Canadian INSURANCE Course

Chapter 1
Insurance Industry
Overview
© CSI GLOBAL EDUCATION INC. (2011) 1•1

1
Insurance Industry
Overview
CHAPTER OUTLINE
Introduction
Role in the Economy
Risks that People Face
Distribution Options
The Insurance Agent’s Role
Types of Insurance Policies
• Life insurance
• Disability Insurance
• Group Insurance
• Annuities
• Critical Illness
• Accident and Sickness
• Long-Term Care
The Underwriting Process
Evolution of the Industry
Financial Ratings
1•2 © CSI GLOBAL EDUCATION INC. (2011)

ONE • INSURANCE INDUSTRY OVERVIEW 1 •3
INTRODUCTION
Life is uncertain. The future is largely unknowable. Insurance helps people remove the risk
associated with going about their lives by compensating them when misfortune occurs.
Insurance is all about managing risk—the financial risk that death, illness or disability would
have on a policyholder as well as his or her dependants.
The insurance industry is of major importance in Canada. According to the Canadian Life and
Health Insurance Association (CLHIA)1, approximately 26 million Canadians own life or health
insurance. By the end of 2009, Canadians owned just over $3.47 trillion in life insurance.
As of the end of 2009, there were 96 life and health insurance companies in operation in this
country. The life and health insurance industry employs over 131,000 people—about 55,000
are full-time employees, and approximately 76,000 are independent agents who earn at least
part of their income from the life and health insurance industry.
Yet the Canadian life insurance industry, which has a long history in Canada, with some
companies in current operation having been in existence for more than a century, has
undergone some radical changes in recent years. Since the middle of the 1990s, powerful
forces such as industry consolidation, the rise of the Internet, historically low interest rates
and changes in the corporate structure of insurance companies themselves (e.g.,
demutualization), have affected this market.
ROLE IN THE ECONOMY
LEARNING OBJECTIVES
After reading this section, you should be able to:
• Describe the history and philosophy behind insurance.
The life insurance sector is just one part of the Canadian financial services sector, which includes
banks, credit unions, finance companies, financial planning firms, investment dealers, money
managers, mutual fund dealers, trust and loan companies, and many other types of firms.
However, broadly speaking, for many decades Canada’s financial system was described as
having “four pillars”: banks, brokerage houses, trust companies, and insurance companies. Up
until the 1980s, these were all distinct segments of the financial services sector, with no cross-
pillar activity taking place. This started to change 20 years ago, as banks were permitted to own
brokerage subsidiaries, trust companies offered some banking services to their customers, and
later, other institutions were allowed to offer insurance through subsidiaries.
1
The source for many of the statistics in this chapter have been adapted from the Canadian Life and Health
Insurance Facts, 2010 Edition published by the Canadian Life and Health Insurance Association (CLHIA) Inc.
© CSI GLOBAL EDUCATION INC. (2011)

1•4 CANADIAN INSURANCE COURSE • VOLUME 1
The result is that the financial world has changed, with the companies that make up these
broad financial pillars now offering a wider variety of products. Banks can offer insurance
products, for example, while insurance companies market a number of savings and
investment related products.
RISKS THAT PEOPLE FACE
LEARNING OBJECTIVES
• State and define three personal risks most people face.
Individuals face many types of risks in their day-to-day lives. The different types of insurance
that are available can ease the financial burdens associated with these risks. Property insurance
covers the risks of economic loss of such items as a person’s home or car due to fire, theft,
accident or natural disaster. Liability insurance provides against economic loss from the
policyholder being held responsible for harming others or their property. Personal insurance
provides against the risk of economic loss resulting from the three personal risks that people face:
death, poor health, and outliving one’s savings. Life insurance provides against loss from death;
critical illness, long-term care, disability, and accident and sickness insurance provide against
economic loss from poor health, and annuities insure against outliving a person’s savings.
Life insurance in its basic form promises to pay a benefit upon the death of the person who
is insured. Life insurance is purchased by people for many reasons, including a desire to
cover the costs of a funeral, to create an estate so that a family can be supported, to pay off
existing debts including a home mortgage, and to settle the expenses of an estate, including
the payment of taxes.
Life insurance is available on both an individual and a group basis, for example to an
employer for the benefit of its employees. Annuities are another product typically associated
with insurance companies, and are a guarantee of payments, often for a retiree, that continue
for either a fixed period of time, or a contingent period, such as the recipient’s lifetime.
Other types of insurance cover other risks that individuals face, not just those associated with
death. Critical illness plans pay a lump sum upon the diagnosis of an illness such as heart attack
and cancer, and as such help protect against any prolonged financial hardship associated with
these diseases. Long-term care plans pay an ongoing monthly benefit to a person if he or she
requires constant care for a prolonged medical condition. Disability insurance helps replace lost
employment income by making insurance payments if a policyholder is unable to work because
of disability. Finally, accident and sickness policies address medical services that are outside of
provincial coverage. Accident and sickness coverage may include the cost of semi-private or
private hospital rooms, vision care, ambulance services, hearing aids and other services.

DISTRIBUTION OPTIONS
LEARNING OBJECTIVES
• Define the primary types of product distribution options in the Canadian life
insurance industry.
• Describe the changes in distribution methods that have evolved in the life
insurance industry (e.g., from “career” companies to “brokerages”).
When people think of how to buy life insurance, they typically think of the oldest and most
established route: personal contact with a life insurance agent. However, there are many ways
that insurance can be purchased in Canada, and through other providers of insurance products
than just the traditional insurance companies. Today’s suppliers, in addition to insurance
companies, include:
• Banks, which are allowed to both own insurance companies and sell insurance products,
subject to many restrictions. For example, bank employees can only sell life insurance if
they are separate from the rest of the bank’s sales force that sells other products (such as
mutual funds and savings products);
• Governments, that provide income protection programs (e.g., Canada Pension
Plan, Employment Insurance) as well as health insurance;
• Fraternal societies that can offer products to their members and, sometimes, to
their members’ families as well;
• Medical care plans that provide coverage in exchange for premiums, offered by groups
such as Blue Cross;
• Investment dealers, through their licensed Investment Advisors, can sell life
insurance products; and
• Mutual fund distributors can also sell insurance products through their
appropriately licensed registrants.
The ways of distributing life insurance to people are also changing. The basic route is
through the insurance agent, an individual authorized by an insurance company to represent
that company and its products to potential customers. Decades ago, insurance companies
looked at single means of distributing life insurance, typically through large teams of career
sales agents who represented that one company only in face-to-face contact with clients.
Today, a greater number of insurance firms are concluding that selling to the broadly based
middle-income market through the traditional channel of the career agent is not as profitable as it
once was. In an effort to adapt to today’s more competitive world, companies are looking at
multiple channels to distribute their products. Most firms have either disbanded or reduced their
groups of career sales agents and instead use a network of agents, dealers, brokers and other non-
traditional means of distributing their products. This can include sales through the mail, through
agents selling multiple products, online/web-based sales, or sales in non-traditional locations

(such as stores), all with a heavy reliance on firm advertising and brand recognition, as
opposed to an earlier, personal relationship.
Yet at the same time as companies explore new channels for distribution, they are facing the
challenge of eating into existing sales, thus “cannibalizing” the market. Still other companies
are finding that once promising outlets such as the Internet may serve the customer’s needs for
purposes of price comparisons, but are lacking in the advice and sales support areas, and thus
not generating as many sales as first thought.
THE INSURANCE AGENT’S ROLE
LEARNING OBJECTIVES
• Describe the life agent’s role in the sales and distribution process.
• State the major functions of the life agent.
• Explain the terms “pre-sale service” and “post-sale service” as they apply to the life agent.
Insurance agents are in the service business. Therefore, it is the role of insurance agents not
merely to sell a product, but also to fully and accurately meet the needs of their clients. This
is the concept of total needs planning: providing for meeting the needs of the client as they
face life’s risks. There are three types of personal risks people face: risks during life, risk of
death, and risk of disability. Thus, total needs planning includes understanding the needs of
the client, the products and services that the client already has, and the services that the
insurance agent has available to offer.
This process continues to be necessary as customers are becoming more sophisticated, requiring
integrated and independent advice. From the insurance company end, many companies
have downsized their career-agency forces, while at the same time setting higher
standards of productivity for those who stay. All of this is occurring in a world where the
traditional role of agents and brokers is constantly changing.
There are two basic points where the agent serves his or her clients:
• Pre-sale service includes the entire interaction with a client, from the time of
obtaining the initial referral or making the initial contact, through the assessment
of needs and application/documentation completion.
• Post-sale service includes the actions that the agent undertakes after the insurance
policy has been written. This includes delivery of the policy itself, explanation of
coverage review and answering any questions that the insured may have, and reviews
of other policies that the client may have and how this policy integrates with and meets
client’s needs. It could also include analysis of the client’s overall retirement and
financial needs. It extends to assisting in the settlement of either life or health claims.
Post-sale service is an ongoing process, as peoples’ needs change over a period of time. It is
not a one-time event for the life insurance agent.

TYPES OF INSURANCE POLICIES
LEARNING OBJECTIVES
• Describe insurance products and their benefits, including Life Insurance, Group
Insurance, Annuities, Critical Illness, Long-Term Care, Disability Insurance, and
Accident and Sickness Insurance.
There are a wide variety of insurance products that can be offered, in an almost endless
variety of ways. However, the major types of insurance products include:
Life insurance
In its basic form, life insurance pays a benefit to a beneficiary upon the death of the life
insured. Though there are many types of life insurance that have been developed, they fall
into two basic categories: permanent and term insurance.
Permanent insurance, also known as whole life insurance, is characterized by level premiums
that are more than the actual cost of insurance protection in the early years of the policy. This
extra, or cash value, can be used for retirement, savings, or financial emergencies. If a policy
is given up, the purchaser of the policy is entitled to this cash value.
Term insurance provides a benefit upon the death of the life insured but does not provide any
cash value. While the premiums for this type of insurance are initially lower than for permanent
insurance, they rise over time to reflect higher mortality rates, as the life insured becomes older.
Within Canada, at the end of 2009, of the total amount of individual (non-group) life
insurance in force, 55% was term insurance, while 45% was permanent insurance.
Disability Insurance
Disability insurance helps replace lost employment income by making payments if a person
is unable to work because of disability. Benefits are usually integrated with those from
government plans such as the Canada/Quebec Pension Plan, Workers’ Compensation, and
Employment Insurance so that total benefits do not exceed a certain proportion of the
normal earnings of the individual covered.
In 2009, 11.6 million people in Canada were covered by short term disability plans (which
have benefits starting the first day off work or shortly after, and continuing for a limited
number of weeks) and/or long term disability plans (starting after a certain number of weeks
and continuing payment for a stated term or until a certain age is reached).

Group Insurance
Group insurance is issued, usually without a medical examination, on a group of people
under one contract—typically issued to an employer for the benefit of its employees. In most
cases, the dependants of the group members are also covered. Insurance companies provide
such group insurance to a wide variety of groups (such as professional or fraternal groups), in
addition to employers. Individual insurance is purchased on an individual basis, covering a
single policyholder or sometimes members of his or her family.
Annuities
Annuities are a regular stream of payments, typically made to a retiree, at predetermined
intervals, such as monthly or annually. They last for either a set period of time (i.e. 20 years), or
a contingent period (i.e. the lifetime of the recipient). They include both registered and non-
registered group retirement plans, as well as individual contracts administered by life insurance
companies. Group retirement plans include group registered retirement savings plans (RRSPs),
deferred profit sharing plans (DPSPs) and group annuities. Individual contracts include life
annuities and registered retirement income funds (RRIFs).
In 2009, Canadians paid premiums for over $17.1 billion of individual annuities
and $19.3 billion of group annuities, for a total of over $36 billion.
Critical Illness
Critical illness insurance protects against the financial hardship caused by serious health problems
such as heart attack, stroke or cancer. It is sometimes referred to as dread disease coverage. This type
of policy pays a lump sum to the insured shortly after the diagnosis of the condition. Group or
individual critical illness plans covered about 1.1 million people in Canada at the end of 2009.
Accident and Sickness

Accident and sickness policies, as stated previously, address medical services that are outside
of provincial coverage. The coverage may include the cost of semi- private or private
hospital rooms, vision care, ambulance services, hearing aids and other services.
Long-Term Care
Long-term care policies pay an ongoing monthly benefit to a person if he or she requires constant care
for a medical condition. Long-term care includes a range of services that provides health and personal
care for individuals who are unable to care for themselves. Services range from providing care in the
individual’s own home and include part-time skilled nursing care to providing care
in chronic care hospitals, adult day care centres, or retirement lodges. Long-term care
insurance provides a source of funds to pay for these services.

THE UNDERWRITING PROCESS
LEARNING OBJECTIVES
• Explain the insurance underwriting process and the agent’s role in the process.
Insurance is about, at its core level, identifying and correctly pricing certain risks. An individual
transfers risk by shifting the financial burden of the risk away from themselves to an insurance
company, in exchange for a fee. The insurance company, for its part, must set that fee at a level
to both reimburse it for the financial responsibility it undertakes and provide for a profit for
doing so, by correctly pricing risk. Underwriting is the process of both identifying the risks that
a proposed insured person presents, and classifying the degree of risk from this. The individual
at an insurance company who evaluates these proposed risks is known as an underwriter.
The life insurance agent plays a front-line role in the underwriting process. It is the agent’s job to
carefully and fully collect information from the potential client, and complete the medical history
and explanation of the applicant’s exact job duties component of the life insurance application, to
properly and speedily issue a policy. It is also the agent’s responsibility to inform the client about
the importance of providing accurate information to the agent.
Whether it is life insurance, or long-term disability insurance, underwriters have identified a
range of factors that either increase or decrease the likelihood that a policyholder will suffer an
insured loss. These include both medical and physical factors (medical history, age) and lifestyle
factors (smoking, dangerous recreational hobbies). Once these risks have been identified, they are
classified into categories for the determination of appropriate premium rates to be charged for the
insurance coverage that is requested. This is due to the fact that people in differing risk categories
are charged different premium rates for insurance that is otherwise the same.
There are three broad categories of risk: standard risks (average likelihood of risk loss),
substandard risks (still insurable, but with significantly greater than average likelihood of
risk loss) and declined risks (uninsurable as the risk is too great).
In 2009, approximately 96% of applications for individual life insurance were accepted either on
a standard or substandard basis. Of the 4% that were declined, about 20% were rejected for heart
disorders, 6% for diabetes, 4% for cancer, 50% for other serious health problems, and the rest for
non-medical reasons. Underwriting, issues and claims are covered in detail in chapter 6.

EVOLUTION OF THE INDUSTRY
LEARNING OBJECTIVES
• Describe the difference between federally and provincially chartered life
insurance companies in Canada.
• Explain the differences among stock companies, mutual companies and fraternals.
• Describe the size of the life insurance marketplace.
In Canada there is no single regulatory body that is responsible for the entire financial services
industry. Responsibility is divided between different organizations and between the federal and
provincial governments. For example, banks are federally regulated, while security dealers and
credit unions are provincially regulated. Insurance companies, along with trust and loan
companies, may either be federally or provincially regulated, depending on the location
where the company was registered or incorporated.
A provincially regulated insurer has the right to operate in a province other than its province of
incorporation as long as that insurer obtains the necessary licences from other provincial
insurance authorities. Typically, though, in this case only one of the provincial jurisdictions
will undertake the supervision of the provincially regulated insurance company.
Of the 96 active life insurance companies in Canada, 72 are registered under federal laws,
while 24 are provincial. Though 75% of all life insurance companies are federally
registered, they received 87% of the total premiums for all lines of business.
Well-known companies that are federally registered include Canada Life Assurance
Company (founded in 1847), Sun Life Financial (received charter in 1865), and Manulife
Financial (founded in 1887).
Insurance companies have their internal business affairs arranged in one of three ways. On
of the major ways is as a stock company. The individuals or institutions who have purchased
its shares own the insurance company, like other stock companies. The insurance company’s
profits, or earnings, may be retained by the company to fuel future growth, or can be
distributed to stockholders in the form of stockholder dividends.
Insurance companies can also be organized as mutual companies, which are owned
mutually by the policyholders themselves. Such companies tend to be older and fewer in
number than stock insurance companies. Profits made by the company can be distributed to
the company’s owners, the policyholders, in the form of policy dividends.
Beginning in 1999, a number of well-known names in the insurance field went through the
process of demutualization, where mutual companies reorganized themselves into companies
that issued stock, which then traded on stock exchanges. The result is that the ownership of the
insurance company changes from ownership by its customers, or policyholders, to one that is
owned by stockholders, who may or may not be customers. The benefits of demutualization to
insurance companies included an ease of raising future capital via the stock market, and the
ability to more easily merge with other insurance companies.

ONE • INSURANCE INDUSTRY OVERVIEW 1•11
Companies that have demutualized include Mutual Life Assurance Company of Canada
(which changed its name to Clarica Life Insurance Company), Manufacturers Life Insurance
Company, Canada Life Insurance Company, Industrial-Alliance Life Insurance Company,
and Sun Life Assurance Company. Clarica is now a part of the Sun Life Financial group of
companies. Canada Life is a subsidiary of Great West Life Assurance Company and both of
them in turn are members of the Power Financial Corporation group.
Fraternals are organizations that provide a range of social benefits to their members,
which can also include insurance. Most fraternal benefits societies have members who
share the same type of occupation or ethnic, cultural, or religious background. Fraternals
historically have operated through a local lodge system, and only fraternal members and
their families are allowed to own insurance issued by the fraternal society.
Examples of fraternals operating in Canada include the ACTRA Fraternal Benefits
Society (for television, radio and stage performers), the Knights of Columbus,
Independent Order of Foresters and the Lutheran Life Insurance Society of Canada (Faith
Life Financial is the official trade name).
A number of changes has occurred within the life insurance industry. Consolidation of life
insurance companies has been a major trend within the industry. Between 1996 and 2009,
the number of active life insurance companies has decreased from 131 to the current level
of 96 companies.
In addition, as the insurance market has broadened, the people selling insurance have
changed as well. Insurance has moved from being sold by career agents who were selling
the products of one company only, to financial service representatives who offer a range of
financial savings and protection products, including life insurance.
As of the end of 2009, Canadians owned just over $3.47 trillion in individual and group
life insurance.
Year Total Life Insurance (Millions)

1980 $431,194
1990 $1,157,395
2009 $3,474,000
Geographically, about 41% of the total individual life insurance held in the country is owned
in Ontario, 22% in Quebec, 18% in the Prairie provinces, 13% in British Columbia, and 5%
in the Atlantic provinces.
Growth in individual insurance has been on an upward trajectory since 1980. At that time,
individual insurance accounted for just over 40% of the total life insurance owned by Canadians.
The remainder was accounted for by group insurance. By the year 2009, individual insurance had
grown to exceed group insurance, accounting for 55% of the total insurance ownership.
Excluding those Canadians not covered by insurance, the average amount of life insurance
per person was about $169,000 by the end of 2009.

In 2009, Canadians purchased $311.6 billion of life insurance: $205.7 billion in

individual insurance and $105.9 billion in group insurance.
About half of the individual life insurance policies sold in 2009 involved some component
of permanent life insurance, with the other half being term policies. Since term policies
tend to be for larger dollar amounts, they accounted for two-thirds of the total dollar value
of insurance purchased in 2009.
In 2009, total payments to policyholders of life and health insurance policies, as well as annuities,
amounted to $58.6 billion. Of the $58.6 billion, 45% was paid out under annuity contracts, 37%
under health benefit plans, with the rest from life insurance policies and dividends
to policyholders. To give a meaningful statistic regarding the scope and importance of
the life insurance industry, consider that benefits were paid out at the rate of a little
more than $1.1 billion a week.
FINANCIAL RATINGS
LEARNING OBJECTIVES
• Explain the process of evaluating the financial ratings of insurance companies.
In addition to regulation by the government, insurance companies are monitored by a number
of independent companies. These rating agencies assess the financial health of insurance
companies, and their creditworthiness with respect to the financial obligations they have due to
their outstanding insurance policies. This information is important to consumers, distributors,
regulators, stock and bond holders, and all participants in the financial marketplace.
For example, A.M. Best has been assessing the financial strength of insurance companies
worldwide for over 100 years, and reviews Canadian companies thoroughly through A.M.
Best Canada. Their ratings provide a useful benchmark to evaluate a company’s operations
and competitive positioning. While different rating agencies have slightly different
methodologies for assessment, A.M. Best, for example, assesses an insurance company’s
financial strength, ongoing operating performance (which can affect its financial strength),
and market profile which drives a company’s current and future operating performance.
A.M. Best has 16 different rating levels, ranging from A++ to S (representing a suspended
rating). These are grouped into descriptive categories. For example, “Superior” is A+ and A++,
“Excellent” is A and A-, and “Good” is B++ and B+. All of these ratings are considered to be
secure, in that insurance companies with these ratings are seen to be stable, and able to withstand
adverse changes in economic conditions. Companies with ratings below the B+ level are seen as
vulnerable to negative changes, and are considered to be higher risks.
In addition to A.M. Best, other ratings agencies, which cover a broad range of industrial
companies, also review insurance companies. These companies include Moody’s
Canada and Standard and Poor’s Canada.

Chapter 2
Individual Life
Insurance Products

2
Individual Life
Insurance Products
CHAPTER OUTLINE
Introduction
Needs Met by Life Insurance Products
• Personal Needs
• Personal Life Insurance and Taxation
• Business Needs Met by Life Insurance Products
• Business Life Insurance and Taxation
• Choosing a Life Insurance Policy to Suit Specific Needs
Term Life Insurance
• How Term Insurance Works: An Example
• Advantages and Disadvantages of Term Life Insurance for the Policyowner
• Level Term, Increasing Term, and Decreasing Term Insurance
• Renewable, Non-Renewable, and Convertible Term Insurance
• Choosing Term Insurance to Meet Specific Needs
Permanent (Whole) Life Insurance
• Term Insurance vs. Permanent Insurance
• Advantages and Disadvantages of Whole Life Insurance
• Participating vs. Non-Participating Whole Life Insurance
• Premium Offset Policies and Dividend Projections
• Guaranteed and Adjustable Whole Life Insurance

Universal Life Insurance
• Unbundling the Three Pricing Factors
• Yearly Renewable Term and Level Cost of Insurance Mortality Costing
• Guaranteed and Adjustable Mortality Costs
• Impact of Investment Choices on the Viability of a Universal Life Contract
• Early Withdrawals, Loans, and Leveraging
Choosing Permanent Insurance to Meet Specific Needs
Supplementary Benefits and Riders
• Waiver of Premium Rider for Disability Benefit
• Waiver of Premium for Payor Benefit
• Disability Income Benefit
• Accidental Death and Dismemberment
• Accelerated Death Benefit Riders and Common Accelerated Death Benefits
• Term Insurance Riders on Permanent Life Insurance Policies
• Guaranteed Insurability Benefit or Guaranteed Insurability Option
• Paid-Up Addition Rider
• Split-dollar Arrangements
Insurance Policy Limitations, Provisions, and Beneficiaries
• Standard Policy Provisions
• Additional Provisions in Permanent Life Insurance Policies to Access Accumulated Cash Value
• Primary and Contingent Beneficiaries
• Preferred Beneficiaries and Policies Issued Before 1962
• Revocable and Irrevocable Beneficiary
• Absolute Assignment of a Life Insurance Policy
• Policies Issued Before 1982
Individual Life Insurance Products to Meet Specific Client Needs

INTRODUCTION
As an agent, your livelihood depends on your ability to prospect for clients and to provide those
clients with insurance. In doing so, your objective is not just to sell insurance products. Your
objective is to advise and offer solutions to your clients that entail the use of insurance products
to meet their financial and estate planning needs. To provide that service you must have a
thorough knowledge about the wide range of life insurance products on the market today and the
provisions and benefits they represent. That knowledge is important as you assist your clients to
plan for their future by establishing financial objectives and by addressing the personal risks that
could prevent them from meeting their goals. In this chapter, you will learn about the
characteristics and features of life insurance products. You will also learn about the ways in
which life insurance can provide financial and estate planning solutions in both a personal
and business setting.
Throughout this chapter and in other chapters also, you will come across the
following terms: “insured”, “policyowner”, “policyholder” and “life insured”.
Confusion arises because although most life insurance contracts are two-party
contracts, there are many instances of third-party contracts. Here is what these
terms ordinarily imply:
In a two-party contract, the insured, policyowner, policyholder and life insured is the same
person, the other party being the insurer. However, in a third-party contract, it is the insured or
policyowner who insures the life of another person (for instance, a spouse), and so there are three
parties to such a contract: the insured/policyowner/policyholder, the life insured and the insurer.
Policyholder and policyowner generally mean the same thing and refer to the person who owns
the policy. Again, in a two-party contract, the policyowner/policyholder is also the life insured.
Example: Ruston, a father of three and husband of Rita, buys a $100,000 life insurance policy
on his own life from Celestial Life Insurance Company.
Here Ruston is the policyowner, policyholder, insured and life insured. Celestial is the
second party, the insurer.
If Ruston instead decides to purchase a policy on the life of his wife, Rita, it becomes a third-
party contract where Ruston is the policyowner, policyholder and insured, Rita is the life insured
and second party, and Celestial is the third party, the insurer.

TWO • INDIVIDUAL LIFE INSURANCE PRODUCTS 2 •5
NEEDS MET BY LIFE INSURANCE PRODUCTS
LEARNING OBJECTIVES
• identify the personal needs met by life insurance products;
• discuss reasons why a business should purchase life insurance;
• explain the nature of business continuation insurance;
• explain how businesses might use a buy-sell agreement;
• explain the benefits to a business of purchasing key person life insurance;
• explain the tax-favoured treatment of the proceeds of a life insurance policy to
the beneficiary for both personal and business life insurance policies;
• explain the benefits of using life insurance proceeds to help defray the capital gains
taxes triggered by death for both personal and business life insurance policies;
• given several case studies containing specific client information, select the most appropriate
insurance product category: for example, life, disability, critical illness, accident and sickness;
• select the most appropriate individual life insurance products to match a particular
client’s situation and needs.
Personal Needs
Life insurance allows people to address the financial risks of dying too soon, living too long, or
becoming disabled. These risks mean that individuals cannot provide the necessities of life for
their surviving family members or repay mortgages, loans, taxes or other financial obligations.
DYING TOO SOON

Most individuals earn the financial resources they need to live comfortably and acquire assets
from a salary, commissions, or business income. These sources of income end when the
individual dies. If the individual dies too soon, he or she may not have met all of his or her
obligations, whether it is a loan or mortgage to be repaid, or building up sufficient financial
resources to allow family members to continue to live as they are accustomed to do. Life
insurance in its many different forms can help address the risk of dying too soon.
Life insurance can provide:
• an estate for someone who does not have many assets to pass along to surviving heirs;
• funds to provide a continuing income to the beneficiaries;
• the financial resources to help children pursue their education;
• funds to ensure that the family has free and clear possession of the family home or
other family assets;
• money to pay income taxes, probate fees or to pay off debts;

• an emergency fund for survivors after the death of an income earner;

• funds to pay final expenses such as funeral and burial costs and also cover legal and
executor fees.
LIVING TOO LONG

Individuals who outlive their financial resources may face a life of poverty or may have to
rely on the goodwill of others to survive. Life insurance products, such as deferred and
immediate annuities, can address that risk by allowing individuals to put money aside so
that one day, they will have an income that is guaranteed for life with an annuity.
Life insurance companies offer a wide range of annuities to help individuals accumulate funds
to provide for an income during their retirement years. Deferred annuities offer individuals the
opportunity to contribute to plans that allow for the accumulation of savings using various
financial products, such as interest-bearing accounts or segregated funds that invest in equities.
When the individual retires, he or she can choose to receive a retirement income in one of
several ways.
The most common retirement income plan is an annuity policy that guarantees the holder a
regular income for a specific period or for life. Life annuities may have additional
guarantees available upon the annuitant’s death. Some pay the annuity for a specific period
and the payments continue to a named beneficiary if the annuitant dies during the
guarantee period. Annuities may also be offered on a joint-and-last-survivor basis,
whereby the annuity payments continue after the death of one of the joint annuitants.
Payments cease only upon the death of the surviving annuitant.
BECOMING DISABLED
Life insurance products have been developed to address the needs of individuals who suffer a
critical illness, or who for health reasons cannot care for themselves. Life insurance
companies also offer disability income plans that provide a regular income to a policyholder
who has suffered a disability.
OTHER USES
In addition to addressing the risks that everyone faces, life insurance can help people
achieve certain financial goals.
For example, Eva wants to make a significant contribution to her favourite charity. She does
not have the means to make a large gift, and her salary level does not allow her to
accumulate the kind of gift she has in mind. She can apply for a life insurance policy and
appoint the charity as the beneficiary. For a relatively small regular premium payment she
can ensure that when she dies, the charity she chose will benefit from her gift.

TWO • INDIVIDUAL LIFE INSURANCE PRODUCTS 2•7
Personal Life Insurance and Taxation
TAX-FAVOURED TREATMENT OF LIFE INSURANCE PROCEEDS

Under the current Income Tax Act, death benefit proceeds from a life insurance policy
are not considered a taxable benefit to the person who receives them. Because of this
favourable tax treatment, individuals can carry out estate planning without having to
discount the amount to be paid because of tax owing on the benefit paid. Beneficiaries of
a life insurance policy can be assured that they will receive the proceeds of the policy in
their entirety, without tax consequences.
For example, a parent who has established an insurance program to meet the educational
needs of her children can be sure that when she dies, all the policy proceeds will be
available to set up a fund to provide for the children’s education. Similarly, if an individual
buys life insurance as a form of mortgage insurance, he knows that the entire death benefit
will be applied to the mortgage.
USING LIFE INSURANCE PROCEEDS TO DEFRAY CAPITAL GAINS TAXES

When an individual dies, the executor of the estate must complete a final tax return. In the final
tax return, all of an individual’s income from all sources, earned up to the date of death and not
previously taxed, becomes subject to income tax. At the same time, any capital property that an
individual owns is considered disposed of (that is, treated as if it had been sold) for income tax
purposes. The difference between its fair market value and its original cost is the capital gain or
loss. For any property that has a capital gain (that is, the fair market value exceeds the original
cost), the excess amount must be reported as capital gain income; 50% of that amount is taxable.
Although life insurance represents a valuable asset to an estate, the amount of the life
insurance benefit paid out either to the deceased’s estate or to a named beneficiary is not
considered a taxable amount for income tax purposes.
Life insurance is therefore a valuable tool for defraying the potentially large tax liability for
the capital gains realized upon a property owner’s death. Rather than the heirs of a deceased
property owner having to sell a property in order to obtain the funds necessary to pay the
taxes, they can use life insurance proceeds to pay the taxes.
The executor of an estate must ensure that all of the taxes owing on the income, assets, and
capital property of the deceased have been satisfied before the property can be delivered free
and clear to the beneficiary. In fact, the Income Tax Act makes both the executor and the
beneficiary “jointly and severally liable”(either the beneficiary, the executor or both
together) for any unpaid income taxes owing on assets that are transferred to the beneficiary
under the terms of a will, or directly, outside of the will, to a named beneficiary.
If the person who died had enough life insurance, the beneficiary can take possession of the
deceased’s property, without any current taxes owing. The assets will be transferred, and
their cost to the beneficiary will be deemed to be the fair market value of the property at the
time of the deceased’s death. The beneficiary will be liable only for the taxes owing on any
value that accrues after assuming ownership.
It should be noted that assets left to one’s spouse are deemed to have been sold
immediately before death at cost; therefore, no capital gains arise on the “rollover.” On
the spouse’s death, however, the entire capital gain based on the original purchase price
would be included for income tax purposes.

Business Needs Met by Life Insurance Products
THREE FORMS OF BUSINESSES

In Canada most businesses are operated as sole proprietorships, partnerships, or
incorporated businesses owned by one or a small group of shareholders.
A sole proprietorship is owned and operated by one person. There is no distinction between
the assets and liabilities of the business and the individual. All of the individual’s assets and
resources are used to satisfy the debts and obligations of the business. If the sole proprietor
suffers a serious disability, the business will probably close, because its success depends on
the talents and efforts of the individual. If the sole proprietor dies, the business ceases.
A partnership is an association of two or more individuals who operate a business for
profit. As general partners, each individual is liable for the debts and obligations of the
other partner(s). Usually, each partner contributes capital or work effort to the business. If
one partner becomes disabled, the partnership may suffer, since the disabled partner may
continue to receive distributions from the partnership under the terms of the partnership
agreement. If one of the partners dies, the partnership ceases. The remaining liabilities of
the partnership are the responsibility of the surviving partner(s).
An incorporated business is an entity that is separate from the people who own it. When an
individual incorporates a business, he or she establishes a separate legal entity and limits his
or her liabilities to the amount of his or her investment in the business. The individual’s
personal assets and liabilities are not mingled with those of the corporation. Unless the
individual personally guarantees the debts and obligations of the corporation, the
corporation’s liabilities remain with the corporation. If the individual, as a major shareholder
of the corporation, dies, the corporation continues to exist.
WHY BUSINESSES PURCHASE LIFE INSURANCE

Insurance can help address the needs of the individuals who engage in any of these three
forms of business.
Disability insurance can provide much needed income if the sole proprietor becomes ill or
disabled. Life insurance can also be used to fulfil any remaining obligations, such as business
loans and employee salaries, if the business is wound up on the death of the sole proprietor.
The disability or death of a partner usually has similar consequences to those facing a sole
proprietorship. A disabled partner cannot contribute his or her services to the partnership, even
though the partnership’s commitments remain. A partner’s death dissolves the partnership. In
addition to outstanding liabilities that must be satisfied by the surviving partners, the heirs
of the deceased partner may expect to receive some benefit from the deceased’s interest in the
partnership arrangement. Disability and life insurance can support the financial well-being of the
partnership and of the partners who are left when one partner becomes disabled or dies.
Although a corporation survives the death of its principal shareholder, he or she may have been
essential to the business. The shareholder’s shares are capital property that will pass to his or
her beneficiaries. Surviving shareholders may want to acquire the deceased’s shares to maintain
the day-to-day operation of the business without the involvement of the beneficiaries, who may
have no knowledge of the business and who may want to withdraw assets from the business in
the form of dividends without helping to maintain or grow the business. Life insurance, in this

situation, allows the surviving shareholders to buy the deceased’s shares from the beneficiaries
and provides capital to maintain the business after the loss of an important contributor.
BUSINESS CONTINUATION INSURANCE

Small businesses, whether sole proprietorships, partnerships, or private corporations, depend on
one or a few principal owners to ensure the continued operation of the business. If one of the
principal owners dies, the business will not only lose the revenues that that person generated,
but creditors may also require the repayment of any loans or liens that were guaranteed by
the deceased owner. The family of the deceased may insist on the disposal of business
assets to provide a legacy to the deceased’s heirs or payment from the surviving owners
in exchange for their ownership interest in the business.
Business continuation insurance is intended to ensure the survival and continuation of a
business by providing insurance proceeds to compensate in part for financial losses
resulting from an owner’s death.
ESTABLISHING A BUSINESS LIFE INSURANCE PLAN

Life insurance plans can be established in a number of ways, depending on the nature of
the business.
Sole Proprietorship
In a sole proprietorship, upon the death of the proprietor, all of his or her assets and liabilities,
including the assets and liabilities of the business, pass to the deceased’s estate. The estate must
repay any debts and obligations left by the proprietor. The executor of the estate may have to sell
the business assets to satisfy those obligations. The executor must also consider provisions of the
will that are intended to provide for the deceased’s family or other beneficiaries. Former
employees may also seek some financial compensation from the business. The pressure to
meet all these obligations may force the executor to sell off or liquidate the business assets at
prices lower than their fair market value, leaving the heirs, other owners, or employees with
far less than an unforced sale would have realized.
Under such circumstances, life insurance on the life of the sole proprietor can produce
liquid funds at the right time to repay creditors and provide for the needs of the family,
other beneficiaries, and employees. Insurance may even provide enough money to fund
the continuation of the business under the direction of the employees.
Partnership
In a partnership, there are financial consequences after the death of one of the partners who has
contributed financial support or personal services to the success of the business. The surviving
partners may want to continue the business under a revised partnership arrangement. If so, those
partners must determine the financial interest that the deceased held in the partnership and
reimburse the deceased’s heirs for the value of that interest. At a time when the business may be
struggling to overcome the loss of one of its contributors, the surviving partners may not have
enough money to satisfy the interest owing to the beneficiaries of the deceased’s estate.
The proceeds of life insurance on the life of the deceased partner can be used to meet these
obligations. Life insurance can be owned by someone other than the person whose life is insured
provided there is a financial interest in the life of the insured person, and the owner can be the
beneficiary of the life insurance proceeds. The partners can therefore take out life insurance on

each other’s lives and be the beneficiaries of those plans. When a life insured partner dies, the
beneficiaries receive the insurance proceeds. They can apply those proceeds to maintaining
the business or acquiring the deceased’s interest in the partnership from his or her heirs.
Corporation
In a corporation, the interest of any one of the owners is determined by the value of the
owner’s shares in the business. When one of the shareholders dies, the shares become part
of that person’s estate, subject to disposition under his or her will. The executor may be
authorized to sell the deceased’s shares or transfer them to a beneficiary named in the will.
Shares of a private corporation may have little liquidity. In other words, there may be no
one willing to buy the shares, since the shares may be of value only to the surviving
shareholders and the beneficiaries who inherit them.
The beneficiaries may continue to hold the shares and receive income in the form of
dividends, or they may benefit from an increase in the value of the shares over time.
However, the beneficiaries may have no interest in the day-to-day operation of the business,
nor may they have the right skills to contribute to its success.
If the deceased was the only shareholder, the shares will have little value, since the value of the
business relied on the deceased’s efforts. The business may have to be wound up and the assets
sold at less than their fair market value to pay off creditors and provide for family members.
If there are other shareholders, they may not want to use corporate earnings to pay dividends,
but may want to retain earnings in the company to keep it going.
Life insurance can help solve these problems. A shareholder can acquire life insurance on his
or her own life and name the business as beneficiary. As a corporation survives the death of a
principal owner or shareholder, life insurance proceeds paid to the corporation can be used to
maintain the business or to acquire the shares from the deceased’s beneficiaries.
Alternatively, the corporation itself can take out insurance on the life of a principal
shareholder and name itself as beneficiary. The corporation will receive the life insurance
proceeds, which can be used to acquire the deceased’s shares or invested in the corporation.
BUY-SELL AGREEMENTS
Businesses with more than one partner or shareholder must consider the following questions:
• What happens when one partner or major shareholder dies?
• How will the value of the deceased’s interest in the business be determined upon his
or her death?
• Will the life insurance proceeds be used for the purpose they were intended?
One way to address these concerns is by establishing buy-sell agreements that set out the
terms and conditions under which a deceased’s interest in a business will be transferred to
other interested parties. The buy-sell agreement will usually include, among other things, a
commitment by one person to purchase the financial interest of a second person in a business
following the second person’s death, and by the second person to direct his or her estate to
sell his or her interest in the business to the first person.

Sole Proprietorship
In this form of business, the most likely participant in any agreement to sell a business
interest is a key employee of the business. The buy-sell agreement may specify the method
of transferring the business and either assign it a predetermined value or stipulate some
formula for determining its value.
The employee agrees to buy the business from the estate. The employee purchases a life
insurance policy on the life of the sole proprietor. The policy names the employee as the
beneficiary. When the sole proprietor dies, the employee will use the insurance proceeds to
acquire the business interest as specified under the terms of the buy-sell agreement.
Partnership
A partnership buy-sell agreement is usually described as a criss-cross agreement. Each
partner agrees to acquire a proportionate share of a deceased partner’s interest. The buy-sell
agreement states the terms and conditions of the purchase and commits each surviving
partner to abide by the terms of the agreement. The buy-sell agreement also establishes a
value or a formula for determining a value for the business at the time a deceased partner’s
interest is purchased by the surviving partner(s).
Each partner purchases life insurance on the life of each of the other partners. The purchasing
partner pays the premiums and is the beneficiary of the policy. Depending on the number of
partners, several policies may be required to meet the obligations to buy a deceased partner’s
interest. Partners may jointly own a policy on the life of one of the partners or establish a trust
that owns the policies and receives the funds to pay the premiums. In Canada, it is not a usual
practice for the partnership itself to own the life insurance policy.
John, Betty and David are equal partners in a manufacturing firm. If John died, it would
make the most sense for Betty and David to purchase John’s interest in the firm from his
estate. That way, John’s family has the money from the sale of the interest and Betty and
David can continue running the business as equal partners. Having a buy-sell agreement in
place will outline who will buy the interest, for how much, and how that sale will be funded.
Corporation
A buy-sell agreement can be arranged among a corporation’s shareholders to purchase each
other’s shares, or the corporation itself can participate in a buy-sell arrangement to purchase
the shares of a deceased shareholder.
Each shareholder may own and be the beneficiary of an insurance policy on the lives of
each of the other shareholders, or the corporation itself can purchase life insurance on the
life of each shareholder and be named as beneficiary. In either case, the insurance proceeds
are used to purchase the deceased’s shares from his or her estate.
KEY PERSON LIFE INSURANCE

Key person life insurance addresses the financial risk to a business of losing the contribution of an
important employee, proprietor, partner, or shareholder through death. The revenues generated by
the key person’s efforts will cease and the business needs cash flow to meet its obligations.
Creditors will seek assurances that the business can continue to function without that person and,
in the worst case, will call in outstanding loans and liens. Key person life insurance provides a
temporary cash flow to the business to allow it to meet its liabilities and raise (or, at least,
maintain) creditors’ confidence that the business can survive the sudden loss of a key contributor.

Typically, the business takes out insurance on the life of the key person and the business is named as
beneficiary. Determining how much insurance is sufficient means estimating the value of the
contribution that the key person makes to the success of the business. The amount of insurance may
represent the present value of future earnings that the business would forgo because of the key
person’s death. Alternatively, the person’s bottom-line contribution to profits can be used
to calculate the amount of insurance required. For example, if the key person’s work
accounts for 30% of business profits, then a policy in that amount will be purchased and
payable to the business.
At the same time, the business must look for someone with adequate abilities to replace
the talents of the deceased. Life insurance can provide a financial cushion to allow time to
find and train a suitable replacement. The business can estimate these costs and buy a
policy in that amount that is payable to the business.
Key person insurance, like other forms of life insurance, is exempt from taxes. The business can
rely on the entire proceeds to address the financial loss expected from the key person’s death.
Business Life Insurance and Taxation
TAX-FAVOURED TREATMENT OF LIFE INSURANCE PROCEEDS

For shareholders of private corporations, life insurance has another important application. When
a shareholder dies, the fair market value of his or her shares, less their cost base (the amount that
the shareholder originally paid for them), is considered a capital gain to be reported in
the shareholder’s final tax return. The shareholder’s estate then takes ownership of the shares
at an adjusted cost base equal to their fair market value. In a share repurchase agreement, the
corporation agrees to purchase the deceased’s shares from the deceased’s estate. The
corporation may pay for the shares using the proceeds of a life insurance policy on the life
of the deceased shareholder in which the corporation is named as beneficiary.
USING LIFE INSURANCE PROCEEDS TO DEFRAY CAPITAL GAINS TAXES

Policy proceeds payable to the corporation as beneficiary, upon the death of a shareholder, are not
taxable (similar to what happens with personal life insurance). The method that the corporation
uses to acquire the shares from the estate affects the way in which the deemed capital gains from
the shares are treated in the deceased shareholder’s final tax return. The policy proceeds may be
distributed as a tax-free capital dividend using the corporation’s capital dividend account.
This is a complex application of the proceeds of a life insurance policy to defer a tax liability
in a business situation. It highlights the critical importance of a proper life insurance
program in planning for the transfer of assets for owners and shareholders of private
corporations. This topic will be covered in greater depth in Chapter 7 on Taxation.

Choosing a Life Insurance Policy to Suit Specific Needs

The following examples illustrate the importance of carefully assessing a situation in order
to choose the best possible product or combination of products for a client. In many cases,
the first product that comes to mind may be inadequate to cover the situations that might
arise. It is also imperative to review clients’ needs as their circumstances change.
Example 1: Young Parent Dying Suddenly with a Lot of Debt

Cameron and Anita had been married for fi ve years when Cameron was killed in an automobile
accident. They were the parents of twins born three years after their marriage. The year before the
accident, the couple had purchased a home and arranged for a $100,000 mortgage. At the time,
both Cameron and Anita were working and they felt comfortable with that size of mortgage.
The mortgage company had recommended that the couple insure the mortgage debt. They took
the advice and each acquired a term insurance policy for $100,000 face amount. When Anita
provided the appropriate documents to her insurance company, the company issued a cheque
for $100,000 to Anita as the beneficiary.
Anita was able to repay the mortgage, and take ownership of the family home free and clear.
Was this an appropriate solution?

This is an example of insurance planning to meet a single, specific need. The couple recognized
the risk of being unable to repay the mortgage if either of them died. Each of them purchased a
term life insurance policy for that purpose. The solution that was recommended was appropriate.
However, there were alternatives. They could have purchased a joint life policy with benefits
payable on the first death, rather than two separate policies.
Should they have considered other financial needs in addition to the single need to
cover their mortgage?
For example, what if either of them became disabled? Since they relied on both incomes to
make the mortgage payments and meet their other expenses, if one of them became disabled
and was unable to work for an extended period of time, they might not have been able to
maintain the mortgage payments. If they did not have long-term group coverage through
their employer, they should have considered applying for disability income insurance to
address the risk of becoming disabled.
Also, although the mortgage has been taken care of, Anita faces other short- and long-term
expenses. What about her financial goals for educating her children and her eventual
retirement? Perhaps Cameron and Anita should have completed a more comprehensive
insurance and financial needs analysis.
Example 2: A Family Member Who Contracts an Illness with a Poor Prognosis for Survival
After ten years of marriage, Waldo was diagnosed with cancer of the liver. He and his wife operated a
small business that required both their efforts. Because of Waldo’s illness, he was unable to devote much
time to the business. Martha, his wife, was distracted from attending to the business while she attended
to his needs. Unfortunately, the prognosis was poor and Waldo was not expected to live longer than one
year. Business revenues began to dry up and the couple were faced with bankruptcy.

Their life insurance agent offered a solution to the dilemma facing the couple. Waldo had a life
insurance policy that contained a living benefits provision under which a portion of the life insurance
benefit was payable if Waldo contracted a terminal illness that reduced his life expectancy to one
year or less. Waldo provided the appropriate claim information and the insurer paid a portion of the
death benefit. The couple were able to apply the funds to keep the business afloat. After Waldo’s
death, Martha was able to turn her attention to maintaining a business that was still a going concern
rather than one that had suffered serious financial problems.
What other options were available to Waldo and Martha?

Since Waldo and Martha’s efforts were critical to the success of the business, they should
have also considered disability income policies. Although Waldo’s life expectancy was short,
a disability income policy that provided a monthly income after a brief elimination period (30
days, for example) would have provided funds for running the business. Martha could then
use the full death benefit from the life insurance policy to take care of final expenses when
Waldo died and attend to other expenses of the business and in her personal life.
Example 3: An Individual Who Suffers a Disability with Hope for Recovery

Ingrid was a successful architect who operated her own business. A divorced mother of two
young children, she relied entirely on the income that she earned from her business to support
her family. One day on her way to her office, Ingrid sustained life-threatening injuries in an
automobile accident. She was treated in hospital for several weeks, followed by a number of
months of rehabilitation. During this period, she was unable to perform any of the functions of
her occupation and she was unable to earn any income.
Three years before her accident, her life insurance agent had recommended that she purchase
a disability income policy, to provide her with a monthly income in case she became disabled
and unable to work. Based on the income she was generating from her business, Ingrid
acquired a disability income policy that would pay her $5,000 a month if she became disabled
and unable to perform the duties of her occupation. The policy had a 30-day waiting period and
a maximum two-year payment period for any disability.
Ingrid began receiving a monthly income of $5,000 from the insurer beginning 30 days after the accident.
She was disabled for 18 months and continued to receive a monthly income during that time. She
recovered fully and was able to resume her career at the end of the 18-month recovery period.
Was this policy appropriate for Ingrid’s situation?

Since Ingrid’s disability lasted for 18 months, her benefits did not expire. If her disability
had continued for longer than two years, she would have been faced with serious financial
problems. Perhaps a five-year benefit period or a benefit period to age 65 might have been a
better choice when she applied for the policy. She might have also considered applying for a
partial/residual disability benefit provision, in case she was able to resume her career, but
only on a part-time basis.
Example 4: A Business Owner Who Is Injured

James owned and operated a small contracting business. He rented an office for fi ve full-time
employees. The business incurred regular monthly expenses that were managed from the
revenues generated by the business. Most of those revenues were the result of James’s efforts.
His life insurance agent suggested that he consider an office overhead insurance plan. Under
the terms, a benefit amount equal to monthly expenses incurred by the business, up to a certain
maximum, would be paid if James was unable to work.

James suffered a serious illness that left him completely disabled for several months. During
that time he was able to pay the regular monthly expenses for the business from the
disability benefit he received under the office overhead policy.
What other products would have been helpful to James when he became disabled?
In addition to the office overhead expense policy, James could have considered applying
for a disability income policy as well. In addition to meeting the regular expenses of the
business, he would have been entitled to receive a regular monthly income to meet his
personal and other business needs.
Example 5: An Older Individual Who Develops a Debilitating Illness

Imelda was a widow who owned her own home where she lived alone. She had three grown
children who visited her from time to time. Overall, she was able to take care of herself and to live
independently. Then Imelda began to show signs of Alzheimer’s disease. It soon became apparent
that she could no longer take care of herself. Her children did not feel that they could care for her
because she required constant attention. Imelda was moved to a chronic care facility.
The monthly expense for her care and shelter was $5,000. The children considered selling Imelda’s
home to defray these costs. Fortunately, Imelda had taken out a long-term care policy that provided a
monthly benefit in the event that she was unable to perform certain daily activities and required
regular care from an attendant. The benefit paid under the policy defrayed the cost of Imelda’s
ongoing care.
What would have happened to Imelda and her children if she had not had the long-term care policy?
• While Imelda’s family might have been able to place her in a provincially funded
nursing home, all Imelda’s assets, as well as any pensions she was receiving, would
most likely have been used up to provide her with the care she needed, especially if
Imelda lingered in this condition for many years.
• The provincially funded nursing home might not have provided the standard of care that
the family could otherwise afford with the available long-term care policy benefits.
• Depending on her condition, one of Imelda’s children might have had to take her into
his or her home. If she required constant monitoring and care, her family would have
faced a tremendous burden.
Example 6: An Older Individual Dies, Leaving a Large Estate

Several months before Roger and Susan were due to celebrate 40 years of marriage, Roger died,
leaving all of the assets they had both acquired during the marriage to Susan. In addition to a family
home, Roger and Susan owned a cottage in northern Ontario, a chalet in British Columbia, and a
condominium in Florida. Roger’s executor was able to transfer the property in such a way that no tax
became due on the value of the properties at the time of Roger’s death. When Susan dies, however,
all of the property will be considered disposed of and capital gains taxes will be calculated on all of
the property, except the family home which is exempt as a principal residence.
Several years before Roger’s death, Roger and Susan had purchased a whole life insurance policy for
$250,000 on a joint-and-last-to-die basis. When Roger died, the life insurance continued on Susan’s life.
When she dies, the life insurance proceeds will be paid to her estate. She has directed in her will that the
insurance proceeds should be used to pay the capital gain taxes owing on the properties.

The properties will be transferred to her surviving children.
What problems might arise from Roger and Susan’s plan?

• Since the insurance benefit will be paid to the estate, the amount will become part of the
estate assets and will be included in the amount on which probate fees are calculated.
Roger and Susan would have been better off naming a specific beneficiary.
• The three properties could be valued at Susan’s death at amounts that far exceed the
amount of life insurance. Although the insurance benefit may reduce the problem, the
estate may be faced with a larger-than-anticipated income tax bill. Some of the estate
assets that are to be distributed to the beneficiaries may have to be sold to satisfy the
income tax owing. The insurance should be increased as the property values increase.
TERM LIFE INSURANCE
LEARNING OBJECTIVES
• explain how term life insurance works;
• explain the primary advantages/disadvantages and limitations of term life insurance
for the policyholder;
• differentiate among level term, increasing term, and decreasing term life insurance;
• differentiate between renewable and non-renewable term insurance;
• explain the term “convertible term insurance”.
How Term Insurance Works: An Example

Donna has worked hard to establish her fashion design business, making business attire for women
executives. She now wants to expand her business to other fashion lines. To do so, she needs
financing to hire qualified staff, carry out research, and acquire larger business premises.
She approached a number of financial institutions with a strong business plan; although
some have refused to provide financing, one or two banks are interested in her plans.
The banks are concerned that the success of the expansion relies directly on Donna’s efforts
and her continued ability to run the business. Her business plan anticipates that given financial
backing of $250,000, she can turn a profit by the beginning of the fourth year and bring in net
profits of $500,000 per year within 10 years. She will make interest-only payments on the loan
out of business revenues and will pay out the full $250,000 in 10 years.
One bank is prepared to offer Donna a $250,000 loan, but it seeks assurance that if she dies
before the business has started to generate sufficient revenues, her company can pay off the loan.
The most direct way to provide that guarantee is to insure Donna’s life. The company would
own the policy and be the beneficiary. A collateral assignment could be made under the policy

in favour of the bank, so that if Donna dies before the loan is repaid, the bank will
receive $250,000.
Level term life insurance may be the best choice in this situation. The liability is for a
limited period of time – 10 years. The liability is constant and does not change over the
loan period. Once the loan has been repaid, the liability no longer exists.
Term life insurance works best in circumstances like this, where there is a specific,
defined financial risk for a limited period of time.
Advantages and Disadvantages of Term Life Insurance for

the Policyowner
Among the range of life insurance products available to the consumer, term life insurance can be
the most cost-efficient way to insure a risk that will disappear over time. Term life insurance
can provide for repayment of a mortgage if the mortgagor dies or allow children to pursue
higher education if one or both of their parents die. In these cases, there is an identifiable
potential risk and a limited period of time over which the risk might be realized.
For example, if a mortgage is in place for 25 years, then the liability for that mortgage will
end in 25 years. Permanent life insurance is not required to meet the debt obligation.
When the insurance is purchased, depending on the age of the insured, the cost of a term
life insurance policy is most likely going to be less than the cost of a permanent life
insurance policy for the same coverage.
If the purpose of the insurance does not have an anticipated expiry date, then term life
insurance may not be the best solution. If, for example, an individual wants to bequeath an
inheritance but does not have the financial resources to provide the desired amount,
permanent life insurance may be the way to realize that goal. Term life insurance will not do
the job. The individual cannot predict when he or she will die, so the coverage period for a
term life insurance policy may expire well before the insurance proceeds are needed.
Under a term life insurance policy, the policyowner may not miss any premium payments
without the coverage lapsing. Each premium must be paid within the grace period to keep
the policy coverage in force. If any premium remains unpaid after the grace period expires,
the policyowner must apply to reinstate the policy. As part of this application for
reinstatement, the policyowner must not only pay all the premiums that are due (with
interest in many cases), but also submit evidence of the insurability of the person whose life
is insured. If the health of the insured person has deteriorated since the policy was first
taken out, the insurer may refuse to reinstate the life insurance coverage.
Level Term, Increasing Term, and Decreasing Term Insurance

A level term life insurance policy is one that provides a level amount of term insurance
coverage for a specific period of time. Insurance companies offer level term insurance
policies with durations of one year, five years, ten years, or twenty years, or for a period
ending when the insured person turns 65. This kind of insurance would be appropriate if the
amount of the obligation will not change over the term. For example, level term insurance
could be used to cover a demand loan, because the principal amount does not change and the
client makes interest payments only.

