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t is hard to believe that Canada’s prime lending rate was 22.75
per cent in August 1981.How times have changed.Currently
at three per cent (January 2013), prime is near the record
low of 2.25 per cent in April 2009. While ultra-low interest
rates have fuelled a housing boom, they’ve wreaked havoc
on the Canadian life insurance market.
At the root of the problem is the securing of the funds
necessary to meet future obligations. In the current interest rate environ-
ment, many insurers are finding it difficult to invest in such a way that
will cover their longer-term liabilities. But while low interest rates may
be the most obvious issue, it’s more than just interest rates alone.
“We’re in something of a ‘perfect storm’ right now,” says Terry Zive,
president of Zive Financial Inc. and chair of CALU’s Policyholder Tax
Task Force.“Ultra-low interest rates, changes to International Financial
Reporting Standards (IFRS), a review of the exempt test, regulatory
I
The winds of change are blowing through Canada’s insurance
industry in the form of a shrinking product lineup on the shelves
of many insurance companies, substantial changes to the features
and benefits of remaining products, and changes to accounting
standards and legislation governing life insurance policies.
What is the impact of these changes and what do they mean
for advisors and their clients? Michael Callahan reports
Change
PHOTO:ERICPEARLE/GETTY
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changes such as potential commission disclosure, steep declines and
high volatility in global capital markets — these are all contributing
factors. As you can see, it’s not just interest rates, but rather a com-
bination of these factors that is placing significant stress on the insur-
ance industry.”
Let’s take a closer look at several key changes in the insurance
industry, including a discontinuation of some products, significant
changes to others, and changes to industry standards and govern-
ment legislation.
CHANGES TO EXISTING PRODUCTS
The Canadian insurance industry has already undergone significant
changes in recent years. Permanent life products, such as whole or
universal life (UL) plans, are becoming more expensive as many
insurers have substantially increased rates. Taking it a step further,
several insurance companies have removed permanent life products
from their shelves altogether.
While changes to the exempt test rules may drive change in the
future, low interest rates and changes in IFRS accounting standards
are the driving forces behind the changes today. Insurance compa-
nies are now required to do mark-to-market accounting at the end
of every quarter. This essentially means higher capital requirements
for products with guarantees as companies are now required to hold
larger capital reserves to ensure they will be able to meet those lia-
bilities.As a result,we’ve seen the cost of permanent products increase
dramatically while some companies have discontinued permanent
life insurance products entirely.
Zive, who has over three decades of industry experience, says it’s
nothing new.“There’s a lot of pressure on the industry today. But
our industry has been around for well over a century. It’s very
resilient. Of course, after a period of significant change it may not
look the way it does today. But it will ultimately adapt and survive.”
Going forward, those changes will be reflected in the features,
benefits and re-pricing of products.Although guaranteed pricing is
common today,it may not be tomorrow.While we’ve seen the prod-
uct shelf shrinking in recent years,Zive sees it expanding in the future.
“[What’s happening in the industry] is very interesting,”he says.
“We expect to see new products on the shelves of all insurers, specif-
ically on the UL side. Thirty years ago, adjustable pricing was com-
mon whereas UL was not. Going forward, I think we’re going to see
a return to adjustable pricing, within certain parameters of course,
but ultimately dictated by the ongoing changes to the primary deter-
minants of insurance pricing: interest rates, mortality rates and
expenses.”
A shift from fixed to adjustable pricing will be a significant change
in the mindsets of advisors and clients alike. As Canadians, we’ve
become used to guaranteed pricing. But a move away from guaran-
teed pricing could be quite attractive to clients.Guarantees are expen-
sive, and lower guarantees mean lower capital requirements. This
translates to lower costs for insurers,and subsequently cheaper prod-
ucts for consumers.
Zive anticipates a strong market for these new products as there
will likely be many clients willing to accept a lower guarantee in
return for lower overall costs. However, clients must be aware that a
lower guarantee also means more risk is being transferred away from
A move away from guaran-
teed pricing could be quite
attractive to clients.
Guarantees are expensive,
and lower guarantees mean
lower capital requirements.
This translates to lower
costs for insurers, and
subsequently cheaper
products for consumers.
the insurance companies and placed on the clients.This is not unlike
the shift we’ve seen employers make in recent years from defined
benefit to defined contribution plans, putting more responsibility
on the shoulders of the individuals.
These changes represent considerable challenges though, not
only for the insurance companies and product design teams but also
for advisors. There will no doubt be a steep learning curve for advi-
sors who provide insurance solutions to their clients. “Ultimately,
it’s our job to determine what level of risk is acceptable for our
clients,”adds Zive.“We must ensure we’re using products appropri-
ately and effectively.”
MTAR AND THE EXEMPT TEST
Permanent life insurance typically comes in three forms: term-to-
100 (T100), universal life (UL), and whole life insurance. Unlike
T100, both UL and whole life policies allow the policyholder to
accumulate investments inside the policy. The amount that can be
accumulated inside a policy is governed by the maximum tax actu-
arial reserve (MTAR).
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The MTAR calculation is a critical component of the exempt
test, which is actually a collection of tests administered by an insur-
ance company when a whole or universal life policy is first issued,
and subsequently on an annual basis on every policy anniversary.
Insurance companies administer their policies to ensure the invest-
ment accumulation inside whole and universal life policies does
not exceed the MTAR limit (thereby retaining tax-exempt status).
