When the past catches up to the insurance industry…

I have said last year that the past is catching up with the insurance industry and that this industry must clean up its act. Before we discuss the implications of the new concept of a tax avoidance policy, it is necessary to understand why such a provision was deemed to be necessary.

 There are two cultures in the insurance industry. There is a culture of cheaters who can’t sell the need for insurance and therefore resort to cheating and lying to sell insurance products either as an investment or a tax shelter. This culture has more than 40 years worth of history and started with the introduction of the single premium life insurance which forced the government to introduce amendments to the ITA under the form of the exemption test to outlaw this tax avoidance strategy.

 However this did not discourage these cheaters. The more complicated the ITA became, the more resourceful and imaginative these cheaters became. It is also important to understand that the roots of this culture of cheating did not reside with the advisors. The roots of this culture resided in the many life insurance head offices .

 With many gaps existing in the ITA regarding the taxation of life insurance, there were a lot of opportunities for abuses. Instead of being responsible where the insurance companies could have reached a consensus as to how to deal with these gaps, the cheaters walking the halls of these companies started to use these gaps in the ITA as marketing and competitive advantages over other insurance companies. This could therefore only go downhill as other companies were forced to match tax abuses against tax abuses in order to remain competitive.

 As shown by the 10/8 strategy, the cheater’s culture was empowered by the willingness of the government to grandfather tax avoidance strategies.  When I was working for these insurance companies how many times I cautioned my employer against abusing the ITA to be told not to worry because the government would protect these abuses by grandfathering them. And they were proven right. Many people like me refused to promote, support and sell the 10/8 strategy to clients. This meant saying no and losing hundreds of thousands of commission.

 The people who used the 10/8 strategy in order to avoid paying taxes on income were right not to worry by believing the government would protect them. This is what happened when the government offered to pay the cost of their exit strategy out of this tax avoidance concept. Still today the government refuses to reveal the cost of getting these cheaters out of the 10/8 strategy. You also have to understand the recklessness of these cheaters. Unchecked the 10/8 strategy had the potential to bankrupt the Canadian government. It was not a question of if; it was a question of when. This is what the power of compounding interest deduction against income can do…

 It was therefore not surprising that the Canadian government faced with an irresponsible industry willing to do anything in order to create sales decided to introduce this tax avoidance policy to close down any possibilities of future abuses. Normally the insurance industry would have strongly objected but the government picking up the tab to get people out of the 10/8 strategy became the price for their silence.

 Still many people in the industry are angered by this. In the end, it is those who are honest and have not abused the system that are punished because now we are faced with a tax avoidance provision that specifically applies to insurance and can apply to any transactions made on life insurance.

 What is the true purpose of this provision?

 Considering that the tax avoidance provision 245(3) is broad enough to include insurance transactions does this mean this provision is redundant? Absolutely not. The purpose of this provision is other than tax avoidance.

 1.  This is an anti-grandfather provision. You have to remember that the insurers were successful in marketing their tax avoidance strategies by betting on the government history of grandfathering their abuses. By introducing the provision of a tax avoidance policy, the government has ended this practice. It will now be impossible for any future tax strategies created by the insurers to be grandfathered when they are considered as tax avoidance.

 2. This provision shifts disclosure to the insurer and insurance agent. In the past, if a client had some reservations as to the legality of tax strategy created and promoted by an insurer; this client would be told to seek counsel with his lawyer or accountant because article 245(3) was a general tax provision. The tax avoidance policy is a life insurance provision and must be explained by the advisor in the same fashion that this advisor has to explain what is the ACB of a policy, the exempt test of a policy… Effectively, this tax avoidance policy provision will have the effect and impact of a cold shower on any sales that push the tax envelope.

 3. This provision creates an ethical duty on the part of the advisor. Failure by the advisor to mention this provision or explain it adequately will create an ethical infraction on the part of the advisor.

 4. This provision shifts liability to the insurer and advisor for any strategies involving insurance that could be considered tax avoidance. The tax avoidance policy provision will certainly make it easier for a client whose policy was deemed to be a tax avoidance policy to seek civil damages against the insurer and advisor.