Many insurance policies with short durations contain an option to renew the policy for
an additional period. Usually, a policy can be renewed only until the insured person
reaches a maximum age.
Increasing term insurance provides a death benefit that increases on each policy anniversary by a
specific amount. The amount may increase by a fixed percentage or according to some variable,
such as the Consumer Price Index. The premium increases along with the coverage increase.
Increasing term would not be an ideal option to cover a tax liability at death. Increasing term
may be employed in situations where the liability being protected against is both temporary
and increasing. For example, this insurance could be used to protect the value of a key
employee in an organization where the employee’s salary is expected to increase every year..
Decreasing term insurance provides life insurance protection that decreases by a specific
amount on each policy anniversary. In most plans the policyowner pays the same insurance
premium for coverage that reduces over the term of the insurance coverage. The reduction
may be a specific amount applied on each policy anniversary, or, in the case of mortgage
insurance, the decreases may follow the reduction of the mortgage principal.
Renewable, Non-Renewable, and Convertible Term Insurance
Renewable term life insurance allows the policyowner to renew the insurance coverage for
an additional period without providing evidence of insurability (health questionnaire, blood
sample, urinalysis). A five-year renewable term policy usually allows the policyowner to
renew the coverage after each five-year term until some maximum age (often between 65 and
85). The renewal premium is based on the age of the person whose life is insured at the time
the policy is renewed. Most policies contain a table that lists the guaranteed renewal
premiums at each renewal age.
Non-renewable term insurance does not include the option to continue the insurance
coverage beyond the stipulated term of coverage. This restriction would apply to products
such as level term insurance to age 65. The only option available to the policyowner at that
age would be to convert the term insurance coverage to permanent life insurance.
If the term life insurance policy is approaching its term, but the insurance risk remains,
convertible insurance policies offer an opportunity to convert the coverage to a permanent
life insurance plan. If the policyowner wants to maintain the same level of insurance
coverage, the new premium may be very expensive, because the premium is usually
determined according to the current age of the life insured. The policyowner can either:
• lower the amount of insurance coverage; or
• convert the term insurance policy, but make the new insurance effective from the
original issue date of the term insurance policy. The permanent life insurance
premium will be calculated based on the life insured’s original age. The policyowner
will have to pay an amount equal to the reserve that would have accumulated if the
permanent life insurance policy had been in effect from the original issue date.
The premiums for renewable and convertible term life insurance plans are higher than those for
term plans that do not have these options. Since both options allow the policyowner to renew or
convert the policy coverage without providing evidence of insurability, an individual whose
health is deteriorating will likely elect both options, so insurers must charge a higher premium for
the options. Insurers also restrict the age at which these options can be exercised.

Choosing Term Insurance to Meet Specific Needs

Example 1: Level Term Insurance
Amelia holds a $100,000 line of credit for her small business, most of which she has used. She
had assigned certain business property to satisfy the line of credit, but she wants to insure the
line of credit amount to preserve the property for the business in the event of her death. She
intends to maintain the line of credit for a relatively short period and pay it off as her business
revenues grow. She does not have a specific period in mind for repayment, however, so she
decides to purchase a five-year term policy with a renewable feature.
Amelia feels that if she can reduce or eliminate the amount loaned under the line of credit
within fi ve years, she can allow the policy to lapse. Depending on business conditions, if the
loan amount continues in effect, she would like to have the choice of renewing the term life
insurance policy for another five years.
By having a $100,000 level term insurance policy in place, Amelia does not have to be
concerned about using the line of credit up to the limit. Even if the line is maximized when she
dies, the full $100,000 will be repaid.
Example 2: Increasing Term Insurance

XYZ Corporation has bought a key person term insurance policy on the life of its president,
Craig Lowe. Craig’s skills and leadership are essential to the organization’s success and the
$1,000,000 insurance plan was considered adequate to address the financial implications of
Craig’s death. The purpose of the insurance is to keep the company afloat while it seeks a
replacement with Craig’s talents. The policy proceeds would also be used to find and attract
someone with a level of expertise similar to Craig’s.
However, the company value and Craig’s value to it are increasing in terms of real dollars:
$1,000,000 in current dollars will depreciate over time in light of rising inflation.
XYZ has therefore bought a term plan that insures Craig until he turns 65, with an increasing term
benefit. The face amount of the policy will increase with the annual increase in the Consumer Price
Index. The increases are processed automatically by the insurer, without XYZ having to provide
evidence of Craig’s insurability. There is an overall cap of $5,000,000 on the face amount, but the
company feels that there is enough room to insure the risk of losing Craig, expressed in real dollars.
Example 3: Decreasing Term Insurance

Pat and Mary have recently bought a home together and taken out a $200,000 mortgage, to be
repaid over 25 years. They feel that it would be wise to purchase life insurance so that if either
of them dies, any remaining mortgage principal can be paid off.
A friend suggested that they each buy a $200,000 term life insurance policy, with a term of 25 years.
Their agent, however, gave them a life insurance quote for a decreasing term insurance plan whose
face value decreased along with the mortgage principal under the amortization schedule. The annual
premium cost of the decreasing term insurance plan is less expensive than a level term product.
Their agent also explained that they could purchase one plan that insures both their lives on a joint-
and-first-to-die basis. That is, if one of them dies before the end of the term, the death benefit will be
paid to the survivor and the proceeds can be used to pay off the outstanding mortgage.

PERMANENT (WHOLE) LIFE INSURANCE
LEARNING OBJECTIVES
• identify the primary characteristics that distinguish term insurance from permanent
life insurance;
• explain the advantages and disadvantages of whole life insurance;
• explain the difference between a participating whole life contract, including
dividend options, and a non-participating whole life contract;
• explain how a changing dividend scale affects the completion of a premium offset policy;
• explain the differences between guaranteed and adjustable whole life insurance.
Term Insurance vs. Permanent Insurance

Most life insurance policies, whether term or permanent, are based on the level premium
concept. Without a level premium, the insured would at first pay a smaller premium that
reflects the anticipated mortality level for people of that age, based on the mortality table
used for that particular type of coverage. As the insured person ages, the premium would
increase, since the older one becomes, the greater is the likelihood of dying. Ultimately, the
annual cost to maintain coverage would become prohibitive.
Remember: the principle of life insurance is to have available sufficient funds to pay all the
death claims that are expected to occur for those in a particular age group. As the group gets
older, the number who die each year increases and the number of survivors left to contribute
premiums decreases.
Under the level premium approach, the premium that an insured person pays at first is more than
adequate to cover the claims of those in that age group that die. As the person grows older, the
premium is insufficient to cover the claims of those in the older age group that die. However, the
excess premiums paid in earlier years, together with investment return earned on those amounts,
provide sufficient funds to cover the anticipated claims expected to occur in any year. The excess
amounts, together with investment earnings, are known as a policy reserve.
For term insurance, the level premium applies to a coverage period that may be as short as one
year or as long as to age 100 for Term to 100 plans. Traditionally, the term coverage terminates
at some point, and the policyowner receives no further benefit after it expires. However, in many
Term to 100 plans, premiums are payable to age 100 at which time the policy becomes paid up
for the entire face value and coverage continues for the rest of the life insured’s life.
The reserve build-up for permanent life insurance continues to grow until, after many years, the
reserve equals the amount of life insurance that must be paid out under the policy. The insurance
coverage does not expire as long as the policyowner continues to pay the premiums on
schedule. For term insurance, the annual mortality charge is based on the full amount of coverage.
For permanent life insurance policies, the annual mortality charge is based on the net amount
at risk (face value of policy less the cash surrender value). Each permanent life insurance policy
accumulates a reserve as premiums continue to be paid. That reserve provides a cash value for the

policy. The policy offers certain options, including cash loans, loans to pay premiums, and a
cash surrender value option. If the policyowner exercises certain options, the policy will be
terminated. These options will be described in more detail later in this chapter.
Advantages and Disadvantages of Whole Life Insurance

One important advantage of whole life insurance is the fact that, as long as the policyholder continues
to pay the premiums, the insurance coverage will always remain in effect. Therefore, for any risk that
has no predictable expiry date, whole life insurance provides a guaranteed amount of money to address
the risk. If, for example, the estate of an insured person is required to pay heavy taxes when that
person dies, the death benefit will completely or partly cover these costs.
Whole life insurance also offers a cash surrender value. The policyowner can apply for a
loan against the cash surrender value of the policy. Therefore, a whole life policy can be
a way of financing a loan. A term life insurance policy has no such provision, simply
because it has no accumulating cash value reserve.
A whole life insurance policy may contain non-forfeiture provisions that can be used to keep
the policy coverage in force, even though the policyowner stops paying the insurance
premium. A standard policy allows the policyowner to pay the premium up to 30 days (the
grace period) after the date the premium is normally due without the policy lapsing. Non-
forfeiture provisions cover situations in which the policyowner does not pay the premium
within the grace period. The policyowner may choose from a range of options.
1. The automatic premium loan provision takes effect when the grace period
expires. The policyowner receives a loan against the policy’s cash value, which is
used to pay the premium. The policyowner is charged interest on the loan,
according to provisions contained in the policy.
2. The reduced paid-up non-forfeiture option means that the policy remains in force, even
though no more premiums are paid. The amount of coverage is the amount that the
current cash value will fund. The cash value will increase because of reinvestment, but
at a slow rate, since no more premium payments are made. For example, if an individual
has a policy with an original death benefit of $50,000, and cash surrender value of
$10,000, he or she could opt to change it to a fully paid-up policy with a death benefit
somewhere between the cash surrender value and the original death benefit. Paid-up
means the policy is fully paid for and no future premiums are required. The amount of
coverage provided by the paid-up policy would be determined based on the cash value
of the policy and the age and sex of the life insured at the time the option is exercised.
3. The extended term insurance option provides insurance coverage for the same amount as the
life insurance policy, but only for a limited period of time, such as three years. The amount of
time that the coverage remains in effect depends on the cash value available to fund
the new term policy, and on the age and sex of the life insured at the time the
option is exercised.
4. Finally, the policyowner can simply cash in the policy for the amount of the cash
surrender value and terminate the policy.

A term life insurance policy has none of these options. If the policyowner fails to pay an
outstanding premium within the grace period for its payment, then the term policy lapses.
Although the policy contains provisions allowing for reinstatement of the coverage, those
provisions require the payment of all premiums that are overdue, with interest, and the
submission of satisfactory evidence of insurability for the person whose life is insured under the
reinstated policy. If the insured person’s health or other circumstances have changed during the
time that the policy has been in force, the insurance company may decline to reinstate the policy.
One disadvantage of a whole life insurance policy is that the premiums for a similar amount
of coverage for applicants of the same age are considerably higher than the premiums for a
term life insurance policy. If an individual requires a specific amount of insurance for a
limited time, then term life insurance may be the more cost-effective alternative.
Participating vs. Non-Participating Whole Life Insurance

The owner of a participating life insurance policy may receive a policy dividend
periodically, whereas the owner of a non-participating life insurance policy will not. In
other words, the owner of a participating policy is entitled to share in the insurance
company’s distribution of any of the company’s surplus.
Insurers establish their premium rates based on estimates of mortality rates, expenses, investment
earnings, and other factors. If those estimates prove more conservative than actual experience, the
insurer will realize greater revenues than those required to meet its obligations. These obligations
include the requirement, established by regulators, to maintain an adequate level of reserves
to meet future insurance liabilities. If the insurer has excess revenues that are not required
to fund mandatory reserves, they can be distributed as policy dividends to policyowners
who hold participating policies.
Policy dividends are considered a refund of premiums to policyowners. Policy dividends are not
considered taxable income in the same way that a dividend from a stock is considered taxable
income. The owner of a participating life insurance policy will generally pay a higher premium than
the owner of a non-participating policy who has the same amount of coverage. Over time, however,
the comparative costs of non-participating and participating life insurance policies may be quite
similar, because of the policy dividends distributed to owners of participating policies.
Policy dividends are not guaranteed for participating policies. Insurance companies publish
tables of projected dividends for their participating policies, but every table is published with
the caution that these dividend assumptions are projections only, not guarantees. When
dividends are distributed, policyowners receive them on the anniversary of the day they took
out the policy. Annual dividends tend to increase for a policy over the years.
The policyowner may receive the dividend in one of a number of ways, according to the
options that are available under the policy provisions:
• Cash dividend option
Under this option, a cheque is issued to the policyowner for the amount of the
dividend declared each year.

• Premium reduction option

The insurer applies the policy dividend toward the payment of the annual premium. During
the early years of a policy, the dividend declared will be less than the premium due. The
policyowner receives a premium notice for the difference. For policies that have been in
force for a while, the dividend declared may exceed the annual premium. In this case any
balance of the dividend remaining can be received under one of the other dividend options.
• Leave on deposit to accumulate interest option

Dividends may be left on deposit with the insurance company. The policyowner can
withdraw the dividends, plus any accumulated interest, at any time. When the
insured person dies, the dividend accumulation is usually paid to the beneficiary
when the death benefit proceeds are paid.
• Paid-up addition option
Dividends may be used as a net single premium to acquire additional paid-up insurance
on the life insured’s life. The additional insurance is issued on the same plan as the basic
policy, for the amount that the net single premium will buy, considering the age of the
person being insured. The additional insurance does not require evidence of insurability.
Consequently a person whose health has deteriorated can acquire additional life insurance
that he or she might not otherwise be able to obtain. The additional insurance also has a
cash value, if the basic policy provides for a cash value.
• Additional term insurance option

Dividends may be applied as a net single premium to acquire one-year term insurance
on the life of the person being insured. Typically, the amount of term insurance will not
exceed the policy’s accumulated cash value in the year. The additional coverage
received would be based on the age and sex of the insured person. If the dividend
amount exceeds the amount required to pay for the term insurance, the excess may be
used under one of the other options.
Premium Offset Policies and Dividend Projections

A number of life insurance companies have faced lawsuits from policyowners who had
purchased life insurance policies under a premium offset payment plan. Essentially, the
insurance company projected a premium payment plan based on assumptions about future
policy dividends to be declared under a participating life insurance policy. Based on these
projections, a prospective policyowner could expect that a life insurance policy would be
fully paid up within a relatively short period of time. Depending on the rates of return
assumed under the projections, the policy could be fully paid for in as little as ten years. No
further premiums would be required to keep the policy in force.
Many such policy plans were sold at a time when interest rates were high and dividend
projections were generous. However, as interest rates fell and returns on investment failed to
fulfil the projections, policyowners whose premium paying periods were projected to end in a few
years were told that they would have to continue paying premiums for several more years.

Although the projections that were generated when these policies were sold were not
intended to be guarantees of performance, the selling methods used and the policyowners’
expectations implied at least some level of guarantee for these numbers. Some insurance
companies decided to abide by the projections under which these policies were sold.
Nevertheless, dividends and projected returns on dividends are not guaranteed. Insurance
companies’ assumptions about mortality, investment earnings, and expenses may not be
borne out by their actual experience. Companies have reduced their dividend scales, and
interest earnings on declared dividends have suffered from the very low investment rates
of return that have prevailed in recent years.
Guaranteed and Adjustable Whole Life Insurance

The premiums for traditional life insurance products are determined by projecting over the
life of the product all the components from which the premium rates are derived. Insurance
companies use pricing factors such as estimated mortality experience, investment earnings,
expenses, and other contingencies over many years to establish premiums for people of all
ages. Because the estimates must be made over such a long period of time, the assumptions,
particularly investment return assumptions, tend to be very conservative.
During the 1980s, the cash surrender values of permanent life insurance policies were much
lower than the investment returns for other financial products. Permanent life insurance
products lost popularity, even though insurance companies guaranteed that the premium rate
for each life insurance policy would remain the same for the life of the policy.
To compete with other financial products and to take account of changes affecting mortality and
expenses, insurance companies introduced products for which the premiums and benefits were
subject to adjustment from time to time. For example, an adjustable policy might guarantee the
premium rate and associated level of coverage for five years. After five years, the insurance
company would adjust the premium, the coverage, or both, after reviewing the product in light
of changes in mortality rates, investment returns, expenses, and contingencies. The premium
and coverage for the next five years might decrease, increase, or stay the same, depending on
the company’s experience with the product and on projections for the next five years.
Various adjustable life insurance policies were introduced to the market place, culminating
in the creation of the Universal Life Insurance policy.

UNIVERSAL LIFE INSURANCE
LEARNING OBJECTIVES
• explain the advantages and disadvantages of universal life (UL) insurance;
• explain the benefits to a policyholder of the universal life insurance feature of
unbundling the three pricing factors;
• explain and provide examples of the difference between yearly renewable term (YRT)
and Term 100 (T-100, also known as Level Cost of Insurance or LCOI) mortality
costing in a universal life product;
• explain and provide examples of the difference between guaranteed and adjustable
mortality costs;
• explain and provide examples of the impact of investment choices on the viability
of a universal life contract;
• explain the implications of early withdrawals, loans, and leveraging of a
universal life insurance policy.
Universal life insurance offers a great deal of flexibility compared to traditional life insurance
products. The degree of flexibility provided allows a UL policy to “mimic” any form of life
insurance. Many key policy features can be changed throughout the life of the policy. These two
aspects of UL often result in “universal” appeal to purchasers, policyholders and agents.
For example, if an individual aged 30 buys a $250,000 whole life insurance policy with an
annual premium of $2,000, he or she must continue to pay that premium for the duration of
the policy in order to maintain all the benefits it provides. The anticipated mortality costs,
investment earnings, and expenses are established for the life of the policy. The policyowner
has no contractual right to change any provisions of the contract that relate to the amount of
insurance coverage and the premiums.
A universal life insurance policy, however, allows the policyowner to make adjustments
to the insurance plan:
• The policy can provide different death benefit face amounts for up to five insured lives
and insured lives can be removed at will or added subject to underwriting;
• Four death benefit options can be offered that either keep premium payments low,
provide a maximum death benefit, maximize tax deferred/sheltered growth within the
policy, or achieve a balance of these;
• Contracted death benefits (face amounts) can be reduced at will or increased
subject to underwriting;
• Total death benefits may increase or decrease depending on the death benefit option
selected and the investments maintained within the policy account;

• Policyowners have a wide range of investment options from which to select to make-up
the investment account (also known as policy account, policy reserve, cash reserve,
cash value). Investment account options can be integrated to result in a custom portfolio
that can be changed throughout the life of the policy to meet the policyholder’s
changing risk tolerance or financial needs;
• Mortality costs for the policy can be based on Yearly Renewable Term (YRT)
insurance or Term-to-100 (T-100) insurance. A YRT mortality base can be
converted to a T-100 mortality base during the life of the policy;
• A range of premium payments is permitted between a required minimum and a regulated
maximum within which the policyowner is free to select and change as desired or needed.
The mortality costs, investment returns, expenses, and other costs for contingencies are subject
to periodic review within a UL policy and adjusted within certain limits defined in the contract.
So a policyholder who acquired a UL policy for a $2,000 annual premium may, after a period of
time specified in the policy, be able to maintain the same life insurance plan for a smaller annual
premium. The investment account portion of the universal life policy may result in sufficient
growth to allow a greater death benefit or lower premium payments. Mortality costs will be
reassessed based upon company experience and may be decreased or increased. The company’s
expenses will also be examined and that portion of the cost may be adjusted.
Although the policyowner selects the face amount of the policy when it is issued, the death
benefit payable may be greater than that amount, depending on the contract provisions and
death benefit option selected. There are often four death benefit options offered with the first
three being quite standard across universal life policies:
1. Level Death Benefit – the beneficiary receives either the contracted face amount or
the policy cash value, whichever is greater.
2. Level Death Benefit Plus Cash Value – the beneficiary receives both the contracted
face amount and the investment account.
3. Indexed Death Benefit – the beneficiary receives a contracted face amount that increases
annually based on a fixed percentage or a benchmark such as the Consumer Price Index.
4. Premium Advantaged Death Benefit – the beneficiary receives the contracted face
amount and the investment account with mortality costs being managed to allow for
maximum, tax deferred account growth within regulated limits.
In summary, a policyowner can choose, within certain limits, the policy’s face amount and death
benefit and the size of the premium, based on conditions existing when the policy is issued. The
policyowner can alter these choices during the life of the policy, although the company must
approve any changes that will increase the amount of risk covered by the policy.
One potential disadvantage of universal life insurance is that the factors that determine the
premium cost of maintaining a certain level of life insurance coverage may mean that the
premium increases over time. These costs depend on the number of claims submitted to the
insurance company, its expenses and other contingencies, and the investment returns on the
portion of each premium that is not applied to pay insurance costs. Much like premium offset
plans that anticipated a certain level of dividends, the initial projections of premium requirements
for a universal life insurance plan may prove to be inaccurate. Over time, a policyowner may be

obliged to pay more than the policyowner who has a traditional whole life insurance
policy for the same amount.
Another potential disadvantage of universal life insurance is that it may result in “analysis
paralysis” due to all the options that provide its flexibility and the elections that need to be
made to set up the policy. Universal life can be difficult to explain for the agent and
difficult to comprehend for the client.
Unbundling the Three Pricing Factors

One insurance company promoted its universal life insurance product as providing “a plan
for all reasons.” The slogan tried to convey the flexibility to the policyowner in designing
a custom program of life insurance using a universal life insurance policy.
A universal life insurance policy offers flexible amounts of coverage, flexible premiums,
and a wide range of investment options. This level of flexibility is made possible by the
separation or unbundling of the principal elements of life insurance.
The three principal elements that are unbundled are:
• mortality charges;
• investment earnings;
• expenses.
A universal life insurance policy operates in this way. The policyowner pays a premium to the
insurer. The insurer takes a small administration fee and then applies as much of the premium
as necessary to cover the costs of the contracted face amount. These costs include the mortality
cost based either on YRT or T-100, the provincial premium tax (about 3%), expense charges,
and a profit loading. These risk charges and the way they are calculated are described in the
policy contract provisions. The remainder of the premium is directed to the policy account
and invested in the different options based on percentages selected by the policyowner.
The accumulating cash value in the policy after risk charges and expenses have been
deducted becomes the investment account including investment returns that contribute to
the growth in value of the policy. See Figure 2.1 below for a pictorial depiction.

FIGURE 2.1 UNIVERSAL LIFE INSURANCE PREMIUM FLOW
Policyowner Remits Premium Payment to Insurer

Minimum to Maximum Range
Policyowner May Vary the Premium within this Range a Number of Times Each Policy Year
The Required Minimum Only Pure Insurance Costs Leaves Nothing for the Investment Account
Any Premium in excess of the Minimum is directed to the Investment Account
1
The Maximum Allowed is established by the Policy’s Annual MTAR
Insurer
Retains a Processing Fee
Then
1. Pays 2. Invests
Mortality Cost Tax Deferred/Sheltered Investment Account

Death Benefit Based on YRT or T-100 Policy Reserve / Cash Surrender Value
Provincial Premium Tax

Approximately 3% Policyowner Selects Investment Option(s)
Expense Charges - Daily Interest Savings

Operating & Administrative Costs - 1, 3, 5, 10, or 20 Year GIAs2
- Index Linked Accounts or Portfolios
Profit Margin Loading - Segregated Funds or Portfolios
Industry & Product Competitive - Mutual Fund Based Accounts or Portfolios
- Managed Accounts or Portfolios
A single option may be chosen or premiums may be

directed to a number of options on a percentage basis
allowing for a customized portfolio. The investment
mix can be changed a limited number of times each
policy year.
3.
Annually Taxable Side Account3
(For Holding Premiums in Excess of MTAR1 – Regulated Maximums)
Daily Interest Savings

Figure Notes:
1
MTAR = Maximum Tax Actuarial Reserve - a mathematical formula designed to replicate the premiums and growth required of a
20-Pay, Endow-at-Age-85, Whole Life Policy – the most aggressively funded policy prior to the appearance of Universal Life.
MTAR was put in place by the Canada Revenue Agency to prevent policyholders and taxpayers from taking undue advantage of
the tax deferred/sheltering nature of the investment growth within life insurance policies.
2
GIAs = Guaranteed Income Accounts (a.k.a. Deferred Income Annuities or DIAs). The life insurance industry’s equivalent of GICs.
3
The insurer closely monitors all UL policies to ensure regulated maximum premiums and regulated maximum growth within the policy is not
exceeded. If a UL policy is projected to exceed allowed limits, the insurer contacts the policyowner with options to restore the status of the
policy. If necessary, the insurer will request the policyowner to cease making premium payments and/or direct premiums to the Side Account
and/or shift investment dollars to the Side Account to maintain regulatory status. Once the policy is within regulated limits and status allows,
the insurer will move funds from the Side Account back into the Investment Account.

MORTALITY CHARGES
This component is usually expressed in a table of insurance charges contained in the policy
contract. Mortality (the risk of death) is commonly expressed in terms of deaths per thousand
people per year in a specified risk group. For an insured person, the mortality charge is
the amount needed to cover the risk of insuring that person, given his or her age and risk
classification. The mortality charge is one of the first items deducted from a premium payment.
The contract will usually express this mortality charge as a rate per thousand dollars of the
net amount at risk. The net amount at risk is normally the death benefit amount minus the
current cash value of the policy.
Most universal life insurance contracts specify that the mortality charge will never exceed
a specified amount. Most also allow the insurance company to lower the risk charge if the
company’s mortality experience is favourable (that is, if fewer people than expected in a
particular age group die and the company does not have to pay out as many claims as it
originally projected).
INVESTMENT RETURNS
The most flexible component of a universal life policy is the alternatives available for the
investment of the premium contributions beyond what is used to cover mortality costs
and expenses. This amount forms the cash value of the policy. Most contracts specify that
the cash value of the policy will be credited with at least a minimum rate of interest.
Beyond that, the company will specify some standard by which prevailing rates of return
will be credited to the cash value account depending on the investment option(s) chosen.
The contract generally expresses the method of determining the rate to be credited by
reference to some standard, such as the rate earned by Government of Canada Bonds with
five years left to maturity.
Net premiums may be invested in much the same manner as guaranteed investment
certificates. The net premium is invested at the prevailing interest rate and the cash value is
the accumulation of net premium deposits and their accruing interest.
Many contracts offer the policyowner the choice of investing the net premiums in segregated
funds of the insurance company, index linked accounts, mutual fund based accounts, or
managed accounts. This method allows for investment in vehicles such as equities and the
creation of customized portfolios employing asset allocation principles.
EXPENSES
Insurance companies levy charges against the policy to cover their costs of administration.
Expense charges can be applied as a percentage of the annual premium, as a monthly
administration fee charged against the cash value, or as a specific service charge to
cover the processing of changes, loans, withdrawals, and surrenders.

Yearly Renewable Term and Level Cost of Insurance Mortality

Costing
A universal life insurance contract specifies how the current mortality cost for the amount of
the death benefit payable under the policy will be calculated. The policy contract includes a
table of the mortality costs per thousand dollars of death benefit and the attained age of lives
insured under the type of policy.
The policyowner can choose how to determine the death benefit amount under the policy.
The death benefit amount is determined according to the face amount selected by the
applicant at the time that the policy is issued, and the cash value that has accumulated under
the policy. The policyowner may choose either a level amount equal to the face amount of
the policy, or the face amount plus the cash value that has accumulated under the policy.
In calculating the mortality risk charge for the level amount of death benefit in any period, the
company multiplies the current mortality cost by the net amount at risk. In the case of the level
death benefit, the net amount at risk is the face amount minus the current cash value.
In calculating the mortality charge for the face amount plus cash value death benefit, the
mortality cost is multiplied by the face amount. Expressed another way, the mortality cost is
multiplied by the face amount, plus the cash value, minus the cash value (i.e., without taking
the cash value into consideration). The net amount at risk remains level and equal to the face
amount throughout the life of the policy.
The policy contract offers a choice of yearly renewable term (YRT) costs or level cost of
insurance (LCOI) charges. Level cost of insurance is based on a Term-to-Age-100 policy. If
LCOI is selected at policy issue, there is no opportunity to convert to YRT. If YRT is selected
at policy issue, the policyowner can later elect to convert to LCOI.
Under the yearly renewable term option, the mortality costs to be charged increase at each
policy anniversary according to the age of the person being insured. Under the level cost of
insurance costing method, the mortality cost applicable to the life insured based on his or her
age at the time the policy is issued remains constant over the life of the policy.
In choosing one or the other alternative, the policyholder should know that YRT mortality costs
will be lower than LCOI mortality costs when the policy is issued. Over time, and depending on
the issue age (age of the life insured at the time the policy was issued), the YRT costs will
eventually exceed the LCOI costs. If the policyholder intends to keep the plan in force for a
specific period of time, then YRT charges may be more cost-effective than LCOI. If the universal
life policy is designed to operate like a whole life insurance plan, then LCOI charges may be
more cost-effective. Another option is to take advantage of the opportunity to convert from a
YRT cost base to a T-100 cost base. When an insured is younger, the lower cost of YRT
allows a greater amount of premium to be directed to the investment account. A cross-over
point is usually reached in the 45 to 50 age range when the cost of YRT approaches and
begins to exceed that of T-100. Switching to LCOI charges at that point would allow the
greatest amount of premium to continue being credited to the investment account.
With a universal life policy, death benefits can also be increased year after year based on a
certain set percentage. The indexed amount is often based on the Consumer Price Index (CPI) or
can be a set percentage chosen by the policyholder. There is a maximum allowable increase in the
death benefit set in the policy contract. The premium charge will reflect this kind of arrangement
and be more expensive than a regular universal life policy with a level death benefit. A client will
often choose this type of setup in order to combat inflation or if they have a life insurance need

that will continue to grow. Increasing capital gains exposure on a cottage property is a very
good example of this need.
Guaranteed and Adjustable Mortality Costs

Whether the mortality costs are chosen as YRT or LCOI, the policy contract will specify a
maximum mortality cost that will be charged according to the age of the insured. The
contract will also specify that current mortality costs charged may be less than the maximum
guaranteed charge, depending on the number and size of the claims submitted to the
insurance company for a particular product.
A policyowner may elect to have maximum mortality costs guaranteed for the life of the
policy at time of issue. This election will cost more at the outset than allowing the insurer to
vary mortality costs based on its claims and operating costs. However, it may cost less over
the long term if the insurer’s claims and operating costs are higher than projected.
Impact of Investment Choices on the Viability of a Universal

Life Contract
For many universal life insurance contracts, the policyowner can choose how the cash value
component of a universal life insurance policy will be invested. The usual choices are:
• A basic fixed interest account: the account is credited monthly with an interest rate
calculated on the basis of some benchmark e.g., 90% of the change in interest on 10-
year Government of Canada bonds with three years left to maturity. The cash value is
retained in the general funds of the life insurance company.
• A general fund investment to which current rates of interest are credited: the
policyholder selects an investment term, such as five years. Interest is earned on the
account based on prevailing investment rates for fixed-income investments of the same
investment term. The type of investment operates like a Guaranteed Investment
Certificate (GIC) or money market account.
• An index fund investment: interest is credited based on the performance of an index
fund which is a type of mutual fund that tracks the performance of a broad diversified
market index such as the S&P/TSX 60. Index funds are available that give the
policyholder exposure to domestic or foreign fixed-income investments and/or the
major equity markets of the world.
• A segregated fund investment: Segregated funds are investments or pooled funds
sponsored by insurance companies. They are considered insurance products. The
premiums paid, minus any front-end charges, are credited to a segregated fund account.
The investment choice within the segregated fund is broad. Policyowners can choose
among equity funds, bond funds, balanced funds, money market funds, or any other
investment choices available with segregated fund investments.
• A mutual fund based investment: Mutual funds the insurer is affiliated with are used as a
base from which the value of the policyholder’s account is derived and valued. A broad
range of mutual fund options is usually available within a universal life insurance policy
including balanced funds and fund-of-fund options.

All income and growth within the policy account occurs on a tax deferred basis as long as regulated
limits are not exceeded. When UL policies first appeared, there were no Canada Revenue Agency
limits on how much could be paid into the policies or how much growth could accrue within them.
Many wealthy taxpayers made excessive use of UL to avoid tax. The government moved quickly to
prevent this by using a 20-Pay, Endow-at-Age-85 Whole Life policy as the benchmark for maximum
premium payments and tax deferred growth. Until the appearance of UL in the insurance market, 20-
Pay, Endow-at-Age-85 was the most aggressively funded type of whole life policy available. Canada
Revenue Agency developed a mathematical formula called MTAR (Maximum Tax Actuarial
Reserve) to set the maximum premiums allowed each year to a UL policy and the maximum rate of
growth that could occur on a tax deferred basis. As long as the MTAR limits are maintained, the UL
policy will retain its exempt status for tax purposes. If MTAR is exceeded, the insurer and
policyowner have 60 days after policy year-
end to rectify the problem and retain exempt status. If exempt status is lost, it is lost
permanently, and all future growth within the policy will be taxable on an annual basis.
As long as MTAR limits are respected and the proceeds of the policy are paid out to a
beneficiary as a result of the life insured’s death, then true tax sheltering is achieved as all growth
within the policy along with the face amount can be received tax free by the beneficiary.
Early Withdrawals, Loans, and Leveraging

When an individual applies for a universal life policy, he or she must first decide on the
amount of coverage required, the type of death benefit desired, and the amount of premium
that can be afforded.
Then, the applicant must decide what investments to hold within the policy account. This
should be based on the policyowner’s risk tolerance as with any other form of investing. The
choice can range from a simple interest-bearing account to a segregated fund portfolio that
has an aggressive investment philosophy.
Once these choices have been made, a policy projection can be created depicting future death
benefits, investment account balances, cash surrender values, and premium payment options.
Projections assume that any accumulated money in the plan will remain to accumulate to
provide the projected returns.
A policyowner has some options to access policy value under the terms of the contract.
POLICY LOAN
A universal life policy usually allows a policyholder to take a policy loan against the cash value
directly from the insurer. This provides a very quick way to borrow money at reasonable rates
without having to go through the credit checks and financial disclosure required by lending
institutions. The method of charging interest on such policy loans is described in the policy and
is usually a benchmark rate, such as the interest earned on Government of Canada bonds with a
certain maturity date. Policy loans will usually be granted within a week or two of application.
If the policyowner uses the loan for investments, the Income Tax Act permits the tax deduction
of the interest paid on the policy loan. The policyowner must determine the potential cost/benefit
trade-off of this course of action. The gross cash value of the policy will continue to enjoy the
returns generated from the investment vehicle(s) selected. If the insured person dies while there
is still a loan outstanding on the policy, the amount of the loan, plus the interest owing, will be
deducted from the amount of the death benefit paid to a beneficiary.

A policy loan will not affect the exempt status of the policy as there is no actual or
deemed disposition of any part of the policy.
WITHDRAW CASH VALUE

The policyowner may also withdraw a portion of the cash value that has accumulated under
the policy. The cash value available for investment is reduced by the withdrawal.
Consequently, after a withdrawal, there may be less than enough value remaining in the
policy to attain the objectives anticipated at the time the policy was issued. The policyowner
may have to increase premium payments, adjust the death benefit, or replace the amount
withdrawn, plus interest, to achieve the initial objectives.
Withdrawing cash from a UL policy is considered a disposition by Canada Revenue
Agency and results in the policy losing its exempt status from the time of withdrawal.
LEVERAGING A UNIVERSAL LIFE POLICY

A universal life policy can be used as collateral for a loan from a financial institution.
Borrowed funds can be placed in other forms of investment. If these investments realize a
higher after-tax return than the tax deferred investment account in the universal life policy,
the policyowner will benefit. However, the policyowner may have to increase the premium
contribution in order to maintain the life insurance policy according to the plan objectives
chosen when it was issued. Collaterally assigning a universal life policy is not considered a
deemed disposition for tax purposes and the policy will retain its exempt status. Absolute
assignment of a policy would constitute a deemed disposition and a loss of exempt status.
CHOOSING PERMANENT INSURANCE TO MEET

SPECIFIC NEEDS
LEARNING OBJECTIVES
• recommend the most appropriate permanent individual life insurance products to
meet specific client needs.
Example 1: Couple with Accumulated Assets and Property
Jack and Mae have just celebrated 25 years of marriage. Their three children have finished
their education, left home, and started their careers. Both Jack and Mae are in their mid-forties.
The couple are typical “empty nesters” and they are looking forward to this new stage of their
lives. Jack is a vice-president in the financial services industry and Mae is a high school
teacher. They both earn a better-than-average income and, other than a mortgage on their
home and on a condominium in Florida, they have no debts.
The couple jointly own their home, which is worth about $400,000. Mae inherited some
vacation property in northern Ontario, on which she had a cottage constructed. Although the
cottage cost $100,000 to build, the total value of the cottage and property is now about
$250,000. They rent out the condominium in Florida and intend to use it as a winter getaway
when they retire in about 20 years. The couple also owns two other properties in town that
they rent to students who attend the local university.

Recently, the couple met with their financial planner to discuss their retirement goals and to
review their current financial status.
Their planner made one point that disturbed the couple. Their assets and property holdings
represented a sizeable estate that, when they die, would be subject to heavy income taxes. If
they wanted to pass these assets and property along to their children, they would have to find
the resources for their executor to pay those taxes without having to dispose of some or all of
the holdings. As the planner explained, any asset that they owned that increased in value
would be subject to capital gains taxes when they die. This tax liability could be delayed until
the surviving spouse died, but payment of that tax liability was inevitable.
The planner suggested that one way of making sure that the estate held enough liquid funds to pay
the taxes was to acquire life insurance. Jack and Mae were both in excellent health and they could
expect to live well into their retirement years. The insurance benefit would have to be available once
both of them had died. That meant both of them would have to apply for life insurance.
Although they could calculate what the tax liability would be if they died immediately, they had no way of
knowing how much their holdings would appreciate over time. Ideally, the amount of life insurance they
acquired should increase in some way to keep pace with the growth in the value of their holdings.
They knew they needed permanent life insurance, since the need for the insurance was long
term. They also knew that upon retirement, they wanted to reduce any regular expenses as
much as possible. That included the expense of paying premiums for life insurance.
Which life insurance product would meet Jack and Mae’s insurance needs?
Jack and Mae may want to consider applying for a participating whole life insurance policy.
They could choose the paid-up additions option for the policy dividends. Dividends declared
under the policy would be applied as a single premium to buy additional paid-up insurance
for whatever amount that the dividend would purchase. Although dividends are not
guaranteed, the amount of dividend declared each year would presumably increase and larger
amounts of paid-up insurance would be added to the policy benefits.
They could also consider a universal life insurance policy and select a death benefit option
that would pay an amount equal to the face amount of the policy and the cash value.
Since they do not want to continue to pay premiums on the policy after they retire, they could
choose a policy with a premium paying period that ends at a specific time. For example, they
could choose a life paid up at age 65 policy. Although they would not have to pay premiums
after they turned 65, the policy would continue in force without a reduction in the policy’s
benefit provisions.
They could also choose a universal life insurance policy and establish a premium
contribution level that would be projected to have fully paid for the policy by the time they
turn 65. The important difference between a universal life insurance policy and a permanent
non-participating life insurance policy paid up at age 65 is that the benefits and premium
paying period of the permanent life policy are guaranteed. The universal life insurance policy
does not provide the same guarantee. Whether or not the universal life policy becomes fully
paid up depends on the performance of the investment fund in the policy.
Once the agent had explained the options and the implications of each one, it was up to Jack
and Mae to decide which policy best suited them.

Example 2: Charitable Bequest

Endora is single and is an active participant in a local charity. She wants to support its efforts as much as
possible, but she has limited resources. She lives modestly and has a pension plan through her employer
that will allow her to retire comfortably. She has heard that she can apply for life insurance and name the
charity as beneficiary. She has a family history of longevity and she is in good health. She cannot afford
large premiums, but she wants to make sure that the benefit is as large as possible.
What life insurance product would meet Endora’s needs?

Since Endora wants to provide a benefit to the charity when she dies, a permanent life
insurance plan is the most appropriate.
If she wants to acquire the largest amount of insurance possible, yet keep the premiums
affordable, then a permanent life policy payable for life will provide the most benefit
for the premium payment.
Since she appears to have the financial resources to keep paying the premium, even if she becomes
disabled, she may want to avoid adding any additional benefits such as waiver of premium.
She can choose between a participating and non-participating whole life policy. She would
pay a higher premium for the participating plan, but the dividends declared over time under
the participating plan may ultimately provide a larger death benefit. Since the dividends are
not guaranteed, she will have to choose between a guaranteed death benefit and a death
benefit that includes a guaranteed face amount plus the value of accumulated dividends.
Endora can also choose a universal life plan and select the largest face amount for the premium
she intends to pay. The premium term and ultimate values are not guaranteed, however, and
Endora must take that into consideration when she makes her choice of insurance plan.
Example 3: Creating an Estate

Wanda is a single mother who struggled to raise her two children, who are now married and
raising their own families. Wanda earns a good salary and is able to live comfortably, now
that her children are independent. Given the difficulties that she encountered raising her
children, Wanda wants to leave an inheritance to them that will help them raise their children
and give her grandchildren the opportunity for a university education.
She does not have a large estate and nothing of significant value to pass on. She wants to set
aside an amount each month to pay the premium on a life insurance policy. She is in good
health, and given her family history, she expects to live well into her retirement years. She
wants the largest amount of insurance she can get for her premium dollar.
What life insurance product would meet Wanda’s needs?

A term life insurance policy will provide a larger face amount of insurance than a
permanent life insurance plan. Wanda must consider, however, the likelihood that she could
outlive the term insurance coverage.
A permanent life insurance plan may be the better choice, since she wants to make sure that
her children receive a good inheritance upon her death.
If she wants the largest amount of life insurance that she can get for the premium that she
can afford, then a plan with premiums payable for life may be her best choice.

Wanda can choose between a non-participating and a participating life insurance policy. The
premium for the participating policy will be higher than that for the non-participating policy for
the same face amount of insurance coverage. She must consider whether the dividends projected
to be paid on a participating policy would provide a larger death benefit, considering both the
face amount and the dividends that could accumulate under the policy. Wanda must keep in
mind that the dividends projected to be paid under a participating policy are not guaranteed.
Wanda could also consider a universal life insurance policy. Although she must pay mortality and
expense charges through the premiums that she contributes, the balance of the premiums are
deposited to an investment fund. The deposits will earn current rates of return. If Wanda chooses
the face amount plus cash value option available under a universal life plan, the benefit ultimately
paid out upon her death may be larger than the death benefit under the non-participating plan, or
the death benefit plus dividend accumulations under the participating plan. However, the
investment returns under a universal life insurance policy are not guaranteed.
The insurance agent should explain all these options before allowing Wanda to choose the
plan with which she is most comfortable.
Example 4: Funding a Shareholder Buy-Sell Agreement

Craig, Pierre, and Darlene are the owners and sole shareholders of a closely held corporation.
Since the shares are property, when one of them dies, the shares he or she owns will pass to his or
her estate for sale or distribution to the heirs. Unlike publicly traded shares, the shares of this private
corporation are not very liquid. Their sale to a third party might not happen quickly and may not
attract the price that the heirs would seek. At the same time, the surviving shareholders might not
want to deal with the heirs of the deceased as shareholders or with new shareholders who might not
have the same objectives for the business as the surviving shareholders.
To address these concerns, the shareholders have drawn up a buy-sell agreement for the purchase of the
deceased’s shares. Under the agreement, the executors of the deceased shareholder’s estate agree to sell
the deceased’s shares to the surviving shareholders and the surviving shareholders agree to buy them.
The agreement specifies a price for the shares or a formula for determining their price.
Although the agreement resolves the problem of the disposition of the deceased’s shares,
Craig, Pierre, and Darlene are concerned about how they will pay for the shares when the time
comes. Since the surviving shareholders agree to purchase the deceased’s shares, they must
use business resources or their own resources. Their financial planner has recommended life
insurance on each of the shareholders’ lives as a way to meet that financial obligation.
What type of life insurance policy would be appropriate for Craig, Pierre, and Darlene?
The three must decide how long the buy-sell agreement will remain in place. For example,
if they agree that their respective shares will be sold to the remaining shareholders when
each of them retires, there is a limit to their need for life insurance. They may want to
consider term life insurance on each life for a term ending at age 65.
If they buy term insurance, they may want to consider increasing term insurance. Although
they know the value of the shares at present, the value may increase over time. The face
amount of a level term insurance policy may be inadequate to provide the funds necessary to
complete the buy-sell arrangement.
If the shareholders want to keep their shares indefinitely, permanent life insurance may be the
better solution. The insurance benefit must be large enough to meet most, if not all, of the cost

of acquiring the shares. If the value of those shares is determined by means of a formula, the
exact amount of the obligation may not be known when the insurance is acquired.
Non-participating permanent life insurance provides a guaranteed death benefit, but the
shareholders would not be able to increase the death benefit without paying a larger
premium and providing evidence of insurability for any increases in insurance coverage.
Therefore, they might consider participating life insurance. The dividends paid under the
policy could be deposited under the paid-up addition option to provide life insurance of the
same type as the basic policy. Under the option, each dividend would be applied as a single
premium to purchase the amount of insurance that the premium will support. That option
would provide for an increasing insurance benefit within the provisions of the policy. The
shareholders must keep in mind, however, that dividends are not guaranteed.
Alternatively, the three could apply for universal life insurance policies and choose the face
amount plus cash value death benefit option. The value paid out under the policy will be
larger than the face amount alone. The amount of the death benefit equal to the cash value
will depend upon the returns for the investment component of the policy.
A universal life insurance policy will allow the shareholders to increase their premium
contributions if they believe that the death benefit should increase to reflect an increase in
the value of the shares.
SUPPLEMENTARY BENEFITS AND RIDERS
LEARNING OBJECTIVES
• describe the supplementary benefits that may be purchased with a life insurance
policy, including accidental death and dismemberment (AD&D), monthly disability
benefit, and waiver of premium;
• explain the purpose of accelerated death benefit riders and the key provisions of three
common accelerated death benefits: the terminal illness (TI) benefit, the dread disease
(DD) benefit, and the long-term care (LTC) benefit;
• explain, using examples, the purpose of adding term insurance riders to permanent life
insurance policies, including additional term insurance coverage for the primary
insured person and coverage for additional persons, including spousal and children’s
term rider and children’s term rider;
• explain the guaranteed insurability benefit (GIB) rider, its benefits, and its appropriate use;
• explain the paid-up additions rider.

Waiver of Premium Rider for Disability Benefit

Aida owns and is insured under a universal life insurance policy with a face amount of
$50,000, a plan objective of whole life, and a planned premium of $500 per year, which she
pays monthly under a pre-authorized payment plan. The policy also includes a term
insurance rider of $25,000 and an Accidental Death Benefit.
Aida has developed a very serious illness and is unable to work at her job as a teacher. She
is now on long-term disability under the provisions of her employer’s group insurance plan.
Although she currently receives about two-thirds of her full employment income, she is
concerned about her expenses. She has contacted her agent to find out if she can reduce her
monthly premium obligation under the policy. Although she finds it a burden, she realizes
that her family will need the insurance benefit if she dies.
Her agent confirms that the policy includes a waiver of premium benefit. The waiver of
premium benefit would become effective if Aida incurred a total disability. Total disability
is defined as the inability of the insured person to perform the essential duties of her current
occupation, or any other occupation for which she is suited by education, training, or
experience. Aida must submit appropriate documentation to the insurer supporting any
claim for benefits, including a statement from her attending physician.
Once the insurer has recognized her claim, Aida must continue to pay premiums during a
waiting period stipulated in the benefit provisions. In this case, the waiting period is three
months. Some insurers require a six-month waiting period.
At the end of the waiting period, the insurer will waive all of the premiums that Aida paid since
the onset of her total disability and refund the premiums that she paid during the waiting period.
Some insurers waive premiums only from the conclusion of the waiting period onward.
The waiver of premium benefit waives not only the premium for her universal life policy, but
also for the term insurance rider and the accidental death benefit.
Effectively, the insurer pays the premium on Aida’s behalf, since she retains all her rights and
privileges under the contract during her disability. For example, her term insurance rider is a five-year
renewable term insurance plan. If Aida is still disabled when the term rider reaches its renewal date,
the coverage will renew automatically and the premiums will continue to be waived.
The term plan provides for a conversion privilege under which Aida can choose to convert the term
coverage to a permanent life insurance plan. Her waiver of premium benefit provides that if she is
still disabled on the last date that she is eligible to convert her term insurance coverage, her insurer
will automatically convert the plan to whole life insurance for the same amount of coverage and
continue to waive the premiums on that plan until she recovers, or dies.
This provision in Aida’s policy is more generous than the provisions available from some
other insurers. Some allow a conversion, but require the insured to pay premiums on the
conversion plan.
Waiver of Premium for Payor Benefit

Gerald owns and pays the premium on a juvenile life insurance policy that insures the life
of his two-year-old son Mark. The juvenile policy insures Mark for a sum of $5,000 until
he reaches age 21, at which time the insurance coverage automatically increases to $25,000.

Gerald pays for the policy each month by pre-authorized cheque. He wonders what would
happen if he dies, or becomes disabled and unable to maintain the premium payments on
his son’s policy. His agent suggests adding a waiver of premium for payor benefit to the
policy. This benefit provides that in the event that Gerald, as the owner of his son’s policy,
dies, or becomes disabled, the premiums due under the policy until Mark reaches age 21
will be waived by the insurer.
Gerald applies for the benefit and provides evidence of his insurability in order to qualify.
The application is accepted and the benefit is added to the policy.
Now, if Gerald suffers a serious disability because of accident or illness, then the premiums
falling due under the policy will be waived as long as his disability continues. If he dies, the
premiums will continue to be waived.
Gerald’s agent explains that if Gerald is disabled for three months or more, then the insurer
will begin to waive premiums that were due on and after the commencement of his disability.
According to the agent, this is a liberal approach to administering this type of disability claim.
Some insurers require that an applicant for the waiver of premium benefit must be disabled
for at least six months, and premiums will be waived only from that point on.
To qualify for the disability benefit, Gerald must suffer a disability that prevents him from
performing the duties of his regular occupation. If he continues to be disabled for two years
and is unable to perform the duties of any occupation for which he is suited by education,
training, or experience, the premiums will continue to be waived.
For example, Gerald is an accountant and is employed as a controller in a corporation. If he
suffered a disability, the insurer initially would consider him disabled if he could not
perform his duties as controller. If after two years, he is unable to perform the duties of an
accountant in any capacity, then the premiums would continue to be waived.
Disability Income Benefit

Norah is a mail clerk in a small company that has few employee benefits. Norah is concerned that
there is no salary replacement benefit in effect if she becomes disabled and unable to work.
Norah is a single mother of a five-year-old boy. She recently purchased a $50,000 term life
policy on her own life, because she wanted to provide money for her son if she died while he
was still a child. At the same time, she is concerned about providing for herself and her child
if she suffers a long-term disability.
She asks her agent about disability insurance. The agent informs her that she can apply for
disability income coverage as a benefit under her life insurance policy. If Norah provides
evidence of insurability and qualifies for the coverage, her insurer will add a disability income
benefit to her life insurance policy that will pay her a monthly income if she becomes disabled.
Disability insurance can also be purchased separately without owning a life insurance policy.
The benefit will provide $10 a month for every $1,000 of life insurance coverage. To qualify
for the benefit, Norah must have been totally disabled for at least three months. Total disability
is an inability to perform the essential duties of her own occupation or, after two years, of any
occupation for which she is reasonably suited by education, training, or experience.

