It starts with avoiding too much information.
With files from Vern Lunz, Insurance Specialist, Manulife Securities.
Most people would probably agree there’s a limit to how much information they can process about any given subject. This might be particularly true when it comes to choosing an insurance plan, given there can be so many variables, options and subtle differences between plans.
Manulife Securities Insurance Specialist Vern Lunz says that presenting too much information right off the bat can be confusing and perhaps intimidating for clients, which can risk putting the sale of any product in jeopardy. So why not take a simpler approach to helping them find the right solution? There’ll be plenty of time afterwards to walk them through the finer details of a particular plan, perform your due diligence, explore all the relevant options and give the client confidence in your recommendations.
Let’s look at a real-life example of how this can be achieved.
A client in his early sixties, who was quite successful in real estate, implemented a freeze on his real estate corporation shares. The frozen value of the company included a locked-in tax liability of $5 million. With the help of his accountant, the client was trying to determine the best way to fund that liability.
In general terms, there are four ways to fund a tax liability:
- Borrow money
- Sell assets at the time of death
- Start a separate fund
- Purchase insurance
Each option has its advantages, disadvantages and tax consequences, but insurance can be the least expensive alternative because premiums are always less than the death benefit – and insurance provides funds that can be structured on a guaranteed basis exactly when they’re needed.
When the client decided his best course would be to purchase insurance, he was presented with four potentially suitable products:
- Universal life insurance with a level cost to age 100
- Universal life with yearly renewable costs to age 85
- A participating whole life policy with a guaranteed 10 pay cost structure
- A participating whole life policy with an early premium offset payment structure
Considerations included outlining the annual premium, the number of premiums required, the accumulative premiums paid, and the death benefit and cash values from each year, up to 30 years.
The internal rate of return (IRR) was another key piece of information that would help the client decide which product represented the best value. The IRR is a financial metric that estimates the profitability of potential investments by indicating the after-tax rate of return that the insurance product produces over time. The higher the IRR, the more value for the client.
As shown in the comparison, the universal life options provide the best IRR in the early years. But since the premium payments must be made over the long term and the death benefit doesn’t increase, the IRR decreases over time.
The whole life options provide the best IRR values over the long term, which the client preferred since he didn’t have to pay premiums throughout the life of the product. The whole life options also provide the largest credit to the corporation’s capital dividend account (CDA) in the shortest time. With corporate-owned insurance, the insurance proceeds less the adjusted cost basis of the policy are credited to the corporation’s CDA. The CDA credit is the tax-free amount that can be paid out of the corporation. The insurance proceeds would be used to pay the tax and since the tax was personally owed, it was important to build a mechanism to transfer funds out of the corporation.
The client decided that the Whole Life Par 7 Pay (Cost to 90) plan was the most suitable for his situation. It provided more than enough liquidity to fund his taxes. It would be funded in about seven years and it produced a reasonable after-tax rate of return over the long term. Additionally, it created an increasing cash value that would be helpful if he needed access to more money.
Once the specific product was settled upon, the client was presented with more detailed policy information to ensure he understood the guaranteed and non-guaranteed aspects of the policy and was comfortable with all its assumptions. When this was completed, the client was aware of all options, including how the rate of return could be increased by using a leveraged arrangement if he was willing to accept additional risk.
How a leveraged arrangement works
- The client maximum funds an insurance policy
- The policy is used as collateral to get a loan against the cash surrender value of the policy
- The client borrows 100 per cent of the deposit made into the policy by providing some additional collateral
- The proceeds of the loan are invested to gain or produce income
- The client deducts the interest expense on the loan and part of the net cost of pure insurance
The client liked the idea of a leveraged arrangement that provides the insurance and gets his funds working without being tied up in the insurance policy. However, although he understood it would minimize the insurance cost while maximizing his return, he decided on the regular-funded insurance policy since he already had the money in the corporation and wanted to avoid incurring any additional long-term debt or complexity.
A fine line
Insurance advisors know that every client’s situation is unique and not every solution is suitable for everyone’s needs. They are also knowledgeable about which products work well in certain situations. There’s a fine line, however, between offering a client enough information to make a sound decision about the plan they might want and overwhelming them with so much information that, in effect, they could be convinced to avoid making any decision at all. Simplifying the process and respecting the client’s tolerance for details up front can mean the difference between meeting their needs and raising the risk of losing a sale, which is as good a reason as any to be cautious with too much information.