 Life transactions that will be impacted by this provision:

 The tax avoidance policy target insurance transactions directly as listed in the explanatory notes in regards to the life insurance policy exemption test. This provision will also impact indirectly any transactions made on a life insurance policy since such transaction only have to reduce or increase the accumulating funds of the policy to potentially qualify as tax avoidance; as a result any transactions made on an insurance policy could trigger a 60 days’ notice from the government. Basically the burden of proof upon receipt of this notice will rest with the policy owner to explain and prove that the transaction was done for a valid purpose other than obtaining a tax benefit. Examples of such transactions are:

 1.  Overinflating the amount of insurance on a Universal Life with a YRT COI and then reducing and minimizing the amount of insurance to the ETP line will be an avoidance transaction. Also any changes to the face amount in order to reduce the COI and maximize the cash value is now potentially an avoidance transaction. Therefore such changes must be documented and the client and advisor must be ready to demonstrate that the initial face amount was justified and needed. This is truly the death of insurance as a tax sheltered investment.  The consequences for the industry could be enormous because while the policy count for policies sold in this fashion may be low they represent at least 50% of the premium sold in the industry.

 2. The cost of insurance of a Universal Life policy is usually deducted to age 100. However many insurance companies in order to circumvent the exemption test have decided to compress the Cost of insurance over 5, 10, or 20 years. There is no economic benefit for the client to prepay this cost of insurance since at death the client does not get back what he has prepaid. The only purpose of this transaction is to circumvent the ETP of a policy in order to be able to put more money in the policy in the early years. Any of these policies sold after 2015 would be an avoidance policy.

 3. This provision will also impact other sort of policies indirectly such as multilife policies. By being able to add multiple insured under one policy, it is possible for one of the insured to borrow the ETP of the other insured (ETP is done at the policy level and is the sum of all the ETP of the different coverage). The notes state that: “the transaction will be an avoidance transaction unless it may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit of the policy being an exempt policy”. Again documentation will be critical to prove that the reason to put all of the insured under one policy was other than taking advantage of the increased exemption test. It’s even more important if the policy is divided afterwards tainting the transaction from a tax avoidance perspective.

 4. The same would apply to a term rider on a life insurance policy. For example if a husband needs $500,000 of insurance and the wife needs $250,000 of term insurance. Instead of buying a separate term policy, the term coverage could be purchased as a rider. As a result, the exemption test instead of being applied to $500,000 of coverage only would be the sum of the ETP for the $500,000 and $250,000. This means the husband would be able to put a lot more premium in the early years of the policy. Is this an avoidance transaction? Difficult to say and it will be up to the courts based on the interpretation of the tax avoidance policy provision to decide what is an efficient transaction and what is an avoidance transaction. There are now risks with this strategy and this risk increases greatly if the policy is divided afterwards because of a divorce for example. Again documentation will be important but this is certainly not what a client will like to hear.

 We now can see how the tax avoidance policy provision will change the sale of insurance. How does the advisor warn the client against this provision if he decides to buy a multilife policy or add a rider?  It introduces an element of fear into transactions that I would have considered as being efficient from a tax perspective.


 With this tax avoidance policy provision, we are seeing the end of the marketing of the Universal Life as an efficient tax shelter and also as a competitive investment. It never was anyway unless there was cheating involved. However this will have a great impact on the distribution of life insurance. This provision could reduce life sales by as much as 50%. Insurers will have no choice to focus their efforts back towards marketing need driven products which are much simpler in their nature. These products such as mortgage insurance are considered commodities. The good news is there is still a lot of potential growth in this market including term insurance, guaranteed wholelife and combo (critical illness/disability/insurance) products. Still the margins of these products are much lower than Universal Life and competition is getting more ferocious. Technology is now driving sales of these products but it is still undecided whether technology will enable clients to buy these products directly from the insurer or whether this technology will empower the advisor to showcase the value of his knowledge and advice.