Accidental Death and Dismemberment

Warren owns a farm and spends much of his time operating farm equipment. He has a good
life insurance program, but he wonders what will happen if he suffers a serious injury while
running the farm equipment.
Warren’s agent suggests that he consider adding an Accidental Death and Dismemberment
benefit to his life insurance coverage. Warren applies for and obtains Accidental Death and
Dismemberment coverage for a lump sum benefit of $100,000. If Warren suffers a serious
injury, the insurer will pay him the full $100,000 benefit. A schedule will be provided to
Warren listing benefit amounts payable for various types of injury.
For example, the full benefit would be paid if Warren lost both arms or the sight in both eyes.
He would receive a partial benefit if he loses one limb or the sight in one eye. Loss is defined
as either the actual loss of the limb or organ or the loss of use of the limb or organ (for
example, because of paralysis).
Accidental death insurance is defined under the Uniform Life Insurance Act as “insurance
undertaken by an insurer as part of a contract of life insurance whereby the insurer
undertakes to pay an additional amount of insurance money in the event of death by
accident of the person whose life is insured.”
[In 1925, the common law provinces (all except Quebec) first enacted uniform life
insurance legislation on insurance contracts and beneficiary rights. These acts, known
collectively as the Uniform Life Insurance Act, are updated periodically and apply to all
contracts made in the jurisdiction concerned. Similarly, accident and sickness insurance
legislation enacted over the years in the common law provinces is sufficiently similar that
it is referred to as the Uniform Accident and Sickness Act.]
Accelerated Death Benefit Riders and Common Accelerated Death

Benefits
An important proponent for developing accelerated or living insurance benefits was Dr. Christian
Barnard, a heart surgeon who performed the world’s first heart transplant. He felt that those who
survived critical illnesses, even for a short while, would be able to afford special care or take care
of other expenses and liabilities if they received an insurance benefit while they were alive. Those
who did not die immediately from a critical illness might incur significant expenses for their
personal care, while at the same time losing their regular sources of income.
In the 1980s, Prudential of America introduced an informal living benefit program for its
policyowners, particularly those who were suffering the lingering illnesses caused by the
AIDS virus. Working outside the provisions of the policy contract, Prudential arranged for
advance payment of a portion of the life insurance death benefit. The remainder of the
death benefit was paid upon the death of the insured. This “living benefit” was intended
for those whose life expectancy was short, to allow them to pay for health care or palliative
care or to realize certain personal goals.
Other insurance companies followed suit in providing living benefits in circumstances where the
delay in receiving a death benefit caused hardship for the insured and his or her family. For
example, in one case, the husband in a husband-and-wife run business became terminally ill. His
wife was unable to give her full attention to the business while she attended to her husband’s
needs. The business was suffering and in danger of closing. Since the business would represent an

important source of the wife’s income after her husband died, it made sense to negotiate a
living benefit. With a portion of the death benefit, the couple was able to maintain the
business until the husband’s death.
Since the inception of living benefits, the coverage has been formalized within insurance
contracts to provide benefits while the insured is still alive.
Accelerated death benefit riders allow the policyowner to elect to receive a portion of the death
benefit before the insured person dies, if the insured person is diagnosed with a critical illness.
The illness would usually be sufficiently serious to reduce life expectancy to 12 months or less
and involve the need for special care of the sick person. The benefits include:
• terminal illness benefit;

• dread disease benefit;
• long-term care benefit.
TERMINAL ILLNESS BENEFIT

Under this benefit, a portion of the death benefit is paid to the policyowner if the insured
person suffers a terminal illness. The definition of what constitutes a terminal illness is
stipulated in the contract provision. It usually requires that a physician certify that the
individual’s life expectancy is 12 months or less.
The amount of benefit varies, depending on the contract. The maximum benefit is usually a
percentage of the policy’s face amount up to a certain maximum. The amount paid out
reduces the final death benefit, so that after the insured person dies, the beneficiary receives
the difference between the terminal illness benefit and the policy’s face amount.
Example: Jerry has a $500,000 permanent life insurance policy which he purchased at age 32. Jerry is
now 47 years old and has been diagnosed with a terminal form of skin cancer. His doctors have given him
between 9 and 12 months to live. Jerry has an accelerated death benefit rider on this policy that covers
terminal illness. This rider permits Jerry to obtain 30% of the face amount up to a maximum
of $100,000 as a living benefit in case of terminal illness. In Jerry’s situation, 30% of the face
amount is greater than $100,000 so Jerry will be able to collect $100,000 from the life insurer.
He can use that money to do what he pleases; for instance, he could try out experimental
treatments and expensive drug regimes, he could go on an extended trip (provided his health
permits him to travel) or he could make a pilgrimage to a holy place and get spiritual succour at
a critical time in his life. When Jerry passes away, the life insurance company will deduct the
$100,000 already paid out from the face amount and his beneficiary will receive $400,000.
DREAD DISEASE BENEFIT

Under this benefit, a portion of the policy’s face amount is paid to the policyowner if the
insured person contracts one of a specific group of serious illnesses or suffers from certain
conditions, including, but not limited to:
• cancer;
• AIDS;
• kidney failure;
• heart attack;

• stroke;
• coronary bypass surgery.
The benefit can be paid in a lump sum or in monthly instalments over a short period of time.
LONG-TERM CARE BENEFIT

Long Term Care (LTC) insurance provides benefits to cover the expenses associated with care
received when a disability is so severe that an insured is unable to perform the Activities of
Daily Living (ADL). Benefits are usually paid out if the insured person is unable to perform two
or more ADLs, which include eating, bathing, dressing, or moving without assistance, or if the
insured suffers from conditions that affect ADLs, such as incontinence.
LTC coverage, which is most often associated with people at or near retirement age, pays for
a broad range of services that are not covered by medical insurance programs, including:
• adult day care;
• home health care;
• nursing home care;
• residence in a skilled nursing facility (nursing home);
• residence in an assisted living facility;
• residence in an Alzheimer facility;
• caregiver respite care.
Without this coverage, people who must pay for long-term care might have to liquidate
accumulated assets that were earmarked for another use. Coverage is most often renewable for
the lifetime of the insured person, or until the maximum lifetime benefits have been paid out.
As a rider to a life insurance policy, the Long-Term Care Benefit pays a monthly benefit to
the policyowner if the insured requires constant care for a medical condition. The monthly
benefit is usually a percentage of the base policy’s death benefit or face amount (the two are
synonymous). Many policies define eligibility for coverage by considering the inability of
the insured person to perform the Activities of Daily Living.
Term Insurance Riders on Permanent Life Insurance Policies
REASONS FOR ADDING A TERM INSURANCE RIDER

Why would a policyowner add a term insurance rider to a permanent life insurance plan,
instead of increasing the face amount of the permanent life insurance policy or applying for
a separate term life insurance policy?
The combination of a permanent life insurance policy and a term insurance rider is a convenient
way of organizing an individual’s and a family’s insurance plans. The cost of the term rider is
likely to be less than a separate term insurance plan for the same amount, because the policy fee
is smaller (or is waived entirely) for the term insurance rider. Also, the term insurance rider can
be maintained under the automatic premium loan non-forfeiture option of the permanent life
insurance policy. If the policyowner fails to pay the premium on a term insurance policy, the
coverage lapses. If the policy combines permanent life insurance with a term insurance rider,
failure to pay a premium will invoke the automatic premium loan provision. If there is sufficient
loan value in the policy, the coverage (both permanent and term) will continue.

In establishing a life insurance program, a policyowner should address needs that require a
permanent life insurance solution, such as capital gains taxes at death, and needs that require a
temporary solution, such as paying off a mortgage. The term insurance rider allows policyowners
to address a range of insurance needs. As circumstances change, the policyowner can adjust
his or her insurance plan, by terminating the term coverage, for example, or by
exercising the conversion privilege under the term insurance rider.
TERM COVERAGE FOR A SPOUSE OR CHILDREN

Since insurance planning affects all the members of a family, an insurance program can
include coverage for the spouse and children under one insurance policy.
Term coverage for a spouse can address the cost of providing care for children during their
minority if the spouse insured by the term rider dies. Term coverage on the children can
address the costs of burial and other costs associated with the death of a child.
This coverage is usually sold based on units of coverage. For example, each unit provides
$5,000 of term insurance coverage on the spouse and $1,000 of term insurance coverage on
each child. The children’s coverage does not require separate premiums for each child.
Every child in the family, including adopted children and newborns (beginning 15 days
after birth) are covered automatically at no extra premium.
The children’s coverage insures each child until he or she reaches a stated age, usually 21 or
25. Each child has the option to convert his or her coverage to an individual life insurance
policy on his or her own life without having to provide evidence of insurability. The
premiums would be based on the child’s attained age.
Example: Rodney Ramirez is a 40-year-old married man and a father of fi ve children ranging in age
from 3 years to 15 years. His wife, Mary, at age 36, is expecting their sixth child. Two years ago,
Rodney applied for and obtained a $250,000 whole life insurance policy on his life, naming Mary as
beneficiary. A friend of Rodney has recently advised him to purchase a term insurance policy on
the life of Mary and also on the lives of each of the kids and Rodney thinks that is a great idea.
He contacts his agent and outlines the situation. What should his agent recommend and why?
Rodney’s agent is likely to recommend that he add term insurance riders on his $250,000
policy, one on the life of Mary as well as a children’s rider. The benefit of the children’s rider is
that it will cover all fi ve children in the family and the sixth child will be covered automatically
(starting 15 days after birth) without Rodney having to pay an extra premium. Under the terms of
this policy, Rodney can purchase up to $10,000 of coverage on each child that insures the child
until he or she reaches age 21. For Mary, he can choose an amount between $10,000 and
$125,000 (i.e., up to 50% of the face amount of the main policy).
This arrangement neatly ties in all the insurance that Rodney needs on his family members in one policy
that also offers enhanced features and options available only with permanent life insurance policies.
Getting six other term insurance policies, one for Mary and one for each of the fi ve kids, is likely to cost
much more with policy fees and other administrative tasks. Also, Rodney would have to remember to
get a policy on the sixth child’s life and pay an additional premium if he did not add a children’s rider to
his whole life policy. Rodney will also have the option of exercising a conversion privilege under the term
rider if he wants to convert the term insurance, for whatever reason, to permanent insurance. Once
again, using riders allows a degree of flexibility to Rodney and his family that would not be available
through the purchase of separate term insurance policies.

Guaranteed Insurability Benefit or Guaranteed Insurability Option

The guaranteed insurability benefit (GIB) or guaranteed insurability option (GIO) is a benefit that
a policyowner can purchase to acquire additional life insurance without having to provide evidence
of insurability. In effect, a person can choose to pay a relatively small premium for the
opportunity to increase his insurance coverage in the future, even though he might not
otherwise qualify because he is no longer insurable. For example, a 25-year-old man who has
recently married may not need or be able to afford a large amount of insurance. He would
need more insurance later on in his life as his family grows and he takes on more obligations.
In the future, however, if his health deteriorates, he might not qualify for additional
insurance. He can acquire a GIB that allows him to buy additional insurance at certain
times before he reaches age 40 (some insurers offer the benefit until age 45).
The GIB specifies a number of dates on which the policyowner can elect to purchase additional
insurance, without providing evidence of insurability. The amount of insurance that the
policyowner can purchase on each option date may be the same type and amount as the basic
policy or some other amount of insurance of the same type as that of the basic policy.
The policyowner may also exercise the purchase option earlier than stipulated, for example,
upon his marriage or the birth of a child. The policyowner must make the election to
purchase the additional insurance and pay the premium. If he does not take advantage of the
option on the date it is available, he cannot make the election later, and that option is lost.
Some riders provide that if the policyowner dies within a short period (60-90 days) after
an option date without having purchased additional insurance, the insurer will pay the
additional insurance amount.
If the base policy contains a waiver of premium benefit and the insured person is disabled at
the time of an option date, the insurer will automatically issue the additional insurance
coverage. The waiver of premium benefit may specify that the premiums on the additional
coverage will be waived until the insured person recovers or dies.
Paid-Up Addition Rider

The policyowner can apply for this rider on the life of an insured person by providing appropriate
evidence of insurability. Once the addition of the rider is approved, the policyowner can buy,
on each anniversary of the establishment of the base policy, an additional amount of
insurance. The additional insurance, which is purchased by paying a single premium, is
usually whole life insurance that accumulates its own cash value.
The rider provisions limit the minimum and maximum amounts of paid-up insurance that
can be purchased by stipulating the minimum and maximum single premium that the
policyowner can pay when exercising this option.
The option of purchasing additional paid-up insurance can be used to complement insurance
planning programs. For example, the amount of paid-up insurance acquired each year can
approximate the yearly increase in a policy’s cash value (e.g. the cash value in the policy increases
by $100 so the policyholder buys an additional $100 of life insurance). The death benefit that is paid
out eventually will equal the face amount of the policy, plus the cash value, whereas normally, the
death benefit is the face amount of the policy. The cash value is not paid out

separately. The insurer’s liability is the face amount, less the cash value (or reserve) and that
is the net amount at risk.
Split-dollar Arrangements
In business insurance planning, a corporation and a key employee may set up a split-dollar
arrangement as part of a life insurance program. The corporation will pay a premium that
represents the accumulating cash value and the key employee will pay a premium that represents
the death benefit portion. Under the terms of the split-dollar arrangement, the corporation owns
the cash value and the key employee owns the death benefit. When the key employee dies, the
insurance company will pay the face amount under the provisions of the split-dollar arrangement.
Part of the payment represents an amount equal to the cash value, which belongs to the employer.
The balance belongs to the beneficiary of the deceased employee.
Since the cash value or reserve under a life insurance policy accumulates until it approaches
the value of the policy’s face amount, under a split-dollar arrangement, the part of the death
benefit that represents the employee’s interest will shrink as the cash value (the
corporation’s interest) grows. The employee can stabilize his or her stake in the insurance
plan by including a paid-up addition rider. This option effectively maintains the death
benefit payable to the employee’s beneficiaries at a level amount.
Split-dollar arrangements can be structured in numerous ways and can be most effectively
used within a universal life plan of insurance, primarily because of its flexible nature.
INSURANCE POLICY LIMITATIONS, PROVISIONS, AND

BENEFICIARIES
LEARNING OBJECTIVES
• explain the impact to the client of the following standard policy limitations and
provisions: 10 Day Right of Rescission, Entire Contract, Suicide, Incontestability,
Grace Period, Reinstatement, Smoking Status, Misstatement of Age or Sex, Settlement
Options, Material Misrepresentation;
• list and describe the additional provisions of permanent life insurance policies that
build a cash value: the non-forfeiture provision and a policy loan provision;
• explain the difference between primary and contingent beneficiaries;
• identify and explain the features of a preferred beneficiary clause;
• explain the difference between a revocable beneficiary and an irrevocable beneficiary;
• explain the consequences of an absolute assignment;
• recognize that there are issues to address and that assistance may be needed with
policies issued prior to 1962;
• recognize that there are issues to address and that assistance may be needed with
policies issued prior to 1982.

Standard Policy Provisions

Most standard life insurance policies contain provisions that limit how they can be applied
and that give the policyowner certain rights and responsibilities. We will illustrate these
provisions using examples.
10 DAY RIGHT OF RESCISSION

Margaret is a 24-year-old accountant who recently graduated from a university business
program. She has amassed a sizable student loan that she must begin paying off almost
immediately. She has also recently moved away from home and is renting her own apartment
for the first time. A friend suggested that she might consider buying life insurance to cover
her debt, so that if she died before her loan is repaid, her parents as next of kin would not be
faced with repaying her debts.
Margaret took the advice and applied for an insurance policy. She was approved, her agent
delivered the policy to her, and she paid the first premium. Five days after she accepted the
policy, she discovered that her student loan was insured and in the event of her death the debt
would be paid off. While Margaret realized that life insurance was an important part of her
financial and estate planning, she felt that her current financial obligations were daunting
enough without the added burden of a regular life insurance premium.
Her agent had clearly outlined the 10-day right of rescission provision of the policy and it
was also clearly described on the policy’s cover page. It gave Margaret 10 days (from the
date the policy was delivered to her) to change her mind and cancel the policy. Margaret
decided to exercise the rescission right and she contacted her agent. The agent took back the
policy and refunded Margaret’s initial premium.
ENTIRE CONTRACT
Allan planned to buy a $100,000 term insurance plan, to be paid for monthly by pre-
authorized cheque. When Allan spoke to his agent, the agent described the waiver of
premium benefit that Allan could add to the plan at an extra premium and Allan agreed that
it would be a good idea to add the benefit. As they were filling out the forms, Allan was
distracted by a telephone call and when the agent placed the completed application before
him to sign, he did so without reviewing the form.
Shortly thereafter, his agent delivered the policy. Allan listened politely while his agent
explained the terms and conditions of the coverage but he didn’t fully take in the details.
Two years later, Allan suffered a serious disability that prevented him from working. He was
having trouble financially and he was considering cancelling his life insurance because he could
not afford the premiums. A friend asked Allan if he had a waiver of premium benefit on his
policy and suggested that Allan check his contract. Allan remembered discussing such a benefit
and he thought that he had agreed to its addition. When he checked with his agent, however, the
agent advised him that the benefit had not been included in his insurance policy.
Allan insisted that he had wanted to add the benefit and that the agent should have made sure
that it had been included. Although the agent apologized for a possible misunderstanding, the
insurance company was not willing to amend the contract and add the benefit.

Allan sought legal advice. Based on a review of Allan’s application, a copy of which was
included in the policy contract, and the provisions of the policy, it was clear that the waiver of
premium benefit had not been requested in writing, nor did the contract refer to the benefit.
The policy contract stipulated under its entire contract provision that the terms of the
contract were limited to the written application and the written provisions of the policy.
No oral statements could affect the terms of the policy.
SUICIDE
Glen was a successful executive in a dot.com corporation. The company, in recognition
of his contribution to its success, bought an insurance policy on his life for $1,000,000.
Within one year, the company’s fortunes changed dramatically and its future prospects were
gloomy. Glen took the downturn personally and in a fit of desperation took his own life. The
company submitted a claim for the death benefit. After an investigation into the
circumstances of Glen’s death, the insurer declined the claim under the suicide provision of
the policy contract. The provision stated that if the life insured committed suicide within two
years of the policy’s issue date or within two years of its reinstatement, the policy would be
terminated. Only the amount of premiums, less any policy loan, would be payable.
The company sued for the benefit. The insurer was bound to prove that Glen’s death was
the result of suicide beyond any other explanation. The insurer proved its case.
If Glen had committed suicide two years or more after the policy was issued, the insurer
would have to pay the death benefit.
MATERIAL MISREPRESENTATION
Applicants for life insurance policies answer application questions and provide information about
their current physical and mental health, as well as information about any medical or other
personal history that is pertinent to assessing the applicant’s qualification for life insurance.
The insurer relies on that information to determine if it is willing to issue a life insurance
policy on the applicant’s life.
As with any contract, the accuracy of the applicant’s written statements determines the validity
of the contract. If the insurer has relied on incorrect information to issue a policy, then it has the
right to rescind (that is, cancel) the contract. This right is laid down in contract law and in the
provincial insurance acts that define the rights and obligations of the insurer and the insured in
drawing up and implementing a life insurance policy contract. “Material” means that the
information that was omitted or not accurately stated was such that, had the insurer known
the information, it would not have issued the policy at all or would have issued the policy
on a different basis, such as for a higher premium.
In contract law, statements made by the parties who are negotiating the contract may
be considered either warranties or representations.
• A warranty is a statement that, when considered and found not to be completely
and literally true, will invalidate the contract.

• Representations are statements that are expected to be substantially true, that is, they
may contain inaccurate details, but the main part of the information is true. One party
to a contract can challenge its validity only if representations by the other party
during the creation of the contract are found to be substantially untrue.
For example, Judy, an applicant for life insurance, states that she has not been treated for a
medical condition within the last five years. She has forgotten that she had emergency
room treatment for a badly cut finger four years previously. She has therefore made a
statement that is untrue.
Was Judy’s statement a material misrepresentation? Her statement did not disclose all of her
medical treatment. If the insurer had known about Judy’s emergency room treatment, would it
have assessed her risk differently? In all probability, the treatment for the cut finger is not
material and the information, if it had been disclosed, would have had no bearing on the insurer’s
decision to accept or decline the risk. Therefore it is not a material misrepresentation.
If the contract provisions required that all of the statements put forward in an application
be treated as warranties, then the validity of the contract could be challenged, even for a
minor inaccuracy like Judy’s. In the early days of life insurance, insurers attempted to
treat every statement by the applicant as warranties. If any of the applicant’s statements
were not literally correct, then the insurer would take steps to rescind the contract.
Statutory law and case law surrounding life insurance contracts have established that
statements made on an application for insurance are considered representations, not
warranties. Judy’s statement on the application is substantially true, if not literally true.
The provincial insurance acts require insurance contracts to specify that the insurance company
can rescind a policy only if it discovers that the applicant for the policy has materially
misrepresented one or more facts contained in the application in a way that would prevent the
insurer from accurately assessing the risk of insuring that applicant. The insurer’s right to
rescind a contract is limited, however, to two years from the date a policy comes into effect.
INCONTESTABILITY
When Gwen applied for a life insurance policy, she failed to disclose that she suffered from
high blood pressure and was on high doses of medication to control her blood pressure
levels. Her application was processed without a medical form and there was no indication on
the application that she was receiving any kind of medical care.
Within one year, Gwen died as the result of an automobile accident. Her executor applied for the
death benefit under the policy. Because Gwen’s death had occurred so soon after the policy had
been issued, the insurer conducted an investigation. The investigator found out that Gwen had
not disclosed the fact that she was being treated by a physician for high blood pressure. After
receiving a report from Gwen’s physician, the insurer concluded that if the information had been
disclosed at the time of the application, the company would not have issued a standard policy.
The claim was denied under the incontestability provision of the contract.
The incontestability provision states that “In the absence of fraud, the insurer will not contest
the policy after it has been in force for two years during the lifetime of the insured from the
time that the policy takes effect or two years from the date it has been reinstated, if later.”

This means that during the first two years that the policy is in force, the insurer can rescind
the policy if the applicant for the policy has made a material misrepresentation. After the
first two years are up, the policy becomes incontestable.
In this case, despite the fact that the life insured died as the result of an unrelated cause,
the insurer had the right to invoke the incontestability provision.
If Gwen’s death had occurred after the policy had been in force for two years, the insurer would
either have had to pay the claim or prove that the misrepresentation was fraudulent. To be
considered guilty of fraud, the applicant must have knowingly and intentionally misrepresented a
material fact about her insurability with the clear intent of getting the insurance company to issue
a policy it might not otherwise have issued. If Gwen’s heirs sued the insurance company for
failure to pay the claim, it would be the responsibility of the insurance company to prove that
Gwen knowingly and intentionally failed to disclose the material information.
The provision includes the stipulation “during the lifetime of the insured” in order to prevent
the pursuit of a claim more than two years after a policy has been issued, even though the life
insured died before the end of the two-year contestable period.
GRACE PERIOD
Section 182 (2) of the Insurance Act of Ontario states as follows:
Where a premium, other than the initial premium, is not paid at the time it is due, the
premium may be paid within a period of grace of,
(a) thirty days or, in the case of an industrial contract, twenty-eight days from and
excluding the day on which the premium is due; or
(b) the number of days, if any, specified in the contract for payment of an overdue premium,
whichever is the longer period.
Emmanuel owned a $200,000 term insurance policy on his own life for which he paid the
monthly premiums by pre-authorized cheque. Recently, he changed bank accounts, but forgot
to inform his insurance company. The next month, his pre-authorized cheque was returned to
the insurer as unpaid. The insurer immediately notified Emmanuel by mail that the payment
had not been honoured and sent him a premium notice for the overdue premium.
Emmanuel failed to pay the premium within 30 days of its due date. The policy lapsed, subject to
a provision that allows Emmanuel to apply for reinstatement of the policy by submitting evidence
of insurability and paying all due premiums, including late payment interest.
If Emmanuel had paid the premiums within the grace period, there would have been no
changes to his policy. The policy stays in force during the grace period. If Emmanuel were
to die after the end of the 30-day grace period, the insurer would not honour any claim for
benefits, because the coverage had lapsed.
It should be noted that some insurance companies include a 31-day period of grace.
Section 182(3) of the Insurance Act of Ontario states as follows:
Where the happening of the event upon which the insurance money becomes payable occurs
during the period of grace and before the overdue premium is paid, the contract shall be deemed
to be in effect as if the premium had been paid at the time it was due, but the amount of the

premium, together with interest at the rate specified in the contract, but not exceeding 6 per
cent per year, and the balance, if any, of the current year’s premium, may be deducted from
the insurance money. R.S.O. 1990, c. I.8, s. 182.
This provision indicates that if Emmanuel had died during the 30-day period of grace,
the insurance company would pay $200,000 less overdue premiums.
REINSTATEMENT
Upon learning that his policy had lapsed, Emmanuel contacted his insurer. The representative
explained that Emmanuel could apply to have his term life insurance policy reinstated under
a provision of his policy contract. The provision states that the policyowner can apply to
reinstate a lapsed policy within two years of its date of lapse by:
• completing a reinstatement application;
• providing acceptable evidence of the insured person’s insurability;
• paying all due premiums plus late payment interest at a rate of no more than
6% compounded annually.
Emmanuel complied with all of the conditions and the insurer reinstated his term life
insurance policy.
The benefits of reinstating a lapsed policy rather than applying for a new policy are either
to maintain a type of contract that is no longer available for purchase, or to preserve the
insurance age of the life insured so he or she does not have to purchase a new policy at an
older age and pay higher premiums and instead maintain the premiums that were specified
under the original policy.
SMOKING STATUS
Most insurers offer preferred premium rates to applicants who do not smoke. Some insurers
describe non-smokers’ premium rates as standard rates and the rates for smokers as sub-
standard rates.
In any event, applicants who stipulate that they have not smoked a cigarette, cigarillos, small
cigars, or marijuana or other tobacco products within the last twelve months are eligible for
non-smoker premium rates. However, some insurance companies waive certain kinds of
tobacco use such as occasional cigar or pipe smoking. An applicant for non-smoker rates
does not have to be someone who has never smoked.
Winston discussed the purchase of a life insurance policy with his agent. The agent showed
Winston the rates for non-smokers and smokers and Winston was impressed by the
difference in premiums. Winston decided to apply for a $100,000 term life insurance
policy. When his agent asked about Winston’s smoking habits, Winston indicated that he
did not smoke. In fact, Winston did smoke cigarettes on a regular basis. The policy was
issued on a standard basis with non-smoker premium rates.
The two-year contestable provision means that within the first two years of the policy, the insurer
can cancel the contract if it is discovered that the applicant made material misrepresentations
on the application. Failure to disclose a frequent smoking habit would be considered a material
misrepresentation. If the policy has been in force for more than two years, the insurer would

have to prove that the applicant acted with fraudulent intent to make the insurer issue the
policy under the terms available to non-smokers, rather than those available to smokers.
Some insurers include a provision in their contracts that stipulates that if the insured person’s
smoking habits are misrepresented in the application, the insurer will modify the coverage to the
kind it would have issued at any time that the misrepresentation is discovered.
This provision, however, may not be supported by current provincial legislation governing
insurance contracts. The life insurance acts of the provinces allow insurers a two-year
contestable period to cancel contracts that have been issued because of a material
misrepresentation. The acts allow insurers to modify the contract for two reasons only: if the
age or the sex of the applicant has been misrepresented. The acts do not allow for
modification of the contract for any other reason, so modifying the contract to reflect the fact
that the applicant is a smoker may not be upheld in law.
MISSTATEMENT OF AGE OR SEX

Eldon was born in a region of the country where birth records were not completely accurate.
When he applied for a life insurance policy, he informed the insurer that he was 30 years old.
The company issued a $100,000 term life insurance policy on Eldon’s life and charged a
premium based on age 30 rates.
Five years later, Eldon died as the result of a serious illness. His executor received
conflicting information about Eldon’s age and sought to confirm his true age. The executor
was able to confirm that Eldon was actually five years younger than was believed.
When the executor provided proof of Eldon’s true age to the insurer, the company revised the
amount of insurance to the amount that the same premium would purchase for a 25-year-old.
The provincial insurance acts have specific provisions relating to a misstatement of age. If at
any time the insurer discovers that the age of an insured person has been misstated, it has the
right to adjust the coverage accordingly.
“Where the age of a person whose life is insured is misstated to the insurer, the insurance
money provided by the contract shall be increased or decreased to the amount that would
have been provided for the same premium at the correct age.”
“Where a contract limits the insurable age and the correct age of the person whose life is
insured at the date of the application exceeds the age so limited, the contract is, during the
lifetime of that person, but not later than five years from the date the contract takes effect,
voidable by the insurer within 60 days after it discovers the error.”
Although the insurance contract does not have to contain any provision concerning a
misstatement of age, most insurers stipulate the manner in which misstatements of age will
be addressed under the policy. The provision may specify the insurer’s actions if the
misstatement is discovered during the life insured’s lifetime or after the life insured’s death.
Many insurers also include misstatement of sex in the same provision.

SETTLEMENT OPTIONS
Randy is the beneficiary of his wife’s $200,000 life insurance policy. His agent has informed
him that he can either receive a cheque for $200,000 or deposit the money under one of the
settlement provisions of the policy. The agent describes the options available under the
settlement option provisions of the policy:
• Randy can leave the funds on deposit at interest. This option guarantees that a stated
minimum amount of interest will be paid on the funds. The interest will be paid
periodically, according to a schedule agreed upon between Randy and the insurer. Randy
can withdraw the funds at any time and he can name another person (a contingent payee)
who will receive the interest income after Randy himself dies.
• Randy can arrange to receive the principal and interest over a fixed period. The
provision will state a minimum amount of interest to be credited.
• Randy can elect to receive a fixed amount of money periodically. How long the payments
will continue depends upon the amount of the withdrawals and on the interest earned.
• Randy can set up a life income. Under this option, the death benefit is used to purchase a
life annuity. (A life annuity guarantees to provide a regular income to the annuitant for
at least the annuitant’s lifetime.) The amount of the periodic payments depends on the
size of the annuity that the death benefit will buy and on Randy’s age. Randy can choose
one of the following life income options:
– The straight life income option: the policy proceeds are used to provide an income for
Randy’s lifetime. Payments cease upon his death. This is a risky choice, since
Randy might die after receiving only a few payments.
– The life income with period certain option: Randy will receive annuity payments for his
lifetime. If he dies before the end of a certain period of time (ten years, for example),
payments will continue to the beneficiary he has selected for the balance of the period.
– Refund life income option: Randy will receive a lifetime annuity. Upon his death, the
insurer will pay the beneficiary any balance remaining from the purchase price of
the annuity.
– Joint-and-last-survivor annuity: the annuity benefit will be payable for the lifetimes of
two annuitants, usually spouses. In this case, since Randy’s wife is deceased, this
option may not be appropriate.
Each choice represents a different level of annuity payments. Randy would receive the largest
annuity payment by electing the straight life annuity, although he risks losing the purchase
amount if he dies prematurely. The other choices represent smaller payments, although more of
the principal paid to set up the annuity is preserved for Randy’s beneficiaries.

Additional Provisions in Permanent Life Insurance Policies to

Access Accumulated Cash Value
Permanent life insurance policies accumulate a cash value because of the level premium reserve
system. In traditional life insurance policies, the contract includes a table that lists the cash value
figures that are available at each anniversary of the policy. Most tables provide the year-by-year
values for the first ten years or so, then the values at every fifth anniversary, and finally the
values at significant anniversary dates, such as the year that the insured person turns 75.
Under the policy contract provisions, each policyowner has access to the accumulating cash
value for certain purposes.
AUTOMATIC NON-FORFEITURE PROVISION

An important provision is the automatic non-forfeiture provision. A life insurance policy that
accumulates a cash value generally contains an automatic premium loan non-forfeiture option
provision. This means that, if the policyowner fails to pay a premium within the grace period,
the insurer will issue a loan against the policy’s cash value for the amount of the premium
and will keep the policy in force. Interest will be charged on the loan at a rate stipulated in
the contract. Additional automatic premium loans will be granted for other unpaid premiums
until the loan amount equals the cash value. At that point, the policy will lapse.
OTHER OPTIONS
The policyowner of a policy who stops paying premiums on a policy with a cash value has
other options.
• The policyowner may terminate the policy and receive the cash surrender value.
• The policyowner can elect the reduced-paid-up non-forfeiture option. Under this
provision, the insurer applies the current cash value as a net single premium to
purchase paid-up insurance of the same type as the base policy. The amount of the
paid-up insurance policy will be less than the amount in effect before the non-forfeiture
provision is exercised. The contract usually provides a table of paid-up insurance
amounts available at various policy anniversaries.
• The policyowner can elect the extended term insurance non-forfeiture option. The insurer
applies the current cash value to purchase term insurance for the full coverage amount
provided under the original policy for as long a term as the cash value can provide.
LOAN AGAINST CASH VALUE

The policyowner can apply for a loan against the cash value of the policy. The maximum
amount of the loan is equal to the cash value less one year’s interest. Interest is charged
annually and billed to the policyowner on the policy anniversary. Any unpaid interest is
added to the amount of the loan principal.
The policyowner is not obliged to repay the loan. If the loan, plus accruing loan interest,
exceeds the cash value of the policy, the policy will lapse. If the insured person dies when a
loan is still outstanding, the value of the loan and any accrued and unpaid interest will be
deducted from the death benefit otherwise payable to the beneficiary.

Primary and Contingent Beneficiaries

All life insurance policies that pay a death benefit allow the policyowner to appoint a
primary beneficiary of the insurance proceeds. The beneficiary may be:
1. An individual, such as a spouse or a child.
2. The policyowner himself or herself. In this case, if the policyowner is not the same person
whose life has been insured, upon the life insured’s death, the policyowner receives the
death benefit. If the policyowner is the person whose life has been insured, then when the
policyowner dies, the death benefit is payable to that person’s estate.
3. A class of persons, such as “all my children”.

If there is only one named beneficiary and that person or group of persons dies before the
insured person, then when the insured person dies, the death benefit will be paid to the
policyowner or to the deceased’s estate if the insured person is also the policyowner.
A policyowner can select a contingent beneficiary; that is, beneficiary who will receive
the death benefit if the primary beneficiary dies before the person whose life is insured.
There can be a series of contingent beneficiaries. For example, a policy may identify the
beneficiary as: “My wife Brenda, if living, otherwise my son, Walter, if living,
otherwise my brother Vic, if living, otherwise my estate.”
Preferred Beneficiaries and Policies Issued Before 1962

In the common law provinces before July 1, 1962, certain beneficiaries were considered preferred
beneficiaries. This group consisted of spouses, children, adopted children, parents, grandchildren,
children of adopted children, and adoptive parents of the person whose life is insured.
If the beneficiary of the policy belonged to this group, the policyowner could not exercise
certain policy provisions, such as cancelling the policy or taking a policy loan, without the
written consent of the preferred beneficiary. The policyowner also could not change the
beneficiary to a class outside of the preferred beneficiary group without the consent of the
preferred beneficiary. The policyowner could, however, appoint another member of the
preferred beneficiary class without the consent of the previous preferred beneficiary.
Revisions to the provincial insurance acts have resulted in no distinction between
preferred beneficiaries and other beneficiaries for policies issued after June 30, 1962.
Nevertheless, some life insurance policies have been in effect for 45 years or more. The
beneficiaries appointed under these policies may belong to the preferred class of
beneficiaries. In fact, even very recent beneficiary appointments under these policies may
be considered preferred beneficiary appointments.
If a policyowner holds a life insurance policy that names a preferred beneficiary, the exercise of the
policyowner’s rights under the policy will require the written consent of the preferred beneficiary.
If your clients have old policies, make sure that they are aware of these restrictions.
If you cannot answer their questions about these old policies, you should ask a more
experienced agent or a specialist in this area.

Revocable and Irrevocable Beneficiary

Since July 1, 1962, a policyowner has had the right to name any person or group as
beneficiary without restricting his or her right to exercise any of the policy’s provisions.
The policyowner can also change the beneficiary at any time, without the previous
beneficiary’s consent. This means that beneficiary designations are revocable, unless the
policyowner chooses to appoint a beneficiary irrevocably.
“An insured may in a contract, or by a declaration other than a declaration that is part of a
will, filed with the insurer at its head or principal office in Canada during the lifetime of
the person whose life is insured, designate a beneficiary irrevocably, and in that event the
insured, while the beneficiary is living, may not alter or revoke the designation without
the consent of the beneficiary and the insurance money is not subject to the control of the
insured or of the insured’s creditors and does not form part of the insured’s estate.”
An irrevocable beneficiary, once named, must give his or her consent whenever the policyowner
wishes to exercise some of the options available under the policy, such as the policy loan provision,
surrender of the policy for its cash value, or the appointment of another beneficiary.
The document that appoints an irrevocable beneficiary must clearly indicate that choice.
One province, Nova Scotia, requires that the beneficiary appointment form clearly indicate
that the policyowner understands the restrictions placed on the exercise of the policy
provisions when an irrevocable beneficiary is named.
If a beneficiary is named in a will, the beneficiary is considered revocable, even if
the will provision intends to appoint the beneficiary irrevocably.
“A designation in favour of the ‘heirs’, ‘next of kin’ or ‘estate’ of the insured, or the use of
words of like import in a designation, shall be deemed to be a designation of the personal
representative of the insured.”
Absolute Assignment of a Life Insurance Policy

An assignment is an agreement under which one party transfers some or all of his ownership rights
in a property to another party. A life insurance policy is considered a property, therefore ownership
rights can be transferred to someone else. A life insurance policy contains a provision that outlines
the insurer’s obligations relating to the assignment of a policy. These provisions are:
• the insurer is not responsible for the validity of any assignment;

• the insurer must receive a copy of the assignment;
• the assignment must not contravene any actions taken under the policy by the insurer
before receiving the assignment: this means that if the insurer has made any payment or
taken any other action before receiving the copy of the assignment, it is not required to
rectify that action, if that action contravened the provisions of the assignment.
Under an absolute assignment, the policyowner transfers all rights, title, and interest in the
contract to the assignee. The absolute assignment is, in fact, a change of ownership. For
example, Fred owns a life insurance policy on his own life. His wife, Doris, is the
beneficiary. Fred decides to assign his policy to Doris and give her full control of the policy.
Fred is no longer a party to the contract, although he is still the life insured.

Why would someone assign a policy to someone else? Assignment may occur during a
divorce, for example. Suppose Doris gets a divorce from Fred. She is the beneficiary of the
policy and Fred is the life insured. As part of the divorce agreement, Doris has the policy
absolutely assigned to her and takes charge of the policy. This way she does not need to
worry about Fred cancelling the policy. As part of the divorce agreement, he might still be
responsible for paying the premiums, but if he does not, Doris will be made aware of this.
An absolute assignment constitutes a gift or a sale of the policy. If the policyowner gives the
contract to another party, there is a deemed disposition of the policy. The amount of the deemed
disposition is the cash value of the policy. If the cash value exceeds what the policyowner paid
for the policy, the transferring party must report the excess as income for income tax purposes.
If the policy is sold under the terms of the absolute assignment in an arm’s-length
agreement (an arm’s length transaction involves two parties who are not related by blood or
close financial ties), the disposition is the amount that has changed hands.
In some cases, the policy is considered to change hands at the value of the policy’s adjusted
cost basis (ACB), that is, the recipient takes over the policy at its current cost and there is no
deemed disposition. This rule applies when the policy is transferred from its owner to a
child, spouse or former spouse under certain conditions. This rollover of the policy is
considered to take place if the interest in a life insurance policy has been transferred free of
charge from the policyowner to the child, spouse, or former spouse, and a child of the
policyowner (or a child of the recipient) is the life insured.
Policies Issued Before 1982

Canada Revenue Agency (CRA) introduced a number of changes to the taxation of life
insurance policies issued after December 1, 1982. Life insurance policies in effect before
December 2, 1982 that have not undergone substantial increases in benefits and premiums
since that time are still subject to the tax rules that were in effect before that date.
The December 1, 1982 rules led to the distinction between exempt and non-exempt policies.
Exempt policies have to meet a certain definition specified in the Income Tax Act and are
intended mainly to provide benefits at death. The maximum tax actuarial reserve represents
the maximum amount that can be accumulated within an exempt policy while retaining its
exempt status. A non-exempt policy is, of course, one that does not meet the statutory
definition. Policies issued prior to December 2, 1982 are grandfathered (that is, not subject to
these rules) and treated as exempt policies.
Therefore, any request to replace an existing policy with a new contract must be reviewed
carefully in view of the changes in the taxation of life insurance policies. The policyowner
would forgo certain tax advantages by replacing a contract issued before December 2, 1982
with a new contract issued after that date.
• In the older policies, the adjusted cost base of the policy includes the entire premium
paid. For policies issued after December 1, 1982, premiums for additional benefits and
riders are not included in calculating the adjusted cost base and each year an amount
representing the net cost of pure insurance (NCPI) for the year is deducted from the cost.
Consequently, more of the policy’s surrender value will be taxable if the policy was
issued after December 1, 1982, since the cost base is smaller.

• For certain policies, such as endowment plans, issued after December 1, 1982, the
accumulating value is subject to accrual taxation, much like the accumulating value of
a GIC or Canada Savings Bond. The policyowner must pay tax on an accrued value,
even though he or she has not received any income. Endowment policies created before
December 2, 1982 continue to accumulate value on a tax-deferred basis.
• When the life insured dies, any life insurance policy issued after December 1, 1982
and taxed on an accrual basis will be subject to tax on any amount accrued that was
not previously taxed.
• For policies issued before December 2, 1982, the policyowner could withdraw part of the
cash surrender value tax-free, up to the limit of the policy’s adjusted cost base. For
policies issued after December 1, 1982, the amount of cash value that can be withdrawn
tax-free is reduced due to the NCPI serving to shrink the adjusted cost base.
• For policies issued before December 2, 1982, the cash value can be used to acquire
an annuity without attracting tax, that is, the transaction is not considered a taxable
disposition. For policies issued after December 1, 1982, buying an annuity with a life
insurance policy is considered a disposition and the excess of the cash value over the
policy’s adjusted cost base is taxable as income.
The income tax provisions relating to permanent life insurance policies are complex and the
taxation of each “in force” policy must be carefully considered in any review of an insurance
program, particularly for policy contracts issued before December 2, 1982. As an agent, you
may need to work with a tax specialist so that you can give clients the most up-to-date
information available.
Although most agents focus on bringing in new clients, you might have clients who own
old policies and want to understand them better. You must either be able to answer the
client’s questions or get the answers from a reliable source.
VIDUAL LIFE INSURANCE PRODUCTS TO MEET

SPECIFIC CLIENT NEEDS
The following examples depict situations where different types of individual insurance
would be applicable.
Example 1: Providing for Child with Special Needs

Edwin and his wife Mary have cared for their mentally challenged son during his childhood. It
is likely that he will need lifetime care and he will not be able to support himself. Both parents
are concerned about what will happen if their son survives them. They have established a
trust for his benefit. The financial institution will administer the trust.
Although they can fund the trust with periodic contributions, they now want to make sure that
the trust has sufficient funds if one or both of them dies or becomes disabled and unable to
work. They are also concerned about having to finance the trust once they retire. Insurance can
help address their concerns.

What product(s) would you recommend that they consider?

Edwin and Mary could apply for life insurance on each of their lives, with the death benefits to
be paid to the trust for the benefit of their son. The type of life insurance should be permanent
(whole) life, since it is unknown how long Edwin, Mary, or their son will live.
If the trust relies on contributions from Edwin and Mary, then they should consider
disability income insurance on the life of the one who earns the most money, to make sure
that they will have the resources to continue to provide funds for the trust.
They could also consider setting up a deferred annuity plan to begin when the older of the
two retires. Once the annuity payments begin, they can be paid into the trust. The parents’
income after retirement may not be large enough to maintain their living expenses and
contribute to the trust.
Example 2: Planning for Serious Illness

Milton operates his own business as a sole proprietor. He is able to earn a good living from the business.
He relies solely on his own efforts to keep the business going. He is approaching 40 years of age. His
father and an uncle both contracted cancer at about the age of 40 and he is concerned that he might be
susceptible to the disease because of his family history. He wants to make sure that if he does become ill,
he will have some financial support if he is unable to continue to operate his business.
What insurance product(s) should Milton consider?

Milton might want to consider a life insurance plan that pays a benefit for a dread disease or
a terminal illness. If Milton develops a serious form of cancer, he will receive a lump-sum
payment that he can use as he sees fit. Milton should also make sure he has a personal
disability insurance plan in place. If he is unable to work, he still requires an income to pay
for his daily living expenses.

Chapter 3
Individual Disability and

Accident & Sickness
Insurance

3
Individual Disability and

Accident & Sickness
Insurance
CHAPTER OUTLINE
Introduction
Disability Insurance
• The Purpose of Disability Income Insurance
• Non-Cancellable, Renewable, and Cancellable Disability Contracts
• Defining Total Disability
• Benefit Periods of Short-Term Disability (STD) and Long-Term Disability
(LTD) Insurance
• Elimination Periods and Qualification Periods
• Establishing the Benefits Payable to a Disabled Person
• Other Policy Benefits and Provisions
• Exclusions and Limitations on Disability Coverage
• Specialized Types of Disability Coverage
• Federal Government - Sponsored Disability Benefit Programs
• Coordination of Benefits on a Disability Insurance Policy
• Tax Treatment of Individual Disability Insurance Policies
Accident and Sickness Insurance
• Provincial Health Insurance
• Provisions of an Accident and Sickness Policy

Critical Illness Insurance Policy
• Benefits
• Waiting Period
• Definitions
Long-Term Care Policy
Selecting an Appropriate Insurance Product for a Specific Client

INTRODUCTION
For most people, the ability to earn an income is their most important financial asset. Take
away that ability and they will not be able to sustain their standard of living or repay their
debts. They may lose assets that they acquired through loans and mortgages. Statistically, the
odds of suffering a disability that lasts 90 days or more before age 65 is 1 in 8.
In this chapter, you will learn about the characteristics and features of disability and accident
and sickness insurance and how they can help mitigate the loss of employment income.
DISABILITY INSURANCE
LEARNING OBJECTIVES
• explain the purpose of disability income insurance and why a client might need this
type of coverage;
• define non-cancellable, guaranteed renewable, conditionally renewable,
optionally renewable, and cancellable disability contracts;
• explain the various definitions of total disability that are commonly used in
disability insurance policies;
• compare the benefit periods of short-term and long-term disability insurance;
• explain the meaning and purpose of an elimination period and qualification period;
• describe common methods used to establish the amount of disability benefits that
will be paid to a disabled person;
• describe, using examples, the use and advantages of the waiver of premium benefit,
the presumptive disability benefit, and optional benefits available with disability
insurance policies, including partial disability benefits, residual disability benefits,
future purchase option benefits, and cost-of-living adjustment (COLA) benefits;
• list the common causes of disability that may be excluded from coverage under a
disability insurance policy;
• distinguish among specialized types of disability coverage, including key person disability
coverage, disability buy-out coverage, and business overhead expense coverage;
• compare the federal government-sponsored programs that provide short-term and
long-term disability benefits, including Employment Insurance and CPP, to privately
available disability insurance;
• describe typical limitations and exclusions of a disability insurance contract;
• explain the impact of coordination of benefits on a disability insurance policy;
• describe the tax implications of various types of individual disability insurance policies.

THREE • INDIVIDUAL DISABILITY AND ACCIDENT & SICKNESS INSURANCE 3•5
The Purpose of Disability Income Insurance

People who work for companies or institutions may have group disability insurance through their
employers. Many people, however, are self-employed, or work for employers who do not provide
disability insurance through a group plan. If these individuals suffer a serious disability, even one
lasting only a few months, they may lose everything that they have worked for. Many people
have amassed large amounts of debt. If their ability to earn income is disrupted because of a
disability, even for a short while, they may not be able to cope with that debt. Individual disability
insurance is therefore designed to help meet the risk of losing the ability to earn income.
Let’s look at an example. Ella owns a successful florist shop in partnership with Samantha,
her close friend. Eldon, Ella’s husband, is a mechanic who works at a small repair shop. He
earns a reasonable salary. A year ago, the couple bought a new home and took out a large
mortgage. Their living expenses are high, because they have two young children in day care.
While Ella and Eldon took out life insurance to pay off the mortgage in case either one of
them died prematurely, neither of them considered applying for disability insurance.
Six months ago, both were seriously injured in an automobile accident. Eldon was permanently
disabled and Ella faces a long recuperation period. Although their friends and relatives are
sympathetic to the couple’s misfortune, none has the resources to take care of the expenses that
continue to fall due. The couple has no income from which to make mortgage payments, or
to maintain their lifestyle. They cannot take care of their children and rely on Ella’s parents
to supervise them. Eldon is unable to return to his job. Ella’s business is suffering and is in
danger of closing.
Ella and Eldon’s situation is typical of many people who have little or no disability insurance.
Although they may receive some benefits from automobile insurance or CPP disability benefits,
they have always relied on their ability to earn an income. If they had bought disability insurance,
they would have been able to survive their disability with a much lower level of financial loss.
Eldon could have obtained a disability plan to provide tax-free income of up to, say, 70% of
his earned income. Ella could have taken out a disability income policy to offset the loss of her
personal income. She might also have considered a Business Overhead Insurance policy to pay
for the ongoing expenses of her business, and a disability buy-out plan that would fund the sale of
her share of the business to her partner Samantha if her disability proves to be long-term.
Although this scenario may be unusual, it is quite possible. Many people do not have
adequate disability insurance to contend with the financial loss they will suffer if they
become disabled for even a few months. The remainder of this chapter describes the features
of disability and health insurance available to individuals.
The Uniform Life Insurance Act defines disability insurance as “insurance undertaken by
an insurer as part of a contract of life insurance whereby the insurer undertakes to pay
insurance money or to provide other benefits in the event that the person whose life is
insured becomes disabled as a result of bodily injury or disease.”
Non-Cancellable, Renewable, and Cancellable Disability Contracts

Unlike life insurance policies, disability income plans may be subject to cancellation
by the insurer or renewable at an increased premium rate at the insurer’s discretion.
Once a life insurance policy is issued and the insured pays the first premium, the insurer cannot
cancel or modify the coverage in any way, unless the insured fails to pay the premium and allows

the policy to lapse. The only disability income plan that provides a similar level of guarantee is
the non-cancellable disability plan. Under this plan, the insurer must renew the policy, as long
as the insured continues to pay the premiums, until the insured person reaches the age limit for
coverage stipulated in the policy. The premiums on this type of policy are guaranteed to remain
at the level that was established when the policy was issued and the policy provisions cannot be
changed. Some of these policies allow the insured to continue the coverage beyond the usual
maximum age, provided that the insured person continues to be gainfully employed; in these
cases, the insurer will determine the premium.
The guaranteed renewable policy requires the insurer to renew the policy, as long as the
insured person continues to pay the premiums, until the insured attains the age limit specified
in the policy (usually 60 or 65). The insurer may increase premiums for guaranteed
renewable disability insurance policies only if it increases the premiums for an entire class of
policies. (A class of policies is a group of policies with some similar characteristic, such as a
group of insured persons who are in a particular risk category.)
The conditionally renewable policy allows the insurer to refuse to renew the policy when it is
due for renewal for one or more reasons specified in the policy, such as the age or employment
status of the insured. The insurer may increase the premiums for any class of conditionally
renewable policies in which the insured is part of, thus raising the individual’s premiums.
The optionally renewable policy allows the insurer to refuse to renew the policy when it is
due for renewal. The insurer can also modify the provisions of the policy and increase the
premiums for a class of policies.
Cancellable policies are those that the insurer can cancel at any time, for any reason, by
notifying the policyowner that the policy is cancelled.
The risk classification of the person insured usually determines the kind of renewal provision
available. Risk classifications are generally related to the occupation of the insured person,
because the type of occupation has a bearing on the expected rate of sickness or injury. Using
statistical information on the types of disabilities associated with different occupations, insurance
companies rank occupations from the lowest to the highest risk of disability.
The levels of risk can be categorized as the following:
1. The lowest risk of disability is found among most professionals who work mainly in
offices, such as physicians or lawyers.
2. A low classification of risk applies to occupations such as office workers, librarians, and
bookkeepers and those who have some non-hazardous duties outside the office (e.g. research).
A medium-risk classification applies to those who are employed in non-hazardous occupations
that involve some clerical duties, but who do not work full-time at a desk. This group might
include plant supervisors and superintendents who oversee the work of others.
3. A high-risk classification applies to people who do light manual work of a skilled or semi-
skilled nature in a non-hazardous industry, such as mechanics, electricians, or plumbers.
4. The highest risk classification includes occupations such as truck drivers or taxi
drivers, positions that are physically demanding and are subject to outside
interventions such as traffic and violence and carry a high risk of injury and illness.

Some occupations, such as professional athletes or seasonal workers such as lumberjacks

and fishermen, fall outside of these classes. Individuals in unclassified occupations are
considered for disability insurance coverage on a case-by-case basis.
Someone who is assessed at the lowest level of risk will be offered the broadest kind of
coverage, usually non-cancellable or guaranteed renewable. Those whose occupations fall
within the highest risk classifications may be eligible for conditionally renewable or
cancellable insurance, because the insurer is likely to incur higher-than-anticipated claims for
people in this occupational group. If the insurer finds that the amount paid out in claims
exceeds the amount taken in through premiums, it will take steps to cancel a particular group
of policies, for example, those held by truck drivers.
Defining Total Disability

Insurers use different definitions of disability in the policies they issue, depending largely
on the occupational risk classes involved.
For the lowest-risk classes, the definition of disability is usually the own occupation
definition (also characterized as regular occupation). That is, if an insured person suffers a
disability that prevents him or her from performing the essential duties of his or her own
occupation, that person will be considered disabled, even if he or she is, or can be, gainfully
employed in a different occupation. For example, a surgeon who suffers a serious injury to
his hands will be considered disabled and eligible for benefits, even though he may be able to
teach or work as a medical professional in some capacity other than surgery.
For others, the definition of total disability may be the inability of the person insured to perform
the essential duties of any occupation. This means that after being disabled for a certain period
(usually two years), the person insured will be considered disabled only if he or she is unable
to work at any occupation for which he or she is suited by reason of education, training, or
experience. For example, a chartered accountant who is the vice-president of finance for a
large corporation may suffer a disability that prevents her from performing her duties as vice-
president. After two years of continuous disability, if she can work at any occupation for
which she is suited by education, training, or experience, such as a more junior position in the
finance department, or as a self-employed accountant, then her disability benefits will cease.
This definition is rather restrictive.
It should be kept in mind that insurers use different descriptions for the same definition. In
other words, the “any occupation” definition in one insurer’s contract could be quite different
from the “any occupation” definition in another insurer’s contract. Some insurers use
different terms altogether, such as “gainful occupation”. Therefore, the precise wording in a
contract needs to be examined.
Many policies provide “own occupation” coverage for a certain period (say the first two
years) of the disability, then switch to the more conservative “any occupation” definition for
the rest of the period of disability.

Benefit Periods of Short-Term Disability (STD) and Long Term

Disability (LTD) Insurance
Disability insurance is designed to provide replacement income for a person who
becomes disabled long enough to allow the insured to recover and resume normal work
activity, or, if the person is severely disabled, to provide replacement income during the
insured’s shortened lifetime.
The period during which benefits will be paid can vary from as little as six months to one year, to
the period between the date the insured person becomes disabled and the date the insured person
reaches the age of 65. Of course, the longer the benefit period, the higher the premium.
Short-term disability income plans offer disability benefits for a limited time, usually up to six
months or a year. LTD benefits begin after STD benefits end. Once the insured person becomes
disabled, he or she will receive disability payments until the end of the benefit period. Therefore,
an individual who buys a disability insurance policy with a two-year benefit period can expect to
receive payments for two years after becoming disabled. When the two years are up, the payments
will cease, even though the insured person may continue to be disabled.
Individual disability insurance policies are also available for longer terms of five years or
more, or up to age 65. Those who want the security of a longer period of benefit payments
can select a longer term. The premiums will be higher than those of the short-term plan for
the same benefit amount, since the insurer risks having to pay income benefits until the
disabled person reaches retirement age.
Benefit periods do not continue for life under disability plans. Their purpose is to replace the income
lost to the insured person who is unable to work and earn a wage. The longest period of coverage
extends to age 65. At that age, the individual would normally retire and begin receiving pension
payments from the government or through a private pension plan. Since the retiree would no longer
work to earn a wage, there is no further need for an income replacement plan.
Elimination Periods and Qualification Periods

Individual disability insurance policies contain an elimination period, also known as the
waiting period. This is the period after an insured person suffers a disability during which no
benefit payments are made. For example, Maurice has a policy that pays a monthly benefit
of $500 for a maximum of two years, with an elimination period of 30 days. If Maurice is
injured and submits the appropriate claim forms, his benefit payments will start at the end of
the 30-day elimination period and continue either until he recovers or until the end of the
two-year benefit period, whichever comes first. If his disability lasts less than 30 days, he
will not receive any benefit payments.
The elimination period saves the insurer from having to review and pay benefits for
disabilities that last only a short time.
The length of the elimination period in an individual disability income plan affects the premiums
that the insured person pays. The longer the elimination period, the lower the premium required
for the same amount of disability coverage. The elimination period might be as long as 365 days
or more, or as short as a day. If a plan offers first-day coverage, the benefits are payable from the
first day that the insured person becomes disabled. These plans are usually short-term and the
first-day coverage applies to disabilities caused by injury rather than illness. Such a plan might
provide a seven-day elimination period for disabilities resulting from an illness.

