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Knowledge the best policy

An expert explains types of life insurance, compares benefits

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Death is inevitable, so are taxes, and most people buy life insurance with those two ugly truths in mind.

Yet life insurance is often the last thing on most people's plates, financially speaking. After brushing up on RRSPs, TFSAs, RESPs and a heap of other pertinent information to successfully navigate our financial life, life insurance concerns often fall by the wayside.

If you're new to the life insurance game or just have some unanswered questions you've been leery of asking your insurer or broker about, here's a little help.

Ron Sanderson is director of policyholder taxation and pensions at the Canadian Life and Health Insurance Association, which represents Canada's largest life insurance firms. With more than 30 years of experience, consider him a life insurance master imparting insider wisdom to you.

Who needs life insurance?

Risk is often in the eye of the beholder. Some people may see no need for life insurance and if they're lucky, they may never regret that decision. They'll die of natural causes in old age, having lived a fruitful life where most of their taxable assets upon death have been dispersed prudently beforehand to minimize estate taxes.

But life often doesn't play out that well. People do die young, leaving a family behind. Still, most of us make it to old age and have accumulated substantial assets.

Yet this wealth is often taxable upon death, meaning there's less left for family and charity.

Life insurance can help address both problems, Sanderson says.

"Insurance is designed to provide dollars when you need them," he says. "But is it the first priority that everyone should think about?"

Putting food on the table, a roof over your family's heads and clothes on your kids' backs are certainly more important than paying an insurance premium.

But beyond the immediate needs, insurance is just as essential as retirement and education savings when others depend on you to earn a paycheque or manage the household.

"For most people, if they have loved ones who would suffer if they weren't available to provide an income stream, then life insurance makes sense," Sanderson says.

Term life insurance, which provides coverage for a set period such as 10 or 20 years, is the most affordable and prudent option.

It's ideal for young families without a lot of free cash flow, who would need to replace a parent's lost income while the children are young. Premiums are less than other types of insurance. For example, a 30-year-old non-smoker can get a 10-year term policy with a $500,000 death benefit for about $25 a month.

Other policies, such as whole life and universal, also provide coverage for growing families, but premiums are more costly and better suited for people who want coverage not just to replace lost income, but also to help ease the estate tax burden if they die later in life. Term insurance is often too costly for people past age 65, whereas whole and universal policies can be paid up by then and will provide coverage much longer, if not for the policyholder's entire life. Death benefits are tax-free, of course, providing an inheritance or paying off estate taxes on other assets in a will.


Whole versus universal

If you want to be covered for life, you've got options. Whole life and universal life are the most common policies. Here's how they work. "Let's imagine you're going to a car dealership and you buy a car," Sanderson says. "That's the whole life approach."

You can still choose from a number of different models. You can pay premiums for the rest of your life for coverage. You can pay a higher premium so after 10 years, for example, you're paid in full and covered for life. You can withdraw funds from the policy, using it as a nest egg, although that may reduce the payout upon death.


The universal life approach offers even more options. "It's like going to the parts counter and saying, 'I want to buy a chassis for a new Chev Impala, but I really want Corvette fenders,' " Sanderson says. " 'I also want it to be fuel efficient, so I'll go down the street to the Toyota dealer and buy the engine out of a Prius, and then I'll put those together and build it myself.'"

Unlike whole life, where the insurer decides how to invest the premiums, a universal life plan lets you to choose from a number of investments the insurer offers.

"If you think that Japanese high-tech fund is a really good investment right now, you can invest your premiums that aren't used for the cost of insurance in that investment," Sanderson says.

Of course, most insurers don't offer Japanese tech funds or anything else that risky. Insurance is about hedging bets, not making wild wagers on the markets. The choices generally range from bond funds to well-diversified equity funds.

Other offerings similar to whole and universal plans are term-100 policies that provide coverage for life, the drawback being you may pay premiums for life. In addition, many shorter-term plans can be converted to permanent plans.

"This can be a very important feature, since we are all likely to develop health complications as we age, which may make buying a permanent policy too expensive, if it is even available," Sanderson says. "So a conversion right ensures you can have protection that will last."

Unlike term plans, however, whole and universal life insurance often have higher premiums early on, while later in the game, you're paying less or no premium. With term plans, the premium increases with age.


Smoking and all those other things we shouldn't do, but often do anyway

We all want to pay the lowest premium possible, but lifestyle choices can get in the way. Smoking, past and current illegal drug use and other risky activities such as extreme skiing will increase the premium cost on application. Alcohol use may or may not.

"If you're the person who has a glass of wine at dinner three or four nights a week, that's not an issue," Sanderson says. "If you're the type of person who has a bottle of scotch for breakfast, that's going to be an issue."

Of course, it may not be possible for an insurer to determine whether you drink a breakfast of scotch whisky. But it's important to be upfront about your activities. You might pay more in premiums, or you might not be able to even get coverage in some cases. But it's better to be honest than lie about your activities because even though you'll be dead, your beneficiaries might not receive the payout and you would have paid all those premiums for nothing. And don't think an insurer won't investigate whether you've upheld your end of the bargain.

In some cases, you may be able to get a policy crafted that will exclude coverage for risky activities.

"So if I'm killed by a beer truck when I cross the street, insurance coverage will pay off," Sanderson says. "If I'm killed in a plane crash where I was the pilot, the insurance won't pay out.'"

Most of us don't skydive or fly planes, but many of us like the occasional puff of... something. Smoking cigarettes, cigars, pipes or marijuana are classified in the same risk category. You're still insurable, but the premiums are almost twice as much as for non-smokers.

Generally, after a year of being smoke-free, the premium drops significantly, and those who were underwritten as smokers can reapply for a lower rate after a smoke-free year.

In case you're thinking about bluffing your way through, insurers do require blood and urine tests and look at medical records, and the courts don't look fondly on fibbing.

"Life insurance contracts are agreements that lawyers say are made in 'utmost good faith,' and that means we have to deal with you fairly and you have to deal with us fairly," Sanderson says. "If there's something you know that you would reasonably expect to be of concern to an insurer about making a decision whether to insure you and what to charge you for that insurance, then you have to reveal that."

Still, he says once you're covered under the insurance plan, then decide to puff away a cigar, your policy is likely to remain valid.

"In theory, the day after the policy is delivered and the first premium is paid, you could take up smoking again," he says. "We wouldn't like that, but we can't go back and say, 'This person lied on the application.' I think it would be difficult for us to say, 'This person fully intended to start smoking again.' "


Don't hate the player, hate the game

These days, people like to beat up on the insurance firms as much as they do banks. Premiums are increasing. You have to jump through more hoops to be covered and, let's face it, insurers can be sticklers about contracts when it comes to payouts.

But Sanderson says times have been tough for insurers in the last decade and will be for the next one. To make money, they use premiums to invest in low-risk instruments that pay a high enough return to cover their obligations (paying death benefits) and turn a profit. The problem for them lately is market returns have been less than kind and bond yields are near record lows.

"Because we're not getting those returns in the market, premiums are going up, and at the same time," he says, adding regulators are also increasing their capital requirements.

Sanderson argues insurers do more than help mitigate risks for consumers. They invest large amounts of money in the stock market, businesses and resource development. They might even hold the mortgage on your house.

"Those are important things for Canadians," he says. "To make sure we have a viable business provides a lot of value to a lot of people."

Republished from the Winnipeg Free Press print edition August 18, 2012 B10

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