17 comments on “When the past catches up to the insurance industry…
  1. unpatriote says:

    John McCormack

    Universal life insurance policies. I have always had difficulty fully comprehending these products. They are heavily promoted by life insurance sales people. Is this a primary target of the ITA changes mentioned above?

  2. unpatriote says:

    Richard Proteau
    Insurance specialist, Insurance evaluator, Insurance fraud investigator, Insurance consumer Advocate, Columnist

    John, I have yet to meet a client who understands a Universal Life. It is a complex product where disclosure has been intentionally poor. However when it is sold as an investment, the strategy is simple. On the negative side of positioning this as an investment, you have the Cost of insurance which the client knows about since it is reflected in the illustration. There is also the MER of more than 3% which is not reflected in the illustration. For example, when the policy is illustrated and a rate of return is selected of 8% and the MER is 3%, the software will not generate an illustration of 5% (8-3). So the client has to make the mental correction of knowing this is based on 11% return. On the positive side, income earned is not taxed (aside at the IIT level). So to make a Universal Life investment viable, the positive side (tax shelter and therefore tax saved) must become greater than the negative side (Cost of insurance + MER) to compete against other type of investments. To do this the industry had 2 strategies available. 1) Put as much money in the policy upfront to maximize the tax saved. Therefore this meant circumventing the exempt test of a policy by getting near as possible to a single premium policy or 2) maximize interest deductions against income through a leveraging arrangement at no risk to the client by rigging the interest spread as it was done with the 10/8 (10% guaranteed loan rate + 8% guaranteed return). So the target of ITA changes is not per say Universal Life but the use of its tax shelter to position it as investment. However since most UL are sold on this basis, Universal Life becomes de facto the target of this change. With this change, you won’t be able to use Universal Life as an investment. If you invest in a UL, it’s because you do not want to pay premium to age 100. Department of Finance hates Universal Life. As one senior official told me: “The insurance industry should have stucked to selling whole life”. With these changes to the ITA, the Department of Finance has turned this into a reality…

  3. unpatriote says:

    john McCormack

    Richard, I don’t know if your explanation is 100% correct or not, as I still don’t properly understand it, and don’t expect I ever will. That is definitely an “A” grade answer as it sure sounds right. I find this topic a challenging one as a CPA, CGA and a CFP. If I was motivated to be licensed to make commissions on universal life policies, I sure would put in a lot more zeal to fully comprehend this hard-to-comprehend insurance product. I can only imagine the bewildered expressions on your clients faces when you attempt to explain it to them in “layman’s” terms.

  4. unpatriote says:

    Jason Watt CD CLU RHU
    CFP and CLU Instructor

    John, Richard’s explanation is technically correct, but too detailed.

    There are two pricing models for Universal Life insurance, and it falls to the agent to determine which is right for the client. (They are Level Cost of Insurance and Increasing Cost of Insurance, or Yearly Renewable Term(YRT).)

    Let’s say that we have a client who is looking for investment growth in addition to a death benefit. That client should probably get a YRT Cost of Insurance policy. A YRT policy has a cost of insurance similar to a term insurance policy. That is simple.

    The investment component of a YRT UL contract includes the option to invest in various funds that mirror mutual funds or index accounts, or can provide guaranteed returns. (Though any guaranteed return product in a UL contract provides such low returns as to be meaningless.) Any dollars contributed to the policy attract a 2% premium tax (in most provinces), so you are effectively investing only 98% of your intended investment. UL contracts do have higher MERs than a straight investment in a mutual fund, but I don’t agree with Richard that they are all 3%. Because of poor disclosure requirements, the actual MER can be hazy, and this, in my mind, is the worst part of UL.

    The growth in the contract attracts no income tax consequences for the investor. There is tax paid (the Insurance Investment Tax), but it is paid directly by the insurer. With most insurance contracts, the invested amount increases the death benefit, though other arrangements are possible. The entire amount is paid as a tax-free death benefit.

    If the policy owner wishes, the invested amount can be withdrawn or collateralized early, but this may have tax consequences.