A qualification period (also referred to as probationary period) for disability coverage is a period of
time that an applicant must wait before applying for disability insurance. This restriction usually
applies to individuals covered by group insurance. Typically, a new employee will have to wait for a
certain period, such as three months, before becoming eligible for group disability insurance.
In individual disability insurance plans, the term qualification period applies to the period in
which residual benefits are payable under the policy. For occupations in the lower-risk
category, insurers offer coverage that includes full disability payments during the period in
which the insured person is totally disabled and unable to work at all, and reduced (residual)
benefits that cover lost earnings if the insured person returns to work but cannot earn income
at the same level as before the disability. The residual benefits may be available after the
insured has been disabled for a certain period, such as six months. If the insured returns to his
or her original occupation before six months have elapsed, he or she will not qualify for
residual benefits. This six-month period is the qualification period for residual benefits.
(Residual benefits are described in more detail later in this chapter.)
Establishing the Benefits Payable to a Disabled Person

Disability insurance is intended to indemnify the insured for the loss of earned income caused
by a disability. The insured person should not, however, be placed in a better financial state
after becoming disabled than he or she was before the disability. The benefit amount paid to a
disabled person should bear a relationship to the individual’s income before the disability.
Otherwise, the insured person would have no financial incentive to return to work and might
be tempted to prolong the period of disability.
For individual disability insurance products, the underwriting process involves establishing
a coverage level that approximates the potential economic loss that the applicant might face
in the event of becoming disabled.
There are two ways to determine a reasonable level of coverage.
1. Determine the amount of monthly income that the insured would need to cover
recurring expenses.
2. Determine an amount that addresses the insured’s needs but that does not act as a
disincentive to return to work, by calculating an amount of monthly income that does not
exceed a reasonable percentage (e.g., 75%) of the earned (primarily wages/salaries) and
investment income that the insured received prior to the onset of the disability.
From the perspective of the insured person, the disability income benefit must be
adequate to provide for all his or her regular monthly expenses.

For example, Jason and his family have the following monthly expenses:
Expense Monthly Amount

Mortgage $ 800
Car $ 350
Food $ 1,200
Clothing $ 500
Utilities $ 500
Gas $ 150
Insurance $ 250
Telephone $ 50
Emergency Expenses $ 200
Total $ 4,000
If Jason becomes disabled and no longer able to earn income, he and his family will still be
faced with about $4,000 of expenses every month. A disability income policy that provides
a monthly income of $4,000 would address those expenses.
An insurer considers a number of factors in setting a benefit amount.
• The level of earned income that the applicant is currently receiving. Earned income
consists of salary, commissions, fees, or other income earned because of business
activity. The insurer assesses the applicant’s gross employment earnings before tax, or,
for self-employed persons, business income minus business expenses. Since most
disability benefits are tax-free, the insurer does not pay 100% of earned income. The
insurer may offer monthly benefits of up to 75% of earned income, depending on the
income level. If the insurer replaced 100% of a disabled person’s income, the insured
person would have no incentive to go back to work, because he or she would be in a
better financial situation than before the disability.
• Income that continues after the applicant becomes disabled. Dividends and interest
from investments are one source of income that would be unaffected by the recipient’s
disability, for example. The insurer may reduce the amount of monthly benefit to reflect
unearned income.
• Other potential sources of disability benefits. An applicant’s private plan
coverage is a factor, as well as payments under Employment Insurance (EI), CPP
and Workers’ Compensation.
Consider Jason’s situation from the insurer’s perspective.
• If Jason earns $5,000 a month before tax, the insurer might consider providing Jason
with a disability income policy of about 75% of his gross earned income, or $3,750.

• If Jason has a regular investment income of $500 a month, the insurer will factor that
into the amount of disability income payable.
• If Jason is covered under Workers’ Compensation (also known by other names such as
Workplace Safety and Insurance Board), the insurer might reduce the available benefit
further. In Ontario, for example, Jason could receive 85% of his take-home pay (up to a
ceiling of 175% of the average industrial wage for Ontario) if he suffers a job-related injury
or illness. The insurer will factor that into the calculation, or offer Jason non-occupational
coverage, that is, coverage for an injury or illness sustained away from the job.
• The insurer would consider EI benefits that Jason is entitled to receive if he is injured
and unable to work. EI pays a maximum benefit of $468 per week for 15 weeks.
Rather than reduce the amount of monthly benefit available, the insurer might offer
an elimination period that recognizes the EI benefits that Jason is entitled to receive.
• The insurer will also consider other disability insurance that Jason carries, including
group long-term disability and other personal disability insurance on Jason’s life.
Other Policy Benefits and Provisions
WAIVER OF PREMIUM BENEFIT

The waiver of premium benefit for a disability income policy operates in the same way as the
waiver of premium benefit in a life insurance policy. If the insured suffers a disability that
qualifies as a total disability under the terms of the policy, the insurer will waive premiums
that fall due during the period that the insured is disabled. Unlike life insurance, in which this
benefit is optional and requires a higher premium, the disability insurance waiver of premium
benefit is a standard policy provision.
The waiver of premium benefit becomes effective when the insured has been disabled
continuously for a specified period of time, usually three months. Once the insured has
satisfied the waiting period, premiums falling due from the date of the disability are waived.
If the elimination period for the commencement of disability payments is less than the
normal waiting period for the waiver of premium benefit, premiums will be waived at the
conclusion of the elimination period for disability benefits. For example, if a policy has a 60-
day elimination period but has the usual 90-day waiting period for the waiver of premium
rider to take effect, the waiting period would be reduced to 60 days. In addition, if the
insured person pays any premiums during the waiting period, these premiums will be
refunded once the waiting period is over.
For example, Ingrid is insured under a disability insurance policy with an elimination period of
365 days. If she is disabled for a shorter period, her income is covered under Workers’
Compensation. Ingrid suffers a serious disability that will probably keep her from working for
at least two years. The waiver of premium benefit under her policy has a waiting period of three
months. During those three months, Ingrid must continue to pay the premiums for the policy.
Once she has satisfied the three-month waiting period and is still disabled, the insurer will
waive premiums that have fallen due from the date of onset of her disability.

PRESUMPTIVE DISABILITY
A presumptive disability is one of a specific number of conditions identified in a policy
contract, such as total and permanent blindness, loss of the use of any two limbs, or loss of
speech or hearing in both ears. If the insured suffers a presumptive disability, the insured will
be considered totally and permanently disabled.
Once an insurer is satisfied that the insured has suffered a presumptive disability, no additional
periodic claim forms will be required and the insured will receive disability benefits under the
policy for the length of the benefit period. Even if the insured is able to return to full-time
employment in an occupation for which he is suited by education, training, and experience, the
disability benefits will continue until the benefit period expires.
Andrew worked as a graphic designer at XYZ Corporation. He was involved in an automobile
accident that left him a paraplegic and wheelchair-bound. After eight months of care and
intensive rehabilitation, Andrew was able to resume his occupation on a full-time basis. Andrew
was insured under a disability insurance policy that paid $500 a month for a two-year period.
The insurer received full claim information from Andrew and his attending physicians.
Andrew began to receive monthly payments at the conclusion of the 30-day elimination
period specified in the policy, and without further claim requirements, continued to receive
$500 a month for two years.
PARTIAL DISABILITY BENEFITS

In the early days of disability insurance, insurers only recognized a state of total
disability; one was either fit enough to work in some capacity or one was unable to
pursue any gainful employment. This resulted in two issues:
1. Disabled individuals receiving benefits would delay returning to work (malinger) until
confident they could resume their job/career full time for the rest of their working
years, or until their benefits ran out. If they returned to work for any period of time,
they were no longer considered disabled and benefits were immediately terminated.
2. Disabled individuals, who returned to work and found they could not perform most of
their normal duties, or could not perform them for a full day, often received substantially
reduced pay. These individuals would then have to rely on the recurrent disability clause
of their policy (if included) and re-initiate the claim with significant processing
requirements by both the insured and the insurer; a time consuming and costly process. If
the policy did not include a recurrent disability clause, the insured was at a loss.
To address these issues, most policies now contain a partial disability clause for all risk
classifications and policy types to encourage individuals to try returning to work as soon as
possible. An insured may be considered partially disabled if attempting to return to work,
but unable to work at full capacity. There is no requirement to show a loss of income as the
clause is based on loss of time and/or duties. This is particularly useful for newly employed
individuals who have limited prior earnings (e.g. someone just entering the work force).
Most disability policies provide a schedule for the level of benefits that the insured would
qualify to receive under different conditions when attempting to return to work. Normally,
partial disability benefits are limited to a maximum of 50% of the total disability benefit and are
provided for a limited period such as 3, 6, 12 or 24 months. Some policies pay a fixed 50% of
the total disability benefit until full recovery or for the period covered by the partial disability

clause. Some policies also offer a continuing 25% of the full benefit after the partial period
has expired for the duration of the long term coverage (e.g. 5 years, 10 years or to age 65).
Partial disability clauses do not usually contain any requirement to prove loss of income
during the claim. This is important if the claim is of a short term nature or the insured
cannot prove a residual loss.
The partial disability clause was introduced to address the difficulties of malingering and of
the insurer having to deal with multiple recurrent disability claims. The insured could be
confident that trying to return to work would not immediately result in benefits being
terminated and that income could be maintained.
RESIDUAL DISABILITY BENEFITS

For occupations that fall into lower risk classifications, a residual disability clause is
available that provides for payment of part of the full disability benefit if the insured
resumes some, but not all of the duties of his or her occupation, or resumes work on a
reduced work schedule as part of his or her recovery efforts.
Most insurers that offer residual benefits require the insured to have been on claim for total
disability before applying for the benefit and/or to have been on claim for the full period of
a partial disability clause. Some insurers do not require the insured to have received (or been
eligible to receive) total benefits before claiming for residual benefits. This provision could
be very important as most disability claims are not for total disability, but for long-term
partial or long-term residual disability. Many types of sickness or injury do not result in total
disability yet can seriously limit the ability to earn income and be long lasting (e.g., back
problems, dialysis, certain types of cancer).
Residual benefits are calculated by comparing the insured person’s earned income before the
onset of the disability to the income earned after resuming some work duties or returning to
work part-time. The difference in amounts is divided by the person’s normal earnings to
establish a percentage earnings loss. Usually the residual benefit pays a portion of the full
disability benefit amount based on the percentage earnings loss. If the percentage earnings loss is
80% or greater, the full benefit will be paid; if it is 20% or less, no residual benefit will be paid.
For example, Nora, a physician who suffered a serious ailment, may be able to take on a
modest workload by seeing a limited number of patients while she is recovering. Most of her
income can be attributed to her own efforts through the fees she charges for medical
procedures. Assume Nora had a disability insurance policy that pays her a monthly benefit
of $7,000. If she earned $10,000 a month before she became disabled and later went back to
work seeing fewer patients and earned only $4,000 a month, she would be entitled to a
residual benefit of $4,200 a month from her disability policy; ($10,000 - $4,000/$10,000) =
60% × $7,000 monthly benefit = $4,200 residual benefit.
Without going into the technicalities of partial and residual disability benefit clauses, disability
definitions, occupation classes and related policy provisions, it is generally understood that partial
disability payments are made for a restricted period of time (usually 3, 6, 12, or 24 months) when
a disabled insured returns to work but cannot perform all of the important duties of the job or
cannot put in a full day’s or week’s work. If the disability is deemed to be long term (beyond the
partial disability coverage period) or permanent, or if the partial disability period is exhausted and
the insured is still incapable of performing their full duties or working on a full time basis, then
the residual benefit would apply and be paid until full recovery or for the duration of the policy
benefit period (e.g., for 5 years, 10 years or to age 65).

RECURRENT DISABILITY
This happens more often than one would suspect. A person becomes disabled, recovers from the
disability and resumes work only to become disabled again. That’s when a recurrent disability
provision comes into effect. Basically, it says that for a person with a recurrent disability, within a
specified period of time (say 6 months), from the same or related cause, the waiting period will be
waived. The individual will, in effect, be considered to have been continuously disabled.
FUTURE PURCHASE OPTION BENEFITS

Like the guaranteed insurability option available under a life insurance policy, the future benefit
option allows someone insured under a disability income policy to purchase additional disability
insurance on certain dates without having to provide evidence of insurability.
Unlike life insurance benefits, however, the person with disability insurance must prove that his
or her income has increased to a level that will justify the additional disability insurance. This
requirement is necessary, because a policy that offered an insured the opportunity to receive a
benefit that exceeded his or her earned income might invite unfounded claims.
COST-OF-LIVING ADJUSTMENT (COLA)

The cost-of-living benefit can be made available in two ways.
1. If an insured person becomes disabled, the benefit can be indexed to provide an
increase in income based on some standard that measures increases in living costs.
Typically, that standard is the Consumer Price Index (CPI). The benefit is calculated
by comparing costs for the current month with costs for prior months and applying the
percentage increase to increase the monthly benefit being paid to the insured.
2. COLA can also be applied to the calculation of residual benefits. To reduce the effect of
inflation, the insured’s income is calculated in a way that takes into account the change in
value of that income. For example, if the Consumer Price Index has increased by 4% since
the insured person became disabled, then a person who used to earn $5,000 a month would
be deemed to have earned $5,200 a month in current dollars. If the insured is now able to
earn $2,000, the residual percentage loss is calculated as ($5,200 – $2,000) $5,200 =
61.5%. If the person’s original earnings had not been restated in current dollars, then
the residual percentage loss would be calculated as ($5,000 - $2,000) $5,000 = 60%.
This may not seem like a significant difference, but if a residual disability continues
for a long time, the depreciation of the value of prior income can severely diminish
the value of the benefit payable.
Exclusions and Limitations on Disability Coverage

Insurers establish premium rates based (in part) on morbidity tables that estimate the
likelihood of disability for each risk class. In order to ensure the accuracy of these estimates,
insurers usually exclude certain causes of disability. These exclusions include:
• injuries or sickness that are a result of war, declared or undeclared, or any act of war;
• intentionally self-inflicted injuries;
• injuries received because of active participation in a riot;

• disability resulting from normal childbirth or pregnancy; however, complications of

pregnancy are covered (these are physical conditions that doctors consider distinct
from pregnancy, even though they may be caused or worsened by pregnancy);
• occupation-related disabilities or sickness for which the insured is entitled to
receive disability income benefits, such as Workers’ Compensation.
Also, if the underwriting process reveals that the applicant cannot be offered a standard
policy based on normal criteria for age, sex, and occupation, then a disability contract
may be issued with specific limitations or exclusions.
For example, Wayne, a vice-president in a public relations firm, has applied for personal
disability insurance coverage of $3,000 a month. He has requested a benefit period to age 65
with an elimination period of 30 days.
During the underwriting process, the insurer notes that Wayne has suffered from “lower back
pain” from time to time. Each episode of back pain has been very debilitating, leaving Wayne
unable to move for a few days. In each instance, he has recovered completely and has been able to
resume all of his regular activities. The cause of the pain has not been positively diagnosed. It
may be muscle-related (Wayne likes to play recreational hockey) or related to a degenerative disc.
The insurer may charge an extra premium rating that allows the coverage as applied for,
but recognizes that Wayne has a higher probability than normal of suffering a long-term
disability. The insurer has several options.
• It could offer Wayne disability insurance coverage, with an exclusion rider. The rider
would exclude from coverage any disability resulting from a back problem.
• It could offer Wayne coverage with a qualified condition exclusion rider; this is often
used for certain conditions where it is possible to forecast the length of time required to
recover. The rider specifies a certain elimination period and benefit period for the
particular condition, and a more generous elimination period and benefit period for all
other illnesses or injuries. If Wayne’s experience with back problems has been very
short periods of debilitating pain, the insurer may consider covering both back injuries
and illnesses relating to the back, but with a longer elimination period and a shorter
benefit period than for other disabilities that Wayne might suffer.
• If the insurer feels that the back condition may have a long-term impact on Wayne’s
overall health, it can offer coverage that is more restrictive than the coverage that Wayne
originally wanted. Rather than charge an increased premium or issue coverage exclusions,
the insurer can offer coverage with a longer elimination period and/or a shorter benefit
period or a lower level of coverage. For example, the insurer may offer Wayne coverage of
$1,500 a month with a 60-day elimination period and a two-year benefit period.
• The insurer may deny any optional benefits applied for by Wayne.
Other limitations include:
• Obesity. The applicant’s height and weight are a factor in determining whether
standard coverage will be offered. An insurer will consider premium adjustments if
an applicant’s weight falls outside the normal weight for people of his height.

• High-risk activities. The insurer may offer disability coverage on a modified basis if the
applicant engages in an activity that presents more than usual hazards. For example, the
insurer may offer a policy that excludes coverage for a disability suffered from
activities, such as hang gliding, private flying, or motor vehicle racing.
• Financial considerations. Insurers also attempt to avoid overinsurance by considering
coverage based on financial considerations as well as health considerations. Income
limits are based on the total amount of coverage that the insurer will issue for a given
level of earned income that the applicant receives. The insurer will not allow someone to
get more money while they are disabled than while they worked.
• Other sources of coverage. Insurers reduce the amount of coverage they would otherwise offer
for a given level of earned income by the amount of coverage that the applicant has from other
sources of insurance. Insurers set upper coverage limits for each occupation class.
Specialized Types of Disability Coverage
KEY PERSON DISABILITY INCOME COVERAGE

Key person disability income coverage is different from disability income insurance that
provides a monthly income to an individual during the period that he or she is disabled. A key
person plan pays a monthly income during the time that the insured is disabled, but it is the
company, which employs the individual, that receives the payments.
The key person is not usually the owner of the business, but an employee who contributes
significantly to the fiscal well-being of the company. An owner of a company who is also a
major contributor to its success can get individual disability insurance on his or her own life
and receive the monthly income benefit while disabled. The owner can also get business
overhead expense insurance to pay the regular expenses of the company while the disability
continues. A key person will usually have his or her own disability income plan that pays a
regular monthly income during a disability to replace income he or she would have earned
otherwise. Under a key person disability plan, the company owns the disability insurance
plan on the employee and receives any benefits payable under the plan.
The purpose of the coverage is to restore, at least to some extent, the income that the business is
losing as the result of the key employee’s disability. At the same time, the company must look
for a replacement for the key employee, particularly if the disability is expected to last for a
long time. The coverage provides the financial resources to find, hire, and train a replacement
and to recapture the revenues lost because of the key employee’s disability.
The benefit amount under a key person plan is usually based on the key person’s monthly
salary and is designed to replace lost revenues and pay for the search for a replacement.
Usually, the company values the key person for insurance purposes at twice his or her
monthly salary. The company will provide an individual policy that will pay the insured an
income while disabled. An additional key person policy is obtained for a similar amount of
coverage with benefits payable to the company.
The key person plan meets a short-term need. The company should know early on if the key
employee will be able to return to work within a reasonable time, or if a replacement must be
found. Once a replacement is hired and trained, the company can anticipate a return to higher

income levels within a number of months. Benefit periods for key person plans are typically
6, 12, or 18 months. Elimination periods are relatively short, usually 30, 60, or 90 days,
because the company needs to replace lost revenues as quickly as possible.
The definition of total disability is usually the own occupation definition of disability. The
employer needs to replace the income of someone who is unable to perform the essential duties
of his or her specific occupation, so a more conservative definition of disability might not provide
the coverage at the time it is needed. The specific work done by the key person is essential to the
success of the business. Since the coverage is short-term, an insurer’s risk exposure is limited
with the “own occupation” definition and will not have potential long-term effects.
DISABILITY BUY-OUT COVERAGE

Disability buy-out coverage addresses the problem of a major shareholder or partner in a
business who becomes disabled.
Partnerships and private corporations handle the risk of the death of a partner or shareholder by
establishing buy-sell agreements that spell out the way in which the interest of a deceased partner or
the shares of a deceased shareholder will be transferred to the remaining partners or shareholders. A
comprehensive buy-sell agreement addresses the following questions: What will happen to the
partner’s or shareholder’s interest in the business? Will that interest be transferred to the deceased’s
heirs, who may not be qualified to contribute to the business’s success? Will the
interest be sold to a third party who may not have the same plans for the business as the surviving
partners or shareholders? How will the value of the deceased’s interest be measured?
To fund the buy-sell agreement the business can obtain the requisite funds to compensate
fairly the deceased’s heirs for the value of his interest by acquiring life insurance on each
partner or shareholder’s life. Typically, the beneficiary provisions of a life insurance policy
on a shareholder or partner direct the proceeds to the surviving partners or shareholders (or
to the corporation for corporate share repurchases). The buy-sell agreement then directs the
payment of the insurance proceeds from the surviving associates to the deceased’s estate as
compensation for the deceased’s interest.
But what happens if a partner or shareholder becomes disabled? A disabled partner or shareholder
presents the same dilemma as one who dies. In addition, the business has to be concerned about
the continued presence of the disabled partner or shareholder. Presumably, the disabled party will
look to the business for income even though he or she is not contributing to its successful
operation. The organization therefore must address the following problems:
• the reduction in business income while an active partner or owner is disabled;

• the need to buy out the disabled person’s interest if his or her disability
continues indefinitely.
Like buy-sell agreements that take effect when a partner or shareholder dies,
organizations can also establish buy-out agreements that take effect when a partner or
shareholder suffers a disability. The disability buy-out agreement must address the
following issues, which should parallel the provisions in the disability insurance policy:
• Determining the disabled individual’s value to the business. If each partner’s or shareholder’s
value to the business can be estimated, then a disability plan can be established to pay a specific
periodic or lump sum amount established under the provisions of the agreement.

• Establishing a specific period of time for which the partner or shareholder must be
disabled before the buy-out occurs. When this period is defined, an elimination period
can be specified in the policy to determine when benefits will start.
• Defining what conditions constitute a disability. The definition must be reflected in
the disability policy that is used.
• Determining the method of funding the buy-out.
• Defining how the payment will be made.
A disability buy-out policy should therefore contain the following provisions.
1. Coverage amount. If each partner’s or shareholder’s value has been estimated at the
time the disability buy-out agreement is created, the coverage amount can be established
within the underwriting practices of the insurer.
2. Elimination period. The elimination period in the policy will usually be a period that
allows for some certainty that recovery from the disability is remote. Many insurers set
the elimination period at a minimum of twelve months, but may provide for elimination
periods of 18, 24 or 36 months. Again, the purpose of this type of policy is to provide the
funding when a buy-out becomes the most appropriate action. The policy is not designed
to provide an income to the disabled person until he recovers.
3. Definition of total disability. The definition will most likely require that the insured be
unable to perform the essential duties of his own occupation. The purpose is to buy out
the interests of a partner or shareholder who is unable to perform the work of the
position he or she occupied in the organization. At the same time, the definition might
be extended to require that the individual does not continue to work within the
organization. This modification makes it clear that the policy is intended to provide the
means to buy out the insured’s interest completely and that the disabled person will no
longer have any interest in the organization.
4. Trigger date. This is a unique feature in disability buy-out insurance. Under an individual
disability income policy, once the elimination period has been satisfied, disability benefits
continue to the claim applicant until he or she recovers or the benefit period ends. Under a
disability buy-out plan, once the elimination period has ended, the benefit is paid out.
There is no need for the claimant to prove continued disability beyond that point. The
buy-out takes place and the full benefit specified in the policy is paid.
5. Payment of benefits. The disability buy-out plan offers the claimant the option of
receiving the benefit in a lump sum, in instalments over a specified number of months,
or in a combination of both.
6. Renewability. Some contracts guarantee that the policy can be renewed at a guaranteed
premium, or guarantee that it can be renewed, but at an increased premium.
The disability buy-out plan is unlike an individual disability income plan. First, once a claim
is accepted under the disability buy-out plan, the benefit paid out completes the insurer’s
obligations under the contract. The claim payment, which can be made either in a lump sum
or through a series of payments, completes the contract and the policy expires. Second, if the

insured’s relationship with the partnership or corporation ends, the coverage will cease,
because the purpose of the coverage no longer exists.
BUSINESS OVERHEAD EXPENSE COVERAGE

Sole proprietors, partners, and principal shareholders of private corporations who become
disabled face the loss of income for personal and family expenses. At the same time, they
have to contend with the ongoing expenses of the business. The business overhead
expense policy provides a monthly payment to cover business expenses incurred during
the insured business owner’s disability period.
Business overhead expense policies are usually issued for relatively short benefit periods,
from 12 to 24 months. The benefit period should not be longer than two years. If a disability
lasts that long, the insured will not likely recover to return to the business. Elimination
periods may be 30 to 90 days. A 30-day elimination period is typical, since most businesses
do not have the cash flow to cover overhead expenses for a longer period.
The amount of money available each month under this type of policy depends on the
insured’s occupation and the type of business he or she conducts. For example, a lawyer who
relies primarily on the fees he or she bills to maintain the business will qualify for a higher
monthly benefit than the head of an organization who relies on the efforts of more than one
individual to bring in business. In this case, while a disability to the head of the company
may depress the cash flow, it will not have the same critical effect as a disability suffered by
someone who is the major contributor to the business.
Most plans define total disability as the inability to perform the duties of the insured’s
regular occupation. That makes sense, since it is the insured’s inability to earn income
that puts the company’s ability to pay its overhead expenses at risk.
BOE policies usually cover expenses such as:
• employee salaries;
• employee benefits and payroll taxes;
• rent;
• heat;
• water;
• electricity;
• telephone and telephone answering services;
• interest on business debts, including interest on mortgage loans for premises
used in operating the business;
• association dues;
• accounting, billing, and collecting fees;
• depreciation of furniture and equipment;
• premiums for business insurance;
• postage and stationery;
• laundry, maintenance, and janitorial services;
• other fixed expenses normally incurred in managing and operating a business.

Expenses that are not covered include:

• salary, fees, or other compensation for the owner;
• payment on the principal of any debts;
• cost of equipment, furniture, or merchandise.
These items are not covered because they are really investments, rather than expenses.
Although the policy specifies a maximum monthly benefit, once the insured becomes
disabled, the whole amount may not be paid every month. Many policies reimburse the
insured only for the monthly overhead expenses actually incurred up to the monthly limit.
Once the benefit period expires, no additional benefits will be paid, even though the
expenses incurred were less than the cumulative monthly benefits. For example, if the
policy provides a monthly benefit of $4,000 for a 12-month benefit period, the maximum
benefit amount payable for any one disability is $48,000. If actual expenses incurred over
the 12-month period are $30,000, that is the amount the claimant will receive.
Some plans take a different approach. If, under the same policy described above, the insured
was still disabled at the end of the 12-month benefit period, the insurer would continue to
reimburse the claimant for actual business expenses each month to a monthly maximum of
$4,000 until the total benefit of $48,000 was paid out. Other plans reimburse the claimant for
the actual amount of overhead expenses incurred in any month (which might be more than
$4,000 in a given month) until the maximum total under the policy is paid out.
Federal Government–Sponsored Disability Benefit Programs
EMPLOYMENT INSURANCE
The Employment Insurance (EI) program is administered under the federal Employment
Insurance Act. The program provides financial assistance to people who lose their jobs through no
fault of their own because of a work shortage, seasonal unemployment, restructuring or mass
layoffs. EI is also available to those who are unable to work because of illness or injury.
To qualify for sickness benefits under EI, the employee must have a decrease of 40% or
more in weekly earnings and must have accumulated 600 insured hours in the previous 52
weeks or since his or her last claim. Insured hours are paid hours of employment on which
the employee paid EI premiums.
The basic benefit is 55% of the employee’s average insured earnings to a maximum of
$468 a week. Insured earnings are those on which EI premiums are based. Maximum
insurable earnings for the purposes of EI premiums and benefits are $44,200 a year.
Sickness or injury benefits are paid for a maximum of 15 weeks.
EI sickness or injury claims will be reduced by the amount that the employee receives as:
• income, including wages or commissions from employment;
• payments for lost wages owing to an accident or work-related illness from sources
such as Workers’ Compensation;
• income from group insurance for sickness or loss of income;
• accident compensation for loss of wages under a motor vehicle accident insurance plan;

• retirement income from an employment pension, including Canada Pension or

Quebec Pension plan benefits, based on employment income.
The following types of income will not reduce an EI claim for sickness or injury benefits:
• disability benefits from Canada Pension or Quebec Pension plans;
• Workers’ Compensation payments from a permanent settlement;
• supplemental insurance benefits under a private plan approved by Service Canada
for sickness benefits;
• private sickness or disability wage-loss insurance programs;
• retroactive increases in the employee’s wages or salary.
There is a two-week waiting period before benefits are paid. The first payment of any
claim is made within 28 days of the start of the claim and every two weeks thereafter.
CANADA PENSION PLAN DISABILITY BENEFITS1

The Canada Pension Plan (CPP) [or Quebec Pension Plan (QPP)] pays a monthly benefit to
anyone who has contributed to CPP (or QPP) and who is considered disabled according to
the plans’ guidelines.
To be considered disabled, an individual must be suffering from a severe or prolonged
physical or mental disability that prevents him or her from working regularly at any job.
The disability must be long-term or one that may shorten the individual’s life.
An individual must have a minimum level of earnings to make contributions to the CPP.
For 2011, the minimum level of earnings to qualify for disability benefits is $4,800. This
figure is adjusted annually.
To qualify for disability benefits, an individual must have contributed to the CPP in four of
the last six years at or above the minimum level of earnings. If an individual has contributed
to the CPP for 25 or more years and applied for a CPP disability benefit on or after March 3,
2008, he or she needs to have made contributions in three of the last six years, at or above
the minimum level of earnings.
However, under certain Canada Pension Plan provisions, an individual may still qualify
if he or she:
• worked in another country with which Canada has a social security agreement
and contributed to the pension plan of the other country;
• delayed applying (that is, if the individual qualified when he or she first became
disabled, but did not apply immediately and now, having decided to apply, no longer
qualifies as having contributed to CPP in four of the previous six years);
• stopped contributing to Canada Pension Plan or reduced his or her contributions
while raising children who were under seven years of age;
• obtained enough Canada Pension Plan credits from a former spouse or common-law
partner through credit splitting;
• was medically unable to apply.
1
http://www.hrsdc.gc.ca/en/isp/pub/cpp/disability/benefits/disability.pdf

Disability payments stop when the recipient:

• is no longer disabled, according to Canada Pension Plan rules; or
• reaches the age of 65, when a Canada Pension Plan retirement pension begins (or
between 60 and 65, if the recipient takes early retirement); or
• dies.
The disability benefit is made up of two parts: a flat-rate amount and a variable amount based
on how much, and for how long, the applicant has paid into the Canada Pension Plan. There
is a maximum amount that can be paid. If the Canadian cost of living index rises, disability
payments are increased as of the following January.
In December 2010, the average Canada Pension Plan disability benefit was $809.50 a
month. The maximum amount in 2011 is $1,153.37 a month.
The Canada Pension Plan disability benefit is not a permanent benefit. From time to time,
representatives from the Canada Pension Plan may check to see if the recipient has
recovered sufficiently to return to work. The program also provides services and return-to-
work incentives. You may attend school or do volunteer work without fear of losing
benefits as long as you have not regained the capacity to work. CPP will also provide
vocational training if they determine that you would likely be able to return to work with a
vocational rehabilitation program. The disabled person’s condition must be stable and their
physician must approve. CPP benefits will not be stopped while attending the program.
Recipients can earn up to a certain maximum from working ($4,800 in 2011) without informing
Service Canada and without losing their benefits. This amount changes from time to time.
Once a recipient earns more than the maximum specified amount from work, Service Canada
must be informed. Service Canada may choose to discontinue the disability payments or
continue them if the recipient is unable to work on a regular basis. There is no fixed dollar
amount at which benefits are automatically stopped. Because everyone’s medical condition
and capacity to work are unique, each person’s circumstances are considered individually.
If the recipient is able to work on a regular basis, Service Canada may offer a vocational
rehabilitation program, which allows the recipient to re-train and provides a three-month work
trial period, during which the recipient continues to receive CPP benefits while working.
The Canada Pension Plan will provide vocational rehabilitation if all the following
conditions are met:
• the individual is receiving a Canada Pension Plan disability benefit;
• the recipient would likely be able to return to work after participating in a
vocational rehabilitation program;
• the recipient is willing and able to undergo a vocational rehabilitation program;
• the recipient’s medical condition is stable;
• the recipient’s doctor approves.
If the recipient is eligible for a survivor’s pension, the Canada Pension Plan combines it with
the disability benefit. The combined benefit comes as one monthly payment. The maximum
combined survivor/disability amount is the same as the maximum disability benefit.

The federal government does not pay disability benefits after the recipient turns 65. The
Canada Pension Plan retirement pension is based on the recipient’s pensionable income at
the time he or she became disabled. The maximum CPP pension amount in 2011 is $960
and is fully indexed to inflation as measured by the Consumer Price Index. A disabled
person can also apply for an Old Age Security pension beginning at age 65.
Coordination of Benefits on a Disability Insurance Policy

In underwriting a disability application, the insurer examines all of the applicant’s sources of
income to justify the amount of monthly disability benefit that the applicant is requesting. The
insurer will look at actual earnings, other disability income plans that the applicant participates
in, and any potential benefits available under government income plans such as Workers’
Compensation, Employment Insurance, or CPP. The insurer wants to make sure that the
applicant will not be able to claim a disability income that exceeds his or her actual earnings.
Many insurers add a provision to disability insurance policies stipulating that if an insured person
presents a disability claim, the benefit amount payable, together with all sources of income,
including disability benefits from other plans, will not exceed 100% of the insured’s earnings
before the onset of the disability. Although the insurer analyzes the applicant’s other sources of
income during periods of disability, once the insurance is issued, there is nothing to prevent the
insured from seeking to receive money from other disability income plans or sources of income
that are not interrupted during periods of disability. The coordination of benefits provision allows
the insurer to reduce the benefits payable under the policy if it discovers during the claims
assessment process that the insured is entitled to benefits that total 100% or more of his or her
income before he or she became disabled. The insurer will refund any premiums paid towards the
coverage that is excluded from the claim benefit. The purpose is to make sure that the claimant is
not better off on disability than he or she was while working.
Tax Treatment of Individual Disability Insurance Policies
INDIVIDUAL DISABILITY INCOME POLICIES

If the policyholder is also the insured, he or she pays premiums from after-tax dollars, so the
premiums are not deductible for tax purposes. Benefits paid out under the plan are not taxable.
For example, Gord, a musician with a traveling band, purchases a disability insurance policy
and pays premiums of $1,000 a year. He is entitled to disability income payments of $4,000
a month (66% of monthly income of $6,000). If Gord falls off the stage at one of his spirited
performances and injures his back badly, he will get $4,000 a month from the insurer. Since
Gord is paying the $1,000 in premiums using after-tax dollars (i.e., the premiums are not tax-
deductible), the disability income benefit of $4,000 a month is also not taxable.
EMPLOYER-FUNDED DISABILITY INCOME INSURANCE

If an employer pays all or part of the premiums for an individual (as opposed to group) disability
income insurance policy, the employer can deduct the amounts paid for tax purposes. Premium
amounts paid by the employer are a taxable benefit for the employee, but any benefits paid
to the employee under the plan are tax-free. For example, Wendy is insured under a disability
income insurance policy for monthly disability income benefits of $3,000 (66% of monthly salary
of $4,600). Her employer, Ivanhoe Inc., pays the premiums for this policy. Assume that the
premiums add up to $700 a year. Ivanhoe can deduct the $700 in premiums for tax purposes.

Wendy will declare $700 as a taxable benefit received from Ivanhoe and, in the event that
she becomes disabled and gets the monthly income benefit of $3,000, that amount will be
received tax-free by Wendy.
KEY PERSON DISABILITY INSURANCE

If a policy is owned and paid for by the employer to insure a key employee, and the benefits are
payable to the employer, the premiums paid by the employer are not deductible, but any benefits
received are tax-free. For example, Amy is a marketing VP at Global Finance Corp and a member
of the senior executive team. She is considered a key person by Global Finance and the company
purchases a key person disability insurance policy for Amy. The premiums are $2,000 a year and
Global Finance pays them. The beneficiary of the policy is Global Finance. If Amy gets disabled,
the company would start receiving disability income benefits from the key person policy on Amy.
In this case, Global Finance is the owner of the policy, pays the premiums and receives the
benefits. The $2,000 annual premiums will not be tax-deductible by Global Finance; by the same
token, the monthly income benefits that Global Finance receives will be tax-free.
BUSINESS OVERHEAD EXPENSE POLICIES

The insured under the policy is entitled to deduct the premiums from taxable income as a
business expense. The benefits paid out under the policy are taxable income to the insured.
However, since the benefits are used to pay regular business expenses, which are deductible
from taxable income, there is no net tax liability.
DISABILITY BUY-OUT PLAN

The policyowner of such a plan may be a partner or shareholder in a business other than
the person insured, a trust that is overseeing the buy-sell arrangement, or the business
entity itself (corporation or partnership). The premiums paid by the owner are not tax
deductible, but the benefits paid are tax-free.
Since the payments under the disability buy-out plan are used to compensate the disabled
partner or shareholder for his or her interest, that interest is considered disposed of (that is,
sold) for income tax purposes.
The taxation of the disposition of a partnership or shareholder interest can be very complicated.
If the benefits under the plan are paid to a disabled partner to compensate him or her for
the partnership interest, and if the payment exceeds the individual’s cost for the business
interest, he or she may incur a taxable capital gain. This may occur whether the payments
are made in a single lump sum or over a period of time.
For corporations in which shareholders hold buy-out insurance on each other’s lives, the
benefit paid out is considered a payment for the purchase of the disabled shareholder’s
interest. The payment could generate a capital gain if the proceeds exceed the disabled
shareholder’s costs. If the payments are made over a period of time, the capital gain may be
deferred over several years under the reserve provisions of the Income Tax Act.
For corporate share repurchases, the benefits paid out are tax-free up to the limit of the
shareholder’s paid-up-capital. Any excess is deemed a dividend to the disabled shareholder.

ACCIDENT AND SICKNESS INSURANCE
LEARNING OBJECTIVES
• explain the rationale for and coverage provided by individual A&S (health or
travel) insurance policies to supplement provincial or territorial coverage;
• describe the provisions generally included in individual A&S insurance policies and the
potential impact of these provisions on a disability claim, including renewal, grace
period, incontestability, pre-existing conditions, claims, physical examination, change of
occupation, and over insurance;
• describe the tax implication of an A&S insurance policy.
Provincial Health Insurance

Each province provides health care coverage in conjunction with the federal government.
The federal government helps fund provincial health insurance plans that meet the
following standards:
1. Public administration: The program must be administered on a non-profit basis
by a public authority appointed and accountable to the provincial government.
2. Comprehensiveness: The program must cover all necessary hospital and medical
services and surgical-dental services provided in hospitals. In addition to these
insured health services, the provinces are encouraged to provide certain extended
health care services as defined in the Canada Health Act such as prescription drugs.
3. Universality: 100% of the province’s legal residents must be entitled to insured
health services.
4. Portability: Coverage must be portable from one province to another. The waiting
period for people who move from one province to another must not exceed three
months. Insured health services must also be made available to Canadians when they
travel to other provinces or other countries. In these cases, payment for services within
Canada is made by the home province at the host province’s rates; payments for services
outside Canada are made at the home province’s rates.
5. Accessibility: Insured services must be provided on uniform terms and conditions for all
residents. Residents must have reasonable access to insured services, and their access must
not be prevented or hindered, either directly or indirectly, by charges or other barriers.
Reasonable compensation must be paid to physicians and dentists and adequate
payments made to hospitals for insured services.
Some provinces have extended their health insurance programs to cover certain individuals
for some dental services, including routine services performed in a dentist’s office. Some
provincial plans also cover certain drugs prescribed by physicians.

Government health insurance is mandatory coverage, which means that a person or group
cannot opt out of the provincial health care plan and sign up with a private insurer for
services that are already covered by provincial plans. The government does, however, allow
private insurers to cover medical services that are not covered by provincial plans.
These extended health care plans may cover costs such as semi-private or private hospital rooms, eye
care, drug prescriptions, ambulance services, or hearing aids. Although provincial health insurance
plans do cover some medical expenses for Canadians who travel outside the country, the coverage is
based on the rates that would be charged for the same medical procedure or hospital coverage in the
province, whereas the actual costs for those medical services may be much higher in another country
(e.g., in the United States). Therefore, private insurers can provide medical coverage for provincial
residents who travel outside Canada that will reimburse them fully for medical expenses in other
countries. The cost of such coverage depends on the applicant’s age and the length of time the
applicant intends to remain outside Canada.
Private health insurance, in the form of accident and sickness insurance, rounds out the medical
coverage available under provincial health insurance plans. Provincial health plans usually
cover basic expenses like hospital stays and prescription drugs while in the hospital. However,
provincial plans are very limited in the coverage they will provide for Canadians while
outside the country.
Private health care plans can provide emergency health and travel insurance above and beyond
what the provincial plans will cover. These plans often cover things such as paying for a
companion to travel with a sick or injured party, paying emergency travel costs such as an air
ambulance, trip cancellation insurance, and accidental death insurance.
Some conditions and restrictions apply to health insurance plans that may affect the
availability of health coverage, the continuance of existing coverage, and the
administration of claims submitted under a private health care plan.
The Uniform Accident and Sickness Insurance Act defines accident insurance as “insurance
by which the insurer undertakes, otherwise than incidentally to some other class of insurance
defined by or under this Act, to pay insurance money in the event of accident to the person or
persons insured, but does not include insurance by which the insurer undertakes to pay insurance
money both in the event of death by accident and in the event of death from any other cause.”
Sickness insurance is defined as “insurance by which the insurer undertakes to pay
insurance money in the event of sickness of the person or persons insured, but does not
include disability insurance.”
Provisions of an Accident and Sickness Policy
RENEWAL
The renewal provision of a health insurance plan specifies the insurer’s right to renew
existing coverage or to charge a higher premium for the same level of coverage when a
premium is due for renewal. The type of policy that has been issued classifies the insurer’s
rights under these plans. (These are similar to the renewal provisions for disability insurance
described earlier.) The policy may be:
• Cancellable: The insurer has the right to cancel the plan at any time by notifying
the policyowner and refunding any premiums that the owner has paid.

• Optionally renewable: The insurer has the right to cancel the policy on the policy
anniversary or on any date when a premium is due. The insurer can also change the limits of
coverage and increase the premium rate for any class of policy. (A class of policies consists
of all policies of a particular type or all policies issued to a particular group.)
• Conditionally renewable: The insurer has the right to cancel a policy at the end of a
premium payment period, for any of the reasons stipulated in the policy, such as the
age or employment status of the insured.
• Guaranteed renewable: The insurer is required to renew the policy as long as the
insured continues to pay premiums, until the insured reaches a certain age. However, the
insurer has the right to increase the premium rate for entire classes of policies.
• Noncancelable: The insurer is required to renew the policy until the insured reaches a
certain age, as long as the insured continues to pay the premiums that fall due. The
insurer cannot increase the premium specified in the policy.
GRACE PERIOD
Under the grace period provision, the policyowner can pay the premium within a certain
period of time after the due date. The coverage remains in effect during the grace period. If
the policyowner pays every month, the grace period is usually 10 days. If the owner pays less
frequently, the grace period is usually 31 days.
INCONTESTABILITY
The incontestability provision limits the insurer’s rights to challenge or deny a claim because
of material misrepresentation made in the application. Misrepresentations are omissions or
incorrect statements made by the applicant that the insurer relied upon in deciding whether or
not to approve the coverage. Material misrepresentations are omissions or incorrect
statements that, if they had not occurred, would have led the insurer to refuse coverage or to
issue coverage on a more restrictive basis.
The incontestability provision limits the time in which the insurer can challenge or deny a claim
because of a material misrepresentation on the application to two years after the policy has been
issued and has remained in force. However, if the material misrepresentation was fraudulent,
there is no time limit. For further information on fraud and misrepresentation, see chapter 10.
PRE-EXISTING CONDITION
A pre-existing condition is an injury or illness (sickness) that an insured experienced
within a specified period (e.g., two years) before the policy was issued.
Insurance applications require a potential insured to disclose all material information that
would, or could, influence the issuance of a policy, or affect a policy’s terms and conditions,
and/or result in a non-standard premium. This is in addition to requiring an applicant to
answer all questions on the application to the best of their knowledge and ability.
A disclosed pre-existing condition may be admitted by the insurer resulting in no adjustment to the
coverage applied for or the premiums required. Otherwise, the insurer will adjust the premium to
compensate for the increased risk, limit the benefit amount or benefit period for the specific pre-
existing condition or related conditions, and/or exclude coverage for any illness

or injury directly or indirectly related to the pre-existing condition. If a pre-existing

condition is dealt with at the time of application by the insurer, the insurer cannot vary the
terms of the coverage at a later time.
If an applicant fraudulently does not disclose a pre-existing condition, the insurer can deny a
claim for benefits at any time in the future if it can prove that the illness or injury is directly or
indirectly a result of the pre-existing condition. If an applicant innocently misrepresents (by
legitimately forgetting or believing the condition to be so minor as to be not material, and/or
by not understanding the agent’s questions/directions during the application process), the
insurer only has a 2-year period during which it could deny a claim based on the pre-existing
condition. After 2 years, the prior existence of the disease or physical condition is not
available as a defence against liability (except in the event of fraud).
CLAIMS
A health policy’s provisions specify the obligations of the insured and the insurer as they
apply to claims made under the policy. Usually, the insured is required to notify the insurer
of a claim within 30 days after the injury or sickness has occurred and to furnish proof of
the injury or sickness to the insurer within 90 days. The insurer must pay benefits within 60
days of receiving proof of a medical claim.
PHYSICAL EXAMINATIONS
After an insured person submits a claim, the insurer has the right to have the insured
undergo a physical examination by a doctor chosen by the insurer. This examination is
paid for by the insurer.
CHANGE OF OCCUPATION
This provision gives the insurer the right to modify the coverage if the insured changes
occupations, because a person’s occupation can affect the likelihood of suffering an illness or
injury. For example, if a woman who has held a desk job changes careers to become a ski
instructor, her risk of injury is increased. If a construction foreman takes on a job in
telephone sales, his risk of injury or illness decreases.
If the insured takes on a more hazardous occupation, the provision usually allows the insurer to
reduce the benefits payable under the policy. If the insured takes on a less hazardous occupation,
the insurer will reduce the premium rate to the level charged for the new occupation.
OVERINSURANCE
Health insurance policies may contain a provision that reduces the benefits payable under a
policy if the insured has other insurance policies to cover the same medical condition. An
over insured person is someone who receives more in benefits from two or more policies
than the actual costs incurred for treatment. Insurers factor in other coverage to reduce the
benefits payable. Any premiums paid relating to the excess coverage will be refunded.
TAX IMPLICATIONS OF ACCIDENT AND SICKNESS POLICIES

For private health services plans (both individual and group) under which the benefits are payable
to the employee, premiums paid by the employer are tax-deductible for the employer and are
not considered taxable benefits to the employee. If the employee pays the premiums,
they are deductible as part of the medical expense tax credit.

Benefit payments to the employee are not taxable, but any medical expenses covered by the
health insurance plan cannot be deducted under the medical expense tax credit.
CRITICAL ILLNESS INSURANCE POLICY
LEARNING OBJECTIVES
• describe the advantages of a critical illness policy;
• describe and provide examples of the conditions that are generally covered under a
critical illness policy;
• explain the circumstances that will result in a payment of benefit under a critical
illness policy;
• explain the importance of different medical definitions used in critical illness policies.
Critical illness insurance provides a “living benefit.” The critical illness policy pays a tax-free lump
sum to the insured person a certain number of days after the insured has been diagnosed with one of a
specific group of potentially life-threatening medical conditions. These may include:
• heart attack;
• stroke;
• cancer;
• paralysis;
• conditions leading to coronary artery bypass surgery;
• multiple sclerosis;
• coma;
• Alzheimer’s disease;
• Parkinson’s disease;
• HIV infection;
• loss of speech;
• severe burns;
• loss of limbs;
• Lou Gehrig’s disease (ALS)
• benign brain tumour
• kidney failure;
• conditions requiring an organ transplant.
A critical illness policy is designed to provide a benefit while the insured person is alive. This is
important when someone suffers a serious illness that affects his or her ability to earn income and
may reduce his or her life expectancy. The financial consequences of a serious illness can often
be worse than those of dying suddenly. The insured person must continue to pay living expenses,

but usually cannot earn income. In addition, the insured’s family may face unusual
expenses to provide special care and treatment for the person who is ill.
Benefits
The benefit under a critical illness policy is paid out in a lump sum and the policy expires
when the insured person contracts a serious illness of the type covered under the policy. The
benefit can be used at the insured’s discretion. It can be used to replace earned income that
may be reduced or disappear entirely, depending on the severity of the insured person’s
condition. It may be used to pay for medical services and treatments that provincial medical
insurance plans do not cover or to renovate a home to make it wheelchair-accessible. It can
also be used to finance a business to which the disabled insured was a key contributor. It can
even be used to take a final vacation if the critically ill person is expected to die. The insured
person and his or her family do not have to wait until the insured person dies before receiving
the benefits and the insured can use the money to do whatever he or she wants to do.
Waiting Period
There is usually a waiting period after the illness is diagnosed before the benefit is paid.
That is, the insured must have suffered from one of the prescribed illnesses for a specific
period of time, without having recovered or died. This waiting period is usually 30 days, but
with some policies, it can be shorter, 14 days, and some policies have no waiting period at
all. If the insured dies during the waiting period, the premiums paid under the policy will be
refunded to the person named as beneficiary. If the person survives the waiting period and
continues to suffer from the medical condition, the insurer will pay the policy benefit to the
insured. Once the insured has qualified for the benefit, the benefit will be paid whether or
not the insured person recovers or dies from the effects of the illness.
Definitions
To qualify for the policy benefit, the insured person must contract one of the medical
conditions listed in the policy and exhibit the symptoms of the illness that are defined in the
policy. For example, the insured may suffer a stroke, as diagnosed by a physician. If the
critical illness policy provision defines a stroke as a covered illness, it will specify the
symptoms that must be present to qualify for a payment of the policy benefit. The policy
might read, “The stroke must be evidenced by neurological deficit persisting for at least 30
days.” If the insured exhibits these symptoms, or more severe symptoms, the insurer would
release the benefit, once any waiting period has been satisfied.
Policies may exclude certain conditions that do not qualify for coverage. For example, in
determining that the insured has contracted a form of cancer that qualifies as a covered illness,
one insurer uses the following exclusions: “Excluding early stage (stage T1N0M0/stage A)
prostate cancer, non-invasive cancer in situ, tumours in the presence of HIV, skin cancer other
than malignant melanoma with 0.70 mm depth or deeper, chronic lymphocytic leukaemia stage
1 or 2, Hodgkin’s disease, pre-malignant lesions, benign tumours, polyps.”
There is no standard definition of the qualifying symptoms stipulated in a critical illness policy.
Each insurer has its own criteria for acknowledging the presence of one of the qualifying
illnesses. For example, qualifying symptoms for paralysis differ among insurers. One policy
states, “Paralysis, as evidenced by complete and permanent loss of use of two or more limbs for

a continuous period of 180 days,” while another specifies, “Paralysis as evidenced by

total loss of voluntary movement of both arms, both legs or one arm and one leg as a
result of injury or disease of the nerve supply.”
Alzheimer’s disease may qualify in some policies as a critical illness only “if the individual
requires a minimum of 8 hours of daily supervision.” Other policies recognize the diagnosis
of Alzheimer’s as a covered condition without specifying any qualifying symptoms.
In summary, the agent must be sure that the insured person understands how the policy contract
defines an illness for the purposes of a claim. For example, the insured might suffer a medical
condition that is diagnosed as cancer, but may not exhibit the symptoms described in the policy.
The insured might also contract a form of cancer that is diagnosed in an early stage and treated
quickly. If so, it may not constitute a qualifying illness and therefore no benefit would be paid.
LONG-TERM CARE POLICY
LEARNING OBJECTIVES
• describe the advantages of a long-term care policy;
• describe and provide examples of the conditions that are generally covered under a
long-term care policy;
• explain the circumstances that will result in a payment of benefit under a long-term
care policy.
A long-term care (LTC) policy is designed to pay for personal care and medical services for
someone who has suffered a debilitating illness that leaves the individual unable to care for
himself or herself and in need of special attendant care at home or nursing home care. Without
long-term care insurance, families of a person with a serious illness would face an unexpected,
large, continuing expense that would seriously deplete or exhaust their financial resources.
A long-term care insurance policy provides coverage for conditions that result in a disability
to the insured that makes him or her unable to perform two or more of the Activities of Daily
Living (ADL) without assistance. These activities include:
1. Walking or managing a walker or wheelchair.
2. Eating - the ability to consume food that has been prepared.
3. Bathing - the ability to wash oneself.
4. Using the toilet - including getting to the toilet and on and off the toilet.
5. Getting into and out of bed -can use equipment to aid themselves.
6. Dressing - the ability to put on and remove clothing.
7. Personal grooming.

Impairments that trigger the payment of benefits may include such conditions as
Alzheimer’s disease, senile dementia, or advanced arthritis.
The provisions of the long-term care policy determine the conditions under which benefit
payments will be paid out under the policy. The LTC contract may require that the insured
be receiving treatment that is medically necessary. Some contracts may require that the
insured be hospitalized for a specific period; others may simply require that a physician
approve personal care for the disabled insured.
The most common measure for determining if benefits are payable is the insured’s
inability to perform the Activities of Daily Living. Insurers may use a variety of methods
for assessing the degree to which the insured is unable to perform the Activities of Daily
Living. The insurer may rely on a physician’s diagnosis, the assessment of a firm that
specializes in such analyses, or develop its own assessment criteria.
The severity of the impairment may dictate whether the contract pays benefits for nursing home
care or home care only. It is assumed that nursing home care is more expensive than home care.
Benefits are paid out when the following types of personal care are required.
• In-Home Health Care: home health aides, homemakers, or personal care
attendants provide health care in the insured’s own home to help the insured
person perform the activities of daily living.
• Adult Day Programs: These programs provide health, social, and other support
services on a part-time basis when a care provider cannot be present.
• Assisted Living Care: Assisted living care facilities promote independent living to
the best of the resident’s ability. The resident must be able to get into and out of bed
on his or her own.
• Nursing Home Care: Nursing home care provides the highest level of services. Care
provided in a nursing home can be defined in three different levels; custodial, intermediate,
and skilled. Custodial care provides assistance with the activities of daily living.
Intermediate and skilled care is provided by nurses and medical attendants trained to care for
patients who cannot care for themselves or whose health condition needs to be monitored.
Long-term care insurance reimburses the insured person for expenses incurred while
receiving these health care services. The benefits are in the form of a daily benefit, such as
$100 per day or $150 per day. Coverage usually ranges from $50 to $400 per day. Payments
may start as soon as the insured person qualifies, or may take effect after a waiting period of
up to one year. Benefit payments may be made for one or two years, a period of several
years, or for life. The applicant selects the length of the waiting period and the length of
time that the benefit payments will continue.

