July 17, 2010

CASE STUDY: WHAT TO DO WHEN YOUR TERM 10 RATES ARE ABOUT TO SPIKE

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A friend asked me to review an insurance proposal from his advisor. This is tough to do when your own standards are exacting but I complied. This walkthrough shows you the process and helps you identify signs of a fair deal.

The Situation

The case is simple. The client has a young family and wants to protect them in case of his untimely death. He owns a business but has no life insurance from his company. So he has $2 million of Term 10 in the form of two policies from two advisors ($1.1 million and $0.9 million). The policies are nearly 10 years old. An advisor provided three different proposals.

What should he do?

The Dilemma

Term 10 is excellent for short term needs. You get the most coverage for the fewest dollars. The problem is that rates shoot up every 10 years. That's partially because you're older and more likely to die. The bigger reason is product design. Initial rates are almost loss leaders due to competition. The insurance companies make their money if you convert your coverage to permanent insurance or if you renew after the 10 years at the much higher rates.

If you still need term insurance at renewal, you face a dilemma. If you renew you pay much more than if you bought a brand new policy. If you apply for new coverage, you undergo new underwriting that usually involves answering many personal questions, giving blood and perhaps additional tests. Not very appealing. Also, you're subject to extra scrutiny if you die within the next two years (contestability period and suicide exclusion clause).

Here are the common practices:
  • convert to permanent insurance: this contractual right lets you skip underwriting too
  • if you're healthy: apply for new Term 10 with full underwriting
  • if you're unhealthy: continue your current coverage at the new higher rates (a contractual right)

The Need

The process system quickly showed that the client wanted to continue his insurance.  Changes such as a larger mortgage make $2.5 million a more suitable death benefit. He likes the tax advantages of permanent insurance but is currently investing as much as possible in his business.

The "obvious" solution is new Term 10 insurance with conversion to permanent coverage in 2-3 years when the current investments boost business revenue.

The Proposals

The advisor proposed $1.1 million of
  1. Term 20
  2. Universal Life
  3. Whole Life
What's missing? Term 10 and a market comparison.  All products were from one company (and in a folder from that company). The insurer ranks low in corporate governance, a measure of keeping promises. You'd think that would matter more than ever, given the turmoil in financial markets.

These proposals were prepared without consulting the client. That's efficient for the advisor but ignores the client's current situation. Coverage needs to be increased to $2.5 million. There were no plans to consolidate both present policies a new policy. The advisor didn't realize there is other coverage --- and didn't ask. 

I did a market comparison and found that two insurers with excellent corporate governance offered better overall rates and better options for conversion to permanent insurance.

Why One Company?

If an advisor only proposes one company, are you getting the best options? Here are possible motivations
  • no choice: the advisor may be tied to a company and only be permitted to sell products they select
  • hidden incentives: the advisor may receive cash or non-cash rewards
  • personal biases: the advisor may simply like a particular company
By coincidence, one company may have the best products for your situation. Your advisor should be able to show comparisons that lead to the recommendations.

The Costly Mistake

The current insurance is owned personally. That's generally a costly mistake. You pay  insurance premiums with after-tax dollars in exchange for a tax-free death benefit. Would you rather pay with a dollar that's worth
  • 54 cents? (after personal tax at Ontario's top personal marginal tax rate of 46%)
  • 84 cents? (after corporate tax of 16%)
The difference is huge. Business owners generally own insurance corporately, which also reduces the problem of  "trapped" retained earnings. The option for corporate ownership was not discussed before.

When the original policies were purchased, the option for corporate ownership was not even discussed. That cost the client thousands of extra dollars over the last 10 years.

Warning Signs

If your advisor shows you insurance proposals, look for these warning signs of shortcuts
  • one company only: no company is ideal in every situation
  • folders from an insurer: perhaps the advisor is tied to that company (not independent) or pinching pennies
  • black & white printing: content is designed in colour these days
  • cheap paper: paper's cheap but maybe the advisor's even cheaper?
  • no narrative: just an assortment of pages. The kit was not organized in any meaningful way. It was just an assortment of illustrations
It's great to maximize benefits while minimizing costs, unless the rewards go to the advisor.

Links


Podcast Episode 75 (6:57)


direct download | Internet Archive page

PS This client also needs critical illness insurance and a proposal was provided. The advisor included a proposal … from that same company.

3 comments:

Ami M. said...

Good points; well done.

I would add that even though it may not be instantly apparent, term insurance products (T10, T20, etc.) vary substantially. This includes substantial variations in contract wording, provisions, etc. One of the areas of variance is in the conversion options and the wording of the convertibility clause in the contract itself. READ and understand the contract wording before signing on the dotted line.

Another point that I'd like to make relating to "term" is that, unless you are absolutely certain that:
a. You will not need the coverage beyond its initial level premium period;
OR
b. You will be in good health and have no contraindicating underwriting issues at renewal;
AND
c. You will not be considering conversion;

then you should carefully examine:
a. Renewal and overall costs;
b. The maximum period during which you may continue to renew the coverage.

One of the best ways to do that is to request that your advisor provide you with a LifeGuide Internal Rate of Return comparison for the duration of need for coverage, along with the initial premium cost comparison. The two comparisons will likely vary since renewal rates on "term" vary among the offerings more substantially than initial period costs.

Promod, you mentioned that the advisor in this case provided an offer from only one company. This is an important point; however, it should be noted that, unless the advisor was using LifeGuide, there is no assurance that the scope of the survey (ie the product offerings that were considered) were not artificially selected to pre-determine the results. The CBC did an expose on this very issue a few years ago and was quite critical of the practice.

Ami M. said...

Good points; well done.

I would add that even though it may not be instantly apparent, term insurance products (T10, T20, etc.) vary substantially. This includes substantial variations in contract wording, provisions, etc. One of the areas of variance is in the conversion options and the wording of the convertibility clause in the contract itself. READ and understand the contract wording before signing on the dotted line.

Another point that I'd like to make relating to "term" is that, unless you are absolutely certain that:
a. You will not need the coverage beyond its initial level premium period;
OR
b. You will be in good health and have no contraindicating underwriting issues at renewal;
AND
c. You will not be considering conversion;

then you should carefully examine:
a. Renewal and overall costs;
b. The maximum period during which you may continue to renew the coverage.

One of the best ways to do that is to request that your advisor provide you with a LifeGuide Internal Rate of Return comparison for the duration of need for coverage, along with the initial premium cost comparison. The two comparisons will likely vary since renewal rates on "term" vary among the offerings more substantially than initial period costs.

Promod, you mentioned that the advisor in this case provided an offer from only one company. This is an important point; however, it should be noted that, unless the advisor was using LifeGuide, there is no assurance that the scope of the survey (ie the product offerings that were considered) were not artificially selected to pre-determine the results. The CBC did an expose on this very issue a few years ago and was quite critical of the practice.

Unknown said...

Thanks for your detailed comments, Ami. I used LifeGuide for the market comparison :)

As you point out, renewal rates are important. The initial rates were competitive but renewal rates were not. They were higher by hundreds of dollars a MONTH. That's a hefty penalty and a consequence of not looking at the market.

While a term quote seems simple, there are many unseen considerations.