  5. unpatriote says:

    Doug Cumpson
    Partner – Tax Specialist at GB Taxes & Accounting

    In short

    Universal Life products if sold as a premium divided in part to insurance and part to a savings program that split the dollar overtime was an acceptable concept. But it was bastardized to leverage the policies to supply huge commissions and to do so the basic strategies were twisted surreptitiously.

    UL policies sold in the 80’s had some merit but in today’s market these are to be shelved like the pension bond policies of the 70’s as not suitable in today’s marketplace.

    The Whole Life Par product policies still seem to have merit to a segmented part of the marketplace to the larger premiums of $400 a month or more.

    Even for people if lesser disposable incomes it always can be argued that smaller Whole Life policies are ideal to cover death benefits as CPP at $2500 death benefit, barely dents the funeral and burial costs today and if sold in concert with large term insurance policies is arguably ideal.

    I always thought are financial planners are supposed to be selling insurance/income replacement plans.

    Today too little life insurance is owned personally and Financial Planners need to ramp it up and aggressively sell this valuable coverage.

    Forget trying to force the slick plans that border tax avoidance strategies.

    Sell insurance coverage. I tell clients constantly to buy life, critical illness and disability coverages, without exception.

    So the amount of sales do not have to drop at all. Roll up the sleeves and pound the pavement or give me the license and I will sell these coverages for the insurers willing to work with me.

    I think most Business owners should be paying $425 a month into a life insurance program consisting if life, disability and critical illness coverages and if it is a husband a wife business the other spouse should be doing the same, if both are making over $51,100 each

  6. unpatriote says:

    Jason Watt CD CLU RHU
    CFP and CLU Instructor

    Richard, I just read your blog post. While I agree with your conclusion (simpler products are generally more desirable), I do not agree with much of what you have written. I believe you have injected much grey area into the new Exempt Test, where it is simply not there. The new Exempt Test is, in my reading, quite clear. Yes, policies stand the risk of becoming Avoidance Policies. The old 60-day rule to fix a policy that has failed the Exempt Test still remains.

    Among other things, I do not agree that:
    1. There is no grandfathering. The new Exempt Test rules will only apply to policies sold in 2015 and later. Policies already in force are grandfathered.
    2. The broad use of the language to define certain insurance agents as ‘cheaters’. While there are valuable elements in your message, this is sure to create a division that means the portions of your post that are most needed will not be read by those who need them most.
    3. The broad indication that insurance should never be used as an investment. I do not support strategies that, for example, substitute insurance for an RRSP or RESP. But I do believe that it can be a valuable part of a broader investment strategy.
    4. Your indication that any short-pay UL policy will be a tax avoidance policy. There is no such indication in the new exempt test.

    I stand ready to be corrected. As always, thank you for posting.

  7. unpatriote says:

    Richard Proteau
    Insurance specialist, Insurance evaluator, Insurance fraud investigator, Insurance consumer Advocate, Columnist

    Jason, first I never said there was no grandfathering. What I have said is that after 2015 with the provision of the tax avoidance policy, the government has ensured that the insurance industry cannot use the previous history of grandfathering to promote tax avoidance strategies after 2015. After 2015, with this provision there will be no more grandfathering for abuses such as 10/8…
    For the MER, I do not know where you get your info. MER on UL are extremely high. In fact some companies went with MER as high as 6% when they offered investment index on Mutual funds net of MER (so the return was net of the MER of the mutual funds and net of the MER applied on the UL). Finally please read the explanatory notes from the government on this provision which I reproduced in part here to show that YRT policies with the minimize option will be considered as being avoidance policies (these are policies where the face amount is high at the beginning and then reduce to walk the MTAR). Here is what the government said: “A policyholder acquires a permanent life insurance policy with yearly renewable cost of insurance charges in order to protect against the mortality risk. The life insurance amount under the coverage is overinflated in the early years of the policy in order to increase the accumulating fund of the associated exemption test policies and to shorten the period over which premiums would be otherwise payable to ensure that the policy is an exempt policy. The transactions involving the excess amount of life insurance that was temporarily acquired during the early years to effectively reduce the pay period of the policy would be considered avoidance transactions.”