The exempt test compares the savings component of a life insur-
ance policy to the savings component of a hypothetical benchmark
policy. In order for a policy to be classified as exempt, its savings
component must not exceed the savings component of this bench-
mark policy. Currently, the benchmark policy is described as a 20-
pay endowment at age 85 policy where the savings component is
determined using the mortality and interest rate assumptions that
were used in determining the premiums of the actual policy (for
non-par policies) or that were used in setting the cash values of the
policy (for par policies).
PROPOSED CHANGES
TO THE EXEMPT TEST
In the federal budget delivered on March 29, 2012, Finance Minister
Jim Flaherty announced preliminary changes to the exempt test.
“We have a high-level overview, but we don’t yet have the details,”
says Steve Krupicz, FSA, FCIA, AVP, Special Case Markets, with
Manulife Financial.“The industry is still waiting for the Department
of Finance to communicate the details of those changes.”
One can still get a general sense of the potential impact from the
higher-level details that have been communicated.As Krupicz explains,
the changes include modifications to both the benchmark policy and
the determination of the savings component of the actual policy.
Benchmark policy. The budget changes the benchmark policy from
a 20-pay endowment at age 85 to an 8-pay endowment at age 90,
measured using a 3.5 per cent interest rate and the Canadian

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Institute of Actuaries (CIA) 86-92 mortality table. This change will
likely result in the following modifications:
• Shortening the assumed payment duration to eight years will
increase the savings component of the benchmark policy, thereby
increasing the maximum deposit to an exempt policy in the early
years of that policy.
• Lengthening the assumed endowment age to 90 will decrease the
savings component of the benchmark policy, thereby reducing the
maximum deposit permitted.
• Changing the mortality and interest assumptions that were used
in determining the premium or cash value of the actual policy may
have varying effects, but will likely lower the savings component of
the benchmark policy which, again, will subsequently reduce max-
imum allowable deposits.
Savings component. The budget also announced that surrender
charges would no longer be deducted in determining the cash value
of the policy. Furthermore, the savings component would be cal-
culated using the same 3.5 per cent interest assumption and CIA
86-92 mortality table as is being prescribed for the benchmark pol-
icy. It is expected that these changes will affect policies as follows:
• Disallowing the deduction of surrender charges will increase the
value of the actual policy, thereby reducing the permissible maxi-
mum deposit to an exempt policy.
• Changing the mortality and interest assumptions used in deter-
mining the premium or cash value of the actual policy will have a
varying effect depending on the levels of the current assumptions
relative to the newly prescribed assumptions.
• The new reserve method, referred to as net premium reserve in the
budget, has only been described in very generic terms.As such, it is
not possible to state definitively the exact impact of this change.
However, from the generic terms used, it is expected that the new
reserve method would generally produce a higher value for the actu-
al policy, thereby reducing the permissible maximum deposit to an
exempt policy.
Keep in mind that these changes are just an overview at this point.
“Since the exact details haven’t been fleshed out yet,it’s hard to accu-
rately determine the full impact of the proposed changes,” adds
Krupicz.“Essentially, we have an idea of the general direction of the
changes,but it’s too early for providers to make product adjustments,
or for advisors to fully understand the subsequent effects.”
INDUSTRY PERSPECTIVE
We’ve seen considerable evolution in the insurance marketplace
over time. Much of this evolution predates the financial crisis, the
economic downturn and the period of record low interest rates.
“Financial institutions have [had to] become more innovative
in the way they run their business and in the products they offer
consumers,”says Joanne Abram, chief executive office of the Alberta
Insurance Council.“This has also impacted the way advisors con-
duct their business and provide advice to their clients. The growth
of the managing general agency (MGA) system of product distri-
bution is a prime example of how the industry has reacted and
adapted to a changing landscape.”
The Alberta Insurance Council makes sure that the insurance
industry in their province is held to the highest standard.As Abram
INSURANCE
points out, “The value of financial advice provided by a licensed,
educated agent or broker has never been more important.
Consumers are being bombarded with insurance options from all
directions, and a generation has grown up with the internet and
social networking sites that offer opinions and suggestions on all
aspects of their lives.”
And yet, despite the vast of array of resources available to
Canadians, basic financial literacy is still noticeably lacking. It is dif-
ficult for one to make a purchase these days without being offered
insurance to offset a debt in the case of a disability, death or loss of
employment. Unfortunately, these purchases are often impulse deci-
sions that are not made within the context of an individual’s over-
all financial plan.
“It is important to remember that when purchasing insurance a
client is purchasing a promise that they will be indemnified against
loss in the event of a specified peril. It’s not a product that clients
can test-drive,”Abram explains.“If they realize after the fact that it
wasn’t the right product or plan, it’s too late. It is therefore essen-
tial that advisors provide comprehensive, sound advice.”
So what does this sea change mean for advisors? Well, it’s safe to
say that many current strategies will have to be revisited on numer-
ous levels. Furthermore, new products, terms and conditions will
no doubt present a learning curve for both advisors who sell insur-
ance and insurance companies alike.
However, it is often said that where there is challenge, there is
opportunity. As Terry Zive puts it, “This is a very exciting time in
our industry.Times are changing and companies,products and advi-
sors must evolve and adapt to the coming changes, whatever they
may be. But make no mistake — the glass is half full, and it can fill
up very quickly.” ấ
MICHAEL CALLAHAN, CFP, is a financial planner at RBC Investments in
Ottawa and can be reached at callahan_michael@yahoo.com. If you would like
a PDF of this article, please contact the editor at kdoucet@advocis.ca.
“This is a very exciting time
in our industry. Times are
changing and companies,
products and advisors must
evolve and adapt to the
coming changes, whatever
they may be. But make no
mistake — the glass is half
full, and it can fill up very
quickly.”
— Terry Zive, financial advisor