SELECTING AN APPROPRIATE INSURANCE PRODUCT FOR A

SPECIFIC CLIENT
LEARNING OBJECTIVE
• given a case study containing information on a specific client, select the most
appropriate products from among disability, accident and sickness, critical illness,
and long-term care insurance to match the client’s situation and needs.
Example 1: Employee with Group LTD Coverage Seeks Advice on Additional Individual
Coverage
Voice mail from Imelda Inquisitive:
Hello. A client of yours suggested that I contact you. My best friend recently suffered a
serious disability and has been unable to keep up financially. His problems have caused me
to consider what might happen if I became ill or was injured.
My employer has a long-term disability plan that pays 70% of my salary if I’m disabled, but
I’m not sure if that’s enough. Can you recommend some coverage that will pay me enough
money to maintain my current lifestyle? Please call me as soon as possible.
How would you respond to Imelda and what type of coverage would you recommend?
Imelda has provided very little information about her personal circumstances and you
must interview her to obtain much more detail. For example, you need answers to the
following questions.
• What kind of coverage does she have with her employer? Under what circumstances
will benefits be payable under her company’s plan and for how long? If the plan pays
her about 70% of her earned income for a long term such as to age 65, she may not
need income replacement through a disability income plan.
• Where does Imelda live? Presumably she has provincial medical insurance coverage, so
A&S coverage may not be needed if her employer provides A&S coverage to address
medical expenses that provincial insurance does not cover.
• What is Imelda’s family history? Have other family members suffered serious illnesses? If
Imelda were to suffer a serious illness, would a lump-sum benefit payment, under a critical
illness policy, help to resolve any financial problems that might arise?
• How old is Imelda? Considering her family’s medical history, is there a possibility that
she could suffer a debilitating illness that would require close attendant care for some
period of time? If so, long-term care insurance may be advisable.

Example 2: Business Owner Requests Disability Income Coverage

Good morning. My name is Matthew Macro. One of your clients gave me your name. I am looking
for information about insurance coverage for illness or injury. I own a software corporation that
employs ten people. I have operated the business for ten years and it was incorporated two years
ago. My role in the organization is to attract new business and to act as the general manager for
the company. The employees develop the software applications that our clients request.
While I have both personal and business life insurance in place in the event of my death, I have no way
of dealing with the consequences of my inability to work if I get sick or injured. I’m 40 years old and in
general good health. My parents are both alive and continue to enjoy good health in their old age.
A friend who operated a business similar to mine recently suffered a heart attack that has left
her unable to attend to her business. Her company recently went bankrupt. I don’t want the
same thing to happen to my business. Would you please contact me to discuss how I can make
sure that if I get sick or injured, my business will not be in danger?
How would you respond to Matthew and what type of coverage would you recommend?
While it is important to gather more details about Matthews’s insurance needs, he has provided
some valuable information. It appears that he has addressed his life insurance needs, but has done
nothing about his risk of becoming disabled. It is also clear that he is an essential part of his
business. If he gets sick or injured, the business would suffer almost immediately.
Once you have conducted a formal needs analysis, you may find that Matthew is a candidate
for disability insurance to replace the income he and his company will lose if he is unable to
work. The details of the coverage will need to be worked out.
• How much monthly disability insurance does he need? To determine the amount, you
need to know the income that Matthew is able to earn currently and other sources of
income that Matthew may receive that will continue even if he becomes disabled. You
must also consider if Matthew has other insurance in place that he would receive if he
became disabled. A government plan, such as Workers’ Compensation, may be
available if Matthew becomes disabled at work.
• How long should the waiting or elimination period be before monthly benefits
commence and how long should the benefit period be? Matthew must consider how
soon after any disability begins he would need to replace his earned income and how
long he would need to receive monthly income benefits.
• Who will own the policy and who will receive the policy benefits? This is for Matthew
and his company to decide. It may be appropriate for the company to own the policy and
be the recipient of the monthly income benefits. The income could then be applied to the
business, and a portion could be paid to Matthew for his personal needs. It might also be
worth considering two policies, one owned by the company and another owned by
Matthew to meet his personal requirements.
Since Matthew is a principal in the business, he may want to consider applying for a
Business Overhead Insurance plan as well. The plan will reimburse the business for
qualifying monthly business expenses if Matthew is disabled.
Matthew is young and healthy, and has no apparent family history of serious medical problems.
So, it might be premature to consider Critical Illness insurance or Long-Term Care insurance.

As for accident and sickness insurance, Matthew and his employees are covered under a provincial
health insurance plan. Matthew did not mention if he and his employees had an extended health care
plan in place. He might want to consider such a plan for all of the company employees.
Example 3: Employee Near Retirement Concerned About Meeting Costs of Critical Illness and
Long-term Care
Hello, my name is Earl E. Retirement. I work for Matthew Macro’s company and he
suggested that I talk to you about my own insurance needs.
I am 55 years old and I have the resources to retire this year. I have worked for Matthew for the
last five years. Before that I worked for a large software company for 30 years and I have
earned a substantial pension. I established a life insurance program when I was in my early
thirties and I feel that my estate plan is in good shape in the event of my death.
I am married and my wife and I recently celebrated 30 years of marriage. We have two
children who are pursuing their careers in another part of the country. My wife and I plan to
travel extensively, at least in the first few years of our retirement.
We hear stories of couples who have encountered serious financial problems because one or both of them
became seriously ill and all of their financial resources have been exhausted because of the cost of special
health care. My wife and I would like to see you to discuss how we can avoid these kinds of problems.
How would you respond to Earl and what type of coverage would you recommend?
Although you will need to spend time with Earl and his wife to assess their long-term
needs, based on the information that Earl has provided so far, you may be able to make
some assumptions about the kinds of insurance plans that may be appropriate.
Earl has indicated that his retirement needs and his life insurance needs have been
addressed. He and his wife are entering their “golden years” and will probably enjoy a
comfortable lifestyle, as long as they both remain reasonably healthy. Provincial medical
insurance will help them address the less serious health problems attendant with aging. But
what would happen if one or both of them contracted a serious illness?
You may want to suggest that Earl and his wife consider a variety of different ways to
address this problem.
Critical illness insurance is a possibility. With this insurance in place, if Earl and/or his wife
were to suffer a critical illness as defined in the policy, they would receive a lump sum
amount of insurance. For example, if Earl contracted a form of cancer, one of the critical
illnesses covered under a typical CI policy, he would receive the insurance benefit upon
satisfying any waiting period. Earl and his wife could decide how to spend the insurance
amount. The funds could be used to finance a special form of treatment not covered under
the provincial health insurance plan; or, the couple might decide to spend the money on
travel or to realize other personal plans, particularly if Earl’s life expectancy is uncertain.
The couple might also consider long-term care insurance plans. If they are currently healthy and likely
to survive to old age, they could set up long-term care insurance plans today in anticipation of the
personal health care they might need as they approach the end of life. If Earl were to suffer a
debilitating stroke in his later years and become unable to care for himself, for example, his wife and
family would have to provide the personal care that Earl would require or find the financial resources
to have someone else provide that care, either at home or in a medical facility. If Earl lived for several
years in a condition that made it impossible for him to care for himself, the cost

of his personal and medical care could drain the family’s resources. Long-term care
insurance would provide a monthly benefit to defray the cost of such care.
Finally, if Earl and his wife plan to travel extensively outside Canada, they might also consider
travel medical insurance. Provincial health insurance plans limit the amounts payable for hospital
care and medical treatment. If Earl or his wife were to suffer an injury or illness while travelling
abroad, the local cost of medical care might significantly exceed the limits of the provincial
health insurance coverage and begin to deplete the couple’s financial resources.

Chapter 4
Group Insurance Products
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4
Group Insurance Products
CHAPTER OUTLINE
Introduction
Group Insurance
• Definitions
• Individual vs. Group Insurance Products
• Contributory and Non-Contributory Plan
• Deductible and Co-Insurance
• Group Insurance Eligibility Requirement Terms
• Methods for Determining Premiums
• Refund Accounting, Non-Refund Accounting, and Administrative Services Only (ASO)
• Coordination of Benefits Guidelines
• The Agent’s Role in Marketing Group Insurance
Group Life Insurance
• Types of Coverage under a Group Life Insurance Plan
• Key Group Life Insurance Policy Provisions
• Tax Treatment of Group Life Insurance
• Basic AD&D and Voluntary AD&D Plans
• Creditor’s Group Insurance
4•2
Group Disability
• Short-Term and Long-Term Income Replacement Plans
• The Use of an Elimination Period in Pricing Group Disability Plans
• Features and Coverage of a Group Disability Plan
• Short-Term Disability Plans and Employment Insurance
• Employee-Paid Premiums for Group Long-Term Disability Plans
• Coordination of Benefits and Subrogation on a Group Disability Insurance Policy
Group Accident And Sickness Insurance And Extended Health Plans
• Medical Services Covered by Provinces and Territories
• Medical Services Included in Employer-Sponsored Plans
• Deductibles and Co-Insurance
• Limitations and Exclusions in Employer-Sponsored Group A&S and Extended Health Plans
• Group Dental Plans
• Employee Assistance Program
4•3
INTRODUCTION
Group insurance or a group insurance plan is one under which a group policyholder provides
insurance, such as life insurance, disability insurance, or accident and sickness insurance, for the
members of that group. Group plans can also be established to provide members with benefits such as
Employee Assistance Programs or pre-paid legal services.
In this chapter you will learn about the generic features of group insurance before moving on to the unique
features of group insurance in life, disability and accident and sickness products.
GROUP INSURANCE
LEARNING OBJECTIVES
• define the following: group insurance, member, group policyholder, waiver of premium benefit,
disability income benefit;
• compare and contrast individual and group insurance products;
• distinguish between a contributory and non-contributory plan;
• explain the terms “deductible” and “co-insurance” and how they affect benefit payments;
• distinguish among the following group insurance eligibility requirement terms: actively-at-work
provision, probationary period, eligibility period, and waiting period;
• explain the relationship of credibility to the choice of manual rating, experience rating, and blended
rating methods;
• explain the features of non-refund accounting, refund accounting, and administrative services
only (ASO);
• explain the Coordination of Benefits guidelines developed by the Canadian Life and Health Insurance
Association (CLHIA);
• determine how a primary and secondary carrier would coordinate benefits;
• discuss the agent’s role in marketing group insurance.
Definitions
GROUP INSURANCE
The essential ingredient of any group insurance program is that an organization contracts with an insurer
for insurance coverage on the lives of the organization’s members. In most cases, the organization is a
company and, as an employer, contracts for insurance benefits on behalf of its employees. Groups may
also consist of multi-employer groups covering employees who are members of a union whose
membership spans many companies. Trustees who administer these group plans on behalf of members are
typically union members.
4•5
Associations can also apply for and establish group insurance plans on behalf of their
members. They can be an association of employers such as the Canadian Automobile Dealers
Association, or a professional association of individuals such as the Canadian Bar
Association.
Some creditor groups may arrange group insurance between an insurance company and a
lender, whose borrowers are insured under the group arrangement.
MEMBER
A member is an individual who belongs to a group. For group insurance purposes, a
member is someone who, because of his or her relationship to the insured group, is entitled
to participate in the group insurance program. The member may be an employee, a union
member, a member of an association, or a creditor.
To qualify for group insurance, a member and the organization to which he or she
belongs cannot have established the relationship solely for the purpose of establishing a
group insurance plan. For example, a member of the Canadian Bar Association
participates because of his or her status as a lawyer and not in order to take advantage of
a group insurance plan offered through the Association.
GROUP POLICYHOLDER
The group policyholder is the organization that contracts with an insurance company to
provide group insurance benefits to its members. In any group insurance arrangement, the
insurance contract is between the entity that represents the group members (an employer
or an association, for example) and the insurance company.
WAIVER OF PREMIUM BENEFIT

Under the waiver of premium benefit, premiums that fall due while an insured person is
disabled are waived by the insurer. This also applies to premiums paid by the employer or
the employee for the group insurance plan that offers the waiver of premium benefit.
The waiver of premium benefit is available for life insurance coverage and for long-term
disability coverage.
Under this provision, the insurance plan is continued while the insured person remains
disabled. The waiver of premium benefit terminates when the insured recovers from his or
her disability or when the period of coverage ends, whichever comes first.
To qualify for the waiver of premium benefit, the insured must be totally disabled. In some
plans, total disability is defined as the inability to be gainfully employed in any occupation for
which the employee is qualified because of education, training or experience. Some group plans
define total disability as the inability to perform the insured’s own occupation for the first 24
months of disability and any gainful occupation after 24 months, while the insured continues to
be disabled.
DISABILITY INCOME BENEFIT

Group insurance disability benefits may be classified as short-term or long-term.
Short-term benefits commence almost immediately once the member becomes disabled
and continue for only a short time. Short-term disability plans can be issued in conjunction
with Employment Insurance benefits. If the short-term plan is properly registered with
Service
Canada, it can reduce the premium requirements for EI. The benefit is stipulated as a percentage of the
disabled person’s earned income.
Long-term disability plans (LTDs) generally commence after a significant period of disability (such
as 180 days). For LTDs, the benefit is based on the disabled member’s monthly earnings, perhaps
60%, up to a maximum such as $5,000 a month.
Disability payments under an LTD plan can continue until age 65, assuming that the insured
member remains disabled under the provisions of the plan.
Individual vs. Group Insurance Products

Life, disability, and accident and sickness products provided under group plans are similar to individual
insurance products, in that they pay a specific benefit upon the happening of the insured event, such as
the death of the person covered under the plan, the onset of a disability, or the need for medical care as
the result of an illness or injury.
Individual and group products, however, have a number of important differences.
CONTRACT DESIGN
Individual contracts are negotiated between the policy owner (who is often the person insured) and the
insurance company. The contract defines the rights and obligations of the policy owner, the insured, and
the insurer. Group contracts are negotiated between a group policyholder (usually an employer) and an
insurance company. The coverage is provided for the benefit of persons insured under the group plan,
usually employees of the group policyholder.
The rights of an insured person under the terms of the group contract may include:
• the right to appoint or change a beneficiary of a life insurance benefit;
• the right to convert the group coverage to individual coverage if the insured person leaves the
organization that holds the group contract, or if the group contract terminates.
UNDERWRITING AND ISSUE

An individual insurance policy is issued only after the insurer has had the opportunity to confirm that
the individual who has applied for insurance coverage is an acceptable risk. Group insurance contracts
are issued once the group underwriter is satisfied that the members of the group who will be insured
under the group plan fit an acceptable risk profile.
The coverage available under the group plan is not negotiated with each member of the insured group.
Instead, the insurer and the group policyholder negotiate methods of determining the amount of coverage
available to each insured person. For life or disability insurance, the amount may be a percentage of the
individual’s salary. In both cases, the coverage may differ among different classes of employees within the
group policyholder’s organization. For example, the coverage limits may be higher for managers than for
clerical workers.
For group insurance contracts, the insurer usually does not require evidence of insurability for any of the
insured persons, unless it is a small group, or unless a member joins after the eligibility period expires.
This is the period during which a member of the group can apply for coverage, and sign an authorization for
payroll deduction of the insurance premiums (if it is a contributory group plan). The insurer will consider the
mortality (risk of death) or morbidity (risk of
4•7
disability) expectations for the insured group as a whole and set premium rates accordingly. A
group insurance plan that insures factory workers represents a higher level of risk than a group
of clerical workers. A group plan that insures a mix of blue-collar and white-collar workers
requires another risk profile that the insurer will assess to establish coverage levels and
premium rates.
PREMIUM CALCULATION
Although the premiums for individual insurance contracts are predetermined by the applicant’s
age and risk classification, group insurance premiums are calculated based on the make-up of
the members of each group and on any previous claims from the group to be insured.
Unlike individual insurance plans, in which the insurer cannot increase the premium during the
term of the contract, each group insurance contract is revised and the premium is recalculated when
the coverage is renewed each year. The insurer considers the group’s claims for the previous year
and any change in the composition of the group when offering to renew the group coverage.
POLICY PROVISIONS
The group insurance contract stipulates the rights and obligations of the group
policyholder and the insurer. The provisions usually include:
• the policyholder’s obligations to pay the premium within the grace period provided;
• the methods of determining the premium requirements;
• the policyholder’s obligations to notify the insurer about new members covered by the plan;
• in some cases, the policyholder’s obligations in administering the plan;
• an incontestability provision that allows the insurer to contest the validity of a group
insurance policy for a period of two years after the contract has been issued;
• when and how the group policyholder or the insurer can terminate coverage under the
group plan.
Persons insured under the group plan are entitled to information about the nature of the
coverage and their rights under the plan. Usually the group policyholder or the insurer
prepares a booklet that describes the coverage and the method of determining the amount of
coverage for each member of the group under the plan. The booklet also describes the
insured’s rights under the plan, such as the right to appoint a beneficiary or the right to
convert the coverage upon leaving the company.
RIGHTS, OBLIGATIONS, AND PRIVILEGES

A person insured under a group plan may not be required to pay any premiums for the
coverage. The employer may pay all of the group premiums for the insured members. The
insured member may apply for optional coverage available under the plan, such as
coverage for a spouse or dependants.
When an individual joins a group that is covered by group insurance, he or she may have
to satisfy a probationary period before becoming insured. Under group insurance, the
insured has access to the insurance coverage only because of his or her status as a
member of the group that holds the policy contract.
4•8
Contributory and Non-Contributory Plan
A contributory group plan requires the employee or group member to pay some or all of the
premium for coverage. In most groups that offer a combination of life, disability, and accident and
sickness benefits, the group policyholder pays the premiums for part of the coverage, such as life
insurance, and the insured members pay for disability coverage. Alternatively, the group
policyholder pays the premium for basic coverage and the insured may apply for extended coverage
for himself or herself or for family members.
A non-contributory plan is one under which the group policyholder pays the entire premium for the
group coverage. For non-contributory plans, group insurers require full participation by all eligible
employees in the group, in order to avoid confusion about entitlement to benefits. For contributory
plans, the insurer will not insist on full participation, but will insist on a high participation level
(perhaps 75%) to make sure that the group’s mortality and morbidity profile includes a significant
cross-section of the group and not just those who present a sub-standard risk.
Deductible and Co-Insurance

A deductible and co-insurance provision generally applies to group insurance under which the insured
person is reimbursed for medical or dental treatment covered under the group plan. A deductible is a
dollar amount that the insured must pay before the plan will reimburse the insured for the
covered expense. For example, the insured may be required to pay the first $300 of any covered
medical treatment during the calendar year; the insurer will reimburse the group plan member for any
additional costs.
Co-insurance limits the amount that the insurer will reimburse the insured to a percentage of the
actual health care cost.
For example, Fred has been billed $1,000 for medical costs that are insured under his group plan. His
insurer has a calendar year deductible of $300. Therefore, Fred must pay $300 and submit a claim for
the remaining $700. If the insurer also has a co-insurance provision under which it is required to
reimburse only 80% of the cost, Fred will be reimbursed for $560, that is, 80% of the $700.
Group Insurance Eligibility Requirement Terms

When a group plan is first established and from time to time thereafter, the group policyholder and
insurer may hold an enrolment drive to register group members for the coverage. The purpose is to
make sure that the insured group is large enough to provide a satisfactory mortality and morbidity
profile.
Under the terms of the enrolment drive, individuals who apply for coverage will be insured
immediately if they satisfy one important criterion: they must be actively-at-work. That means, to be
eligible for the coverage, the employee must be working on a regular basis and not away ill or on
leave. An employee who does not satisfy the “actively-at-work” requirement becomes eligible for
coverage once he or she returns to work on a full-time basis. Enrolment periods are limited; after the
end of the enrolment period, new registrants for coverage are not eligible for coverage immediately.
If the group policyholder is not holding an enrolment drive, new employees or new members of the
group being insured must satisfy a probationary period before they qualify for coverage.
This is the time that a new group member must wait before becoming eligible to enroll in the group
insurance plan.
For non-contributory plans, once the member has satisfied the probationary period, he or she is
entitled to coverage under the plan.
For contributory plans, the probationary period is followed by an eligibility period
(usually 30 days), during which a member of the group can apply for coverage and sign
an authorization for payroll deduction of the insurance premiums. If an eligible member
chooses not to apply for coverage during the eligibility period, he or she may apply later,
but will be required to submit evidence of insurability and be approved for coverage.
A waiting period is the period of time that a covered member must wait before being entitled
to receive benefits under the coverage. This restriction applies primarily to disability income
plans that pay the disabled insured a monthly income, once he or she has been disabled for a
certain period. The waiting period is described in Chapter 3 on disability insurance products.
The concept of group insurance is based on five fundamental principles. Without
adhering to these five principles, group insurance would not be a viable product for the
insurer to offer because of the uncertainty of the risks involved, or it would be much more
expensive for the employer to provide. The five fundamental principles of group insurance
are:
1. Each employee in the group must be actively at work on a full-time basis. The rationale
for this first and most important principle is that an individual who can work full-time is
likely to be in reasonable health. While all employees may not be in good health, as a group,
they will exhibit a level of mortality or morbidity lower than the population as a whole.
Therefore, all eligible employees can be insured under the plan regardless of their health.
2. The employee cannot determine the amount of their coverage. This principle prevents the
employee from selecting coverage at the expense of the plan. The amount of insurance is
determined according to the schedule in the master policy. For example, the schedule may
illustrate that the amount of coverage an employee would be eligible for would depend on
whether they were a factory worker, clerical staff or management staff.
3. Employee contributions must be made through payroll deduction. The employer then
remits a single sum each month to the insurer. This principle also helps address the
“actively at work” requirement.
4. There must be an employer contribution. Often, the employer pays a minimum of 50%
of the plan cost. The employer contribution reduces the cost to the employees, and
thereby increases participation rates. This serves to spread the risk more broadly.
5. There must be a spread of risk. There must be both a sufficient number of lives in the
group as well as a sufficient percentage of employees who participate in the plan.
Wherever there is a deviation from any of these five principles, there should be a
compensating element. For example, where the group is small (i.e. less than 25 lives) and
the spreading of risk principle is not met, evidence of good health may be requested
individually from each employee wishing to join the group.
Brar Manufacturing is a relatively small 15-year-old business based in Brampton, Ontario that makes
precision parts used in mining excavators. Its customers are a handful of large mining machinery
manufacturers. The President is Mr. Sunny Brar and he has been requested (repeatedly
over the last few years) to set up a group insurance and benefits plan by the employees of Brar
Manufacturing; he is finally looking into setting one up. The firm is non-unionized and the
employees are paid competitive wages and salaries.
Here are some features of the group of 30 employees:
• 20 employees are under 35 years of age; 5 employees are between 40 and 45, and the other 5 employees
are between 50 and 55 years old.
• 25 employees work in the plant, four are in sales and on-site service, and one runs the office. All
employees are permanent full-time employees.
• All employees are male, except for the one who manages the office and does the bookkeeping and
payroll. Mr. Brar has already told her that if a group plan is set up, she will be collecting employee
contributions through payroll deduction.
• One employee is currently on long term disability, having injured his back on the job, but he is expected
to return to work shortly after a successful recovery and rehabilitation.
• The five employees over 50 years of age have been with Mr. Brar from the early days of the business;
they have requested Mr. Brar to be allowed to decide how much coverage they want, especially for
life insurance.
• Mr. Brar is a habitual penny pincher and does not want Brar Manufacturing to make any
contributions to the group plan; he is willing to offer a plan that his employees can join, provided
they agree to pay all the premiums.
Based on the information given above about Brar Manufacturing and the five fundamental
principles of group insurance, let us examine if this idea of Mr. Brar’s is going to become reality
and what accommodations may be needed to institute a group insurance plan at Brar
Manufacturing.
• The group fulfills the “actively at work” principle. Except for one employee who is currently on LTD
but is expected to return to work shortly, everyone else is actively at work on a full-time basis.
• Mr. Brar will have to inform the 5 employees who have been with his firm since the early days that
while they cannot choose the amount of coverage for themselves, the group can be set up such that these
5 employees could be put in a different class which would be provided with greater benefits. So, for
example, if other employees get life insurance coverage worth the amount of their annual earnings,
these 5 employees could get life insurance coverage worth 2 (or ever 3) times their annual earnings.
• Employee contributions will be made through payroll deduction at Brar Manufacturing and that
satisfies another fundamental principle of group insurance.
• Mr. Brar will have to loosen the purse strings because a group insurance plan cannot be set up at Brar
Manufacturing without an employer contribution. He may decide to pay a percentage of the premium
costs, say 50%, and let his employees pay the other 50%.
He could conceivably negotiate a reduction in their wages or salaries and give back those reductions in the
form of group premiums. But Brar Manufacturing, as the employer, must contribute to the cost of the group
insurance plan otherwise it cannot be set up.

4•11
• The group composition and size (i.e., 30 employees) is such that there is a good spread of risk with
the majority of employees being under the age of 35. The group insurer is likely to seek 100%
participation in the group plan by the employees of Brar Manufacturing; this would not be a problem
if Mr. Brar offers a fair and reasonable benefits package to his employees and agrees to pay at least
half the cost.
In conclusion then, it would be possible for Brar Manufacturing to set up a group insurance and
benefits plan for its employees once a few adjustments and accommodations are made.
Methods for Determining Premiums

The most important difference between group and individual insurance administration is the way that
premium rates are determined.
Insurance companies establish premium rates for individual products, including life, disability, and accident
and sickness plans using methods that were described in Chapters 2 and 3. For individual life insurance
policies, premiums are developed for every age; once a policy has been issued, the premium rate is guaranteed
to remain the same while the policy remains in force. (There are a few exceptions, such as annual renewable
term insurance and five-year convertible and renewable term insurance, for which premiums do change over
the life of the policy.)
For disability income policies, the premium rates for some plans, particularly those issued to those
employed in professional occupations such as doctors, executives, and lawyers, are
guaranteed not to increase while the policy remains in force. For other occupations, the premium rate for a
policy may increase at the insurer’s discretion. Any premium rate increases are applied to a particular class
of policy, that is, policies covering a certain class of risk.
Individual accident and sickness plans are closer in design to group insurance plans. The premiums
for medical expense plans may increase at the insurer’s discretion, depending on the claims and
expenses incurred by a particular class of policyholders.
The premiums for group insurance plans are calculated for each group based on the insurer’s
assessment of the group’s risk profile. A group insurer is likely to charge a higher premium for long-
term disability insurance for a group of factory workers than for a group of office workers. The group
insurer establishes a premium rate for group coverage in a group that is sufficient to pay all of the claims
that the group is likely to incur, along with the costs of administering the group plan. To make sure that
premium rates are adequate for claims and expenses, the group insurance company sets premiums for one
year at a time and recalculates the premium each year.
MANUAL RATING
When a group insurer is asked to insure a group for the first time, the group insurer uses a manual rating
method to determine the first year premium rates for the insurance coverage issued to the group. Under
the manual rating method, the insurer compares the composition of the new group to similar groups it
has insured before in setting premium rates for the new group. The insurer may also rely on the
experience of other insurers for groups of a similar composition when establishing premium rates for a
new group.
Group insurers also use the manual rating method to establish initial and renewal premium rates for
small groups. In a small group, a few claims more or less during a single year could skew the statistics;
therefore, the claims experience in one year might be significantly different from that in the next or later
years.
The danger for the group insurer in setting premiums for a small group is to rely on a particularly good
claims experience in one year to set the premium rates for the following year. If there is a higher than usual
number of claims the following year, the premiums will be too low. In this case, the experience for small
groups is not considered credible and the insurer has to rely on statistics compiled for other similar groups
to set adequate premium rates.
Take the case of Brar Manufacturing described earlier. Here is a relatively small group of 30 employees.
The business is looking at having its first-ever group insurance plan. So there is no prior history of claims
that a prospective group insurer can examine. In such a situation, the group insurer, in setting the premiums
for Brar Manufacturing, will look at its own experience in insuring similar sized groups with similar
composition in terms of gender and age, and also look at other factors such as type of business, geographic
location, etc. In the event that it cannot find anything relevant within its own client base, it may turn to
other group insurers in order to get proper information. For instance, if the group insurer finds in its
investigation that mining machinery manufacturing firms and their suppliers have relatively more LTD
claims than other manufacturers, then it can adjust the LTD premiums it quotes accordingly.
EXPERIENCE RATING
In contrast to manual rating, group insurers rely on experience rating to set renewal premiums for groups
that are large enough to provide reliable claims experience statistics. Because of the size and composition
of the group, the claims and expense amounts experienced in any one year can be expected to remain
within the same limits in the following year.
If the insurer is establishing the initial premium rates for a new group insurance plan for the group, it
can rely on its experience with other, similar groups, or the group insurance provided for the same
group by a different insurer.
Assume that a large company, such as Hudson’s Bay Co., is seeking quotes on its group insurance plan from
providers. Most companies, big and small, “shop” their group insurance plans
every few years so as to ensure that they are paying competitive premium rates and securing
comparable benefits for their employees. Obviously, HBC has had a long history of providing group
insurance to its employees. So a prospective insurer will go by the “experience” of HBC in quoting
premium rates. It can do so by relying on the previous experience of the HBC group in terms of claims
and in knowing that just because HBC switches insurers does not mean that its group claims
experience will radically change. The large size of the group ensures that there will not be dramatic
changes in the expenses incurred and claims made by HBC employees. In other words, HBC is likely
to have 100% credibility, i.e., the larger the group, the more predictable its potential claims would be.
BLENDED RATING
Some groups are not large enough to demonstrate claims and expense statistics that are entirely
credible, but are large enough to display experience statistics that are partially credible. In these
cases, the insurer will use a blended rating method. That is, the insurer will consider the group’s
actual experience and the experience of other similar groups in setting initial and renewal premiums
for the group coverage. In short, the insurer will use both an experience and manual rating method to
arrive at a premium rate.
4•13
Refund Accounting, Non-Refund Accounting, and Administrative

Services Only (ASO)
Group insurance is a competitive business. Insurers must offer premium rates that are adequate to cover
claims and expenses, yet competitive with rates available through other group insurance companies.
Therefore, in establishing premium rates for each type of coverage within a group plan, the insurer and
the group policyholder may enter into an arrangement whereby the insurer refunds a portion of the
premium paid in the year if the group’s actual claims and expenses are lower than anticipated when the
premium rate for the year was established. If actual claims and expenses exceed the expected level, the
insurer does not request an additional premium for the year just concluded, but will factor in its losses in
setting the premium rate for the following year. This arrangement is known as refund accounting. The
amount refunded to the group policyholder is known as an experience refund or a dividend.
Group plans that do not use this approach are subject to non-refund accounting. The insurer sets
the premium rate for the year and, at the end of the year, retains any amount that exceeds the actual
claims and expenses. However, the insurer will most likely consider any favourable experience in
setting the renewal premium rate.
Instead of obtaining group insurance coverage for their employees through an insurance company, some
employers self-insure certain types of group benefits for their employees. This approach is most suitable
for large groups with reliable experience and an employer with the resources to fund the benefits payable
under the plan. For self-insured plans, employers may enter into administrative services only (ASO)
contracts with an insurance company or third-party administrator for a fee. Under the ASO contract, the
insurer or third-party administrator manages the plan on behalf of the employer by keeping track of those
eligible for the self-insured benefits and other services, such as confirming that the plan funding is
adequate to pay all of the benefits anticipated (actuarial services). Under an ASO arrangement, the
insurer has no responsibility to pay any benefits.
Coordination of Benefits Guidelines

An individual may be covered under more than one group benefits plan that pays for health care or dental
expenses. In most cases, the duplication occurs because two spouses are covered under separate group plans
for health care and/or dental care benefits. Sometimes two different employers cover the same individual,
because he or she has a full-time position with one employer and a part-time position with another. Since any
health or dental insurance plan is designed to reimburse the insured person for costs incurred in
receiving treatment, no insurer will allow an individual to be reimbursed for more than 100% of the
cost of any health or dental
treatment. Consequently, most group contracts contain a coordination of benefits clause that limits
the total benefit amount that will be paid for any one eligible expense to 100% of the cost. If an
individual is covered under more than one group plan, only one of the insurers will pay the bulk of
the claim. The other insurer may pay for any balance of the claim amount not paid by the primary
insurer.
The Canadian Life and Health Insurance Association (CLHIA) is a non-profit organization that represents the
interests of life insurance companies. Through consultation with member insurance companies, CLHIA has
developed guidelines to standardize the manner in which insurance companies determine how claims are
coordinated between insurers when an individual is covered
by more than one insurer for the same benefits. The guidelines set criteria that determine which
insurer will be the primary payor and which will be the secondary payor.
The primary payor assesses the claim and pays benefits as though the claimant was insured under only
one plan. The secondary payor will pay the lesser of the following amounts:
• the amount that would be paid if it were the primary insurer; and
• 100% of the eligible expenses, less the benefit amount paid by the primary insurer.
The following guidelines are used to determine the primary and secondary payors:
1. Any group benefits plan that does not contain a coordination of benefits provision is always the first
payor.
2. The plan under which the claimant is covered as an employee is the first payor.
3. If the individual is covered under plans with different employers, the plan covering the group in which
the employee works full-time is the primary payor; the plan for the group in which the employee works
part-time is the secondary payor.
4. If a claimant is covered under his or her own and a spouse’s plan, the plan under which the
individual is covered as an employee is the primary payor; the plan under which the individual is
covered as a spouse is the secondary payor.
5. For dental accidents, health care plans that provide for accidental dental coverage pay first.
For claims for dependent children, the plan of the parent with the earlier birth date (month/day) in the
calendar year is the first payor. If both parents’ birthdays fall on the same month and day, the plan of the
parent whose first name begins with the earlier letter in the alphabet becomes the primary payor. If the
parents are separated or divorced, the plans pay in the following order:
• the plan of the parent with custody of the child;

• the plan of the spouse of the parent with custody of the child;
• the plan of the parent not having custody of the child;
• the plan of the spouse of the parent not having custody of the child.
If the guidelines do not satisfy a particular situation, then benefit payments are pro-rated between the
insurers according to the actual portion of the total amount that each insurer would have paid if it were
the only coverage provider.
Example 1: Coordination of Benefits – Prescription Drug Claim

Xenia is an employee of ABCL Company and is covered under a group Benefits plan at work. She is a regional call centre
manager and her job is highly stressful. Xenia’s husband, Trey, is an employee of
TRWO Inc. and is also covered under a group Benefits plan at work. He is an industrial engineer there. Both
are listed as dependants on each other’s plans.
ABCL’s plan has a deductible of $100 and an 80% co-insurance factor. TRWO’s plan has no deductible and a
70% co-insurance factor.
Xenia files a drug claim for $500 for ulcer medications prescribed by her gastroenterologist.
4•15
This is how Xenia’s claim will be handled:

ABCL’s plan is the primary payor and, as per the terms of that plan, Xenia will be paid $320 [$500
amount of claim - $100 deductible = $400 x 80% = $320].
Trey then submits the claim to TRWO’s group insurer, which is the secondary payor in this
situation. TRWO’s group insurer will pay the lesser of the following amounts:
i. the amount that would be paid if it were the primary payor, i.e., 70% of $500 = $350
ii. the eligible expenses, less the benefit amount paid by the primary payor, i.e., $500 -
$320 = $180
So, TRWO’s group insurer will pay $180 [the lesser of (i) and (ii)]
The drug expense of $500 initially incurred by Xenia will be reimbursed fully:
$320 by the primary payor and $180 by the secondary payor
It should be noted that this is not always the result that transpires. There can be situations where a claim
even after being submitted to two insurers (primary and secondary) is not reimbursed in full. This happens
because of different deductibles, co-insurance factors, benefit maximums, etc.
Secondary payors are entitled to receive copies of the receipts confirming the actual cost incurred by
the individual and the first payor’s written explanation of its determination of the amount payable.
Example 2: Coordination of Benefits – Family Claims for Prescription Drugs, Dental and
Extended Medical Services
Fred and his wife Kathy are both employed full-time. Both are covered under a group benefi t plan through
their respective employers. James and Lisa, their children, are dependants covered under the plans. Fred’s
birthday is January 28 and Kathy’s birthday is April 7. Therefore, according to the coordination of Benefits
guidelines, Fred’s plan is considered the primary insurer for any health and dental costs incurred for the
children.
Fred’s group benefit plan contains the following provisions:

• Dental coverage: the plan covers basic services and major restorative services, but not orthodontic
services. There is a calendar year deductible per family of $200 for dental treatments. The plan pays
80% of the balance of the cost of covered dental services during the year.
• Prescriptions: the plan has a calendar year $100 deductible per family. The plan pays 80% of the
balance of prescription costs for the year.
• Extended medical services: The plan pays for massage therapy treatments prescribed by a physician.
The plan has a limit of $300 for treatment for any one individual.
Kathy’s group benefit plan contains the following provisions:
• Dental coverage: the plan covers basic services, major restorative services, and orthodontic services. There
is no deductible. The plan pays 80% of the cost of covered dental services during the year, except for
orthodontic treatments, for which the plan pays 50% of the costs
• Prescriptions: The plan pays 100% of prescription costs.

• Extended medical services: The plan pays for massage therapy treatments prescribed by a physician.
The plan has a limit of $500 for treatment for any one individual.
Medical and dental charges for the family during the year are as follows:
Fred
Prescriptions for pain relief and relaxants for back problems $ 500.00
Dental care for a check-up and one filling $ 200.00
Massage therapy treatments $ 800.00
Kathy
Prescription for antibiotic $ 50.00
Blood pressure medication $ 300.00
James
Prescription for antibiotic $ 50.00
Dental care for a check-up $ 94.00
Lisa
Dental care: orthodontic services (braces) $ 700.00
Fred prepared and submitted the following claims to his group insurer:
Dental treatments:
Fred $ 200.00
James $ 94.00
Lisa $ 700.00
Total $ 994.00
His group insurer processed the claim as follows:

Total bill $ 994.00
Exclusions – Orthodontic care $ 700.00
Deductible $ 200.00
Net amount $ 94.00
Pay 80% - $94 × 80% $ 75.20
Prescriptions:
Fred $ 500.00
James $ 50.00
Total $ 550.00

Total cost $ 550.00
Deductible $ 100.00
Net Amount $ 450.00
Pay 80% - $450 × 80% $ 360.00
Medical treatments:
Fred: Massage Therapy $ 800.00

Total cost $ 800.00
Limit $ 300.00
Pay $ 300.00
4•17
Once Fred’s insurer processed the claims, the group claims area issued a payment
along with a statement that provided details concerning the deductions and exclusions
and the net amounts payable.
Kathy then submitted these documents, along with receipts and invoices, to her
group insurer. She also submitted her own claim for her prescriptions.
Dental care
Total costs for the family $ 994.00
Paid by Fred’s insurer $ 75.20
Kathy’s insurer processed the claim as follows:
Cost of basic dental services $ 294.00
It would pay the lesser of (i) and (ii):
(i) Amount paid if it were the primary payor –
$ 235.20
80% of $294
(ii) Eligible expenses less benefit amount paid by
$ 218.80
primary payor $294.00-$75.20
It would, therefore, pay $ 218.80
Cost of orthodontic services $ 700.00
It would pay the lesser of (i) and (ii):
(i) Amount paid if it were the primary payor –
$ 350.00
50% of $700
(ii) Eligible expenses less benefit amount paid by
primary payor $700 – 0 (primary payor $ 700.00
excluded orthodontic services)
It would, therefore, pay $ 350.00
Total payment made by Kathy’s insurer: $218.80 + $350.00 = $ 568.80
Prescription:
Prescription costs submitted to primary carrier $ 550.00
Primary carrier paid $ 360.00
Net submission $ 190.00
Kathy’s prescription costs $ 350.00
Total claims submitted $ 540.00
Kathy’s insurer paid 100% of the claim = $ 540.00
Medical treatment:
Kathy submitted a claim for Fred’s massage therapy treatments. Since his insurer had paid $300 of
the total $800 cost, Kathy’s insurer assessed the claim for the remaining $500. Since the maximum
amount payable for any individual was $500, Kathy’s insurer issued a payment for
$500.
Kathy’s insurer paid all of Kathy’s health insurance costs. There were no claims
submitted to Fred’s insurer for Kathy’s prescription costs.
The Agent’s Role in Marketing Group Insurance

For individual insurance sales, an agent works to find new clients and takes the client
through the needs analysis process. The culmination of this process is the completion of
an application or applications for insurance on the prospect. The applicant deals directly
with the agent in establishing an insurance program.
For group sales, the agent also prospects for new clients among employers who want to
establish a new group insurance plan for their employees or to revise an existing plan. The
process of establishing a group insurance plan is more complex than setting up a program of
individual insurance for one person or a family.
For group insurance programs, the agent helps a prospective client prepare a request for
proposal (RFP) that invites group insurers to bid on establishing a group plan. The bidding
insurers’ group sales representatives may participate in the discussions. The agent works
with the employer to compile pertinent information to give prospective insurers so that they
may assess the composition of the group, its claims experience under current or previous
group plans, and the types of group benefits that the employer is considering. The agent also
helps the employer distribute the RFP for bidding among prospective insurers.
Group sales representatives for group insurers respond to the employer’s RFP for a group
insurance program. The sales representatives’ role is to acquire enough information for the
insurer to make an accurate quote for group benefits, review proposed plans, and prepare and
present a group insurance proposal to the employer.
In other words, the agent is a generalist who helps the employer create and distribute the RFP to
interested insurers. The group sales representative plays a specialist’s role in compiling enough
information about the group to be insured to allow the group insurer to make a sound decision
to make a bid or decline to bid.
Once the bidding process is completed, the agent helps the employer assess the bids and choose
the insurer that offers the best program according to the criteria set by the employer with the
agent’s assistance. The criteria may include the best price, for example, but may also include
qualitative assessments of the insurer’s level of service or the insurer’s financial strength.
Once an insurer has been selected, the agent works with the group sales representative to
explain the provisions of the plan to the employees and enroll them into the plan. The agent
continues to work with the group sales representative to provide service and monitor the
group’s experience with a view to renewing the group plan every year.
4•19
GROUP LIFE INSURANCE
LEARNING OBJECTIVES
• define and explain the following types of group life insurance: term life, dependant
life, survivor income benefit, optional group life, accidental death and
dismemberment (AD&D);
• explain the key group life insurance policy provisions established under the CLHIA
Group Life Guidelines, including benefit amounts, beneficiary designation, conversion
privilege, misstatement of age, settlement options;
• describe the favourable tax treatment of group life insurance for both employer
and employee;
• compare Basic AD&D and Voluntary AD&D plans and how employees qualify for each;
• describe the exclusions usually included in basic accidental death and
dismemberment (AD&D) plans;
• describe the features, benefits, and administration of creditor’s group insurance.
Types of Coverage under a Group Life Insurance Plan
TERM LIFE
Term life insurance is the basic kind of life insurance offered to members of the insured
group. In many instances, the group policyholder pays the premium for all members of the
group, such as in an employer-sponsored group plan. The amount of insurance provided for
each member can be determined in a number of ways including:
• a schedule based on earnings: for example, an employee earning up to $50,000 may
be covered for $50,000 of insurance; one earning $100,000 or more may be covered
for an amount in excess of $200,000.
• a schedule based on position: for example, all salaried employees below executive level
might be entitled to coverage equal to 2 times earnings, while executives enjoy coverage
of 3 times earnings;
• a flat benefit schedule under which each member receives the same amount of coverage;
• a schedule of benefits based on years of service, in which employees with a longer
record of service are covered for higher amounts of insurance;
• a pension schedule in which the amount of life insurance is determined by the
member’s projected pension at retirement;
• a combination of factors such as earnings and position.
The premium rate is reviewed each year when the group plan is renewed and is adjusted
based on the group’s claim experience and the composition of the group. For example, the
premium may decrease when newer younger members join the group, or increase if the group
is made up of increasingly older members.
DEPENDANT LIFE INSURANCE

Dependant life insurance coverage is optional term insurance coverage offered to dependants
of a group member. It is paid for by the member on the lives of the member’s dependants.
A dependant is defined as:
• a member’s married or common-law spouse, or a partner of the same or
opposite sex who has been living with the member for at least 12 consecutive
months;
• unmarried children, including adopted and stepchildren between the ages of 14
days and 21 years of age who depend solely on the member for financial support;
coverage for
dependants who are in full-time attendance at school or university continues until age
25.
Some plans offer coverage to newborn children from the date of birth. Dependent children
insured under the plan, who become mentally or physically disabled, may continue to be
covered under the plan beyond the usual age limits, if they continue to be wholly dependent
on the member for support.
OPTIONAL LIFE INSURANCE

An optional life insurance program allows the group member to apply for additional life
insurance over and above the amount provided under the basic life insurance program for
the group. To be eligible for optional life insurance coverage, the member must already be
covered under the basic group life insurance plan. The benefit available may be based on
a multiple of salary or on units of $10,000 of insurance, for example. In both approaches,
the maximum benefit is limited, depending on the group plan provisions.
The process of issuing optional life insurance is different from that of basic life insurance.
For optional life insurance, the member chooses the amount of coverage. The applicant is
usually required to supply evidence of insurability. In most plans, the member pays the
entire premium for the benefit.
Evidence of insurability is usually required because without it, only individuals in poor
health would be likely to apply. Sometimes, a group insurer holds an open enrolment
period during which members may choose the optional life benefit without providing
evidence of insurability. This usually happens when a new group plan is established, and
the members have only a short period in which to sign up for the optional benefit.
If evidence of insurability is required, the insurer will include a suicide provision under
which payment of the death benefit will be refused if the insured commits suicide within two
years after the issue date of the coverage.
ACCIDENTAL DEATH AND DISMEMBERMENT

Accidental death and dismemberment (AD&D) insurance provides an insurance benefit if
the member dies or suffers a severe injury because of an accident.
Coverage may be issued on a full-time basis or on a non-occupational basis. Full-time
coverage means that the member is covered for accidents at any time. Non-occupational
coverage means that the member is covered only for accidents that occur while he or she is
away from the job. Non-occupational coverage is usually issued if the members of the group
are also insured through Workers’ Compensation.
4•21
If the insured dies from injuries caused by an accident, the death benefit is paid to a designated
beneficiary, usually in a lump sum. The provisions of the typical AD&D benefit stipulate that
death from an injury must occur within a certain period, usually 365 days following the accident,
because as time passes, it becomes more difficult to ascertain that death was caused directly by
the injuries suffered in an accident or from some other cause. Consequently, if an insured survives
365 days after an accident and then dies, no benefit will be paid under the AD&D coverage.
The dismemberment benefit is paid to the insured member. The benefit is paid for the loss
of, or the loss of the use of, a part of the body. For example, the full benefit is paid if the
insured loses both hands or both feet, or the use of both arms or both legs. A lesser amount is
payable if the insured loses one arm or one leg, or the use of one arm or one leg. The benefit
payable may be stipulated as a percentage of the principal sum insured.
AD&D coverage is usually automatically added to basic group life insurance. In many cases,
the AD&D amount is equal to the basic life insurance amount. The premium rate is a single
rate per thousand dollars of insurance that is applied to all members covered by the benefit.
SURVIVOR INCOME BENEFITS

Survivor income benefits provide a member’s survivors with a monthly income benefit in
addition to a lump sum death benefit under the basic life insurance coverage. A survivor is a
dependant, as defined for dependant life insurance. The benefit amount can be a flat amount
or a percentage of the member’s salary at the time of his or her death.
Key Group Life Insurance Policy Provisions

Employers and other organizations that negotiate group insurance plans on behalf of their
members consider costs and services as well as benefits when they select group insurance
plans. Since group plans are subject to annual renewal at premium rates that factor in the
group’s composition and claims experience, group policyholders may consider alternative
group insurers for more cost-effective products.
Since group plans can be replaced, the CLHIA, insurers, and regulators have established
guidelines to define and protect the rights and interests of group members who rely on this type
of insurance to address their life and health risks. The guidelines consider the following issues.
BENEFIT AMOUNTS
The guidelines require group policyholders to consider benefit amounts when one group
insurance plan is replaced by another. If a group policyholder decides to change insurers, the
guidelines ensure that a plan member of the original group who continues to be a member of
the plan does not lose any coverage or benefits because of the change in insurers. This is
particularly important if the member is receiving benefits under the original group and does
not satisfy the “actively-at-work” condition to qualify for coverage under the new group plan
at the time the change in insurers takes place.
Any member or member’s dependant who was insured under the original plan is entitled to
insurance under the new plan, as long as he or she is eligible for insurance under the new plan. A
particular class of member that was covered under the original plan might not be included in the
negotiations for the new plan coverage. For example, a company might have maintained group
insurance by class for its factory workers and separately for its office staff. In negotiating a new
group plan, the employer might decide to cover each class under a different plan. Consequently,
the factory workers would not be entitled to coverage under the new plan that insures office staff.
If the new plan continues to cover the class of member covered under the original plan, the
member is entitled to coverage under the new plan equal to the lesser of the amount to which the
member is entitled under the new plan and the amount for which the member was insured under
the original plan. For example, if Joe was insured for $150,000 of basic group life insurance under
the original plan and the new plan offers insurance of $200,000 for Joe’s member class, then the
new insurer is obliged to insure Joe for only $150,000 under the guideline provisions.
If the insured member is disabled at the time the original contract is replaced, the guidelines
specify the original and new insurer’s responsibilities with respect to that member. If the
member became disabled under the original contract before it was replaced, the original
insurer must consider the claim, as long as it has received proper notice of the claim within
at least 180 days after the member became disabled.
The guidelines take a similar approach to waiver of premium claims. That is, the original
insurer is responsible for any waiver of premium claim for a disability that occurred while
the original contract was in force, as long as it received proper notice of claim within 180
days after the disability began. In addition, if the claimant dies because of the disability, the
original insurer is responsible for the death claim.
The continuance of all of a member’s coverage under the original plan is not guaranteed
under the replacing plan. The replacement contract can be negotiated on different terms from
those of the original contract. For example, the new insurer is entitled to ask for evidence of
insurability before providing coverage on any member. Some types of coverage, such as
dental coverage for orthodontic treatments, may not be available to the group members once
the replacing plan takes effect.
In summary, the guidelines are intended to make sure that members of the original plan
who would be entitled to coverage under the terms of the replacement plan as new
members must be included in the new plan coverage. If a member is disabled when the
replacement plan takes effect, he or she must not be excluded from coverage, simply
because he or she is not actively at work.
BENEFICIARY DESIGNATION
Under an individual life insurance plan, the policyholder has the right to appoint a
beneficiary or to change the beneficiary designation. The policyholder of a group insurance
contract is usually an employer who has acquired a group plan on behalf of its employees.
The regulations affecting group life insurance give the insured employee the right to
designate a beneficiary for the benefits payable upon the insured employee’s death.
Some group insurance benefits restrict the beneficiary designation. For example, if the employee
takes out life insurance coverage on the life of his or her spouse or dependent children, the
employee is the beneficiary. For survivor benefits that become payable on the death of the insured
member, the member’s spouse or dependent children are the beneficiaries.
4•23
CONVERSION PRIVILEGE
When an insured member’s group life insurance coverage terminates because he or she stops being a
member of the insured group, the group contract allows that person to convert the group life insurance
coverage to an individual life insurance plan without having to provide evidence of insurability. The
conversion privilege allows the insured to apply for an amount of individual life insurance equal to the
amount of the insured’s group coverage, up to a maximum of $200,000. The premium rate for the
individual plan is based on the insured’s attained age on the date of the conversion.
The insurer is required to offer at least a term insurance plan with premiums renewable annually or a
level premium term to age 65. However, insurers may choose to allow the individual to covert to any
other type of individual life insurance plan that it normally offers to individuals. For example, the insurer
may offer the insured member the opportunity to purchase a whole life insurance plan if it regularly
issues such a type of plan.
The insured has 31 days after his or her group coverage expires to exercise the conversion
privilege.
The conversion privilege is also available when the group plan itself terminates. The amount available
under the conversion privilege is the amount of the group life coverage, less any amount of group
insurance that the insured becomes entitled to under any replacement group plan. The maximum amount
of life insurance available to be converted is $200,000.
For example, Alice was a member of XYZ Company’s group life insurance plan with Group Co. Insurance.
Under the schedule of benefits, she was entitled to $400,000 of basic group life
insurance. XYZ cancelled the plan and acquired a replacement plan with New Group Assurance. Under
the terms of the new group plan, Alice is covered for $300,000 of basic group life insurance. Alice can
therefore apply for individual life insurance coverage with Group Co. for up to $100,000. She has 31
days from the date the Group Co. plan terminates to apply for the individual coverage without having to
provide evidence of insurability.
Note: If the New Group plan provided Alice with only $150,000 of coverage, Alice would be able to
apply for only the maximum of $200,000 of individual life insurance with Group Co.
Group insurance plans usually allow coverage on the insured’s spouse to be converted in a similar
manner.
MISSTATEMENT OF AGE
The provincial insurance acts require that if the life insured’s age has been misstated on an insurance
application, any benefits payable will be adjusted to provide for the amount of insurance that would be
payable to someone of the insured’s actual age for the amount of premium being paid under the plan.
There is a similar provision for certain types of group life insurance coverage, such as optional life
insurance.
Under this coverage, the member can apply for additional group life insurance. The member must
provide satisfactory evidence of insurability and the premium payable is based on the member’s attained
age. If the member’s age has been misstated, the benefit amount is adjusted to the amount available to
people of the insured member’s actual age and the premium is adjusted to coincide with the premiums
payable for the benefit at the true age.
Some plans state that the benefit will be adjusted based on the amount of the premium that the
insured member has been paying. For example, Gary applied for $50,000 of optional life
insurance, stating his age as 40. He paid a premium of $200 per year. If his actual age when the
insurance was issued was 45, the insurer could adjust the plan in one of the following ways. It
could adjust the premium to the age 45 rate of $300 and charge Gary for the premium in
arrears, or it could reduce the benefit amount to a level that a $200 annual premium would
purchase for a 45-year-old male.
SETTLEMENT OPTIONS
Like the options available to policyholders and beneficiaries under individual life insurance
policies, group life insurance plans allow an insured member or his or her beneficiaries to
receive the insurance benefit in some manner other than in a lump sum. These options may not
be specified in the group insurance contract, but insurance companies typically provide the
following alternative options for receiving life insurance proceeds:
• the death benefit can be left on deposit to earn interest;

• the death benefit can be paid out in instalments over a period of time;
• the death benefit can be paid out in equal instalments until the proceeds are exhausted;
• the death benefit can be paid out in the form of a life or term-certain annuity.
Tax Treatment of Group Life Insurance

The most important consideration in the taxation of group life insurance is the death benefit
paid to the beneficiary of a deceased member. The death benefit is tax-free to the
beneficiary.
Under group life insurance plans for which an employer pays the premiums, the premiums
contributed during the tax year are tax-deductible for the year by the employer. On the other
hand, an employee who is insured under a group life insurance plan for which the employer
pays the premiums must report the premiums as a taxable employee benefit on his or her
income tax return.
Basic AD&D and Voluntary AD&D Plans

Basic AD&D insurance provides a death or disability benefit following an accident to an
insured member. Usually the benefit amount is equal to the benefit payable under the
member’s basic group life insurance.
Voluntary AD&D is similar to basic AD&D coverage. However, because it is optional, the
insured member usually pays the entire premium. The benefit usually provides coverage on
both an occupational and non-occupational basis (around-the-clock coverage).
An insured member can apply for any benefit amount up to a maximum. Since the benefit is
payable only in the event of an accident, no evidence of insurability is required.
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Here is one illustration of AD&D benefits payable.
Description of Loss % of Principal Sum