    As for my comment as to the cheaters, I stand by what I have said. In 2011 when I was at Manulife, policies that will now qualify as tax avoidance policies represented about 75% of sales in both the MGA channel and direct channel. In fact this became quite a scandal since this tax avoidance strategy was promoted internally by marketing personal wanting to reach their sales objectives by teaching advisors to use the ability to reduce the face amount in year 1 or 2 without triggering surrender charges. The problem was that since these surrender charges were needed to recover commission then it meant the insurer was going to lose a ton of money (which happened…) Funny enough it is these cheaters that won the sales trophy…

  8. unpatriote says:

    Richard Proteau
    Insurance specialist, Insurance evaluator, Insurance fraud investigator, Insurance consumer Advocate, Columnist

    Good comment Doug. I agree with you that it’s difficult to view the Universal Life as an investment in today’s marketplace considering its cost and poor performance. It’s still a good option as an insurance product if you want to prepay the COI using a minimum interest rate guarantee while having the flexibility to change premium. However I still view the Whole Life Par product as a good investment vehicle. Unlike the Universal life which invest in the same equity market as mutual funds but with much higher MER, the Whole Life Par fund can be considered as a different asset class which can be used to reduce volatility of an investment portfolio. In the end, in my 25 years career having reviewed hundreds of life insurance plans, for post 90 Universal life, I have never seen a UL on track with what was illustrated. However I have seen many Whole Life Par plan on track where the cash value of the client was different by less than $100 than what had been illustrated. Sadly with demutualization, it’s getting difficult to find a good PAR product…

  9. unpatriote says:

    Richard Proteau
    Insurance specialist, Insurance evaluator, Insurance fraud investigator, Insurance consumer Advocate, Columnist

    for those who want to have the perspective of a customer on UL, here is an analysis made by a consumer which has a very good analytical mind. 90% of what he said is true while 10% needs some precision and correction. Also the analysis should differentiate better between a UL sold as insurance plan and a UL sold as an investment plan

  10. unpatriote says:

    Jason Watt CD CLU RHU
    CFP and CLU Instructor

    Richard, I agree about the minimize options, and had you indicated in the article that you were talking about minimizing, reducing, or optimizing (my favourite euphemism) policies, then I likely would have agreed with you. But you did not discuss that particular provision in your article, instead taking what seemed like a broad swipe at any efforts to use UL in any investment strategy.

    As for the MERs, I did not say that 3% was too high. I said that I don’t agree that they are all 3%.

  11. unpatriote says:

    Jason Watt CD CLU RHU
    CFP and CLU Instructor

    I have previously read the Kundert article. It is a detailed analysis, but it does, as you indicate, miss some important facts and get some others wrong. (Eg. the statement that you can use an RRSP to leverage against – you can, but it deregisters the whole thing.)

    And I am happy to see Par Whole Life undergoing a resurgence. I wish that UL had not overtaken Par as the permanent insurance of choice through the late 90s and 00s. I think your experience with Manulife may not be the best here, as I am seeing agents at Sun (which has a decent Par policy, though not as good as those offered pre-demutualization) selling more and more Par. Unfortunately, Manu doesn’t even have a Par product on their shelf today.

    And as long as you continue to use language like ‘Cheaters’ your comments will continue to go ignored, no matter how valid or correct they might be.

  12. unpatriote says:

    Richard Proteau
    Insurance specialist, Insurance evaluator, Insurance fraud investigator, Insurance consumer Advocate, Columnist

    Jason, i think we are not that far apart in our positions. As a consumer advocate, i believe that enough customers have lost money in UL position as investment. UL can still be a great product as an insurance product but it is not an investment. As for the cheaters, well I am in the process of creating an consumer association for the financial industry to gather the data needed to start the ball rolling on class actions that will recover customers losses for those who have purchase UL as an investment. So no I don’t intend to make friends with the cheaters. I intend to go after them…and believe me as consumers we will not be ignored anymore.

