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t is hard to believe that Canada’s prime lending rate was 22.75per cent in August 1981. How times have changed. Currentlyat three per cent (January 2013), prime is near the recordlow of 2.25 per cent in April 2009. While ultra-low interestrates have fuelled a housing boom, they’ve wreaked havocon the Canadian life insurance market.

At the root of the problem is the securing of the fundsnecessary to meet future obligations. In the current interest rate environ-ment, many insurers are finding it difficult to invest in such a way thatwill cover their longer-term liabilities. But while low interest rates maybe 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 TaxTask Force. “Ultra-low interest rates, changes to International FinancialReporting Standards (IFRS), a review of the exempt test, regulatory

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The winds of change are blowing through Canada’s insuranceindustry in the form of a shrinking product lineup on the shelvesof many insurance companies, substantial changes to the featuresand benefits of remaining products, and changes to accountingstandards 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

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changes such as potential commission disclosure, steep declines andhigh volatility in global capital markets — these are all contributingfactors. 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 insuranceindustry, including a discontinuation of some products, significantchanges to others, and changes to industry standards and govern-ment legislation.

CHANGES TO EXISTING PRODUCTSThe Canadian insurance industry has already undergone significantchanges in recent years. Permanent life products, such as whole oruniversal life (UL) plans, are becoming more expensive as manyinsurers have substantially increased rates. Taking it a step further,several insurance companies have removed permanent life productsfrom their shelves altogether.

While changes to the exempt test rules may drive change in thefuture, low interest rates and changes in IFRS accounting standardsare the driving forces behind the changes today. Insurance compa-nies are now required to do mark-to-market accounting at the endof every quarter. This essentially means higher capital requirementsfor products with guarantees as companies are now required to holdlarger capital reserves to ensure they will be able to meet those lia-bilities. As a result, we’ve seen the cost of permanent products increasedramatically while some companies have discontinued permanentlife insurance products entirely.

Zive, who has over three decades of industry experience, says it’snothing new. “There’s a lot of pressure on the industry today. Butour industry has been around for well over a century. It’s veryresilient. Of course, after a period of significant change it may notlook 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 iscommon 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 seea 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 andexpenses.”

A shift from fixed to adjustable pricing will be a significant changein the mindsets of advisors and clients alike. As Canadians, we’vebecome 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. Thistranslates to lower costs for insurers, and subsequently cheaper prod-ucts for consumers.

Zive anticipates a strong market for these new products as therewill likely be many clients willing to accept a lower guarantee inreturn for lower overall costs. However, clients must be aware that alower guarantee also means more risk is being transferred away from

A move away from guaran-teed pricing could be quiteattractive to clients.Guarantees are expensive,and lower guarantees meanlower capital requirements.This translates to lowercosts for insurers, and subsequently cheaper products for consumers.

the insurance companies and placed on the clients. This is not unlikethe shift we’ve seen employers make in recent years from definedbenefit to defined contribution plans, putting more responsibilityon the shoulders of the individuals.

These changes represent considerable challenges though, notonly for the insurance companies and product design teams but alsofor 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 ourclients,” adds Zive. “We must ensure we’re using products appropri-ately and effectively.”

MTAR AND THE EXEMPT TESTPermanent life insurance typically comes in three forms: term-to-100 (T100), universal life (UL), and whole life insurance. UnlikeT100, both UL and whole life policies allow the policyholder toaccumulate investments inside the policy. The amount that can beaccumulated inside a policy is governed by the maximum tax actu-arial reserve (MTAR). IL

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For Dealer Use Only, Not for Distribution to the Public.© 2013 Franklin Templeton Investments Corp. All rights reserved.

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The MTAR calculation is a critical component of the exempttest, 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 doesnot 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 benchmarkpolicy. In order for a policy to be classified as exempt, its savingscomponent 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 isdetermined using the mortality and interest rate assumptions thatwere used in determining the premiums of the actual policy (fornon-par policies) or that were used in setting the cash values of thepolicy (for par policies).

