100 TFSA Tax-free savings plan TI Terminal illness TIA Temporary insurance agreement UL Universal life WC Workers’ Compensation YRT Yearly renewable term  Life insurance Chapter 1 – Introduction to life insurance module 1 CHAPTER 1 INTRODUCTION TO LIFE INSURANCE MODULE Competency component ▪▪ Assess the client’s needs and situation. Competency sub-component ▪▪ Articulate the client’s needs based on the risks that could affect his financial situation. This is an introductory Chapter and there are no strong ties to one specific part of the Curriculum.  Life insurance Chapter 1 – Introduction to life insurance module 2 1 INTRODUCTION TO LIFE INSURANCE MODULE It has often been said that the only certainties in life are death and taxes. It could be argued that some people will not have to pay income taxes, because they have little or no taxable income or because they manage to structure their financial affairs to avoid them. However, there is no denying that everyone is going to die sometime, and death has implications for their estate and surviving family members. This Chapter provides an introduction to the risk of death and its financial implications. It also discusses general risk management strategies as they apply to the risk of death. 1.1 Risk of death One of the reasons people delay buying life insurance is that they do not want to think about their own death. They either refuse to consider it at all, or they say that it is too far away in the future to worry about today. But the fact is that everyone is constantly exposed to the risk of death – every day, every minute, every second. The probability of dying today might be much smaller than it will be 40 years from now, but the risk is still very real, and it needs to be addressed. In insurance terms, the probability of dying at a specific age is referred to as the mortality rate. There are many factors that influence a person’s risk of death, including age, gender, family history health, smoking status, and even their job and income level. Life insurance companies try to classify or categorize people into groups with a similar risk profile. They then compile historical mortality data for each group, and use that as a basis for estimating an individual’s risk of death. This is discussed further in Chapter 9 Application and underwriting. There are two ways of looking at the risk of death: life expectancy and probability of death. Life expectancy is the average number of years that a person within a certain group and of a certain age can expect to live from that age forward. It assumes that the past mortality experience of the group to which that person belongs will hold true in the future. For example, according to data compiled by Statistics Canada, if we consider all males in Canada who are aged 65, the median male within that group will live another 19.4 years.1 This means that on average, 50% of men currently aged 65 will live until age 84.4 or longer, while 50% will die before reaching age 84.4. 1. Statistics Canada. Life expectancy and other elements of the life table, Canada, all provinces except Prince Edward Island, (Table 13-10-0114-01, 2016 to 2018). [online]. [Consulted August 10, 2020]. https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=1310011401  Life insurance Chapter 1 – Introduction to life insurance module 3 The probability of death is the statistical probability that a person within a certain group and of a certain age will die before reaching his next birthday. It assumes that the past mortality experience of the group to which that person belongs will hold true in the future. The same Statistics Canada study shows that of all of the males in Canada who just turned 65 years of age, 1.231 out of every 100 of those men will die before their 66th birthday.2 In other words, their probability of death is 1.231%. Chapter 9 discusses how insurance companies use this probability of death when they underwrite a life insurance policy and determine the appropriate premiums. Life expectancy and probability of death statistics are compiled for each unique and defined group of people, and are often presented in a format called a “life table” (sometimes also known as a “mortality table”). An extract from a Statistics Canada Life table is provided in Table 1.1. With the exception of the first few years of life, an individual’s probability of death starts quite low and increases very slowly until around age 40. After age 40, it begins to increase more dramatically year over year due to age-related health problems, such as cardiovascular disease. TABLE 1.1 Probability of death and life expectancy vs. age3 PROBABILITY OF DEATH (%) LIFE EXPECTANCY (YEARS) WITHIN THE YEAR AGE MALES FEMALES MALES FEMALES 0 0.477% 0.427% 79.9 84.1 1 0.028% 0.023% 79.3 83.4 10 0.009% 0.008% 70.4 74.5 20 0.068% 0.032% 60.5 64.6 30 0.103% 0.042% 51.0 54.8 40 0.140% 0.047% 41.6 45.1 50 0.295% 0.190% 32.3 35.6 60 0.707% 0.451% 23.5 26.5 65 1.231% 0.731% 19.4 22.1 70 1.807% 1.183% 15.6 18.0 75 2.961% 1.988% 12.1 14.2 80 4.931% 3.425% 9.1 10.8 85 8.348% 6.049% 6.5 7.8 90 14.362% 10.950% 4.5 5.3 95 23.558% 19.104% 3.6 3.6 100 34.271% 29.681% 2.2 2.5 2. Ibid. 3. Ibid.  Life insurance Chapter 1 – Introduction to life insurance module 4 This Table shows that a female’s risk of death is lower than a male’s risk of death at the same age. For this reason, gender is one of the factors that influence an individual’s life insurance premiums, as discussed in Chapter 9. The way an agent uses this information depends on the specific needs he is trying to address. If he is developing a retirement savings plan or retirement income plan, the focus would be on the client’s life expectancy because it helps determine the appropriate planning horizon. When doing insurance needs analysis, the agent may find it useful to educate a client on his probability of death, to help him understand that the risk is real, and that he needs to address it. 1.2 Potential financial impact of death Death is a tragedy, whether it is the loss of a spouse, a child, a friend or a key employee. That tragedy is magnified by the financial consequences of that death. This Section introduces the types of financial impacts that an agent would be thinking about when he explores the risk of death with a client. It does not cover all possible financial impacts, but is simply meant to provide some context before discussing the various types of life insurance. Chapter 10 Assessing the client’s situation provides a more detailed explanation of the financial impacts that an agent should quantify when completing a life insurance needs analysis for a client. 1.2.1 Loss of income One of the most devastating financial impacts results from the death of an income earner, particularly if he was supporting a young family that relied on that income. EXAMPLE Justin and Tanya are both 30 years old and they have three children (1, 3 an