Paralysis (Quadriplegia, Paraplegia, or Hemiplegia) 200%
Loss of Life 100%
Loss of Two Hands, Two Feet or Sight of Both Eyes 100%
Loss of One Hand or Foot and the Sight of One Eye 100%
Loss of One Hand, One Foot or Sight of One Eye 75%
Loss of One Arm or One Leg 75%
Loss of Thumb and Index Finger of the Same Hand 25%
Loss of Hearing in One Ear 25%
EXCLUSIONS FROM BASIC ACCIDENTAL DEATH AND DISMEMBERMENT PLANS

Most AD&D policies have the following exclusions:
• intentionally self-inflicted injuries, including those associated with suicide or

attempted suicide, whether the person is sane or insane;
• injuries sustained during a declared or undeclared war or any act of war;
• injuries sustained during full-time active duty in the armed forces of any
country or international authority;
• injuries sustained while flying as a pilot or crew member of an aircraft.
In addition, if a significant length of time elapses between the occurrence of the accident and
the death of the insured person, the death benefit may not be payable. The length of time is
generally 365 days after the accident.
Creditor’s Group Insurance

Creditor’s group insurance is an arrangement between a money-lending institution and an
insurance company to provide insurance on the life of the institution’s borrowing clients. The
insurance may be life insurance, disability insurance, or, in some cases, unemployment insurance
(to cover a situation in which a borrower cannot repay a debt because of unemployment).
The insured is the individual borrower who pays the entire premium for the coverage.
The beneficiary is the money-lending institution.
• For life insurance, the benefit is the amount of the insured’s outstanding debt to the
money-lending institution.
• Disability benefits take the form of payments to maintain a repayment schedule for
the loan. Once the insured recovers, he or she resumes full responsibility for
repayment of the outstanding debt.
• Benefits for unemployment are similar to disability benefits. A specific maximum

amount of benefit is stipulated for benefits resulting from unemployment.
Creditor’s group insurance is available for mortgages and other types of personal loans. The
lender, through an arrangement with an insurance company, offers its borrowers the
opportunity to purchase life, disability or unemployment insurance against the loan.
The Canadian Life and Health Insurance Association, in conjunction with the provincial
regulators and its member insurance companies, has developed guidelines for the
administration of creditor’s group insurance. These guidelines are intended to protect the
interests of borrowers. Under the guidelines, the borrower is entitled to the following written
information about the insurance coverage:
• a statement that the insurance is voluntary and is not required as part of the loan
approval process;
• a statement that the borrower has a period of at least 10 days after purchasing the
coverage to cancel the insurance and receive a full refund of the premium paid;
• all terms and conditions that might limit or exclude coverage;
• a statement that coverage is subject to acceptance by the insurer and specifying any
further steps the borrower must take to complete an application for creditor coverage;
• the insurer’s obligation to notify the borrower if the coverage is declined;
• the terms upon which the coverage is to commence if the application is accepted;
• instructions on how to contact the insurer to obtain further information or clarification
of any terms and conditions of the coverage.
When coverage is approved, the insurer must issue an insurance certificate that
provides the following information:
• the insurer’s name and head office in Canada and identification of the creditor’s
group contract;
• the borrower’s name;
• a description of the coverage, including the amount, duration, and conditions
concerning eligibility, exceptions, limitations, and restrictions;
• the premium for the coverage, or sufficient information to the borrower to calculate
the premium;
• the circumstances under which the insurance commences;
• the circumstances under which the insurance terminates;
• the procedures to be followed in making a claim;
• a statement that the benefits will be paid to the creditor to reduce or cancel the unpaid debt;
• a statement that the duration of the insurance is less than the term of the loan, or that
the amount of insurance is less than the loan amount, if that is the case;
• a contact for the borrower to call to receive more information about the provisions of
the coverage;
• information on how premium refunds are calculated and on how to apply for a refund.
4•27
GROUP DISABILITY
LEARNING OBJECTIVES
• compare the definitions of disability used by short-term income replacement plans and
long-term income replacement plans;
• describe the rationale for the use of elimination periods in pricing group disability plans;
• describe the features and coverage of a group disability plan and how the plan functions;
• describe the characteristics that a short-term disability plan must have to qualify for
registration under the Employment Insurance (EI) Act for premium reduction purposes;
• describe the advantages to employers of having a short-term disability plan registered
with Service Canada for premium reduction purposes;
• explain the rationale for having an employee pay the premiums for group long-
term disability (LTD) plans;
• explain the impact of coordination of benefits and subrogation on a group
disability insurance policy.
Short-Term and Long-Term Income Replacement Plans
SHORT-TERM INCOME REPLACEMENT PLANS

Short-term income replacement plans usually define disability as the insured’s inability to
perform the duties of his or her own occupation. Some plans, however, define disability
as the inability to perform the duties of any occupation that the disabled person is able to
perform because of his or her education, training and experience.
Under the short-term income replacement plan, for disabilities caused by illness, payments
begin very soon (3 to 7 days after the onset of the illness). For disabilities caused by an
accident, payments usually begin on the first day of disability. Benefit payments are a
proportion of the disabled member’s earned income. Many plans base the benefit percentage
on the plan member’s length of employment.
For example, someone who has less than 6 months of service may be entitled to receive
66.6% of salary over the short term disability (STD) period, which may range from 15 weeks
to one year. Someone with more than one year of service might be entitled to 100% of salary
for six weeks and 66.6% of salary for the remaining coverage period.
LONG-TERM INCOME REPLACEMENT PLANS

Under long-term income replacement plans, disability is defined slightly differently. During the
first 24 months of disability, total disability is considered as the inability to perform the essential
duties of one’s own occupation. After 24 months of disability, total disability is considered as
the inability to perform the essential duties of any occupation for which the insured member is
qualified by reason of education, training, or experience. The disability benefit is calculated as a
percentage of earned income and can be 60% or higher, depending on the plan.
Example: Andrea is employed at Big Corporation as a tax accountant. She has been in the work force for
fi ve years, the last three with Big Co. As a full-time employee, she is entitled to all company group
Benefits, including short-term disability (STD) and long-term disability (LTD) Benefits.
The STD plan provides a benefi t equal to 66.6% of weekly salary. STD Benefits begin after 7
days for a disability caused by an illness. The benefi t begins immediately if the disability is the
result of an accident that requires hospitalization. STD Benefits are payable for up to 17 weeks.
The LTD plan offers 60% of pre-disability gross earnings. Benefits begin when the insured has
been continuously disabled for four months.
Andrea falls ill and is diagnosed with muscular dystrophy. The symptoms of the illness are acute
and leave her unable to fully control some of her major muscle groups. Under the terms of the
STD and LTD plans, Andrea is considered totally disabled. Muscular dystrophy has been known to
enter a remission stage and Andrea’s physicians are treating her to control the symptoms and
maintain her muscle strength as much as possible in the hope that her condition will improve.
Andrea was earning $60,000 a year at $2,307 every two weeks. Federal income tax is
withheld at a rate of 26% or $600 per pay period.
Big Co. pays the premium for the STD plan, so the benefit is taxable income to Andrea.
Andrea’s gross weekly salary is $1,153. During the STD period of 17 weeks, Andrea receives
66.6% of her gross weekly salary, or $770.
Andrea’s disability continues after the end of the STD period and the LTD Benefits begin. Andrea and
her physician hope that she can resume work on a part-time basis within a few months. In the
meantime, she is entitled to full Benefits under the LTD plan. She was paying the premium for the LTD
plan, so the income is tax-free. The plan pays Andrea a monthly benefit equals to 60% of her
gross earnings. Since her gross annual salary was $60,000, her monthly equivalent will be
$5,000. Her benefit will be 60% or $3,000.
After a few months, her symptoms abate and she feels well enough to resume her job on a
part-time basis. She is able to earn about one-half of her pre-disability salary. Her LTD plan
contains a partial disability benefit. Under this provision, the LTD Benefits do not end because
she has returned to work. Instead, the insurer considers the difference between the income she
is able to earn at this point, compared to the income she was earning before her disability.
Since Andrea is able to earn only a portion of her original salary, partial LTD Benefits continue
until she is able to return to the level of salary she earned before her disability.
Another four months go by; Andrea’s symptoms return and she is unable to work at all. Under
the terms of the LTD contract, Andrea’s current disability is considered a recurrence of her
original illness. She will not have to serve another waiting period before becoming eligible to
receive LTD payments. Her full LTD Benefits resume immediately.
4•29
The Use of an Elimination Period in Pricing Group Disability Plans

The elimination period in group insurance plans is also known as the qualifying period
or waiting period. This is the period after the onset of a disability that must pass before
benefit payments commence. For both short-term disability plans (STD) and long-term
disability plans (LTD), the elimination period affects the premium levels for the
coverage.
In STD plans, the elimination period excludes claims for injuries or illnesses that last only a few
days. STD benefits usually have a seven-day waiting period for illnesses. For accidents that
require hospitalization, there may be no elimination period and benefits are payable from the
first day of disability. By eliminating claims for very short-term disabilities, the insurer saves
claim administration costs as well as claim costs.
For LTD plans, the longer the elimination period, the cheaper the premiums will be. An
LTD plan with a six-month waiting period will provide benefits for disabilities of a serious
long-term nature. Disabilities of less than six months can be covered under an STD plan.
Features and Coverage of a Group Disability Plan

A group disability plan replaces earned income when an employee becomes disabled for a
significant period of time. Group disability plans may offer short-term disability coverage as
well as long-term coverage.
Short-term disability (STD) plans may be used to offset Employment Insurance (EI)
premiums. The benefits begin once the insured has been disabled because of an illness or
injury for a short period of time (typically seven days for an illness and immediately for an
accident that requires hospitalization). Benefits are calculated as a percentage of salary,
usually 2/3 of weekly earnings. Benefits under STD plans are paid for periods ranging from
15 weeks to 12 months, depending on the plan.
For coverage purposes, disability is usually defined as the employee’s inability to
perform the duties of his or her regular occupation. Some plans may define disability as
the employee’s inability to perform any occupation for which he or she is qualified by
education, training or experience.
Long-term disability (LTD) plans are designed to complement STD plans and EI benefits.
Benefits under LTD plans commence after an elimination period of six months to a year and
can last up to age 65 (i.e., normal retirement age).
The definition of disability for most LTD plans has three distinct components.
1. During the first 24 months of disability, an insured person will be considered disabled
and entitled to LTD benefits if he or she is unable to perform the essential duties of his
or her occupation.
2. After 24 months of disability payments, the claimant will be considered disabled if he or
she is unable to perform the duties of any occupation for which he or she is qualified by
reason of education, training, or experience.
3. While the insured may be employed in an occupation and still meet the requirements
for a disability claim, the insurer will assume that the claimant is no longer disabled if
he or she is able to earn an income that is equal to or greater than the amount of the
monthly LTD benefit.
The LTD benefit is a percentage of pre-disability monthly earnings. Under plans for which the
employer pays the premium, the disability benefits are taxable to the claimant. These plans may
pay as much as 75% of pre-disability before-tax earnings. Depending on the employee’s tax
bracket, monthly benefits could represent 80% to 85% of pre-disability net after-tax earnings.
Many LTD plans place a cap on the amount of monthly benefit payable. So, for example, a
plan could pay 70% of gross monthly earnings to a maximum of $5,000 a month. A person
earning a salary of $8,000 a month would get an LTD benefit of $ 5,000 (not $5,600, which
is 70% of $8,000).
If the employee pays the premium, the monthly benefits are not taxable. The employer has no
financial responsibility in these circumstances. Consequently, the size of the monthly benefit
depends on the size and composition of the group, the type of work performed by the group,
and an affordable rate of premium. The monthly benefit cannot exceed the claimant’s pre-
disability net income. A non-taxable monthly benefit that equals or exceeds the claimant’s
pre-disability after-tax income is a disincentive to return to work. Most plans stipulate that
the LTD benefits plus income from all sources must not exceed a certain percentage (usually
80% to 85%) of the claimant’s pre-disability after-tax net income.
LTD plans usually state that the monthly disability benefit will be reduced by other benefits
that the claimant is entitled to receive because of his or her disability, such as:
• Workers’ Compensation;
• Canada/Quebec Pension Plan disability benefits;
• any provincial motor vehicle accident insurance benefits;
• any employer-sponsored salary continuance or short-term disability plan benefits
whose payment schedule coincides with the LTD payment schedule.
For example, Amelia earns a gross monthly income of $5,000. Her after-tax net income is
$3,500. Her LTD plan provides a benefit of 60% of pre-disability gross earnings, or $3,000
(which is slightly over 85% of her after-tax net income of $3,500). Although Amelia is
employed in a job sector that exempts her from participating in Workers’ Compensation, she
is entitled to CPP disability benefits if she qualifies.
Amelia suffers a disability that leaves her totally and permanently disabled. She is eligible
for benefits under her LTD plan as well as CPP. Under the terms of her LTD, her monthly
benefit of $3,000 will be reduced by her monthly CPP benefit of $1,010.23. Her LTD insurer
will pay her $3,000 – $1,010.23 or $1,989.77.
Some plans increase LTD payments over time by applying a cost of living adjustment (COLA) to
the monthly benefit calculated at the time the disability commenced. The adjustment is usually
based on any year-over-year increase in the Consumer Price Index, up to a stated maximum.
Many LTD plans provide for partial or residual disability benefit payments if the claimant
returns to work in his or her regular occupation, or one for which he or she is qualified, but
on a part-time basis. Under either partial or residual disability provisions, the benefit is
based on the reduction in earnings that an employee experiences because he or she cannot
work full-time and earn an income equal to his or her pre-disability earnings.
LTD plans usually include a recurrent disability provision, under which the qualifying
(elimination) period is waived when a disability recurs. For example, Fiona is covered under an
LTD plan with a 180-day waiting period. She is disabled for three months, returns to work for
4•31
25 days, and suffers the same disability again. She does not have to satisfy the qualifying period
again. Her current disability is considered to have started at the beginning of the first occurrence.
Once a qualifying period has been satisfied and a claimant begins to receive the LTD benefit,
if he recovers and returns to work and suffers a recurrence of the disability within 6 months,
he will not have to satisfy another qualifying period. His current period of disability will be
considered a continuation of the original period.
Short-Term Disability Plans and Employment Insurance

Employment Insurance benefits were described in Chapter 3 on Individual Disability and
Accident and Sickness Insurance. A brief summary of EI benefits for illness or injury follows.
Every employed person in Canada is required to contribute to the federal government’s

Employment Insurance program. In 2011, the amount required from each employee is
$1.78 per $100 of insurable earnings, to a maximum of $44,200 in insurable earnings. The
maximum annual employee contribution is $786.76. Employers are required to contribute
1.4 times the employee contribution rate, or $2.49 per $100 of insurable earnings. The
maximum annual employer contribution is $1,101.
The basic benefit rate is 55% of average insured earnings up to a maximum of $468 per week.
Employers who offer STD plans may qualify for a reduction in EI premiums, if they register their
plans with Service Canada. For an STD plan to qualify it must have the following characteristics:
• it must offer benefits that are at least equivalent to those that the EI program offers;
• employees who qualify under the STD plan must be covered under the plan within
three months of hiring;
• the waiting period to begin receiving benefits under the STD plan must not be longer
than 14 days;
• the benefits cannot be coordinated with EI benefits; that is, the STD plan must be the
first payor of benefits;
• coverage must be full-time; it cannot be just “on-the-job” coverage;
• the benefit must be payable for a minimum of 15 weeks.
ADVANTAGE TO EMPLOYERS OF HAVING AN STD PLAN REGISTERED WITH SERVICE CANADA

Employers can establish an STD plan with benefits that they consider appropriate for their
employees. For example, an employer in an industry that competes for the services of
highly skilled employees may want to establish a better-than-average disability benefit
program, including an attractive STD plan. If the plan qualifies for registration with
Service Canada, the employer and the employees enjoy a reduction in the EI premium
rates that employer and employees would otherwise pay.
For a qualifying STD plan, the employer’s contribution can be reduced from 1.4 times the
employee rate to 1.180 times the employee rate. If the plan meets the standards, the employer
must demonstrate that employees covered by the plan will receive their portion of the reduction.
The amount to be passed on to the employees must be at least five-twelfths of the total reduction.
Here is an example. An employer’s standard rate per $100 of annual insurable earnings
is 1.4 times the employee rate or 1.4 $1.78 = $2.49. If the employer’s STD plan
qualifies, the employer multiple is reduced to 1.18 times or 1.18 $1.78 = $2.10. The
total employer reduction is $2.49 – $2.10 = $0.39.
The employee’s rate of contribution is reduced by 5/12 of $0.39, or $0.16. Given that the
amount of maximum insurable earnings on which contributions are based is $44,200, the
total employer reduction in EI contributions would be ($0.39 $44,200) ÷ 100 = $172.38.
The portion to be returned to the employee would be $172.38 5/12 = $71.83.
Employee-Paid Premiums for Group Long-Term Disability Plans

The advantage of an employee-pay-all LTD plan is the fact that benefit payments under the
plan are tax-free to a disabled employee. The employer and the insurance company can
negotiate a plan that pays the disabled employee a benefit based upon gross pre-disability
earnings. If the insurer stipulates that the benefit payable under the LTD plan cannot exceed
60% to 70% of the insured’s pre-disability gross earnings, it is easier to compare benefits on
a gross basis than to factor in the taxation of pre-disability gross earnings and post-disability
non-taxable benefits, for all employees covered under the group.
Because the employer is not obliged to pay premiums for the LTD plan, the employer and the
insurance company can offer fair disability benefits that are affordable to the insured employees.
Coordination of Benefits and Subrogation on a Group

Disability Insurance Policy
Coordination of benefit provisions and subrogation provisions are designed to control claim
costs (and consequently the premium costs for the plan) and to make sure that an insured
does not receive more in benefits than income earned before the onset of disability.
Most plans also stipulate that payments would be adjusted to ensure that payments from all
sources will not exceed 80% to 85% of the claimant’s pre-disability after-tax earnings.
To satisfy this requirement, insurers consider benefits from the programs identified above as
well as benefits from other group plans, disability income from CPP/QPP, and income from
any type of employment.
If an employee’s disability is caused by the actions of a third party and the disabled person receives
compensation from another source, the disabled employee must reimburse the LTD carrier
for any benefits paid under the plan. The amount reimbursed must equal the compensation
received from the other source or the amount paid under the LTD plan, if less. This is
known as subrogation.
Under the subrogation provision, an LTD insurer can also pursue an action against a third
party and his or her insurer and require that the LTD claimant participate in the suit fully,
including participation as a witness in any trial. Subrogation, therefore, permits an insurer to
“step into the shoes” of the party that it compensates and sue a party that the
injured/compensated party could have sued.
4•33
Example: Sunil, a computer scientist working for Alpha Corp., is driving to work one morning in early April.
The highways are slick with ice and rain and visibility is poor. Suddenly, out of nowhere, Sunil’s car is hit
by an out-of-control tractor trailer going well over the speed limit. Sunil is severely injured and is
considered totally disabled. Optima Life, Alpha Corp’s group insurance provider, begins paying Sunil
$6,000 a month under the LTD plan (once the elimination period of 6 months has ended). After conducting
its own investigation into the circumstances of Sunil’s accident, Optima Life sues Fortuna Insurance, the
insurance company that covered the owner of the tractor trailer that was involved in the accident. The case
goes to trial, Sunil appears as a key witness, the truck driver is ruled to be responsible for causing Sunil’s
injuries and Fortuna is ordered by the court to pay Sunil a lump sum of $50,000. Now, Optima Life has
made 15 payments (at $6,000 a month) to Sunil by the date of the court decision, i.e., $90,000. When
Sunil gets paid $50,000 by Fortuna, he, under the terms of the subrogation provision, would - in turn –
have to hand over that $50,000 payment to Optima Life.
GROUP ACCIDENT AND SICKNESS INSURANCE AND

EXTENDED HEALTH PLANS
LEARNING OBJECTIVES
• explain the medical services generally covered by provinces and territories, including
hospital services, physician services, and surgical/dental services;
• describe the types of medical services usually included in employer-sponsored group
A&S plans;
• explain the rationale for including deductibles and co-insurance in employer-
sponsored group A&S plans;
• identify the limitations and exclusions usually mentioned in employer-sponsored
group A&S plans;
• describe a typical dental plan, including coverage and coordination of benefits;
• describe a typical extended health plan, including coverage and coordination of benefits;
• describe the primary features of a typical Employee Assistance Program.
Medical Services Covered by Provinces and Territories

Before explaining the services covered by employer-sponsored group insurance plans, it is
helpful to understand the services covered by government health programs.
Each province in Canada, in partnership with the federal government, covers certain medical
expenses for its residents. The federal government contributes funding to each province’s
health insurance plan, provided that the provincial health plans meet the following standards:
• Public administration: The program must be administered on a non-profit basis

by a public authority appointed by and accountable to the provincial government.
• Comprehensiveness: The program must cover all necessary medical, surgical-

dental, and other services provided in hospitals. In addition to these services, the
provinces are encouraged to provide certain extended health care services defined in
the Canada Health Act.
• Universality: 100% of the province’s legal residents must be entitled to insured
health services.
• Portability: Coverage must be portable from one province to another. The waiting
period for new residents must not exceed three months. Health services must also be
covered for Canadians who are temporarily absent from their own provinces. In such
cases, payment for services within Canada is made by the home province at rates
established by the host province; payments for services out of Canada are made at the
rates established by the home province.
• Accessibility: Insured services must be provided on uniform terms and conditions for
all residents. Reasonable access to insured services must not be impeded, either directly
or indirectly, by charges or other barriers. Reasonable compensation must be paid to
physicians and dentists and adequate payments made to hospitals for insured services.
Provincial government health insurance is mandatory. No person or group may opt out of
the provincial health care plan and contract with a private insurer for services covered by
provincial plans.
Although each province follows the standards set by the federal government, each
province sets different limits for the types of medical services covered by its health
insurance plan. The main services provided under provincial health insurance plans are
described below. Details are available from the health ministry in each province.
HOSPITAL SERVICES
Essential hospital care services are covered. Provincial plans pay for all physician and
nursing care that an insured receives in hospital as well as prescription drugs and diagnostic
services done in hospital, such as laboratory tests and X-rays.
They pay for the cost of care in a hospital ward. Private insurance plans may pay the fees for
more expensive semi-private and private rooms.
Provincial plans also pay for any home care services or follow-up care at hospital ordered
by an attending physician.
PHYSICIAN SERVICES
Provincial health insurance plans pay for essential diagnostic and treatment services
provided by a physician. This includes home visits, services provided in hospitals, and
services provided at the physician’s offices.
Certain physician services are not covered by provincial plans. The physician may bill the
patient directly for uninsured services, such as transferring files to another physician, telephone
consultations, preparing certificates of fitness to work, filling out medical forms, conducting
physical examinations for schools or camps, and doing certain cosmetic procedures.
4•35
SURGICAL/DENTAL SERVICES
Provincial health insurance plans pay for some dental surgery done in hospital,
including fractures or medically necessary jaw reconstruction.
OTHER SERVICES
The following services may be covered by one or more provincial health insurance
plans, but coverage is not universal and may be subject to several restrictions:
• ambulance services;
• laboratory tests and X-rays;
• treatment by chiropractors, physiotherapists, podiatrists, naturopaths, osteopaths,
and optometrists;
• vision care;
• drug prescriptions, including a pharma care program exclusively for seniors (all
provinces provide this service);
• nursing care services;
• nursing home or chronic care;
• out-of-province or out-of-country coverage, within certain limits.
Medical Services Included in Employer-Sponsored Plans

Group insurance plans provide coverage for those hospital and medical services that
are not covered under provincial health insurance plans, including:
• the cost of a stay in hospital beyond the provincial health insurance limits;
• prescription drugs;
• private-duty nursing;
• paramedical services such as chiropractic and massage therapy;
• professional licensed ambulance services;
• out-of-country health care services;
• travel assistance in medical emergencies;
• vision care;
• hearing aids;
• accidental dental coverage;
• medical supplies and services.
Deductibles and Co-Insurance

A deductible is an amount that the insured must pay before the group insurer will begin
paying the cost of a medical service. For example, a drug plan may have a calendar year
deductible for the cost of prescriptions of $50. If a claimant pays for only one prescription
that costs $40, the drug plan pays nothing, but the annual deductible is reduced to $10. If,
later the same year, the insured pays for a prescription that costs $100, the deductible is
satisfied and the insurer will consider $90 for payment under the plan.
The drug plan may also have a co-insurance provision. Using the example above, if the plan
has a co-insurance feature under which it pays only 80% of a claim, only 80% or $72 of the
$90 claim will be reimbursed to the claimant.
Deductibles and co-insurance provisions are designed to reduce or prevent the casual use of
the group coverage for minor medical conditions and the administration of claims for small
amounts. These limitations allow an employer to share costs with the employees for some
medical services. Also, these cost containment initiatives help to keep claims costs under
control and keep premium rates affordable for the employer and the employee.
Limitations and Exclusions in Employer-Sponsored Group A&S

and Extended Health Plans
Each medical service covered under a group plan is subject to limits on the total amount
payable. Certain services are excluded from coverage.
HOSPITAL COVERAGE
Most group plans offer coverage for semi-private rooms in hospital. Although some plans
offer unlimited coverage for semi-private rooms, other plans may have a maximum daily
limit on the costs.
Convalescent hospital care (treatment and therapy/recovery and rehabilitation for a
specific medical condition) may be subject to a daily maximum and a limited number
of days of treatment.
DRUGS
Group plans provide reimbursement only for drugs that:
• are considered by a physician to be medically necessary;
• carry a drug identification number;
• have been dispensed by a registered pharmacist.
Since the cost of prescriptions represents the highest proportion of health care claims costs,
insurers and employers are taking specific steps to contain costs. These actions include:
• limiting the amount of coverage for the dispensing fee charged by the pharmacist for
filling a prescription; for example, if the pharmacist charges a dispensing fee of $12.00,
the drug plan may cover only $7.00;
• substituting generic equivalents for prescribed drugs that offer the same benefits as
brand-name drugs;
• specifying a list of drugs that are covered under the plan; new drugs that are not on the
list are not covered until the drug plan renewal is negotiated and coverage for a new
drug is added to the list.
Examples of drug products that are often excluded are vitamins, steroids, infertility drugs,
erectile dysfunction treatments, smoking cessation products, hair growth/restoration drugs
and weight-loss medications. However, some plans, particularly those for unionized
employees, cover some of these products as part of the enhanced benefits obtained through
the collective bargaining negotiation process.
4•37
PRIVATE-DUTY NURSING
Private-duty nursing is home care nursing recommended by a physician for a covered
employee who is not confined to hospital. Most plans pay a maximum amount based on a
yearly or lifetime maximum. The maximum amount of coverage may be limited to between
$5,000 and $25,000 a year.
PARAMEDICAL PRACTITIONERS
Paramedical practitioners include, among others, physiotherapists, speech and massage therapists,
acupuncturists, chiropodists/podiatrists, osteopaths, psychologists, naturopaths and chiropractors.
Paramedical services are eligible for coverage under private group plans only after benefits for
these services have been exhausted under provincial health insurance plans. Some provincial
plans have discontinued coverage of certain paramedical services. For example, chiropractic
services are no longer covered under OHIP (Ontario Health Insurance Plan).
Covered benefits under many group plans are those considered medically necessary. Costs
may be limited to a maximum dollar amount for each visit, a specified number of visits, or a
maximum dollar amount annually for the class of practitioners as a whole or, more typically,
for each type of covered practitioner.
OUT-OF-COUNTRY BENEFITS
Private group plans may provide coverage for emergency health care services incurred
outside Canada. Many plans set limits on the coverage either on the amount payable for
any individual medical treatment or a maximum amount overall.
TRAVEL ASSISTANCE
Travel assistance programs offer support and assistance to covered employees who suffer a
medical emergency while outside Canada. Benefits may include the costs required to return
to Canada for treatment or accommodations for family members in another country while the
afflicted person receives treatment in that country.
Limits may include maximum amounts for family meals and accommodation such as $150
per day. The cost of return to Canada of a deceased’s remains may be reimbursed to a
maximum amount such as $3,000.
VISION CARE
Eyeglasses or contact lenses may be covered under the plan, with limits on the frequency
of new eyeglasses or lenses and on the amount spent. For example, for adult vision care,
coverage is limited to every 24 months and each covered item is subject to a maximum
dollar amount usually between $75 and $300.
HEARING AIDS
Group plans usually impose a maximum benefit such as $500 for hearing aids and limit
repair and replacement costs to every five years.
MEDICAL SUPPLIES AND SERVICES

Devices such as canes, walkers, respiratory equipment, or orthopedic equipment,
recommended by an attending physician may be covered by the plan. The amount of the
cost covered for any device or service may be limited. The kind of device that the plan will
cover may be limited as well. For example, if a walker is prescribed, the plan may cover the
cost of a basic walker, rather than one with special features.
GENERAL EXCLUSIONS
Group contracts exclude coverage of certain costs including those:
• payable under Workers’ Compensation;
• incurred as the result of self-inflicted injury;
• incurred as the result of war, rebellion, or hostilities of any kind, whether or not the
insured person was a participant;
• incurred as the result of participation in a riot or civil disturbance;
• incurred as a result of committing a criminal offence or provoking an assault;
• incurred as part of cosmetic treatments.
Group Dental Plans

Dental plans typically offer services in three distinct categories: basic, major
restorative, and orthodontic.
Basic Services include:
• diagnostic procedures to evaluate an insured’s condition and determine treatment;
• X-rays and laboratory reports;
• preventive procedures such as teeth cleaning, fluoride application, oral hygiene instruction;
• dental surgery, including the removal of teeth;
• fillings;
• periodontal services to treat bone and gum problems;
• endodontic services to treat tooth roots and nerves;
• repairing dentures, crowns or bridgework.
Major Restorative Services include:

• procedures to restore tooth function using crowns, inlays, and onlays (metal or
porcelain casts placed on the surface of the tooth);
• prosthodontic services to replace missing teeth with dentures, bridgework, crowns,
and veneers.
Orthodontic Services include:

• preventing or correcting dental and oral irregularities and jaw defects with devices
such as wires, tooth bonding, braces, and space maintainers.
4•39
Group dental plans usually provide higher levels of coverage for basic services and lower
levels for major restorative services. Although every dental plan offers coverage for basic
services, not every plan covers major restorative or orthodontic services.
Typically, a dental plan pays for covered services based on the provincial Dental Association
Suggested Schedule of Fees for General Practitioners. The plan pays 80% to 100% for basic
services up to a calendar year maximum. If the plan covers major restorative or orthodontic
services, the limit may be 50%, with a calendar year maximum for major restorative services
and a lifetime maximum for orthodontic services. Maximum calendar year benefits for basic
and restorative services generally range from $1,000 to $2,000 a year. The lifetime maximum
for orthodontic services ranges from $1,000 to $3,000, depending on the plan.
If a member of a group dental plan is also covered under another employer’s plan, any
benefits payable will be considered by the primary insurer and any unpaid amounts will be
considered by the second carrier. Duplication of coverage usually occurs because an
individual has dental coverage under his or her own group dental plan and is also covered as
a dependant under his or her spouse’s plan. Treatment for dependent children, who are
covered under both spouses’ plans, will be reimbursed under only one plan as the primary
carrier, and any unpaid balance will be considered for payment under the second plan. An
example of the coordination of benefits was provided earlier in this chapter.
Employee Assistance Program

An employee assistance program (EAP) allows employees to take advantage of professional
counselling services to deal with personal problems. At the heart of every EAP program is
its confidentiality. Any employee who takes advantage of the services provided through an
EAP program is assured that no information will be made available to his or her employer
concerning the problem or the fact that the employee has requested any EAP service.
Programs vary from group to group. EAP services may include:
• crisis interventions such as telephone counselling services and self-help groups
such as Alcoholics Anonymous;
• outpatient services for treatment of alcohol or drug dependency, or professional
counselling for marital, family, or emotional problems;
• in-patient services for serious emotional or dependency problems in hospital, at home,
or in a shelter or halfway house.
EAPs are intended to reduce the cost of employee absenteeism and increase job effectiveness by
helping employees resolve family crises, chronic personal problems, or debilitating emotional
problems that compromise the employee’s ability to perform his or her job effectively.
In a sense, an EAP offers preventive maintenance to help an employee cope with or

overcome personal problems before they lead to dismissal or a long period of disability.
Chapter 5A
Investment Products
© CSI GLOBAL EDUCATION INC. (2011) 5A•1

5A
Investment Products
CHAPTER OUTLINE
Introduction
Overview of Investment Capital
• What Is Investment Capital
• The Role of Financial Intermediaries
• Regulatory Organizations
Brief Overview of Economics
• Economic Principles
• Economic Factors Affecting Security Prices
Security Selection and the Client
• Primary Investment Objectives
• Know Your Client Rule
Risk and Return
• Introduction
• The Risk/Return Trade-off
• Risk – “The Other Side of the Coin”
• Asset Allocation
5A•2 © CSI GLOBAL EDUCATION INC. (2011)

Types of Securities Trading in Capital Markets
• Debt Securities
• Debt Security Risk
• Debt Security Terminology
• Types of Debt Securities
• Debt Security Pricing Principles
• Other Fixed-Income Products
• Preferred Shares
Common Shares
• Introduction
• Rights and Benefi ts of Common Share Ownership
• Tax Treatment of Common Shares
• Stock Market Indices
Derivatives
• Introduction
• Rights
• Warrants
• Options
• Futures and Forwards
Managed Products - Mutual Funds
• Introduction to Mutual Funds
• The Structure of a Mutual Fund
• Pricing of Mutual Funds Units or Shares
• Mutual Funds Fees
Redeeming Mutual Fund Units or Shares
• Calculation of the Redemption or Selling Price
• Tax Consequences
Mutual Fund Regulation, Types, Comparable Risks and Returns
• Self-Regulatory Organizations (SROs)
• Types of Mutual Funds
• Comparing Risk and Return of Different Types of Mutual Funds
© CSI GLOBAL EDUCATION INC. (2011) 5A•3

5A•4 CANADIAN INSURANCE COURSE • VOLUME 1
INTRODUCTION
Capital markets are essentially the “engine” of the Canadian economy. They provide a forum
that allows savers and users of capital to meet and transform savings into investments that
ultimately drive the growth of the country. In this chapter you will learn about different types
of investments including equities, debt securities, common and preferred shares, options and
managed products that help formalize this transfer of capital.
OVERVIEW OF INVESTMENT CAPITAL
LEARNING OBJECTIVES
• List the types of investment products available from insurance companies and other
financial institutions.
• Define what is meant by the power of compounded returns over time.
• List the major types of financial institutions.
• Define various types of investment returns: net versus gross
What Is Investment Capital

In general terms, capital is wealth – both real, material things such as land and buildings
and representational items such as money, stocks and bonds. All of these items have
economic value. Capital represents the savings of individuals, corporations, governments
and many other organizations and associations. It is in short supply and is arguably the
world’s most important commodity.
Capital savings are useless by themselves. Only when they are harnessed productively do
they gain economic significance. Such utilization may take the form of either direct or
indirect investment. Capital savings can be used directly by a couple investing their savings
in a home, a government investing in a new highway or hospital, or a domestic or foreign
company investing in a plant to produce a new product.
Capital savings can also be harnessed indirectly through the purchase of such
representational items as stocks or bonds or through the deposit of savings in a financial
institution. Indirect investment occurs when the saver buys the securities issued by
governments and corporations, which in turn use the funds for direct productive investment
in plant, equipment, etc. Such investment is normally made with the assistance of the retail
or institutional sales department of the advisor’s firm.
In the case of indirect investment through a financial intermediary or financial institution, the
individual, corporation or government may deposit funds in a savings account at a financial
institution. This is a non-contractual commitment because funds can be readily withdrawn

FIVE A • INVESTMENT PRODUCTS 5A•5
on short notice. Savings may also be deposited in contractual accounts such as pension or life
insurance plans where withdrawal is less easy or perhaps not permitted until a fixed future
date. In either case, the financial intermediary attempts, in the meantime, to reinvest the
deposited funds profitably until they must be paid back to the original saver. The institutional
sales department and the money market department of the advisor’s firm assist financial
intermediaries in profitably investing the pooled savings of their thousands of depositors.
POWER OF COMPOUNDED RETURNS

What is a compounded return? Simply put, it’s getting a return on a return. Compounding
takes place when an investment, for example a premium savings account, gives the investor a
return on the original amount invested and on the interest already earned.
For example, say you deposit $10,000 into a premium savings account that provides a 5%
annual rate of return. Here’s what would happen:
At the end of the first year, there would be $10,500 in the account ($10,000 at 5% = $500).
At the end of the second year, there would be $11,025 ($10,000 + $500 interest earned in
the first year = $10,500 at 5% = $525).
If this savings account kept paying 5% a year on a compounded basis, at the end of 20
years, there would be $26,530. The original deposit of $10,000 would grow through the
power of compound returns to $26,530.
Advisors talk about a snowball rolling down a hill to visually portray the magic of compounded
returns (and for Canadians, with our harsh winters, that is a very easy visual to imagine). The
longer the hill (i.e., the investment time horizon), the more time the snowball spends rolling and
the more extra snow (i.e., investment returns) it accumulates along the way. And the steeper the
hill (i.e., the rate of return), the faster the snow can be collected on the way down. So instead
of 5% in the example above, if you invest $10,000 in something yielding 10% a year, then
the investment will “snowball” to an amazing $67,270 in 20 years - more than six times the
original investment.
GROSS VERSUS NET RETURNS

Gross return indicates a return before anything is deducted. So, for example, if you invest
$1,000 in XYZ stock on January 1 and on July 1, upon sale, it is worth $1,100, then your
gross return is $100 or 10% during this six-month period. Net return, on the other hand, is the
rate of return on an investment after related expenses such as commissions and trading fees
have been deducted from the gross return. So, in the previous example, while gross return is
10%, if trading fees amounted to $60 (and assuming there are no other related expenses),
then the net return would be $100 - $60 = $40 or 4%. As such, an investor should pay greater
attention to net returns on an investment instead of gross returns.

The Role of Financial Intermediaries

In this section, we turn our attention to another of the key components of the financial
system, the intermediaries. The term “intermediary” is used to describe any organization
that facilitates the trading or movement of the financial instruments that transfer capital
between suppliers and users. Traditionally, banks and trust companies have concentrated
on gathering funds from suppliers/investors in the form of saving deposits or GICs and
transferring them to users/borrowers in the form of mortgages, car loans and other lending
instruments. Other intermediaries, such as insurance companies and pension funds, collect
premiums and contributions and then invest them in bonds, equities, real estate, etc. to
meet their customers’ needs for financial security.
Investment dealers, which also act as financial intermediaries, serve a number of functions -
sometimes acting on their clients’ behalf as agents in the transfer of instruments between
different investors and, at other times, acting as principal.
The Canadian financial services industry was characterized by what were known as the “four
pillars”: namely, banks, trust companies, insurance companies and investment firms. Each pillar
offered different products and services. For instance, insurance companies did not offer term
deposits and GICs while banks could not issue life insurance policies. In the 1980s and 1990s,
the pillars started to crumble and regulation was loosened up with the deliberate intention
of creating financial powerhouses that could compete not just within Canada but also in the
international sphere. Thus began a wave of consolidation, mergers and acquisitions that resulted
in the trust sector practically being absorbed by the big banks, and investment firms, like Wood
Gundy and Nesbitt Burns, also coming under the umbrella of the big banks. Life insurance
companies started offering all kinds of investment products, including GICs, while banks set up
insurance subsidiaries that could underwrite life insurance and automobile insurance. Mutual
funds are now available through numerous outlets including banks, insurance companies, credit
unions and wealth management companies like CI Funds and Mackenzie Financial Corporation.
Having said this, for purposes of classification, we could say that banks, trust companies and
securities/brokerage firms offer savings instruments including term deposits and GICs,
mutual funds, individual bonds and stocks and RRSPs, RRIFs, and other registered plans.
Securities firms tend to specialize in the more esoteric securities such as derivatives, options,
futures, etc. Life insurance companies offer universal life insurance products, annuities,
including deferred annuities (which are similar to savings instruments), and segregated funds
as well as RRSPs, RRIFs and other registered products. Only life insurers can issue life
annuities while term certain annuities – annuities that make payments over a specific (i.e.,
“certain”) period of time - can be issued by other financial institutions.
Investors’ confidence in Canadian financial institutions is high. It is based on a long record of
integrity and financial soundness reinforced by a legislative framework that provides close
supervision of their basic activities. It is not surprising that deposit-taking and savings
institutions have experienced strong growth in the past decade.
The expansion of chartered bank assets has been facilitated by several factors including:
• Increased international activity
• Changes in the Bank Act that permit banks to compete vigorously in new sectors of
the financial services industry

• The creation of more banks, notably the Schedule II and Schedule III banks. Schedule II
banks are foreign bank subsidiaries (e.g., ICICI Bank Canada) authorized under the Bank
Act to accept deposits, which may be eligible for deposit insurance provided by the Canada
Deposit Insurance Corporation. Foreign bank subsidiaries are controlled by eligible foreign
institutions. Schedule III banks are foreign bank branches (e.g., Rabobank Nederland-
Canada Branch) of foreign institutions that have been authorized under the Bank Act to do
banking business in Canada. These branches have certain restrictions.
Regulatory Organizations
In this portion of the chapter we will examine the regulatory role played by a federal
regulator, the provincial securities regulators, the Canadian Investor Protection Fund
(CIPF), and the various Self-Regulatory Organizations (SROs).
OFFICE OF THE SUPERINTENDENT OF FINANCIAL INSTITUTIONS

The Office of the Superintendent of Financial Institutions (OSFI) is responsible for
regulating and supervising banks, insurance, trust and loan companies, fraternal benefit
societies and co-operative credit associations that are chartered, licensed or registered by
the federal government. OSFI also supervises over 1,200 federally regulated pension plans.
It does not regulate the Canadian securities industry.
OSFI was established in 1987 by legislation that amalgamated the Department of Insurance and
the Office of the Inspector General of Banks and broadened the powers and responsibilities
related to supervising federally regulated financial institutions. OSFI’s enabling legislation
provided for a single regulatory body for all federally regulated financial institutions.
OSFI’s mandate is to:
• Supervise institutions and pension plans to determine whether they are in sound
financial condition and meeting minimum plan funding requirements respectively,
and are complying with their governing law and supervisory requirements;
• Promptly advise institutions and plans in the event there are material deficiencies and
take or require management, boards or plan administrators to take necessary corrective
measures expeditiously;
• Advance and administer a regulatory framework that promotes the adoption of policies
and procedures designed to control and manage risk;
• Monitor and evaluate system-wide or sectoral issues that may impact institutions negatively.
PROVINCIAL REGULATORS
In Canada, the regulation of the securities industry is a provincial responsibility. Each
province is responsible for creating the legislation and regulation under which the industry
must operate. In several provinces, much of the day-to-day regulation is delegated to
Securities Commissions. In other provinces, securities administrators, who are appointed
by the province, take on the regulatory function.

The provincial regulators recognize that their task is a complicated one so they work with
the other regulators, such as the Canadian Investor Protection Fund (CIPF) and the self-
regulatory organizations (SROs) to maintain high standards.
CANADIAN INVESTOR PROTECTION FUND (CIPF)

The securities industry offers the investing public protection against loss due to the financial
failure of any of 200 investment dealers across Canada. To foster continuing confidence in the
firm-customer relationship, the industry created the Canadian Investor Protection Fund.
The assets of the Fund are contributed by the securities industry through regular assessments
paid by member firms based on their gross revenues and risk profile relative to their peers.
The Fund also has access to a substantial line of credit.
The CIPF Board sets the size of the fund to be maintained for the client assets it protects.
Since its inception in 1969, CIPF has made payments, net of recoveries, totaling $36 million
to eligible customers of 17 insolvent members.
All accounts of a customer are covered either as part of the customer’s general account or as a
separate account, to a maximum of $1 million. CIPF does not cover customers’ losses that result
from changing market values of their securities, unsuitable investments or the default of an issuer
of securities. More information about the CIPF is available at http://www.cipf.ca/homepage.aspx
CANADA DEPOSIT INSURANCE CORPORATION (CDIC)

The Canada Deposit Insurance Corporation (CDIC) is a federal Crown Corporation. It was
created in 1967 to provide deposit insurance and contribute to the stability of Canada’s
financial system. CDIC insures eligible deposits up to $100,000 per depositor in each
member institution (banks, trust companies and loan companies) and reimburses depositors
for the amount of any insured deposits if a member institution fails.
To be eligible for insurance, deposits must be in Canadian currency and payable in Canada.
Term deposits must be repayable no later than five years from the date of deposit. The
maximum amount includes all the insurable deposits with the same CDIC member. Deposits
at different branches of the same member institution are not insured separately.
Accounts and products insured by CDIC

• savings accounts and chequing accounts
• GICs and other term deposits that mature in 5 years or less
• money orders, certified cheques, travellers’ cheques and bank drafts issued by
CDIC members
• debentures issued by loan companies
Accounts and products must be held at a CDIC member institution and in Canadian dollars.
Accounts and products NOT insured by CDIC

• mutual funds and stocks
• GICs and other term deposits that mature in more than 5 years
• bonds

• Treasury bills
• Principal Protected Notes issued by corporations, including banks or other CDIC members
CDIC does NOT insure any accounts or products in U.S. dollars or other foreign currency.
CDIC does NOT insure any accounts or products held in banks or other institutions that
are NOT CDIC members.
CDIC insures up to $100,000 in each of the following categories.
• Savings held in one name
• Savings held in more than one name (joint deposits)
• Savings held in trust
• Savings held in an RRSP
• Savings held in a RRIF
• Savings held for paying realty taxes on mortgage payments
• Savings held in a Tax Free Savings Account (TFSA)
To date, CDIC has provided protection to depositors in 43 member institution failures. As
of October 2010, CDIC insured around $600 billion in deposits. More information about
the CDIC is available at http://www.cdic.ca/e/index.html.
SELF-REGULATORY ORGANIZATIONS
A number of organizations within the securities industry are considered to be self-
regulatory organizations (SROs). These organizations include the Bourse de Montreal, the
Toronto Stock Exchange, the TSX Venture Exchange, the Investment Industry Regulatory
Organization of Canada (IIROC), and the Mutual Fund Dealers Association (MFDA). All
firms in the industry must belong to an SRO.
The exchanges’ role in regulation covers many areas including member regulation, listing
requirements and trading regulation. IIROC monitors member firms throughout Canada in
terms of both their capital adequacy and conduct of business. The qualifying and registering
process of these firms is also IIROC’s responsibility. The MFDA oversees the regulation of
the distribution side of the mutual funds industry (the funds themselves remain the
responsibility of the securities commissions).

BRIEF OVERVIEW OF ECONOMICS
LEARNING OBJECTIVES
• List the major effects of economic activities on investments.
• List the effects of inflation on investments.
Economic Principles
GROSS DOMESTIC PRODUCT

The growth of the economy is measured by gross domestic product (GDP). GDP is the
value of all goods and services produced in a country in a year. The real GDP of the
Canadian economy grew on average at about 3.8% per year since 1961. This growth is not
uniform throughout the period as indicated in Figure 5.1.
Economic fluctuations present a recurring problem for policy makers as downturns in
economic growth are directly related to rising unemployment. Moreover, the real
investment sector accounts for the bulk of fluctuations in real GDP. Real GDP is inflation-
adjusted GDP that shows the value of all goods and services produced in a specific year,
using base-year prices. Such fluctuations in output and employment are called the business
cycle and directly affect the value of investments over time
FIGURE 5.1 GROWTH RATE IN REAL GDP
8
7
6
5
4
Growth %
3
2
1
0
-1
-2
-3
'65 '70 '75 '80 '85 '90 '95 '00 '05 '10
Year
Source: Adapted from Statistics Canada, http://www.statcan.gc.ca, 2010

INTEREST RATES
Any description of economic activity must include an explanation of interest rates. Interest
rates are an important link between current economic activity and future activity. For
consumers, interest rates represent the gain from deferring consumption from today to
tomorrow via saving. For investors, interest rates represent one component of the cost of
capital. Thus, the rate of growth of the capital stock, which determines future output, is
related to the current level of interest rates.
Interest rates are one of the most important financial variables that affect securities markets.
Interest rates are essentially the price of credit. Thus, changes in interest rates reflect and
affect the demand and supply for credit and debt.
Interest rates are differentiated according to the duration of the borrowing, the terms of the
loan and the creditworthiness of the borrower.
Money can be borrowed from terms ranging from one day to 30 years (and sometimes
longer). Rates on terms of one year and less are considered short-term, while rates longer
than one year are considered long term. The term structure of interest rates refers to the
pattern of short term through long term rates at one point in time when only the term to
maturity of a financial instrument changes.
Rates also vary from one borrower to another. Governments usually enjoy the lowest rates
because of their low risk of default as a result of their enormous revenue-raising capability.
Central governments usually have the lowest rate of all due to their ability to order the central
bank to print money, if necessary, to repay their debt. Thus in Canada, federal government
treasury bills and bonds represent the benchmark rate. The riskiness of all other borrowers is
compared to the default risk of the federal government.
Rates are higher for borrowers with a greater default risk (i.e., risk of not meeting interest
and/or principal repayments). Among private borrowers, large, diverse and well-established
companies enjoy the lowest rates. Individuals with little collateral and borrowers with a
history of default are charged the highest rates, assuming they are extended any credit at all.
INFLATION
Inflation is an important economic indicator for securities markets because it is the rate at
which the real value of an investment is eroded. Inflation in an economy-wide sense is a
generalized, sustained trend of rising prices. A one-time jump in the inflation level caused by
an increase in the price of oil or the introduction of a new sales tax is not true inflation, unless
it feeds into wages and other costs and initiates a wage-price spiral. Likewise, a rise in the
price of one product is not in itself inflation, but may just be a relative price change reflecting
the increased scarcity of that product. Inflation is ultimately about money growth. It is a
reflection of “too much money chasing too few products”.
The role of inflation expectations is particularly important in determining the level of
nominal interest rates. The real interest rate is the nominal interest rate minus the expected
inflation rate over the term of the loan. Since it is difficult to measure investors’ inflation
expectations, the realized inflation rate is often used as a proxy for the expected inflation
rate. The nominal and ex post (historical) real rates are shown in Figure 5.2.

FIGURE 5.2 NOMINAL AND REAL (EX POST) T-BILL RATES
20
Real Rate
Nominal Rate
15
T- Bill Rates (%)
10
-5
1980 1985 1990 1995 2000 2005 2010
Year
Source: Adapted from Statistics Canada, http://www.statcan.gc.ca, 2010
Nominal interest rates have been trending downwards since the early 1980s. Real rates
fluctuated between 5% and 7% for many years but in recent years dropped below 1%.
If the progress of future inflation is uncertain, then so are expectations of future nominal
interest rates. Bond prices reflect both a change in expectations and any uncertainties
associated with such expectations. In an environment with consistently low inflation, the
pricing of financial instruments, such as government bonds, is more reliable.
Inflation imposes many costs on the economy:
• It erodes the standard of living for people on fixed incomes and those who lack
wage bargaining power. It rewards individuals that are able to increase their income
either through increased wages or changes to their investment strategy in response
to inflation. Consequently, inflation aggravates social inequities.
• Inflation reduces the real value of investments such as fixed-rate loans since the loans
are paid back in dollars that buy less. This can be good for the borrower if his or her
income rises with inflation. But, more likely, inflation results in lenders demanding a
higher interest rate on the money that they lend.

• Inflation distorts the signals prices send to participants in market economies where
prices are critical for balancing supply with demand. Rising prices draw resources into
areas of scarcity and falling prices move funds away from glutted areas. When inflation
is high, it is difficult to determine if a price increase is simply inflationary or if a genuine
relative price change has taken place.
• Accelerating inflation usually leads to rising interest rates and a recession. Thus,
high inflation economies usually experience more severe booms and busts than
low-inflation economies.
In recent years, central banks throughout the world have become more acutely concerned
with the effects of inflation and have increased their commitment to price stability.
THE EXCHANGE RATE

An exchange rate is the rate at which the currency of one country is exchanged for the
currency of another country. Although the United States dollar (US$) exchange rate is the
most important rate for Canada because so much of our business is carried on with the U.S.,
an official exchange rate exists between the Canadian dollar and every other convertible
currency in the world. For example, the impact of a rise in the Canadian dollar against the
US$ might be offset by a fall against the Euro.
The value of the Canadian dollar relative to other currencies influences the economy in a number
of ways. The most important influence is through trade. A higher dollar makes Canadian exports
more expensive in foreign markets and imports cheaper in Canada. Suppose a machine made
in Canada costs $1,000. With the Canadian dollar at US$0.65, it sells for US$650 in the U.S.
If the exchange rate rose to US$0.80, the machine would now sell for US$800, making its
manufacturer less competitive and decreasing sales and probably corporate profitability.
Likewise, a U.S. company that made a similar machine for US$650 in the U.S. would sell it
for $1,000 in Canada with the exchange rate at US$0.65, but only $812.50 with the exchange
rate at US$0.80 which could take sales away from the Canadian company. Large swaths of
the manufacturing sector in Ontario, for example, suffered enormously in 2007 and 2008
because of the rise of the Canadian dollar to par with the US dollar. Many plants ceased
operations and thousands of jobs were lost.
Since many Canadian exporters price their products in U.S. dollars, they often elect to keep
US$ prices unchanged when the value of the Canadian dollar rises even though it results in
less revenue. Such a decision forces the exporter either to accept lower profits or find a way
to reduce the costs of making the product.
A lower exchange rate would have the opposite effect, making Canada’s exports cheaper
and imports more expensive. An exporter that kept its US$ price unchanged would
pocket higher profits or allow costs to rise.

Economic Factors Affecting Security Prices
OVERVIEW
In general, investors are considered to be rational, profit-seeking individuals who react
quickly and try to anticipate the impact that new information or changes in economic
conditions will have on their investments. As a result, security prices should constantly
adjust to new information.
Making decisions to buy, sell or change an asset mix requires an understanding of the
economy, the business cycle, how industries change over time and the relative strength of
individual companies. The following sections review each of these areas and relate them to
investment decisions.
THE ECONOMY
Inflationary price pressures create widespread uncertainty and a lack of confidence in the future.
These factors tend to result in higher interest rates and lower corporate profits. Inflation brings
higher inventory and labour costs to manufacturers which, in turn, must be passed to the
consumer in the form of higher selling prices if profitability is to be maintained. But higher costs
cannot always be passed on as buyer resistance eventually develops. The resulting squeeze on
corporate profits is reflected in lower common share prices.
As inflation drives interest rates up, fixed income securities lose value. This is detrimental to
all investors, particularly those holding fixed income securities. Retired individuals on fixed
pensions find their purchasing power declines when inflation rises (government pension
benefits, though, are fully indexed). Workers on fixed long-term wage contracts are also
affected if inflation begins to outpace their wage gains. In addition, higher interest rates on
loans to new businesses can make these businesses unprofitable.
Recessions or contractions result in higher levels of unemployment and fewer purchases.
With declining sales, companies may downsize and undertake fewer new projects.
When an economy grows (GDP rises), unemployment decreases and the market prices of
equities (i.e., shares) rise. Stable growth is required to ensure a continual rise in our standard
of living. Through the use of monetary policy, the Bank of Canada plays a key role in
attempting to control economic growth and inflation. Monetary policy involves controlling
interest rates and the money supply to stabilize our economy.
The government also employs fiscal policy which can help level out the effects of the business cycle.
The two most important tools of fiscal policy are government expenditures and taxation. These policy
tools are important to market participants because they can affect investment policies, investment
holdings and an investor’s asset mix. Government fiscal policies are disclosed in government
budgets. With changes in fiscal policy, investors and their advisors must re-evaluate their holdings
and possibly alter their investment strategy in response to major changes.
Corporations are also affected by tax changes. Higher taxes on profits, generally speaking,
reduce the amount businesses can pay out in dividends and/or spend to expand plant
facilities. This can lead to lower share prices. On the other hand, a reduction in corporate
taxes can mean increased earnings and higher share prices.