  13. unpatriote says:

    John McCormack

    Based on the above comments, when is a universal life insurance policy justified? What sort of client would this product make sense and would be a good option for insurance purposes, investment purposes, and estate purposes? Or are universal life insurance policies never justified if compared to an alternative term life or whole life insurance product that might be more likely to fully meet the client’s financial long term needs.

  14. unpatriote says:

    John McCormack

    Also, can someone kindly provide approximately what the commissions and possible trailer fees would be for comparable term life, whole life, and universal life policies that are meant to meet the long term financial goals of a client of significant financial means. As an example, perhaps someone that is 32, married, with two young kids, no assets, just renting, who just won the lottery and now has $5 million cash in his bank account. The lottery winner quits his job and retires immediately.

  15. unpatriote says:

    Richard Proteau
    Insurance specialist, Insurance evaluator, Insurance fraud investigator, Insurance consumer Advocate, Columnist

    John this is a good question. Insurance solutions should be built based on the hierarchy of needs. First need to always be addressed is the income replacement and protection. Term insurance is used to deal with this need. When a needs analysis is done, this will determine the amount of insurance needed. Permanent insurance should only then be considered, if after the premium for this term coverage has been determined, the client has money left over. If the client is on track and is saving enough for his retirement, then this money left over can be used to buy and substitute some permanent coverage to the term coverage or to buy disability, long term care or critical illness. This is where a good advisor shines by establishing priorities between competing needs. (disability becomes a primary need if the client is not insured through a group plan)

    When buying permanent insurance, you have to differentiate between investing in a UL to prepay future cost of insurance versus investing in insurance to create a fund value to be leverage at future date. I don’t believe in paying premium to age 100. I like 20 pays and this can be done by using UL with minimum interest guarantee or whole life guarantee. Investing in a UL to create a fund accessible at later date through leveraging is a very bad idea. It’s a poor investment usually involving a lot of risk and usually based on pushing the limits of the tax shelter of insurance (tax avoidance). However sometimes with wealthy clients I have recommended Whole life Par as an investment to reduce risk on a portfolio. I have been a big supporter of Whole life Par as an investment for children. (Both my children have whole Life Par and will never have to buy insurance. I started with 75,000 insurance and the insurance is now worth 150000 in 5 years only…)

    While insurance is a poor investment to provide funds at retirement, it is the greatest product for estate purposes. If a client wants to set aside a set amount of money for estate purposes for his children than insurance should be used through a concept such as estate bond…There is tremendous value to simplifying estate through insurance. One day I will do a survey with those who were named to deal with estates to see how much money was lost because the estate was not protected through insurance and was instead invested in the market and submitted to the volatility of the market.

  16. unpatriote says:

    Richard Proteau
    Insurance specialist, Insurance evaluator, Insurance fraud investigator, Insurance consumer Advocate, Columnist

    John, don’t let commission decides what is right. If a client wins $5 millions at the lottery, there is no need for insurance. If he dies tomorrow, his family is provided. The question is whether he wants insurance. Why would he want insurance? Maybe he would love his children not to have to buy lottery tickets and rely on luck. So an advisor would set up a very conservative retirement plan based on the income the client wants to receive for life. If there is money left over, then he could insure himself to provide money for his children at death. He should also consider buying Whole Life Par for his each of his children. This is the greatest gift. It’s also a tax free rollover when the policy is transferred. It’s easy to control even when property is transferred to children through the benificiary designation. Such plan are extremely inexpensive and can cost between $1000 to $2000 year per children for $50,000 to $100,000 insurance.When my children turn 25 or when they buy their first home, I can’t wait to sit with them and tell them i want to give them a great gift and show the Whole Life Par I bought for them. For commission purpose, most term pay 30 to 35% of the premium. On UL the commission is 50% to 60% of the minimum premium which is a lot more than the term premium. To this the advisor receives a bonus which can vary to 100% to 205% of the base commission. This bonus level is driven by sales volume and therefore those who sell a lot of UL will receive a greater bonus than those who sell term coverage. There is renewal commission on renewal premium. It’s usually around 1% to 5% and it’s not subject to bonus. Finally on UL there is a trailer on the fund invested (.25% to .5% of the fund value)

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