PROPOSED CHANGES TO THE EXEMPT TESTIn the federal budget delivered on March 29, 2012, Finance MinisterJim 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, withManulife Financial. “The industry is still waiting for the Departmentof Finance to communicate the details of those changes.”

One can still get a general sense of the potential impact from thehigher-level details that have been communicated. As Krupicz explains,the changes include modifications to both the benchmark policy andthe determination of the savings component of the actual policy.

Benchmark policy.The budget changes the benchmark policy froma 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 willlikely result in the following modifications:• Shortening the assumed payment duration to eight years willincrease the savings component of the benchmark policy, therebyincreasing the maximum deposit to an exempt policy in the earlyyears of that policy.• Lengthening the assumed endowment age to 90 will decrease thesavings component of the benchmark policy, thereby reducing themaximum deposit permitted.• Changing the mortality and interest assumptions that were usedin determining the premium or cash value of the actual policy mayhave varying effects, but will likely lower the savings component ofthe benchmark policy which, again, will subsequently reduce max-imum allowable deposits.

Savings component. The budget also announced that surrendercharges would no longer be deducted in determining the cash valueof the policy. Furthermore, the savings component would be cal-culated using the same 3.5 per cent interest assumption and CIA86-92 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 thevalue 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 avarying effect depending on the levels of the current assumptionsrelative to the newly prescribed assumptions.• The new reserve method, referred to as net premium reserve in thebudget, has only been described in very generic terms. As such, it isnot possible to state definitively the exact impact of this change.However, from the generic terms used, it is expected that the newreserve method would generally produce a higher value for the actu-al policy, thereby reducing the permissible maximum deposit to anexempt 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,” addsKrupicz. “Essentially, we have an idea of the general direction of thechanges, but it’s too early for providers to make product adjustments,or for advisors to fully understand the subsequent effects.”

INDUSTRY PERSPECTIVEWe’ve seen considerable evolution in the insurance marketplaceover time. Much of this evolution predates the financial crisis, theeconomic downturn and the period of record low interest rates.

“Financial institutions have [had to] become more innovativein the way they run their business and in the products they offerconsumers,” says Joanne Abram, chief executive office of the AlbertaInsurance Council. “This has also impacted the way advisors con-duct their business and provide advice to their clients. The growthof the managing general agency (MGA) system of product distri-bution is a prime example of how the industry has reacted andadapted to a changing landscape.”

The Alberta Insurance Council makes sure that the insuranceindustry in their province is held to the highest standard. As Abram

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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 alldirections, and a generation has grown up with the internet andsocial networking sites that offer opinions and suggestions on allaspects of their lives.”

And yet, despite the vast of array of resources available toCanadians, basic financial literacy is still noticeably lacking. It is dif-ficult for one to make a purchase these days without being offeredinsurance to offset a debt in the case of a disability, death or loss ofemployment. 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 aclient is purchasing a promise that they will be indemnified againstloss in the event of a specified peril. It’s not a product that clientscan test-drive,” Abram explains. “If they realize after the fact that itwasn’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 tosay that many current strategies will have to be revisited on numer-ous levels. Furthermore, new products, terms and conditions willno 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 isopportunity. As Terry Zive puts it, “This is a very exciting time inour industry. Times are changing and companies, products and advi-sors must evolve and adapt to the coming changes, whatever theymay be. But make no mistake — the glass is half full, and it can fillup very quickly.” �

MICHAEL CALLAHAN, CFP, is a financial planner at RBC Investments inOttawa and can be reached at callahan_michael@yahoo.com. If you would likea PDF of this article, please contact the editor at kdoucet@advocis.ca.

“This is a very exciting timein our industry. Times arechanging and companies,products and advisors mustevolve and adapt to thecoming changes, whateverthey may be. But make nomistake — the glass is halffull, and it can fill up veryquickly.”

— Terry Zive, financial advisor