INTEREST RATES AND THE ECONOMY

Investment decisions are forward-looking. Any decision to purchase a security is based on
expectation about the future return from the security. Increased optimism in the market can
generate a rise in stock prices. Consumer pessimism can stall economic growth and decrease
share prices. Moreover, government economic policies may work only through their impact
on people’s expectations. For example, the Bank of Canada makes considerable effort to
maintain the credibility of its commitment to low inflation.
Higher interest rates affect the economy by:
• Raising the cost of capital for business investments. An investment should earn a
greater return than the cost of funds used to make the investment. Higher interest rates
reduce the potential for profits. This, in turn, reduces business investment.
• Increasing the cost of borrowing. Higher interest rates discourage consumers from spending,
especially those intending to buy houses and major durable goods like cars, appliances and
furniture on credit. This encourages consumers to defer spending and save more.
• Increasing the portion of household income needed to service debt, such as mortgage
payments, and reducing the income available for spending on other items. This effect
may be offset by the higher interest income earned by savers.
Lower interest rates, as may be guessed, have the opposite effects. For instance, the housing sector in
Canada has benefited enormously from historically low interest rates in the 2003-2008 period.
SECURITY SELECTION BASED ON THE BUSINESS CYCLE

While both monetary and fiscal policies seek to control economic growth, the Canadian
economy has a tendency to move in waves. Figure 5.3 illustrates the connection between the
business cycle and securities selection.
The economy moves from a low point called a trough to a higher point called a peak and then to
another lower point. Over time, the cycle tends to repeat itself. The rise from the trough to the
peak is called an expansion and the decline from the peak is called a recession or contraction.
In a trough, interest rates and security prices are both low since the economy has been in a
recession. At this point, investors may decide not to invest in debt securities since interest rates
are very low. However, in anticipation of a turn-around in the economy, investors may decide to
purchase equities or equity funds or shift their portfolio mix to a heavier weighting in equities.

FIGURE 5.3 THE BUSINESS CYCLE
Sell short-term bonds, sell common shares

and begin buying long-term bonds
Begin buying Peak

short-term bonds
Rising Trend in GDP
Peak
Expansion
GDP
Contraction Recovery
Expansion Trough Begin buying common stocks and

sell long-term bonds
Time
During the expansion phase, the economy recovers and GDP increases. Employment goes
up and demand for goods rises. As consumers increase their spending, company profits
increase and share prices rise. As the economy nears the peak, the competition for funds
drives up interest rates. Higher interest rates make further expansion difficult. Consumers
are also faced with higher credit card costs, mortgage rates and bank loan costs. At this point
in the business cycle, consumer spending starts to slow or decline.
As the economy approaches the peak, the strong growth in equity prices allows investors to
take profits on their holdings. If investors can recognize that the economy is moving into the
peak, they will begin to move their holdings into higher-rate debt securities. After the
economy reaches the peak of the business cycle, the expansion comes to an end and the
economy begins to slide into a recession. The combination of higher interest rates and
inflation at the peak creates lower consumer demand for goods and services. Corporate
profits start to decline and share prices start to fall.
The economy enters a recession when the level of economic activity (measured by GDP)
actually begins to decline. Slower growth, rising unemployment and falling consumer
spending lead to a fall in the demand for bank loans and consumer credit.
In time, interest rates and prices begin to fall. As interest rates fall, the prices of fixed income
securities rise. Those investors who purchased fixed income securities at the peak experience a
rise in the value of these securities. As mentioned, knowledgeable investors who see a trough
approaching will take their profits on fixed income securities and begin to switch to equities.

In the trough, interest rates decrease which helps spur new confidence in the economy.
Consumer demand rises, stock prices rally and investors start to ride the wave once again.
While it appears that following the wave may be an easy way to make money, there are
some pitfalls:
• It is extremely difficult to predict the exact top and bottom of a business cycle.
• Business cycles vary – some are short and others are several years long.
• Some industries or stocks within an industry may lead while others lag.
• There is no one economic indicator that definitively predicts the future. To help get
a picture of what the future holds, many successful advisors and investors look into
quantitative analysis, which is a study of the economy and how industries and companies
react to changes in the economy. Economic information required to conduct a quantitative
analysis can be obtained from several sources, including Statistics Canada.
SECURITY SELECTION AND THE CLIENT
LEARNING OBJECTIVES
• List the general considerations in evaluating investments.
• Define the “know your client” rule.
• Describe the three statutory rights for the purchasers of securities.
Primary Investment Objectives

Organizations and individuals that are the source of a society’s capital have a tremendous range
of investments in which they may place their savings. This choice among investments is guided
by three primary investment objectives – (1) Safety of Principal, (2) Income and (3) Growth of
Capital and the two secondary objectives – (4) Liquidity and (5) Tax Minimization.
SAFETY
An investor who requires safety will probably invest in fixed income securities or fixed income
funds. Although money market instruments offer safety, their returns tend to be lower than other
types of securities. Safety with higher returns can be achieved through the purchase of longer-term
fixed income securities. The trade-off is that interest rates have a greater effect on longer-term
securities (i.e., increase or decrease in value) than on money market instruments.
INCOME
If cash flow (income) is required, perhaps as a supplement to a person’s other income, fixed
income instruments or fixed income funds may also be the proper choice. It is important to
realize that although many large, well-established companies pay dividends on their common
shares, dividends are not a contractual obligation and could be passed over or omitted.

GROWTH
Capital appreciation, or growth, is usually associated with equity investments or investments in
equity funds. Debt securities pay contractual interest and repay the amount lent at maturity, with
no increase in value. While debt securities may rise in value in the short term, an investor would
not typically use debt securities as a means of generating long-term growth.
The following summary, in very broad terms and disregarding inflation and its effects,
lists the three major types of securities and evaluates them in terms of the three basic
investment objectives:
Safety Income Growth

Bonds
Short-Term Best Very Steady Very Limited
Long-Term Next Best Very Steady Variable
Preferred Stocks Good Steady Variable
Common Stocks Often the Least Variable Often the Most
LIQUIDITY
If clients require liquidity, it is usually because they require funds in the near future, perhaps to
make a major purchase. As such, the investor does not want to put his or her funds at risk and
wants the funds available on request. In this situation, money market instruments or money
market mutual funds may be the most appropriate choice. The trade-off for liquidity, however,
is lower returns. Nowadays, several financial institutions offer high-interest personal savings
accounts which tend to provide returns greater than money market instruments.
TAXATION
While most people want to pay as little tax to the Canada Revenue Agency (CRA) as
possible, tax becomes an issue when you make money from investing. Investment products
can generate three types of income: interest income, capital gains and dividend income. Each
of these income sources is taxed differently in the Canadian tax system. Dividend income
received from taxable Canadian corporations, for example, is taxed at a lower rate than
interest income received from bonds. The tax treatment of investment income is one issue to
consider when creating a suitable product mix for a client. It tends to assume greater
importance as the investor’s income level, and marginal tax rate, rises.
The above discussion provides a very simplistic categorization of investment objectives and
may be misleading if the advisor uses it to sell only one security or fund. Clients can and will
have multiple objectives but not all may rank on an equal basis. One client may require some
liquidity to meet some short-term expenditures with the remainder of the funds being
invested for long-term growth. Yet another may want to balance growth and safety. It is the
advisor’s responsibility to assess the client’s needs and objectives and create an asset
allocation based on the client’s propensity for risk.

Know Your Client Rule
KNOW YOUR CLIENT AND SUITABILITY

An ethical advisor must ensure the suitability of investment recommendations for his or
her clients. The focus of the advisor’s daily business hinges on this all-important matter.
Suitability means ensuring that:
• All recommendations take into account the client’s unique situation and
investment objectives.
• Recommendations are based on personal and financial knowledge of the client
and knowledge of the investment products being recommended.
The Know Your Client (KYC) rule states that the advisor must use due diligence to learn the
essential facts relative to every client and every order. A concerted effort must be made to know
the client – to understand the financial and personal status and aspirations of the client. Thus,
the advisor will make recommendations for the client to invest his or her funds in securities that
reflect, to the best knowledge of the advisor, these considerations. The advisor, having provided
sound advice, will therefore be above reproach for potentially unsuitable purchases and sales of
securities if the client does not heed the advisor’s recommendations.
IMPLICATIONS OF THE KNOW YOUR CLIENT RULE

To effectively match the appropriate investment with the client’s needs, the advisor must
understand the financial and personal status of the client. In general, the KYC rule implies
that the advisor has gathered at a minimum:
• Information on the client’s personal circumstances - his or her investment knowledge

and tolerance for risk.
• Information on the client’s financial circumstances - approximate salary and net worth.
• Information on the client’s investment objectives.
• The client’s age.
Based upon this and other information that has been gathered, the advisor can intelligently
decide upon suitable investments. Client account documentation should reflect all material
information about a client’s current status and should be updated to reflect all material
changes to the client’s status to ensure suitability of investment recommendations. This
information, gathered by the advisor, is usually recorded on a New Client Application
Form. Exhibit 5.1 provides a sample of this form.
Advisors must also be pro-active in regularly updating information about their clients to ensure
that they do not ignore relevant changes in their clients’ circumstances. As clients move through
their life cycles, investment objectives and investment mixes should change. As life events
(birth of a child, divorce, retirement, etc.) occur, the client’s objectives may also shift. The best
protection from regulatory censure for an advisor is to keep updated files.

THE PURCHASERS’ STATUTORY RIGHTS

Canadian legislation provides three statutory rights for the purchasers of securities
issued in Canada under prospectus requirements.
Right of Withdrawal
The relevant securities legislation usually provides purchasers during a distribution by prospectus
with the right to withdraw from an agreement to purchase securities within two business days after
receipt or deemed receipt of a prospectus and any amendment by giving notice to the vendor or its
agent. If a distribution that requires a prospectus is done without a prospectus, the purchaser in most
provinces can revoke the transaction, subject to applicable time limits.
Right of Rescission
Most provinces give purchasers during a distribution by prospectus the right to rescind or
cancel a contract for the purchase of securities if the prospectus or amended prospectus
offering the security contains a misrepresentation (e.g., an untrue statement of a material fact
or an omission of a material fact). In most provinces, a purchaser alleging misrepresentation
must choose between the remedy of rescission and damages. In Quebec, rescission or
revision of the price may be sought without affecting a purchaser’s claim for damages.
Right of Action for Damages

The acts of most provinces provide that the issuer, the directors of an issuer, the seller of a
security, the underwriter who signs a certificate for a prospectus and any other person who signs
a prospectus may be liable for damages if the prospectus contains a misrepresentation. The
same applies to an expert (such as an auditor, lawyer, geologist or appraiser) whose report or
opinion or a summary thereof containing a misrepresentation, appears with his or her consent in
a prospectus. Experts are not liable if the misrepresentation did not appear in their report or
opinion. For example, liability will not arise against the underwriter or the directors if they act
with due diligence by conducting an investigation sufficient to provide reasonable grounds for
a belief that there has been no misrepresentation. If the person or company can prove that
the purchaser of the securities had knowledge of the misrepresentation, the claim may be
considered invalid. The acts also provide certain limitations with respect to maximum
liability that may be imposed and time limits during which an action may be brought.
Criminal Offence
A misrepresentation in a prospectus may also be a criminal offence for both the issuer
and any of its directors or officers who authorized, permitted or acquiesced in the
making of the misrepresentation.

EXHIBIT 5.1 NEW ACCOUNT APPLICATION FORM
NEW ACCOUNT APPLICATION FORM ACCOUNT SUPERVISION

(to be completed by Advisor) O
F
F
I
C
E ACCOUNT I.A.
(1) (a) Name Mr.

Mrs.
Miss
H
......... ...... ....... ...... ...... ....... ...... ...... ....... ...... ....... ...... ...... ....... .
......... ...... ....... ...... ...... ....... ...... ...... ....... ...... ....... ..
o
m
Phones: e
Please Print B
u
s
i
n
e
s
Home address s
O
t
h
e
r
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Street .....
.....
......................................................................................................................................................................................................
F
a
x
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City Province Postal Code .....
Date of Birth ................................................................. Client’s Social Insurance Number............................................. Client’s Citizens hip ........................................................................ ................
Type of Account Requested :

(b) Is Advisor registered in the Province or Yes .................. Cash .................................................................. RRSP/RRIF U.S. Funds ....................................
Country in which the client resides? No .................. Margin ............................................................... Other .......................................................
D.A.P. ................................................................. Pro ............................................................ CDN Funds .................................
(2) Special instructions ........................................................ Hold in Account .................................................... Registered and Deliver ............................................................ DAP...................................................
Duplicate Confirmation ................................................ And/Or Statement ...............................................
N a m e: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Name: .....................................................................................................................................................
A d dr e s s: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Address: .................................................................................................................... ............................
...........................................................................................................................................................................
.................................................................................................................................................................
............................................................................................ Postal Code ........................................................... ............................................................................Postal Code ..............................................................
(3) Client’s Nam e ..... ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ... Type of Business...................................................................................................................................
Employer: A ddre s s ..... .......... .......... ......... .......... .......... ......... .......... .......... ......... .......... .......... ..... .... ... Client’s Occupation................................................................................................................... ..........
(4) Family Information:

Spouse’s Name ........................................................................................................................................... No. of Dependants ..............................................................................................................................
Occupation........................................................................................................................................... Employer ................................................................................................................................................
Type of Business...................................................................................................................................
(5) How long have you known client?..................................................................... Advertising Lead .... .................. Phone In ........................................ Have you met the client face to face?
Personal Contact ..................... Walk In .......................................... Yes ..................... No .....................
Referral by: ..................................................................................................................................... (name) (if customer, give account no.) ...................................................................................................................
(6) If yes for Questions 1, 2, or 3, provide details in (11).
1. Will any other person or persons : (a) Have trading authorization in this account? Yes ................ No ...............
(b) Guarantee this account? Yes ................ No ...............
(c) Have a financial interest in such accounts? Yes ................ No ...............
2. Do any of the signatories have any other accounts or control the trading in such accounts? Yes ................ No ...............
3. Does client have accounts with other Brokerage firms? (Type: ) Yes ................ No ...............
4. Is this account (a) discretionary or (b) managed ................(a) ...............(b)
Insider Information
5. Is client a senior officer or director of a company whose shares are traded on an exchange or in the OTC markets? Yes ................ No ...............
6. Does the client, as an individual or as part of a group, hold or control such a company ( ) Yes ................ No ...............
(7) (a) General Documents Attached Obtaining (b) Trading Authorization Documents: Attached Obtaining
– Client’s Agreement .................. ................. – For an individual’s Account ........................ .........................
– Margin Agreement .................. ................. – For a Corporation, Partnership, Trust, etc. ........................ .........................
– Cash Agreement .................. ................. – Discretionary Authority ........................ .........................
– Guarantee .................. ................. – Managed Account Agreement ........................ .........................
– Other .................. .................
Sophisticated.......
(8) INVESTMENT KNOWLEDGE ..................... EST. NET LIQUID ASSETS
Good...................
......... (Cash and securities less loans
A
Limited................. .............................................
........... outstanding against securities) .....................
Poor/Nil...............
............. PLUS
B
.............................................
ACCOUNT OBJECTIVES ACCOUNT RISK FACTORS ......... EST. NET FIXED ASSETS .....................
Income .................. % Low ................... % (Fixed assets less liabilities EQUALS
Medium ................... % outstanding against fixed assets)
C
..............................................
Capital Gains .................. % High ................... % EST. TOTAL NET WORTH (A + B = C) ....................
Short Term .................. % 100 % APPROXIMATE ANNUAL INCOME FROM ALL
D...........................................
Medium Term .................. % SOURCES .......................
100 %
E
...............................................
EST. SPOUSE’S INCOME ....................
Name
.........................................
.........................................
(9) Bank Reference : .................. ...... Bank credit check-acceptable? Yes .............. No ..............
Branch
.................................
.................................
.................................
...... Or Credit Bureau check-acceptable? Yes .............. No ..............
Refer to
................................
................................
................................
...... Above credit checks considered unnecessary
Accounts
................................
................................
................................
.... Explain in (11)
Deposit and/or Security

received............................................................................
(10) .................................
Initial Buy Solicited Amount
............................................. .......................................... ............................................... .................................................................................
...... ............... . ...............................
Order Description
............................................ Sell.................................... Unsolicited .................................................................................
..... ...................... .......................................... .........................
Advisor’s Signature
................................................
................................................
(11) ....................................... Designated Officer, Director or Branch Manager’s
Approval
Date......................................
...............................................
............................................... Date of Approval
............................ .....................................................................................................................................
Comments:
...............................................
...............................................
...............................................
......
...................................................................................................................................................................
...................................................................................................................................................................
Client’s Signature
............................................... Date
............................................... .......................................................................................................................................
............................................ ...................

RISK AND RETURN
LEARNING OBJECTIVES
• Define the role of a portfolio manager.
• Describe what the term “guaranteed” means when discussing guaranteed
investments, including guarantee of investment capital and guarantee of income.
• Describe the decision-making process to be used when determining the appropriate
investment option to meet the risk tolerance of the client. Use examples to support
your explanation.
• Define the risks associated with investing, including market risk, business risk, interest
rate risk, liquidity risk, currency risk, and inflation risk.
• Draw and explain a risk/reward graph placing investment products appropriately along
the graph.
Introduction
Economists would say that most individuals give up present consumption for future
consumption. Individuals recognize the need to save a portion of their earnings for both
emergency purposes and to fund such future events as retirement or their children’s
education. Most individuals also realize that if they have savings, they must put those
savings to work in order to maintain their purchasing power. This, in turn, means
investing (hopefully) to earn a positive real rate of return. The financial sector services
this need by offering a wide range of products.
RISK AVERSION
Most investors are risk averse, preferring securities offering the least risk. To entice
individuals to invest in higher-risk securities, there must be the expectation of higher returns.
This is known as the risk/return trade-off. However, since future returns are not usually
guaranteed, all things being equal, investors would prefer to reduce risk.
Henry Ford was alleged to have said that the public could have any colour car it wanted, as
long as it was black. The market reality is that consumers want variety – variety in the colours
offered and the features offered. Investors make the same demands. What may have started as
strictly stocks and bonds has led to variations on the initial themes and to the development of a
whole new range of financial products. It is, therefore, important that an advisor understands
the products and the features related to each product, in order to match the appropriate
product with the client’s needs.

DIVERSIFICATION
Risk can be reduced through diversification, but what does diversification mean? The most
obvious analogy is to not “put all your eggs in one basket”. If an investor’s money is spread
over a variety of investments, the loss of part of it does not constitute a financial disaster.
Risk reduction through diversification can be accomplished in many ways:
John diversified his holdings by investing in several asset classes, including
stocks, bonds and money market instruments.
Jill diversified her portfolio by investing in the common shares of companies in
several different industries.
Marsha had only a small amount to invest. To diversify her holdings, she invested in a
balanced Canadian equity mutual fund.
Diversification works because the prices of different stocks and assets do not move in
tandem. The benefit of diversification can be easily seen in Figure 5.4.
FIGURE 5.4 THE BENEFIT OF DIVERSIFICATION

Risk
Number of Securities / Investments
As the number of securities or investments held increases, the exposure to risk falls. By
spreading risk over a variety of investments, the fall in value of one investment will not put
the entire portfolio at risk.
The concept of diversification is one of the cornerstones of the insurance industry. Insurance is
founded on the concept of the law of large numbers which holds that accidents or losses do not
occur to all policyholders at the same time. An insurance company using statistical techniques
can estimate the expected losses from a homogeneous group such as smokers or non-smokers.
Each group is charged a different premium reflecting the coverage for the potential losses and
also a profit for the insurance company. If the potential losses are greater than what a single
insurer is willing to accept, the insurer seeks out other insurers, sharing the premium and sharing
the risk through reinsurance. Again, this reduces risk through diversification.

The concept of diversification is also used in the securities industry when underwriting or
bringing new securities to market. By definition, underwriting means buying a new security
and assuming the risk of not reselling that same security at a higher price. If an underwriter
believes that the risk of reselling the new security is high, the underwriter will form a selling
group or syndicate. As with insurance, each member of the syndicate receives a portion of
the selling or underwriting profits but also assumes a portion of the reselling risk.
POOLED CAPITAL
While risk reduction through the pooling of investment funds has been around for decades, it
did not gain major prominence in Canada until the 1980s. In the early 1980s, financial
institutions in Canada realized that smaller, unsophisticated investors wished to participate in
the markets but were both risk averse and financially challenged. Recognition of these two
basic characteristics gave rise to a rapidly growing industry based on the principles of risk
reduction through diversification and professional management.
By far the most common type of investment pooling method is the open-end investment
fund, more commonly known as a mutual fund. The term “open-end” is used because these
funds continuously sell their own treasury shares or units to the investing public. The shares
are continuously available for purchase – not from other shareholders, but from the fund
itself. This type of fund has been extremely popular with the investing public.
Other managed products aimed at retail investors, such as segregated funds offered by insurance
companies, wrap accounts and pooled funds, have also experienced strong growth. Behind this
explosive growth is the demand of many investors for a diversified package of investments and
related services and for a fee-based rather than a transaction-based approach.
The Risk/Return Trade-off
OVERVIEW
It is every investor’s dream to be able to get a very high return without any risk. The reality,
however, is that risk and return are interrelated. To earn higher returns investors must
usually choose investments with higher risk. The ultimate goal of investing is to choose
investments that maximize returns while minimizing risk.
Given a choice between two investments with the same amount of risk, a rational investor
would always take the security with the higher return. Given two investments with the same
expected return, the investor would always choose the security with the lower risk. Figure 5.5
demonstrates this relationship.

FIGURE 5.5 THE RISK/RETURN TRADE-OFF
Return
Risk
Investors are risk averse, but not all to the same degree. Each investor has a different risk
profile. This means that not all investors choose the same low-risk security. Some investors are
willing to take on more risk than others, if they believe there is a higher potential for returns.
In general, risk can have several different meanings. To some, risk is losing money on an
investment. To others, it may be the prospect of losing purchasing power if the return on
the investment does not keep up with inflation. Risk could also refer to not meeting return
objectives. For example, a retail investor may need to earn a 10% return in order to maintain
a certain lifestyle. Institutional investors may have a target rate of return that they must meet
each year. They may be investing to meet anticipated future cash flows. Thus, risk to an
institutional investor may result from investing inappropriately and, consequently, not being
able to meet anticipated future cash flows. Most retail investors feel that the prospect of
losing money is an unacceptable risk. Institutional investors, on the other hand, are more
concerned with the long-term rate of return on the portfolio and less concerned about the
prospect of losing money on one security.
Given that all investors do not have the same degree of risk tolerance, different securities
and different funds have evolved to service each market niche. Guaranteed investment
certificates (GICs) and fixed income funds were developed for those seeking safety and
equities and equity funds were developed for those seeking growth or capital appreciation.
With reference to guaranteed investments, what does the term “guaranteed” signify? Generally
speaking, the notion of guarantee arises with (i) repayment of the principal amount invested and
(ii) payment of an investment return on the principal amount invested. So, for example, when a
chartered bank issues a Guaranteed Investment Certificate, it is guaranteeing to the investor
that the principal amount will be repaid at maturity and interest at a specified rate will be paid at
specified intervals during the term of the investment. One thing to keep in mind is that such a
guarantee is only as good as the institution that is behind it. However, in Canada, as mentioned
earlier in this chapter, there is an additional layer of guarantee in the form of Canada Deposit
Insurance Corporation. In case a financial institution cannot pay back the principal amount at

maturity and/or the interest accrued on the investment, then CDIC will step in and act as the
guarantor/insurer of last resort (up to a maximum limit and subject to several conditions). This
assumes, of course, that the financial institution is a member of CDIC. It should be noted that
mutual funds, even fixed income and money market funds, do not come with a similar guarantee.
Few individuals would invest all of their funds in a single security. This being the case, a portfolio is
designed around an asset allocation based upon the client’s propensity for risk. The creation
of a portfolio or an asset allocation approach allows the investor to diversify and reduce risk
to a suitable level. The advisor, in turn, needs to understand how risk and return are related
so that the client’s questions can be answered intelligently.
To maintain and increase their purchasing power, investors “rent out” their money. In other
words, they expect some sort of compensation for the use of their money. If investors did not
expect some kind of return, it would not be classified as an investment – it would be a
“donation” without a tax receipt!
Consider the following possible investments and the types of return generated:
Canada Savings Bonds – interest income

Common Shares – dividend income, capital gain
Gold Bars – capital gain
Rental Property – rental income, capital gain
An investor who buys Canada Savings Bonds expects to earn interest income (cash flow). An
investor in common shares expects to see the stock grow in value (capital appreciation) and
may also be rewarded by dividends (cash flow). An investor in a gold bar hopes the price of
gold will rise (capital appreciation) and an investor who purchases a rental property expects
to receive rental income (cash flow) and an increase in the value of the rental property
(capital growth). The caveat on all this is that returns on many investments are somewhat
uncertain or unknown and that is why they are often referred to as “expected returns”.
While an investment may be purchased in anticipation of a rise in value, the reality is that
values can decline. A decline in the value of a security is often referred to as a capital loss.
Therefore, returns can be reduced to some sort of combination of cash flows and capital
gains or losses. The following formula defines the expected return of a single security:
EXPECTED RETURN
Expected Return = Cash Flow + Capital Gain (or – Capital Loss)

Where:
Cash Flow = Dividends, interest, or any other type of income
Capital gain/loss = Ending Value – Beginning Value
Beginning Value = The initial dollar amount invested
Ending Value = The dollar amount the investment is sold for

CALCULATING A RATE OF RETURN

Returns from an investment can be measured in absolute dollars. An investor may state that she
made $100 or lost $20. Unfortunately, using absolute numbers obscures their significance. Was
the $100 gain made on an investment of $1,000 or an investment of $100,000? In the first case,
the gain would be considered as decent, while in the latter it could signal a dismal investment.
The more common practice is to express returns as a percentage or as a rate of return yield.
Within the investment community it is more common to hear that “a fund earned 8%” or “a
stock fell 2%”. To convert a dollar amount to a percentage, the usual practice is to divide the
total dollar returns by the amount invested.
Return % = Cash Flow + / - (Ending Value -Beginning Value) ´100
Beginning Value
The following example illustrates:
RATE OF RETURN ON AN INDIVIDUAL STOCK
a) If you purchased a stock for $10 and sold it one year later for $12, what would be your
rate of return?
Rate of Return = Zero Cash Flow + ( $12 -$10) ´100 =
20% $10
b) If you purchased a stock for $20 and sold it one year later for $22, and during this
period you received $1 in dividends, what would be your rate of return?
$ 1+ ( $22 -$20)
Rate of Return = ´100 =15%
$20
c) If you purchased a stock for $10, received $2 in dividends, but sold it one year later for
only $9, what would be your rate of return?
$ 2 + ( $9 -$10)
Rate of Return = ´100 =10%
$10
The above examples illustrate that cash flow and capital gains or losses are used in calculating
a rate of return. It should also be noted that all of the above trading periods were set for one
year and hence the percent return can also be called the annual rate of return. If the transaction
period were longer or shorter than a year, the return would be called the holding period return.
Adjustments would have to be made to the formula to convert it to an annual rate of return. The
above generic formula will form the basis of yield calculations described later in this chapter.
Choosing a realistic expected rate of return can be a very difficult task. One common method
is to use the T-bill rate plus a certain performance percentage related to the risk assumed in the
investment. Corporate issues with a higher risk profile would be expected to earn a higher
rate of return than more secure federal government issues.

HISTORICAL RETURNS
An understanding of historical returns is important to the investor. Insights into the
market can be gained by studying historical data. These insights are used to determine
appropriate investments and investment strategies.
Consider the following rates of return in Table 5.1:
TABLE 5.1 COMPARATIVE TOTAL RATES OF RETURN ON SPECIFIC SECURITY CLASSES
Annual Total Return (% Change in Value Indices, December to December)
T-Bills Long-Term S&P/TSX

Annual 91-Day Bonds Composite Stocks
Returns (%) (%) (%)
1990 13.48 4.32 -14.80
1995 7.57 26.34 14.53
2000 5.49 12.97 7.41
2001 1.95 6.06 -7.07
2002 2.63 11.05 -15.56
2003 2.57 9.07 25.39
2004 2.47 10.26 11.49
2005 3.37 13.84 21.91
2006 4.16 4.08 10.69
2007 3.86 3.44 10.87
2008 0.83 2.10 -33.25
Source: Bloomberg
A study of Table 5.1 reveals that the highest rates of return were typically achieved by
securities that had the greatest variability or risk. The above historical information serves to
illustrate that risk and return are related. Figure 5.6 demonstrates this relationship graphically.

FIGURE 5.6 RISK/RETURN RELATIONSHIP
High
Derivatives
Expected Return
Common Shares
Preferred Shares
Debentures
Bonds
Treasury Bills
Low High
Risk
While historical returns provide insight into the long-term performance of the market, it is
obvious that past performance is not necessarily indicative of future performance. Since it is
extremely difficult to predict the future, an investor could employ the concept of
diversification – diversification among asset classes – to reduce risk.
RATES OF RETURN AND INFLATION

So far we have looked only at a simple rate of return, what economists call the nominal rate.
For example, if a 1-year GIC reports a 6% return, this 6% represents the nominal return on the
investment. However, investors are more concerned with the real return – the return adjusted
for the effects of inflation.
A client earned a 10% nominal return on an investment last year. Over the same period, inflation
was measured at 2%. What was the client’s approximate real rate of return on this investment?
The approximate real rate of return is calculated as:
Real Return = Nominal Rate – Annual Rate of Inflation
The client in the above example earned a real rate of return of 8% on the investment,
calculated as:
Real Return = 10% – 2% = 8%
THE RISK-FREE RATE

A study of historical returns reveals that there is an investment that usually keeps pace
with inflation and, therefore, provides a positive return. This investment is called a
Treasury bill or T-bill. Since T-bills are considered essentially risk free, all other
securities must at least pay the T-bill rate plus a risk premium to entice clients into
investing. For example, 90-day T-Bills in June 2008 were yielding approximately 2.55%.

Risk – “The Other Side of the Coin”

As has already been pointed out, there is no universal definition of risk. In a statistical sense,
it is defined as the likelihood that the actual return will be different from the expected return.
The greater the variability or number of possible outcomes, the greater is the risk. This can be
illustrated in a simple fashion. If an investor purchases a $500 Canada Savings Bond (CSB)
and cashes the bond one year later, the investor will receive exactly $500 (plus any accrued
interest). However, suppose the same investor purchased $500 worth of common stock at $25
per share in the expectation that the price would rise from $25 per share to $40 one year later.
The investor may receive much more than $40 per share or much less than the original $25
per share. Common stocks are considered much riskier than Canada Savings Bonds since
the future outcomes are much less certain.
TYPES OF RISKS
Financial media mention a great variety of risks including inflation rate risk, business risk,
political risk, liquidity risk, interest rate risk, foreign exchange risk and default risk. These
types of risks (the list is not all-inclusive) are defined below.
Inflation Rate Risk

As explained previously, inflation reduces future purchasing power and the real
return on investments.
Business Risk
This risk is associated with the variability of a company’s earnings due to such things as
the possibility of a labour strike, introduction of new products, the state of the economy
and the performance of competing firms, among others. The uncertainty regarding a
company’s future performance is its basic business risk.
Political Risk
This is the risk associated with unfavourable changes in government policies. For example, a
government may decide to raise taxes on foreign investing, making it less attractive to invest in
the country. Political risk also refers to the general instability associated with investing in a
particular country. Investing in a war-torn country, for example, brings with it the added
risk of losing one’s investment.
Liquidity Risk
A liquid asset is one that can be bought or sold at a fair price and converted to cash on short
notice. A security that is difficult to sell suffers from liquidity risk, the risk that an investor
will not be able to quickly buy or sell a security due to limited buying or selling opportunities.
Interest Rate Risk

When an investor purchases a fixed income security for example, he or she expects to
earn a certain return or yield on the investment. If interest rates rise, the investment will
fall in value; on the other hand, it will rise in value if rates fall. Interest rate risk is the risk
that investors are exposed to because of changing interest rates.

Foreign Exchange Risk

Investors who invest abroad or businesses that buy and sell products in foreign markets run
the risk of a loss whenever the exchange rate changes against foreign currencies.
Default Risk
When a company issues more debt to finance its operations, servicing the debt through interest
payments creates a further burden on the company. Default risk is the risk associated with a
company not being able to make interest payments or repay the principal amount of a loan.
SYSTEMATIC RISK
Certain risks can be reduced by diversification. Systematic risk (or market risk) cannot
be eliminated as it affects all assets within certain classes. Systematic risk is always
present and cannot be eliminated through diversification. This type of risk stems from
such things as inflation, the business cycle and high interest rates.
Systematic or market risk occurs as a result of being in each capital market. When stock
market averages fall, most individual stocks in the market tend to fall. When interest rates
rise, nearly all individual bonds and preferred shares fall in value. Systematic risk cannot be
diversified away; in fact, the more a portfolio becomes diversified within a certain asset
class, the more it ends up mirroring that market.
NON-SYSTEMATIC RISK
Non-systematic, or specific, risk is the risk that a specific security or a specific group of
securities will change in price to a different degree or in a different direction from the market
as a whole. U.S. Steel Canada, for example, may rise in price when the market index falls, or
U.S. Steel Canada, Arcelor Mittal Dofasco and Essar Steel Algoma Inc. (all steel companies)
as a group may fall more than the market index.
Diversifying among a number of securities can reduce this type of risk. Taking diversification
in the equity asset class to the extreme, this type of risk could theoretically be completely
eliminated by buying a portfolio of shares that consists of all the shares in the S&P/TSX
Composite Index (as some pension funds do by using index funds or buying i60s). The fund
manager could also be asked to create a fund that mirrors an index.
Asset Allocation
Once you have a better understanding of the client’s financial objectives and tolerance for risk,
you will need to determine the broad categories from which investments will be selected.
Investment assets can be grouped into three main categories: cash or near-cash equivalents,
fixed income securities and growth (equity) securities. Near-cash items ensure some liquidity
and can include savings accounts, money market instruments and money market funds. Fixed
income securities offer safety and income and include bonds, preferred shares and fixed income
funds. Growth securities usually include common shares and various types of equity funds. As
their name implies, growth securities provide potential for growth or capital gains.
Asset allocation involves determining the optimal division of an investor’s portfolio among
the different asset classes. Portfolio managers perform the same function for mutual funds and
institutional clients. For example, depending on the client’s tolerance for risk and investment

objectives, the portfolio may be divided as follows: 10% in cash, 30% in fixed income
securities, and 60% in equities.
Consider the following examples:
Jenny is a young, healthy, single professional with good investment knowledge, a high
risk tolerance, a moderate tax rate and a long time horizon. She might benefit from the
following asset mix:
Cash 5%
Fixed Income 25%
Equities 70%
Ahmed is a retired individual in a low tax bracket with no income other than
government pensions, a medium time horizon and a low risk tolerance. He requires
income from his portfolio. He might benefit from the following asset mix:
Cash 10%
Fixed Income 60%
Equities 30%
It should be noted that clients’ needs and objectives will change over their lifetimes.
Asset allocation will have to be adjusted to take these shifting needs into account.
Portfolio managers and investors will also alter asset allocations to take advantage of changes in
the economic environment. For example, when the economy enters a period of rapid growth, the
portfolio manager must decide how to best take advantage of the market. He or she would likely
decide that a heavier “weighting” in equities would generate better returns than holding more of
the portfolio in fixed income securities or cash. Alternatively, if the portfolio manager believes
that the market is entering a recession, a heavier weighting in cash or fixed income securities
could be pursued to generate higher returns. This process of altering a portfolio’s asset allocation
to take advantage of changes in the economy is one example of market timing.
THE IMPORTANCE OF ASSET ALLOCATION
Investment returns are derived from:

1. The choice of an asset mix
2. Market timing decisions
3. Securities selection
4. Chance
RATE OF RETURN ON PORTFOLIOS

The expected return on a portfolio is calculated in a slightly different manner from the
rate of return of a single security. Since the portfolio contains a number of securities,
the return generated by each security must be calculated.

PORTFOLIO RETURNS
The return on a portfolio is calculated as the weighted average return on the securities held
in the portfolio. The formula is as follows:
Expected Return: R1(W 1) + R2(W 2) + … Rn(W n)
Where:
R = The return on a particular security

W = The proportion (weight or %) of the security held in the portfolio based on the
dollar investment
RATE OF RETURN ON A PORTFOLIO
The following example illustrates rate of return on a portfolio:
A client invests $100 in two securities – $60 in ABC Co. and $40 in DEF Co. The expected
return from ABC Co. is 15% and the expected return from DEF Co. is 12%. To calculate the
expected return of the portfolio an advisor or investor would look at the rate expected to be
generated by each proportional investment.
Since the total amount invested was $100, ABC Co. represents 60% ($60 ÷$100) of the portfolio and
DEF represents 40% ($40 ÷ $100) of the portfolio. The expected return on the portfolio is:
Expected return = (0.15 x 0.60) + (0.12 x 0.40)

= 0.09 + 0.048
= 0.138 (or 13.8%)
MEASURING RISK IN A PORTFOLIO

While diversification is important, investment managers must also guard against too much
diversification. When a portfolio contains too many securities, superior performance may be
difficult to achieve and the accounting, research and valuation functions may be needlessly
complex and expensive. It is estimated that virtually all non-systematic risk in an equity
portfolio is eliminated by the time 32 securities are included in the portfolio.

TYPES OF SECURITIES TRADING IN CAPITAL MARKETS
LEARNING OBJECTIVES
• Define the various types of investment returns: current yield and yield to maturity.
• Define the term “time value of money.”
• Describe the benefits and limitations of Guaranteed Investment Certificates (GICs)
and Index-linked GICs, and the institutions that issue them.
• Describe the features, benefits and source of Treasury Bills (T-Bills), Canada Savings Bonds,
federal government bonds, provincial government bonds, and municipal government bonds.
• Define the major types of securities trading in capital markets: bonds and debentures.
Debt Securities
Debt securities are contractual obligations between a company or a government and an
investor who has lent money to that company or government. The issuer of the debt security
promises to pay a stipulated amount of interest, known as the coupon rate, over a stipulated
number of years and repay the principal or face value at the maturity of the contract.
As one can imagine, the types of debt securities can vary greatly. Some debt securities can
be for short periods of time, others for a longer period of time. Some can have low coupon
rates, others can have high rates. Some may pay interest annually, others semi-annually and
some even in currencies other than the Canadian dollar.
Investors seeking relative safety or interest income (cash flow) purchase debt securities. Debt
securities rank ahead of preferred shares and common shares in the event of a business failure
which makes them less risky. The payment of interest on debt securities is a contractual
arrangement, meaning it must be paid. A company that defaults on an interest payment will
suffer serious consequences. The company will lose credibility in the marketplace, making it
more difficult when it tries to issue debt in the future. More importantly, missing an interest
payment leads to default of the debt issue. When this happens, the entire debt issue becomes due
immediately. If the company cannot pay, it can be forced into bankruptcy.
Debt Security Risk

As an investment, debt securities tend to have a lower level of risk than equity securities.
However, risk is present with all types of securities. If an investor were to invest in only one
corporate debt security, he or she would be subject to multiple risks. The company may run
into financial difficulty and default on its interest payments or be unable to repay the
principal at maturity.
If interest rates change, the price of the bond will change. If the investor sells the security
prior to maturity, it may be worth less than what the investor originally paid for it. This
relationship between debt securities and interest rate changes will be explained shortly.

Debt Security Terminology

This section deals with the terms needed to understand how debt securities are constructed.
Most of the following terminology would be found in the agreement between the borrower and
the investor. This agreement is called a trust deed, bond contract or bond indenture. The bond
indenture is the detailed legal agreement that states the amount of interest paid, when it will be
paid, when the security matures and any other details that may affect the investor.
BONDS VERSUS DEBENTURES

Debt securities that are secured by a specific pledge of real assets, such as property, are
generally known as bonds. Debt securities that are unsecured, or secured only by the
general credit worthiness of the company, are known as debentures. Other than this
technical difference, they are alike in most other respects. Both have coupon rates,
maturity dates and similar par values. Investor confusion often arises because governments
issue “bonds” when, in fact, they are technically issuing debentures. However, since the
government has almost unlimited taxing powers, there is practically no default risk, so the
term “bonds” has been accepted. Throughout the text, the terms “bonds” and “debentures”
are used interchangeably to denote senior debt securities.
All bonds and debentures rank as senior securities over preferred and common shares. Bonds
are safer than debentures as there are designated assets that can be seized and sold if the
issuer fails to make an interest payment or repay principal at maturity.
COUPON RATES VERSUS MARKET RATES

The coupon rate is the interest rate the borrowing organization offers on a bond when it is first
issued. Coupon rates are quoted as an annual rate but most bonds and debentures pay interest
semi-annually. Coupon rates are different from market interest rates. For example, ABC Inc.
issued a 5-year bond that pays a coupon of 7%. This 7% rate is fixed for the term of the bond.
However, market interest rates do change as a result of the supply and demand of capital and
other factors. Over the five-year term of the bond, market rates can fluctuate substantially. This
risk of rising and falling rates does not affect the coupon payments on the bond. As interest rates
change, however, bond prices will also rise and fall. This represents interest rate risk.
Bond prices have an inverse relationship with interest rates. As interest rates go up, bond
prices go down. Conversely, as interest rates go down, bond prices rise. Figure 5.7 illustrates
this inverse relationship.
FIGURE 5.7
Interest Rates
Bond Prices

If interest rates rise, for example, from 6% to 8%, we know the coupon rate on a bond cannot
change. The problem is that if a bond pays 6% while new debt instruments are paying 8%,
rational investors will not purchase the 6% bond when they could purchase an 8% bond. The
only way that the 6% bond will be sold is if the market offers the bond at a discount or at a
price that is less than par value. As a result, the price of the bond will decrease.
Investors who buy this 6% bond will miss out on the higher coupon rate, but will make a
capital gain when they receive the principal at maturity. If interest rates keep climbing, the
bond’s price will keep falling. Conversely, if interest rates fell below the 6% coupon rate,
say to 4%, investors will be willing to pay a premium (more than par) to earn the 6% coupon
rate offered by the bond. Consequently, the price of the bond will increase. Bond prices
continually change in reaction to changes in interest rates.
PAR VALUE OR FACE VALUE

Par value or face value is the amount of money that the issuer promises to pay at maturity.
Nearly all bonds have a $1,000 par value or are in multiples of $1,000. About the only bonds that
have par values of less than $1,000 are Canada Savings Bonds and provincial savings bonds.
PAR VALUE
ABC Co. issues a 5-year, $1,000 par value bond with a 10% coupon and interest paid semi-
annually. Investors should know that if they purchased the bond, they would receive $1,000 at
maturity and payments of $50 every six months. Interest is calculated as: Coupon Rate x Par
Value. In this case 10% x $1,000 = $100 annually. Since interest is paid semi-annually or twice
a year, the investor would receive, $100 ÷ 2 = $50 every six months.
MARKET PRICES
The price at which the bond is offered for sale is known as the ask price and the price a
buyer is willing to pay for the bond is known as the bid price. Standard practice in the
industry is to quote market prices as a percent of par. For example, a bid of 97 means that
the offering price is 97% of par, or $970. An ask price of 99 would mean that the
bondholder is willing to sell at 99% x $1,000, or $990. The difference between the bid and
ask price is known as the dealer’s spread or profit.
Bonds that trade at less than the $1,000 par value are said to trade at discount. Bonds that trade
for more than $1,000 are said to trade at a premium. For example, an investor purchases a bond
at a price of $970. This bond is said to be trading at a discount to par. Another investor, who
purchases a bond at a price of $1,050, is purchasing the bond at a premium.
MATURITY DATES
With very rare exceptions, all bonds have a maturity date which is the date when the
borrower will repay the debt in full. Maturities can range from less than one year to longer
than 20 years. Debt securities of one year or less are considered to be money market
instruments. Short-term bonds have a maturity of up to three years; medium-term debt,
three to ten years and long-term debt, more than ten years.

In all instances when maturities are quoted, it represents the time from the present to the
maturity date. For example, a bond issued five years ago with a 12-year maturity date
would be referred to as a seven-year bond. When it was issued it was a long-term bond,
but is now considered a medium-term bond. Table 5.2 shows these categories.
TABLE 5.2 CATEGORIZATION OF BONDS BY TERM TO MATURITY
Money Market Short-Term Bonds Medium-Term Bonds Long-Term Bonds

Up to Up to 3 years From 3 to 10 years Greater than 10 years
one-year term remaining to maturity remaining to maturity remaining to maturity
CALL OR REDEMPTION FEATURES

Most corporate bonds carry a call or redemption provision that allows the issuer to call or take back
the debt security prior to its maturity. While there may be a number of reasons for calling in the debt,
the main reason is to allow the issuing company to refinance at a lower cost. For example,
a company issued a 20-year bond with a 10% coupon rate. Interest rates in the market
have subsequently fallen to 5%. Rather than continue to pay a coupon at the higher 10%
rate, the company would sell a new issue at 5% and retire the higher-costing issue.
The call feature is a disadvantage to the investor since the company will only use it when
interest rates have fallen. The call provision forces the investor to relinquish the higher-
paying bond and then reinvest in lower-paying securities. To compensate for that
disadvantage, the investor will likely be offered a premium when the bond is called.
Types of Debt Securities

Just as there are many types of investors, there are many types of debt securities and various
methods of classifying these securities. Debt securities may be classified according to the type
of securities pledged, the place of issue or the currency of issue. The following section describes
the most common types of debt securities that are currently available in the market.
GOVERNMENT OF CANADA LONG-TERM

The Government of Canada is the largest issuer of long-term, marketable bonds in
Canada. These debt securities are usually purchased and sold by investors and institutions
through brokerage firms and other financial institutions. Most Government of Canada
bonds are non-callable. Long-term Government of Canada bonds are similar to long-term
corporate debt securities but carry a lower risk.
REAL RETURN BONDS

In 1991, a new type of marketable bond was issued. The federal government issued $700 million
worth of Government of Canada Real Return Bonds with a nominal return that was linked to the
Consumer Price Index. Both the semi-annual interest payments and the final redemption value of
each bond are calculated by including an inflation factor. For example, if inflation (as measured
by the CPI) increased by 1½% over the first six-month period after it was issued, the value of a
$1,000 Real Return Bond at the end of the six months would increase to $1,015 ($1,000 x .015).
The interest payment for the next half-year would then be based on this amount rather than the

original bond value of $1,000. To calculate the maturity amount, the original face value of
the bond would be adjusted for inflation that has occurred since the issue date of the bond.
In other words, at maturity, the principal would be repaid in inflation-adjusted dollars.
TREASURY BILLS (T-BILLS)

Treasury bills are short-term government obligations. Every two weeks the Minister of Finance
through the Bank of Canada sells treasury bills (T-bills) at an auction. T-bills have original terms
to maturity of three months, six months and one year. Originally, they were available in large
denominations only. As a result, they appealed only to large institutional investors such as
banks, insurance, trust and loan companies and wealthy individual investors. To attract retail
investors, the government now offers T-bills in denominations as low as $1,000.
T-bills do not pay a stipulated rate of interest. Instead, they are sold at a discount (below par)
and mature at 100 or par. The difference between the issue price and par value at maturity
represents the investor’s return. Under the Income Tax Act, this increase is taxable as interest
income not as capital gain.
CANADA SAVINGS BONDS (CSB) AND CANADA PREMIUM BONDS (CPB)

The Government of Canada also issues a slightly different debt security geared for the
smaller investor. These are known as Canada Savings Bonds (CSBs). Unlike other bonds,
CSBs can be cashed by the owner at any bank in Canada at any time. Since they are not
transferable and hence have no secondary market, CSBs do not rise and fall in price and may
always be cashed at their full par value plus (eligible) accrued interest. This means that CSBs
are not subject to interest rate risk and may be an excellent choice either as a short-term
investment or as an emergency source of funds. Purchasers must be Canadian residents with a
Canadian address for registration purposes. Although ownership of a CSB cannot be
transferred or assigned, they may be used as collateral for loans.
Canada Premium Bonds (CPBs) are similar to CSBs but offer a higher rate of interest when
they are issued. They can be redeemed only once a year, without penalty, on the anniversary
of the date of issue and for 30 days thereafter.
COMPOUND VS. REGULAR INTEREST

CSBs pay regular or compound interest. If the bond pays regular interest, the investor will
periodically receive a cheque for the interest owed. If the bond is a compound bond, the interest
will accrue. This means that although the investor has earned interest, it will not be paid out. It
is added to the value of the bond each time it is earned. The bond increases in value as a result
of this accrued interest. After the first period, the interest is calculated not only on the principal
originally invested, but also on the accrued interest that continually builds up. The bond, in
effect, earns the investor interest on interest. Compounding returns can be a powerful
investment tool, as we have seen earlier in this chapter.
PROVINCIAL GOVERNMENT SECURITIES AND GUARANTEES

Just like a federal government bond, a typical provincial bond or debenture issue is used to
provide funds for program spending and to fund deficits. In the same manner that individuals
borrow funds to purchase a house today, provincial expenditures are made today in anticipation
of benefits to be received in the future. Today’s incurred debt is funded through future taxes. In
addition to directly funding public projects, there are numerous provincial guarantees that cover

municipal loans and school board issues. In some instances, provinces extend their guarantee to
industrial establishments, usually as an inducement for a corporation to locate in that province.
Most provinces (and some of their enterprises) also issue T-bills. Investment dealers and
banks purchase them, both at tender and by negotiation, for resale. Most provinces also
issue savings bonds similar to CSBs and CPBs.
MUNICIPAL SECURITIES
Today, the instrument that most municipalities use to raise capital from market sources is the
instalment debenture or serial bond. A portion of the debt of an installment debenture or
serial bond matures in each year during its term. For example, a debenture issue of $1
million may be arranged so that $100,000 becomes due each year over a ten-year period. At
the end of ten years, the entire issue will have been paid off. Some municipalities issue term
debentures that have only one maturity date but these are generally confined to larger cities
such as Montreal, Toronto and Vancouver. Present practice is to pattern issues according to
the market preference for terms and repayment schedules.
STRIP BONDS
The strip or zero coupon bond first appeared in Canada in 1982. Strip bonds are created by
a dealer who acquires a block of existing high-quality bonds. The dealer then separates or
“strips” the individual interest coupons from the principal amount of the bond. The
coupons and the principal are then sold separately at a discount to their par value.
Holders of strip bonds do not receive annual interest payments from the bond. Instead, the
strips are purchased at a discount and mature at par. The difference between the purchase
price and the maturity value is interest income for the investor. Canada Revenue Agency
deems the discounted amount to be interest income, not a capital gain, and as such, a
proportion must be reported each year.
CONVERTIBLE BONDS AND DEBENTURES

Convertible bonds and debentures possess the characteristics of bonds and debentures
because they carry a fixed interest or coupon rate and a maturity date. However, they also
offer the potential for capital appreciation through the right to exchange the debentures or
bonds for a fixed number of common shares of the same company at stated prices during a
certain period of time.
Debt Security Pricing Principles

When a company or government issues a debt security, it contracts to pay a fixed interest
rate for a fixed period of time and at maturity, repay the par or face value. Given this
definition, the current price of the debt security is a function of the coupon rate, the time to
maturity and current interest rates in the market. Since most bonds have a par value of
$1,000, the price at maturity per bond is constant.
Of the three pricing variables, only the coupon rate does not change. As time goes by, the
time to maturity obviously grows shorter. Interest rates, however, fluctuate during the life of
the debt security and are subsequently responsible for changes in the price of all outstanding
fixed income securities. As pointed out earlier, market interest rates are beyond the control
of the investor or fund manager and, therefore, are deemed to be a type of systematic risk.

For investors who expect to hold a bond to maturity, price fluctuations are not a concern.
However, if the investor sells the bond prior to maturity, changes in interest rates and bond
values may mean that the investor will receive a price greater or lower than par or the price
originally paid for the security.
DEBT SECURITY YIELDS

In the investment industry, fixed income securities are traded on the basis of yield, not price.
Debt securities can be viewed in two ways. They can be viewed as both a short-term and a long-
term investment (purchased and held to maturity). As a short-term investment, investors are
interested in the yield generated by the interest (cash flow) relative to the price paid for the bond
(the current yield). The short-term yields allow investors to compare short-term investments in
bonds with other short-term investment opportunities (GICs, savings accounts, T-bills, etc.). In
the long run, the investor must consider both the cash flow (annual interest) and the fact that he
or she may realize a capital gain or loss if the bond is purchased at a premium or at a discount,
and held to maturity. The long-term yield on a bond is called yield to maturity.
CURRENT YIELD
While bonds and debentures are usually considered long-term investments, they can be also
used as shorter-term investments. To compare short-term bond investments with other short-
term investment opportunities, the investor needs a comparative measure. One comparative
measure is referred to as the current yield and is calculated as:
Current Yield = Annual Cash Flow ´100
Amount Invested
Where:
Annual Cash Flow = the dollar amount of annual coupon payments

Amount Invested = market price at time of purchase (quoted as a percent of par)
CURRENT YIELD
An investor is considering two one-year investment alternatives. A one-year GIC with a

yield of 4.80% or a bond with a 4.75% coupon selling for 97½. Based only on yields,
which would be the better choice?
The current yield (CY) on the GIC is obviously 4.80%.
The current yield on the bond:

4.75%´$1, 000
CY = ´100 =
4.87% $975
Based strictly on current yield, the one-year bond has a slightly better rate of return (4.87%)
than the GIC yielding 4.80%.
Current yield is also used when assessing the dividend yield of a preferred or common stock.
Annual Dividend
CY = ´100
Market Value of Common Share

A stock with a current market price of $60 that pays an annual dividend of $6, therefore,
yields 10% ($6 divided by $60 times 100).
APPROXIMATE YIELD TO MATURITY

Approximate yield to maturity (AYTM) is the rate of return an investor will receive if the bond
or debenture is held from the purchase date to maturity. Unlike current yield, AYTM not only
reflects the investor’s return in the form of interest income but may also include a capital gain (or
loss). A capital gain occurs if the bond is purchased at a discount to par and held to maturity. A
capital loss, however, is incurred if the bond is purchased at a premium and held to maturity.
Current yield and AYTM also differ as a result of the definition of the price that is used in
each formula. In the current yield calculation, the market price (at time of purchase) is used.
However, a more precise yield can be calculated on long-term bond investments by
averaging the purchase price with the redemption price which is always par or 100.
In addition, the generic rate of return formula has to be adjusted to take into account that the
investor is trying to arrive at an “annual” rate of return for a bond or debenture that covers a
number of years. To do this, the calculation uses the annual interest in dollars, not the total
interest received over the term, and an annual portion of the total capital gain or loss.
The formula for the approximate yield to maturity is:
AYTM = Annual Cash Flow in Dollars + Annual Portion of Capital Gain (or Loss) ´100
(Price Paid +Price at Maturity)
2
This can be summarized as:

Annual Interest Income + Annual Price Change ´100
(Purchase Price +100)
2
Bond yields are usually based on a $100 par value (or $1,000). Therefore, the yield is not
affected by the actual amount of the bond as interest income, change in price, and purchase
price are all always based on either a $100 par value or a $1,000 par value.
Bond yields are usually rounded off to two decimal places which is accurate enough for
most purposes. The exception is Treasury bills and other money market instruments where
yields are sometimes rounded to three or more places.
While speaking of accuracy, it should be remembered that yield to maturity is an
approximation. A financial calculator or spreadsheet using the present value method is
required to achieve a precise yield. As expected, bond traders use this more precise method.

APPROXIMATE YIELD TO MATURITY
An advisor is asked for the approximate yield on a 10%, $1,000 bond due to mature in eight
years and purchased at 92.
The contractual interest obligation on this bond is 10% of par, and so $100 (10% x $1,000) of
interest income will be paid each year per $1000 of par. Interest income, or cash fl ow = $100.
The bond was purchased at $920 (0.92 x $1,000), and will mature at 1,000. Therefore, it will increase over
the remaining life of the bond by $80 ($1,000 - $920). Since there are eight years remaining in this bond’s
term, the bond will increase in price by $80 over eight years, for an annual gain of $10.
The purchase price was $920. The redemption or maturity value is $1,000. The average price is $960:
($920 +$1, 000) =
$960 2
Therefore, the approximate yield to maturity on a 10%, $1,000 bond maturing in eight years and
purchased at 92 is:
$100 +$10 ´$100
($920 +$1, 000)
2
= 11.4583%
YIELD TO MATURITY AND TIME VALUE OF MONEY

The value of any security is dependent on its expected future cash flows. For example, when
investors purchase a bond or debenture, they expect to receive interest payments for a
prescribed period plus its principal value at maturity. To determine what an investor should
pay for a bond today, we need to determine its present value using a mathematical technique
called the time value of money. This concept recognizes that future returns are not as
valuable as present values. A dollar received in the future is worth less than a dollar received
today. Or, a dollar in your hand today is worth more than a dollar likely to be in your hand
tomorrow or next month. Given a choice of $1,000 today or $1,000 in one year’s time, a
rational investor would choose the $1,000 today. Why? The $1,000 could be invested today
at the prevailing interest rate and, therefore, would be worth more than $1,000 in one year’s
time. As such, future cash flows must be reduced or discounted to arrive at a present value.
The formula for calculating the present value (today’s market value) of a bond can be
summarized as:
Present Value of Bond = Present Value of Interest Payments +
Present Value of Par Value at Maturity
While mathematical formulae can be used, financial calculators are quickly able to
provide the present value of a bond.

TREASURY BILL YIELD CALCULATIONS

Treasury bills (T-bills), as already mentioned, are very short-term securities that are issued at
a discount and mature at par. No interest is paid in the interim, so the return is generated
from the difference between the purchase price and the sale (or maturity) price.
When an investor purchases a T-bill, no capital gain or loss is expected because it is a short-
term debt instrument and its price does not usually fluctuate in value. Canada Revenue
Agency deems the difference between the price paid and the maturity value to be interest
income (a cash flow), not a capital gain. Because T-bills mature in less than a year and yields
are expressed as an annual rate, a further adjustment must be made to the generic formula.
The formula for the yield on a T-bill is:
T-bill Yield = Cash Flow ´ 365 ´100
Amount Invested Term
T-BILL YIELD
An investor purchased a 30-day T-bill for $99,000 that matures at $100,000. Calculate the
annual yield on this investment.
T-bill Yield = $100, 000 -$99, 000 ´ 365 ´100

$99, 000 30
= 0.12289´100
= 12.29
The client will generate $1,000 on an investment of $99,000, or $1,000 ÷ $99,000 = 0.0101. But
this transaction is only over 30 days. To annualize the yield: 0.0101 x 365 ÷ 30 = 0.12289.
Multiply it by 100 to turn it into a percentage.
Other Fixed-Income Products

Other fixed-income products offered by banks, trust companies, caisses populaires, insurance
companies and credit unions tend to have safety as their prime objective. As the financial
services industry becomes more integrated and investors become more sophisticated, new
products are entering the market and traditional offerings are being customized to suit the
diverse needs of investors.
TERM DEPOSITS
Term deposits offer a guaranteed rate for a short-term deposit (usually up to one year).
Usually there are penalties for withdrawing funds before a certain period (for example, the
first 30 days after purchase).
GUARANTEED INVESTMENT CERTIFICATES (GIC)

GICs offer fixed rates of interest for a specific term (longer than a term deposit). Both principal
and interest payments are guaranteed by the financial institution issuing the GIC (and also
insured/guaranteed by the Canada Deposit Insurance Corporation, subject to certain rules). They
can be redeemable or non-redeemable. Non-redeemable GICs cannot be cashed before maturity,
except in the event of the depositor’s death or extreme financial hardship. Interest rates on

redeemable GICs are lower than standard GICs of the same term since they can be cashed
before maturity.
Recently, financial institutions have been customizing their GICs to provide investors with
more choice. For instance, investors can choose a term of up to ten years depending upon the
amount invested (for less than a month, it must be a large amount). Investors can also choose
the frequency of interest payments (monthly, semi-annual, annual or at maturity) and other
features. Many GICs offer compound interest.
GICs with special features include:
• Escalating-rate GICs: The interest rate increases over the GIC’s term.
• Laddered GICs: The investment is divided into equal terms (for example, a five-year $5,000
GIC can be divided into five one-year terms of $1,000 each). As each portion matures, it can be
reinvested or redeemed. This diversification of terms reduces interest rate risk. The objective is
to eventually have a ladder of 5-year GICs, with some maturing every year.
• Instalment GICs: An initial lump sum contribution is made with further

minimum contributions made weekly, bi-weekly or monthly.
• Index-linked GICs: Index-linked GICs are hybrid investment products that combine
the safety of a deposit instrument with some of the growth potential of an equity
investment. They guarantee a return of the initial investment (i.e., principal amount) at
maturity and offer some exposure to equity markets. Most financial institutions offer
these GICs. They have grown in popularity, particularly among conservative investors
who are concerned with safety of capital but want yields greater than the interest on
standard interest-bearing GICs or other term deposits. The main selling feature of an
index-linked GIC is the guaranteed return of the principal amount at maturity even if the
index to which the GIC is linked moves downward during the term of the GIC.
Yields may be a blend of guaranteed interest payments and a percentage of the returns of a
specific market index. Some GICs have returns tied to domestic markets, while others are
tied to global market indices or a combination of benchmarks.
Performance comparisons are difficult; however, some features can and should be compared
in determining whether to invest in index-linked GICs. Along with having different
underlying benchmarks, the terms of these securities will vary. Some tie returns to the level
of the index on a particular date. Some base the return on the average return posted by the
index for a number of periods during the GIC’s term. Others offer “locking-in” provisions
that allow investors to protect (i.e., lock-in) the returns earned as at a specific date, regardless
of what happens afterwards to the performance of the index.
CDIC insures index-linked certificates against issuer default just as it does for conventional
fixed-rate GICs. However, this insurance underlines the fact that returns on index-linked
GICs are considered interest income and are fully taxable.
Although the primary risk to holders of these securities in a market downturn is the forgone
interest that would have been earned by a conventional GIC, this limited risk also implies limited
potential for gain. Holders of these instruments do not necessarily participate fully in the returns
earned by equity markets. Issuers may cap the return of an index-linked GIC at a level below the

potential return of the index. For instance, if the GIC has a 25% cap on returns over a three-year
term and the underlying benchmark goes up by 35%, the investor would get a maximum
of 25%.
• Interest-rate-linked GICs: Interest rates are linked to changes in other rates such as
the prime rate, the bank’s non-redeemable GIC interest rate or money market rates.
Some financial institutions have also developed GICs with specialized features, such as
the opportunity for redemption in a medical emergency or as a vehicle to save for a
home, where regular contributions accumulate towards a down payment.
Preferred Shares
Preferred shares are a hybrid of bonds and common shares. Preferred shares are similar to
bonds in that they offer shareholders a fixed income by paying a regular fixed dividend.
Unlike a bond, however, dividend payments are not guaranteed. It is up to the company’s
board of directors to decide if its preferred dividend payment will be made for that period.
Typically, preferred shareholders rank between the company’s creditors and common
shareholders. They are better protected than the common shareholders but junior to the
claims of the debtholders. It is important to keep in mind that bond and debenture holders are
creditors and preferred shareholders are part owners (as are common shareholders). As noted,
debtholders rank first, preferred shareholders rank second and common shareholders rank
last in the event of a company’s dissolution.
COMMON SHARES
LEARNING OBJECTIVES
• Define the major types of securities trading in capital markets: stocks and stock
market indices.
Introduction
Common shareholders are the owners of a company who initially provide the equity capital
required to start the business. If the venture prospers, the shareholders benefit from the
growth in value of their original investment and from the flow of dividend income. The
prospect of a small investment growing to many times its original value attracts many
investors to common shares. On the other hand, if the business fails, the common
shareholders may lose their entire investment. This possibility of total loss explains why
common share capital is often called venture or risk capital.
Although considered to be a part owner of the business, the common shareholder is in a relatively
weak position, as senior creditors (such as banks), bond and debenture holders and preferred
shareholders all have prior claims on the earnings and assets of the company. Unlike debt interest,
dividends are payable at the discretion of the directors. In many companies, dividend payments

are a routine matter and regularly anticipated by shareholders. Some companies

reinvest all earnings in the business; others lack sufficient earnings to pay dividends.
Rights and Benefits of Common Share Ownership

Common share ownership includes the right to:
• Elect directors, vote on major issues that affect the company and approve
financial statements and auditor’s reports.
• Receive copies of the annual and quarterly reports and other mandatory
information pertaining to the company’s affairs.
• Examine certain company documents such as the by-laws and the register of
shareholders at specified times.
• Question management at shareholders’ meetings.
• Have limited liability.
Benefits of common share ownership include:
• Potential for capital appreciation.
• The right to receive any common share dividends if declared by the company.
• Voting privileges.
• The possibility of enhanced returns through the dividend tax credit.
• Marketability – shares in most public companies can easily be bought or sold.
For many investors, the prospect of capital appreciation is the main attraction of common
shares and, over time, such an attraction has been justified although not all common shares
fulfill this expectation. However, historical returns also indicate that common share prices
can be highly volatile.
As companies earn profits year after year, whatever money is not paid out to shareholders in the
form of dividends will remain in the company as retained earnings. Since retained earnings
form part of common equity, a growth in retained earnings will add to the value of
shareholders’ equity. Assuming a fairly constant number of shares outstanding, the amount
of equity that belongs to each share will increase.
An increase in earnings can lead to an increase in the dividend rate and since yield is
another factor that investors take into account when evaluating stocks, dividend growth can
also lead to an increase in the price of the stock.
Voting rights are an important benefit of common share ownership. However, companies
sometimes have two (or even three) different types of common shares, often designated as Class
A or B. Because all classes may not have voting rights and may differ in other respects such as
dividend entitlement, it is important to know their respective features. Policies have been adopted
to avoid possible investor confusion regarding the rights associated with different voting classes.

Tax Treatment of Common Shares

Investors purchase common shares in anticipation of earning capital gains, which is an
increase in the share price over time (also referred to as capital appreciation). Capital gains
receive preferential tax treatment. Only 50% of any capital gain is added to income and
taxed at the investor’s marginal rate.
Some common shares also pay dividends. If the dividends are from a Canadian company
(i.e., eligible dividends), the investor benefits from the dividend tax credit mechanism —
dividends received in 2011 are “grossed up” by 41% (i.e., 41% is added to the amount of
dividends received) and the grossed-up amount is shown as dividend income on the tax return. A
compensating dividend tax credit equal to 16.44% of the grossed-up amount can be claimed. The net
result is a relatively lower rate of tax on dividend income than what’s payable on interest income. For
example, in BC, at the top marginal rate, interest is taxed at nearly 44%, eligible dividends are taxed
at around 24% and capital gains at close to 22%. That’s why dividends and capital gains are favoured
as a source of income by taxpayers in the upper income brackets.
Stock Market Indices

An index is a statistical measure of the state of the stock market, based on the performance of
certain stocks. There are numerous stock market indices in Canada. The Toronto Stock Exchange
(TSX), the country’s largest, lists 20 indices ranging from the bellwether S&P/TSX Composite
Index and the S&P/TSX 60 Index to lesser known indices such as S&P/TSX Capped Utilities
Index and S&P/TSX Small Cap Index. The S&P/TSX Composite Index is considered to be the
“mirror of the Canadian stock market” and includes over 200 of the largest companies in Canada
while the S&P/TSX 60 Index includes the 60 largest companies in Canada and is akin to the Dow
Jones Industrial Average in the US, in terms of its importance and status in Canada.
DERIVATIVES
LEARNING OBJECTIVES
• Define the major types of securities trading in capital markets: derivatives, options,
futures contracts, rights and warrants.
Introduction
Derivatives are financial instruments that allow market participants to more easily trade
and/ or manage the asset upon which these instruments are based. They are used
extensively by institutional investors, mutual fund managers and speculators. Derivatives
are not asset classes unto themselves. Their values are derived solely from an underlying
interest, which may be a commodity such as wheat or a financial product such as a bond,
stock, foreign currency or an index.
While a stock or bond has a value that can be related to an income flow or an asset base, most of
the value of a derivative stems from the security upon which the derivative is based. A company

can issue derivatives to investors as a method of raising capital or individual investors can
issue them to other parties.
This section covers company-issued derivatives such as rights and warrants and exchange-
traded equity options, and index options. Futures and forwards are also considered in this
chapter as they also derive their value from an underlying security or commodity, such as
corn, hog bellies (bacon), indexes and currencies.
Rights
A right is the term applied to the privilege granted to existing shareholders to acquire
additional shares directly from the issuing company. To raise capital through the issuance
of additional common shares, a company may offer each shareholder the right to buy shares
in direct proportion to the number of shares already owned. For example, the offer may be
based on the right to buy one additional new share for each ten shares held. The
subscription or offering price for the new shares is set lower than the current market price
to entice investors to purchase the new shares. Rights are typically short-term in nature
with a lifespan of between four and six weeks.
Rights are issued to the shareholder in the same way as dividends are paid. The company’s books of
record are closed on a certain date, known as the record date, and all common shareholders
appearing in the record on that date receive rights – typically one right for each share held.
The rights are transferable, and certificates for the proper number of rights are mailed to
each shareholder.
Warrants
The most common definition of a warrant refers to the certificate that allows the holder to buy
shares in the company directly from the company at a set price for a set period of time. Warrants
are often attached to new debt and preferred share issues to make these issues more attractive
to buyers. Warrants give the new issue buyers the potential to participate in capital gains on the
underlying common share’s market price, thereby functioning as a sweetener (or equity kicker).
They are usually detachable either immediately or after a certain holding period and then trade
separately. A warrant’s lifespan is longer than that of a right and normally extends from one to
several years from date of issue. One of the main attractions of warrants is their leverage
potential. Warrants are usually priced much lower than the underlying stock and the warrant tends
to move in the same direction and to the same degree as changes in the price of the stock.
Options
An option is a contract or agreement between a buyer and seller based on a particular asset or
security called the underlying security. The buyer pays a premium or fee to obtain certain rights
from the seller who receives this amount and in turn, takes on an obligation. The contract has a
limited lifespan or time to expiry. The date on which the contract expires is known as the expiry
date and the price or level at which the rights granted to the buyer can be exercised is called
the strike or exercise price. The contract is based on a particular number of shares or units of
the underlying security. In the case of an equity option listed on an exchange, the underlying
contract size is always 100 shares. Options are usually bought or sold through an exchange
facility and, as such, exchange-traded options have a secondary market.

CALL OPTIONS
There are two types of options – calls and puts. A call option grants its holder (or buyer) the
right to buy the underlying security at the strike or exercise price at any time until expiration.
The seller (or writer) of the call has the obligation to sell or deliver the underlying security at
the strike price until the expiry date.
An investor purchasing a call option contract believes that the price of the underlying security
will rise in value. The investor could, of course, purchase the underlying security itself, using
either a cash or margin account. But buying a call option typically offers the greatest potential
return. The decision will depend on the strength of the investor’s belief that the price will
rise. The seller of the call option, on the contrary, believes that the price of the underlying
security will remain the same or decline in value.
PUT OPTIONS
A put option grants the holder or buyer the right to sell the underlying security at the strike
price until the expiry date while the seller or writer of a put has the obligation to buy or take
delivery of the underlying security until the expiry date. The holder of the put option believes
that the price of the underlying security will decline. The seller of the put option, on the
contrary, believes that the price of the underlying share will remain the same or rise in price.
RIGHTS AND OBLIGATIONS ASSOCIATED WITH OPTION POSITIONS

Table 5.3 provides an easy way to remember the rights and obligations associated with
option positions.
TABLE 5.3 RIGHTS AND OBLIGATIONS ASSOCIATED WITH OPTION POSITIONS
Holder or Buyer Seller or Writer

Pays Premium Receives Premium
CALL Has a RIGHT to BUY Has an OBLIGATION to SELL
An underlying interest at a fixed price for a specified time period
Pays Premium Receives Premium

PUT Has a RIGHT to SELL Has an OBLIGATION to BUY
An underlying interest at a fixed price for a specified time period.
Futures and Forwards

Both futures and forwards contracts are derivative instruments used extensively as a risk
management tool by portfolio managers, corporations and manufacturers as well as individual
investors and other hedgers. Speculators wishing to profit from market behaviour also use
futures. Like options, both futures and forwards allow the investor to use a great deal of leverage.
Often very little margin is required from the investor to initiate a trade in these instruments and
although this leverage can be advantageous, it can lead to tremendous risk. Any person trading in

futures and forwards markets should be fully aware of the total risk involved with any trade
and should have the financial resources available to cover worst-case losses.
Futures contracts are legally binding commitments to deliver or take delivery of a specified
quantity and quality of a commodity at a specified future time period and at a price agreed
upon when the contract is initiated. These products trade by open outcry in the trading pit
of a commodity or futures exchange. The delivery time period can be a four to six week
window in the case of a commodity such as corn or wheat or one day for an index contract.
A futures contract does not entail an immediate transfer of ownership of the underlying security.
The contract is set at today’s market prices but is for delivery or consummation sometime in the
future. In actuality, most contracts are closed out in the marketplace prior to this delivery date so
physical deliveries are rare and occur only in about 2% of all futures contracts.
In addition to agricultural products such as wheat, canola, corn, coffee, cocoa, hogs and
cattle, metals (e.g., gold, copper and silver), lumber and plywood, certain foreign currencies
and heating oil also trade on futures markets. Some financial instruments, including several
types of interest rate products and stock indexes, also trade as futures contracts.
Forwards are the over-the-counter equivalent of futures contracts. A forward allows the holder to
make or take delivery of the underlying commodity or financial instrument at some time in the future
at a price that has been negotiated based on today’s market values. Unlike a future, a forward is a
contract between two individuals rather than a contract negotiated on an exchange floor. Forward
contracts have advantages over futures contracts because the details can be tailored
to meet the exact needs of the parties. Forwards, however, can suffer from illiquidity because
there may not be another party willing to accept such a specific contract. Another risk with
forwards is default risk. Futures are cleared through a clearing corporation that guarantees the
performance of the contract. Forwards are backed only by the credit-worthiness of the two parties.
MANAGED PRODUCTS – MUTUAL FUNDS
LEARNING OBJECTIVES
• Describe how a mutual fund works.
Introduction to Mutual Funds

Over the years, a diverse range of managed fund products has emerged to meet the many different
investment objectives of the investing public. The majority of products are individual mutual
funds that are typically part of larger fund families in which a central company manages several
different funds, each with distinct investment objectives. Theses funds are distributed either
directly by the company’s own sales force or through stockbrokers and independent mutual fund
salespeople. Other fund groups are managed and sold in-house (called proprietary funds) by trust
companies, banks, life insurance companies and credit unions.
A fund’s prime investment goals are stated in the fund’s prospectus and generally cover the degree of
safety or risk that is acceptable, whether income or capital gain is the prime objective and the

main types of securities in the fund’s investment portfolio. Individuals who sell mutual
funds must have a good understanding of the type and amount of risk associated with
each type of fund.
An investment fund is a company or trust engaged in managing investments for other people. By
selling shares or units to many investors, the fund raises capital which is then invested according
to the fund’s investment policies and objectives. The fund makes money from the dividends and
interest it receives on the securities it holds and from capital gains obtained through trading its
investment portfolio. A mutual fund may be organized as either a trust or a corporation.
The mutual funds industry in Canada has experienced tremendous growth since 1980. In
1980, mutual fund net assets totalled only $3.6 billion in Canada. By 2000, mutual fund
net assets grew to more than $418 billion. By the end of 2009, mutual fund net assets
totalled approximately $595 billion (source: Bloomberg).
ADVANTAGES OF INVESTING IN MUTUAL FUNDS

Mutual funds offer many advantages for the investing public. Besides offering varying
degrees of safety, income and growth, their chief advantages are:
Low Cost Professional Management

The fund manager, an investment specialist, manages the fund’s investment portfolio on a
continuing basis. Most investors purchase mutual funds because they do not have the
time, knowledge or expertise to monitor their portfolio of securities. It is an inexpensive
way for the small investor to access professional management of their investments.
The fund manager’s job is to analyze the financial markets and select securities that best match
a fund’s investment objectives. The fund manager also plays the important role of continuously
monitoring fund performance in order to fine-tune the fund’s asset mix as market conditions
change. Professional management is especially important when it comes to specialized asset
categories, such as overseas regional funds, sector funds or small-cap funds. These specific
types of funds are called specialty funds.
Diversification
A typical large fund might have a portfolio consisting of 60 to 100 or more securities in 15
to 20 industries. For the individual investor, acquiring such a large portfolio of stocks is
probably not feasible. Because individual accounts are pooled, sponsors of managed
products enjoy economies of scale that can be shared with mutual fund shareholders or
unitholders. In addition, managed funds have access to a wider range of securities and can
trade more economically than an individual investor. Consequently, fund ownership
provides a low cost way for small investors to acquire a diversified portfolio.
Variety of Types of Funds/Transferability

Many different types of funds, from fixed income funds to aggressive equity funds, are
available which enables investors to meet a wide range of objectives.
Most fund families also permit investors to transfer between two or more funds that are
managed by the same sponsor at small or no additional fees. Transfers are also usually
permitted between different purchase plans under the same fund.

Variety of Purchase and Redemption Plans

There are many purchase plans, ranging from one-time, lump-sum purchases to regular
purchases in small amounts under periodic accumulation plans (pre-authorized contribution
plans or PACs). One of the main advantages of mutual funds is the small amount of money
required to invest. With as little as $100, an investor can begin to purchase units in a fund and
make regular contributions through a PAC. Investors who want to redeem their funds also
have a wide variety of plans to choose from.
Liquidity
Mutual fund shareholders have a continuing right to redeem shares for cash at net asset
value. Payments upon redemption must be made within three business days, in keeping
with security industry settlement requirements.
Ease of Estate Planning

A mutual fund share or unit represents a broadly diversified portfolio that continues to be
professionally managed during the probate period until estate assets are distributed. In
contrast, other types of securities may not be readily traded during the probate period even
if market conditions undergo dramatic changes.
Loan Collateral
Fund shares are usually accepted as security for a bank loan.
Margin Eligibility
Fund shares are acceptable for margin purposes and, as such, allow aggressive fund buyers
access to the benefits and risks of leverage in their financial planning.
Various Special Options

Mutual funds consist of not only an underlying portfolio of securities, but also a package of
customer services. Most mutual funds offer the opportunity to compound an investment
through the reinvestment of dividends.
Other benefits associated with managed products include record-keeping features that save
time for clients and their advisors when complying with income-tax reporting and other
accounting requirements. For example, mutual fund companies that administer registered
plans had procedures that monitored an account and flagged it for action if an individual
investor exceeded the 30% limit on foreign content. The February 2005 federal budget
eliminated the 30% foreign property rule, to allow broader international diversification
opportunities for retirement investments.
In sum, mutual funds offer a wide range of flexible money management services.
DISADVANTAGES OF INVESTING IN MUTUAL FUNDS
Costs
For most people, a weakness in investing in a mutual fund is the perceived steepness of their sales and
management costs. Historically, most mutual funds charged a 9% front-end load or sales commission
in addition to a management fee. In comparison, brokers typically charge around a 3% commission on
single stock purchases. Competition in the market has subsequently reduced both load and
management fees and investors are now offered a wider choice of investment

options. Many providers (especially the large chartered banks) offer hundreds of funds for
sale on a “no load” basis.
Unsuitable as a Short-Term Investment

Most funds emphasize long-term investment and, consequently, are unsuitable for investors who
are seeking short-term performance. Since sales charges are often deducted from a plan holder’s
contributions, purchasing funds on a short-term basis is not generally beneficial. An investor
would want to recoup the sales charges, at the very least, on each trading transaction. This
disadvantage does not apply to money market funds which are designed with liquidity in mind.
Unsuitable as an Emergency Reserve

With the exception of money market funds, fund holdings are generally not recommended
as an emergency cash reserve, particularly during declining or cyclically low markets when
a loss of capital could result from an emergency redemption or sale.
Professional Investment Management Is Not Infallible

Like equities, mutual fund shares or units can decline in falling markets where unit values are
subject to market swings (systematic risk). Volatility in the market is extremely difficult to
predict or time and is not controllable by the fund manager.
Tax Complications
Buying and selling by the fund manager creates a series of taxable events that may not suit
an individual unitholder’s time horizon. For example, although the manager might consider it
in the best interests of the fund to take a profit on a security holding, an individual unitholder
might have been better off if the manager had held on to the position and deferred the capital
gains liability.
The Structure of a Mutual Fund
MUTUAL FUND COMPANIES

Mutual fund companies may be set up as federal or provincial corporations. Provided that
they meet certain conditions set out in the Income Tax Act, investment fund corporations
are eligible for a special taxation rate. Under the Act, the corporation’s holdings must
consist mainly of a diversified portfolio of securities and its income must be derived
primarily from the interest and dividends paid out by these securities and any capital gains
realized from the sale of these securities for a profit. Investors in mutual fund corporations
receive shares in the fund instead of units that are sold to investors in mutual fund trusts.
DIRECTORS
The directors of a mutual fund corporation and the trustees of a mutual fund trust hold the
ultimate responsibility for the activities of the fund by ensuring that the investments are in
keeping with the fund’s investment objectives. To assist in this task, the directors or
trustees of the fund may contract the business of running the fund to an independent fund
manager, a distributor and a custodial organization. While the fund itself issues and
redeems its own securities, it may enter into detailed contracts (with independent
managers, distributors and custodians) that identify the services each will provide and the
fees and other charges to which each is entitled.

THE FUND MANAGER

The fund manager provides day-to-day supervision of the fund’s investment portfolio. In trading
the fund’s securities, the manager must observe a number of guidelines specified in the fund’s
own charter and prospectus as well as constraints imposed by provincial securities commissions.
Other responsibilities of a fund’s manager include calculation of the fund’s net asset value or
price per unit or share, preparation of the fund’s prospectus and reports and supervision of
shareholder or unitholder record-keeping. The fund manager must also provide the custodian
with documentation for the release of cash or securities. The fund manager receives a
management fee for these services. This fee is paid annually and is calculated as a percentage
of the net asset value of the managed fund.
DISTRIBUTORS
Mutual funds are sold in many ways: by advisors employed by securities firms, by a sales
force employed by some organizations that control both management and distribution (e.g.,
Investors Group), by independent direct sales organizations and by “in-house” distributors.
The latter include employees of trust companies, banks and credit unions who have duties
other than selling.
CUSTODIAN
When a mutual fund is set up, an independent financial organization, usually a trust
company, is appointed as the fund’s custodian. The custodian collects money received from
the fund’s buyers and from portfolio income and arranges for cash distributions through
dividend payments, portfolio purchases and share redemptions.
Sometimes, the custodian also serves as the fund’s registrar and transfer agent and is
responsible for maintaining ownership records.
Pricing of Mutual Funds Units or Shares
OFFERING/REDEMPTION PRICE
Mutual fund shares or units are purchased directly from the fund (often through a distributor)
and are sold back to the fund when the investor redeems his or her units. Given that they
cannot be purchased from or sold to anyone other than the fund, mutual funds are said to be
in a continuous state of primary distribution. Securities sold in the primary market are
usually sold through an information document known as a prospectus and mutual funds are
no exception to this rule.
The price an investor pays for a share or unit is known as its offering price. In the financial
press the offering price is expressed as the net asset value or NAV. The redemption or selling
price is the price the investor receives when he or she sells the shares or units back to the fund.
When an investor purchases or sells a mutual fund share or unit, the price paid or received will
equal or be very close to the value of the net assets held. It is usually expressed on a per share or
unit basis called net asset value per share (NAVPS). This price is based on the NAVPS at the close
of business on the day that the order was placed. The NAVPS is the theoretical amount a fund’s
shareholders would receive for each share if the fund were to sell its entire portfolio of investments
at market value, collect all of its receivables and pay all of its liabilities.

If a mutual fund does not charge a commission when a share or unit is purchased, an
investor would pay the fund’s current NAVPS. NAVPS is calculated as:
Total Assets -Total Liabilities
NAVPS =
Total Number of Shares or Units Outstanding
For example, ABC fund has $13 million in assets, $1 million in liabilities and one million
units outstanding. The offering price (the price paid by an investor for one unit) would be
calculated as:
NAVPS = $13, 000, 000 -$1, 000, 000 = $12 per unit
1, 000, 000
This would also be the redemption price if no sales charges or fees were levied at redemption.
Mutual Funds Fees

Mutual funds can be categorized according to the type of sales commission or load. If
loads are charged when the investor purchases shares or units, they are called front-end
loads; if fees are charged at redemption, they are called back-end loads. Most load funds
let the investor choose between front-end or back-end charges.
FRONT-END LOADS
Some funds charge a front-end load which is payable to the distributor at the time of
purchase. It is usually expressed as a percentage of the purchase price or NAVPS. The
percentage typically decreases as the purchase amount increases.
Investors should be aware that the front-end load effectively increases the purchase price of
the units and, consequently, reduces the actual amount invested. For example, a $1,000
investment in a mutual fund with a 4% front-end load means that $40 (4% × $1,000) goes to
the distributor while the remaining $960 is actually invested.
Regulations require that front-end loads must be disclosed in the prospectus both as a percentage
of the purchase amount and as a percentage of the net amount invested. In the example above,
the prospectus would state that the front-end load charge would be 4% of the amount purchased
(($40 ÷ $1,000) × 100) and 4.17% (($40 ÷ $960) × 100) of the amount invested.
To determine a fund’s offering or purchase price when it has a front-end load charge, you
must first determine the NAVPS and then make an adjustment for the load charge. Using an
NAVPS of $12 and a front-end load of 4%, the offering or purchase price is calculated as:
Offering or Purchase Price = NAVPS
100% -Sales Charge
So:
Offering or Purchase Price = $12 = $12 = $ 12 = $12.50
100% - 4% 1.00 -0.04 0.96
Note that the sales charge of 4% of the offering price is the equivalent of 4.17% of the net
asset value (or net amount invested):
4% of $12.50 = $0.50
$0.50
= 4.17%
$12

NO-LOADS
Many mutual funds, primarily those offered by direct distribution companies and banks, are
sold to the public as no-loads with little or no direct selling charges. Although there are no
direct selling charges, some discount brokers may levy modest “administration fees” to
process the purchase and/or redemption of no-load funds. These funds, like other funds,
charge management or other administrative fees.
There was a great deal of controversy when no-load funds were introduced. Many felt that
funds had to make money somewhere. As such, the no-load funds were said to have higher
management fees. Prospective purchasers of no-load mutual funds should read the
prospectus carefully as this may or may not be true. Higher management fees may allow
some no-load funds to compensate salespeople through ongoing trailer or service fees, which
are described in more detail below.
BACK-END LOADS OR DEFERRED SALES CHARGES

A growing number of funds do not apply sales charges on the original purchase, except
for perhaps a nominal initial administrative fee, but instead, levy a fee at redemption.
This type of fee is known as a back-end load, redemption charge or deferred sales charge
(DSC). The fee may be based on the original contribution to the fund or on the net asset
value at the time of redemption.
In most cases, deferred sales charges decrease with the length of time that the fund is held. For
example, an investor could be subject to the following schedule of deferred sales charges:
Year Funds Are Redeemed Deferred Sales Charge

Within the fi rst year 6%
In the second year 5%
In the third year 4%
In the fourth year 3%
In the fi fth year 2%
In the sixth year 1%
After the sixth year 0%
For example, an investor purchases units in a mutual fund at an NAVPS of $10. If the
investor decides to sell the units in the fourth year when the NAVPS is $15, the fund will
charge a 3% DSC.
If the back-end load (i.e., DSC) is based on the original purchase amount, the investor
would receive $14.70 a unit, calculated as:
Selling/Redemption Price = Current NAVPS – DSC
= Current NAVPS – (NAVPS at purchase x DSC percentage)
= $15 – ($10 x 3%)
= $15 – $0.30
= $14.70

If instead, the back-end load is based on the NAVPS at the time of redemption, the
investor would receive $14.55, calculated as:
Selling/Redemption Price = $15 – ($15 x 3%)
= $15 – $0.45
= $14.55
TRAILER FEES
Another kind of fee is the trailer fee, sometimes called a service fee. This is a fee that a
mutual fund manager may pay to the distributor that sold the fund. This fee is paid to the
advisor each year as long as the client holds the fund. Service fees are usually paid from
the fund manager’s management fee.
OTHER FEES
A small number of funds charge a set-up fee in addition to a front-end load or back-end load.
A variation of the redemption fee is the early redemption fee. Some funds, even no-load
funds, note in the prospectus that funds redeemed within 90 days of purchase may be
subject to an early redemption fee such as 2%. These fees are charged to discourage short-
term trading and to recover administrative and transaction costs.
SWITCHING FEES
Switching fees may apply when an investor exchanges units of one fund for another fund in
the same family or fund company. Some mutual fund companies allow unlimited free switches
between funds while others permit a certain number of free switches per calendar year.
MANAGEMENT FEES
Management fees vary widely depending on the type of fund, with fees ranging from less than 1% on
money market and index funds to as much as 3% on equity funds. In general, fees will vary depending
on the level of service required to manage the fund. For example, management fees associated with
money market funds are low, in the range of 0.50% to 1%. The management of equity funds (with the
exception of index funds) requires ongoing research and, therefore, higher management fees that
range from 2% to 3%. Index funds, however, try to mirror the market with occasional re-balancing.
Since this strategy is largely a passive buy and hold strategy, management fees are usually lower. In
all cases, management fees are outlined in the prospectus.
Management fees are generally expressed as a straight percentage of the net assets under
management. For example, they could be “an annual fee of not more than 2% of the average
daily net asset value computed and payable monthly on the last day of each month”. This
method of compensation has been criticized because it rewards fund managers on the level of
assets managed and not on the performance of the fund. Of course, a fund that consistently
underperforms will find that its assets will fall as investors redeem their holdings.
The management fee compensates the fund manager but it does not cover all the expenses of
a fund. Other operating expenses like interest charges, audit and legal fees, safekeeping and
custodial fees and the costs of providing information to shareholders or unitholders are charged
directly to the fund. The management expense ratio (MER) represents the total of management
fees and other expenses charged to a fund; it is expressed as a percentage of the fund’s average

net asset value for the year. Trading or brokerage costs are excluded from the MER
calculation because they are included in the cost of purchasing or selling portfolio assets.
MER is calculated as:
Aggregate Fees and Expenses Payable During the Year ´100

Average Net Asset Value for the Year
All expenses are deducted directly from the fund and are not charged to the investor. As such,
fund expenses decrease the ultimate returns to the investors. For example, if a fund reports
a compound annual return of 7.5% and an MER of 2.5%, it has a gross return of
roughly 10%. This means that the MER, expressed as a percentage of returns, is 25%
of the return [(2.5% ÷ 10%) × 100].
Published rates of return are calculated after the management expense ratio has been
deducted and the NAVPS of investment funds is calculated after the management fee has
been deducted. Funds are required by law to disclose in the fund prospectus both the
management fee and the management expense ratio for the last five fiscal years.
REDEEMING MUTUAL FUND UNITS OR SHARES
LEARNING OBJECTIVES
• Identify non-insurance investment products where redemptions would have

tax implications.
After acquiring shares in a mutual fund, an investor may decide to dispose of his or her
shares or units. The mechanics of disposing fund units are fairly straightforward. The client
must notify the fund or the fund’s distributor and request redemption of all or part of his or
her units or shares. At the end of the valuation day, the net asset value is calculated and a
cheque is sent to the investor.
Calculation of the Redemption or Selling Price

Mutual funds redeem their shares on request at a price that is equal to the fund’s NAVPS. If
there are no back-end load charges, the investor receives the NAVPS. If there are back-end
load charges or deferred sales charges, the investor receives the NAVPS less the DSC.
Tax Consequences
Mutual funds can generate taxable income in two ways:
• Through the distribution of interest income, dividends and capital gains realized by
the fund.
• Through any capital gains realized when the fund units/shares are eventually sold.

ANNUAL DISTRIBUTIONS
When mutual funds are held outside a registered plan (such as an RRSP or RRIF), the
unitholder of a mutual fund is sent T3 and T5 forms. Each form lists all income that has been
paid out during the year including dividends that have been reinvested. Both forms show the
types of income distributed including foreign income and Canadian interest, dividends and
capital gains. Each type of income is taxed at the fundholder’s personal rate in the year that
the income was received.
For example, an investor purchases an equity mutual fund for $10 per share and in each of the
next five years, receives $1 in annual distributions composed of $0.50 in dividends and $0.50
in distributed capital gains. Each year, the investor would receive a T5 from the fund company
indicating that he or she must report an additional $1 in income. The T5 could indicate
offsetting dividend tax credits (from dividends earned from taxable Canadian corporations).
It is sometimes difficult for mutual fund investors to understand why they have to declare capital
gains when they have not sold any of their units. There is, however, a simple explanation. The
fund manager buys and sells stocks throughout the year for the mutual fund. If the fund manager
sells a stock for more than its purchase price, a capital gain results. It is this capital gain that is
passed on to the mutual fund holder. Unfortunately, a capital loss that arises when a stock is
sold for less than its purchase price cannot be passed on to the mutual fund holder. These losses,
however, are held in the fund and may be used to offset capital gains in subsequent years.
CAPITAL GAINS ON SHARES OR UNITS

When a fund holder redeems the shares or units of the fund, the transaction is considered a
disposition for tax purposes and may give rise to either a capital gain or a capital loss. Only
50% of net capital gains (total capital gains less total capital losses) are added to the
investor’s income for tax purposes.
Suppose in the above example that the mutual fund shareholder sold his or her shares in the fifth
year at an NAVPS of $16. Having bought them at NAVPS of $10, the investor would have to
report an additional $3.00 in income (per share) for the year (50% × $6 capital gain). This capital
gain would not be shown on the fund’s T5, as this was not a transaction initiated by the fund.
ADJUSTING THE COST BASE

A potential problem may arise when an investor chooses to automatically reinvest fund income in
additional non-registered fund units. The complication arises when the fund is sold and capital
gains must be calculated on the difference between the original purchase price and the sale price.
The adjusted cost base of the investor’s fund holdings will include the original units purchased
plus those units purchased over time through periodic reinvestment of fund income. This mix
of original and subsequent units can make it difficult to calculate the adjusted cost base of
the investment in the fund. Many investment funds provide this information on quarterly or
annual statements. If these statements are not kept, it could be very time consuming to
attempt to reconstruct the adjusted cost base of the investment. In addition, if careful records
have not been kept, the investor could be taxed twice on the same income.
For example, consider the case where an investor buys $10,000 of fund units. Over time, annual
income accrues and tax is paid on it, but the investor chooses to reinvest the income in additional
fund units. After a number of years, the total value of the portfolio rises to $18,000 and the
investor decides to sell the fund. A careless investor might assume that a capital gain of $8,000
has been earned. This would be incorrect as the $8,000 increase is actually made up of two

factors: the reinvestment of income (on which the investor has already paid taxes) and a
capital gain. The portion of the increase due to reinvestment must be added to the original
investment of $10,000 to come up with the correct adjusted cost base for calculating the
capital gain. If, for example, the investor had received a total of $3,500 in reinvested
dividends over the course of the holding period, the adjusted cost base would be $13,500 (the
original $10,000 plus the $3,500 in dividends that have already been taxed). The capital gain
is then $4,500 ($18,000 - $13,500), not $8,000.
DISTRIBUTIONS TRIGGERING UNEXPECTED TAXES

During each year, a mutual fund will realize capital gains and losses when it sells securities
held in the fund. Capital gains are distributed to the fund investors just as interest and
dividends are distributed. If this distribution of capital gains is done only at year-end, it can
pose a problem for investors who purchase a fund at this time.
Consider an investor who purchased a non-registered equity mutual fund on December 1 at an
NAVPS of $30. This fund had a very good year and earned capital gains of $6 per share.
These capital gains are distributed to the investors at the end of December. As is the case with
all distributions, this causes the NAVPS to fall by the amount of the distribution, to $24. At
first glance, one might think that the investor is just as well off, as the new NAVPS plus the $6
distribution equals the original NAVPS of $30. Unfortunately, the $6 distribution is taxable in
the hands of the new investor, even though the $6 was earned over the course of the full year.
For this reason, some advisors caution investors against buying a mutual fund just prior to the
year-end without first checking with the fund sponsor to determine if a capital gains
distribution is pending.
MUTUAL FUND REGULATION, TYPES, COMPARABLE RISKS

AND RETURNS
LEARNING OBJECTIVES
• Describe risk and volatility as they relate to mutual funds.
• Compare and contrast the investment instruments, risk, and volatility of various types of
funds, including: money market funds, mortgage funds, bond funds, dividend funds,
equity funds, international and global funds, specialty funds, real estate funds, balanced
funds, asset allocation funds, index funds, and fund of funds.
Self-Regulatory Organizations (SROs)

Canadian funds fall under the jurisdiction of the securities acts of each province. Securities
administrators control the activities of these funds and their managers and distributors,
through a number of National and Provincial Policy Statements that deal specifically with
mutual funds, and by provincial securities legislation applicable to all issuers and
participants in securities markets.

The Mutual Fund Dealers Association (MFDA) is the mutual fund industry’s SRO for the
distribution side of the mutual fund industry. It does not regulate the funds themselves. That
responsibility remains with the securities commissions; however, the MFDA regulates how
the funds are sold. The MFDA is also not responsible for regulating the activities of mutual
fund dealers who are already members of another SRO. For example, IIROC members who
sell mutual fund products will continue to be regulated by IIROC.
The MFDA has essentially the same powers as other SROs. That includes the ability to
admit members, to audit and to enforce rules through a disciplinary process that can
result in fines, suspension or loss of registration.
GENERAL MUTUAL FUND REQUIREMENTS

Since fund investors buy the fund’s treasury shares rather than previously issued and
outstanding stock, the treasury shares must be registered for sale in each jurisdiction. With
certain exceptions, they must file a prospectus or simplified prospectus (described below)
each year that must be acceptable to the provincial securities administrator.
Because mutual fund investors typically purchase newly issued or treasury shares of mutual
funds, the fund is considered to be in a continuous state of primary distribution. As a result,
each purchaser must receive a prospectus.
THE SIMPLIFIED PROSPECTUS

In order to adhere to the disclosure requirements of a prospectus and allow the
industry to function smoothly, a simplified prospectus system is in place.
The simplified prospectus system consists of:
• a simplified prospectus
• the annual information forms
• the annual audited financial statements or interim unaudited financial statements
• other information required by the province or territory where the fund is distributed,
such as material change reports and information circulars
A mutual fund prospectus is usually shorter and simpler than a typical prospectus for a new
issue of common shares. Under the simplified prospectus system, the issuer must abide by
the same laws and deadlines that apply under the full prospectus system. As well, the buyer
is entitled to the same rights and privileges.
Investors purchasing a mutual fund for the first time must be provided with the simplified
prospectus, the latest financial statements and any other information required to be provided by
the province. The securities acts of most provinces require that a prospectus be mailed or
delivered to all purchasers of securities. This mailing or delivery must be made to the purchaser
not later than midnight on the second business day after the purchase. The annual information
form does not need to be included but should be available to the investor if requested.

THE ANNUAL INFORMATION FORM

Much of the disclosure required in the Annual Information Form (AIF) is similar to that
provided in the simplified prospectus. The AIF contains, in addition to the above,
information concerning:
• significant holdings in other issuers
• the tax status of the issuer
• directors, officers and trustees of the fund and their indebtedness and remuneration
• associated persons, the principal holders of securities, the interest of management and
others in material transactions
• the particulars of any material contracts entered into by the issuer
THE FINANCIAL STATEMENTS

As part of the simplified prospectus system, each fund must provide its investors with financial
statements. Annual audited financial statements must be made available to the securities
commission(s) where the fund is registered on or before the deadline set by the commission(s).
Unaudited financial statements as at the end of six months after the fund’s year-end must
also be submitted to the securities commissions, usually within sixty days after the reporting
date. These statements must also be distributed to new investors.
The following financial statements must be provided:
• The Balance Sheet (Statement of Financial Position/Statement of Net Assets)
• The Income Statement
• Statement of Investment Portfolio
• Statement of Changes in Net Assets
• Statement of Portfolio Transactions
Types of Mutual Funds

Mutual funds offer different risks and rewards to investors and advisors have an
obligation to match appropriate funds with the needs of their clients.
Risk is often discussed in terms of volatility. The more volatile the security or mutual fund,
the greater is the risk. Mutual funds reduce risk through diversification but not all risk can be
diversified away. The following sections discuss those risks that cannot be diversified away,
management fees, and the types of returns an investor expects to receive and the
associated tax implications of these returns.
It was believed that if portfolios were diversified internationally, further risk reduction
would result. While this is marginally true, it is now realized that global markets interact.
For example, when North American markets decline, Asian markets also tend to decline.
Moreover, investing internationally adds a new risk dimension by exposing investors to
foreign exchange risk or currency risk.

All individual risks can be diversified away by creating portfolios. These types of risks are
called diversifiable or non-systematic risks. All those risks that are beyond the control of
the fund manager are called non-diversifiable risks or systematic risks.
There are three basic varieties or asset classes of funds: equity funds, fixed income funds and
money market funds. All other funds in the market are simply variations on these three
themes. For example, equity funds that invest in companies with market capitalization under
a certain amount, say $300 million, are called “small cap” funds and equity funds that invest
outside Canada may be called global equity funds or international equity funds. Equity funds
that invest in companies in the same sector or geographical region are called specialty funds.
All of the aforementioned funds are a type of equity fund. A “fund of funds” is a relatively
recent entrant in the mutual funds marketplace. Essentially, a fund of funds is a fund that
invests in units of underlying mutual funds. They are usually sold “off the shelf” meaning
that the fund of funds has already been created; the investor does not have the ability to
choose the funds that belong in the fund of funds.
MONEY MARKET FUNDS

The primary objective of this type of fund is to produce some income while maintaining
liquidity through investments in short-term money market instruments such as Treasury bills,
commercial paper and short-term government bonds. These funds offer almost no opportunity
for capital gain as they strive to keep the net asset value fixed at a set level (e.g., $10) by
distributing monthly income to unitholders in cash or new units. The relatively low risk of the
underlying securities and the fixed NAVPS make this category of fund appropriate for
investors who want high liquidity and low risk.
While risk is low, money market funds, as is true of all mutual funds, are not guaranteed. While
fund managers try to maintain a stable NAVPS, rapid increases in interest rates could reduce the
value of the shares or funds. Money market funds are, therefore, subject to interest rate risk.
Distributions received from non-registered money market funds are treated as interest
income. Interest received is 100% taxable. Investors include this interest in their income and
pay taxes on the entire amount received.
BOND AND MORTGAGE FUNDS
Mortgage Funds
The objective of these funds is to generate income and provide a high level of safety. It is
possible to have capital gains if the fund trades the mortgages but, for the most part, interest
income is generated. Mortgage funds typically invest in first mortgages on Canadian
residential properties. Some funds also invest in commercial properties.
Unit and share values are affected by shifts in interest rates (interest rate risk) in the same way
that bond prices are affected by changes in interest rates. Nevertheless, because mortgage terms
are usually shorter than bond terms (e.g., one to five years) and because mortgage payments are
made monthly while bond income is received semi-annually, the volatility of mortgage funds is
lower than that of most bond funds. This lower volatility or risk means that mortgage funds are
considered less risky than bond funds. There is also the possibility of default risk but this is
diversified away. Mortgage funds usually hold several thousand individual mortgages.
As with money market funds, distributions are typically in the form of interest income and
are 100% taxable.

Bond Funds
Bond funds are designed to generate a steady stream of income in combination with the safety of
principal. Bond funds invest primarily in good quality, high-yielding government and corporate
debt securities. Their degree of volatility is related to the degree of interest rate fluctuation;
however, fund managers will attempt to change the term to maturity or duration of the portfolio
and the mix of low- and high-coupon bonds to compensate for changes in interest rates.
Interest rate volatility is the main risk associated with this type of fund. If the fund
invests in corporate bonds, it will also be exposed to default risk. For example, a North
American car manufacturer’s shaky financial prognosis has caused major concerns
regarding the “safety” of billions of dollars in bonds that it has outstanding.
The primary source of returns from non-registered bond funds is interest income. The mutual
fund investor may also receive a capital gain if the fund sells some of its bonds at a profit.
BALANCED FUNDS AND ASSET ALLOCATION FUNDS

The main investment objectives of these funds are to provide a balanced mixture of safety,
income and capital appreciation. These objectives are sought through a portfolio of fixed
income securities for stability and income and a broadly diversified group of common stock
holdings for diversification, dividend income and growth potential. The balance between
defensive and aggressive security holdings is rarely 50-50. Instead, managers of balanced
funds adjust the percentage of each part of the total portfolio in accordance with current
market conditions and future expectations. In most cases, the prospectus specifies the fund’s
minimum and maximum weighting for each asset class. For example, a balanced fund may
specify a weighting of 60% equity and 40% fixed income.
Asset allocation funds have objectives similar to balanced funds but they differ from
balanced funds in that they typically do not have to hold a specified minimum percentage
of the fund in any class of investment. The portfolio manager has greater freedom to shift
the portfolio weighting among equity, money market and fixed income securities as the
economy moves through the different stages of the business cycle.
An investor in balanced and asset allocation funds would be subject to market and interest
rate risk depending on the split between fixed income and equity securities. The investor
may receive a combination of interest, dividends and capital gains.
EQUITY FUNDS
Equity funds represent the largest group of mutual funds, based on total assets. The main
investment objective of this type of fund is long-term capital growth. The fund manager
invests primarily in the common shares of publicly traded companies. Short-term notes or
other fixed income securities may be purchased from time to time in limited amounts for
liquidity and, occasionally, income. The bulk of assets, however, are in common shares in
the pursuit of capital gains. Because common share prices are typically more volatile than
other types of securities, prices of equity funds tend to fluctuate more widely than the funds
previously mentioned and are, therefore, considered riskier.
Some equity funds invest in a variety of markets outside of Canada including the United States,
Europe and Asia. These funds invest in markets perceived to offer the greatest opportunity for
growth on a global basis. Investments outside of Canada are also subject to foreign exchange risk
– a non-controllable risk.

As with common stocks, equity funds range greatly in degree of risk and growth potential. These
funds are all subject to market risk. Some equity funds are broadly diversified holdings of blue
chip income-yielding common shares and would, therefore, be classified at the conservative end
of the equity fund scale. Other common stock funds adopt a more aggressive investment stance,
by investing, for example, in young growing companies with an objective of achieving above-
average capital growth. Other equity funds are of a more speculative nature – aggressively
seeking capital gains at the sacrifice of safety and income by investing in certain sectors of the
market (e.g. precious metals funds) or certain geographical locations (e.g. Asian funds).
The tax implications are the same as for any fund that holds equity securities. The
distributions will be in the form of capital gains and dividends, and are taxed accordingly.
SPECIALTY FUNDS
This type of equity fund seeks capital gains and is willing to forgo broad market exposure in
the hope of achieving above-average returns. The portfolio manager concentrates holdings in a
group of companies in one industry (e.g., biotechnology/health sciences), geographic location
(e.g., Far East), or segment of the capital market (e.g., precious metals). While still offering
some diversification, specialty funds are more vulnerable to swings in the sector where most of
their shares are held and/or in currency values if they are holding foreign securities. Many
specialty funds tend to be more speculative than most types of equity funds. One type of
specialty fund is a real estate fund that invests in income-producing real property to achieve
long-term growth through capital appreciation and reinvestment of income. Such funds are less
liquid and may require investors to give advance notice of redemption. Their valuation is based
on appraisals of properties held in the portfolio and is done infrequently (monthly or quarterly).
INDEX FUNDS
Stock indexes and averages are important statistical tools that enable portfolio
managers and investors to measure their portfolio’s performance against commonly
used yardsticks or benchmarks within the stock market. They help gauge the overall
directional move in that market.
A stock market index is a time series of numbers that represent a combination of various
stocks’ prices that can be used to calculate a percentage change of this series over any period
of time. The chosen stocks are considered as representative of the market as a whole. If the
index rises in value, the market it represents is considered to have risen in value.
The index fund manager’s mandate is to match the performance of the market as
represented by a specific index. He or she needs to make sure that the portfolio reflects the
index it is supposed to mirror. For this reason, management fees associated with index
funds are usually lower than those of other equity funds. The purpose of the fund is to track
a specific market index such as the S&P/TSX 60.
Of late, exchange traded funds (ETFs) have gained in popularity. The Toronto Stock Exchange
(TSX) describes exchange traded funds as “a special type of financial trust that allows an investor
to buy an entire basket of stocks through a single security that tracks and matches the returns of a
stock market index. ETFs are considered to be a special type of index mutual fund, but they are
listed on an exchange and trade like a stock.” ETFs have relatively low operating and transaction
costs and, therefore, are offered at very competitive MERs. However, since they trade like a
stock, commissions must be paid upon purchase and sale.

DIVIDEND FUNDS
These funds provide tax-advantaged income with some possibility of capital growth. Dividend
funds invest in preferred shares as well as high-quality common shares that have a history of
consistently paying dividends. Income from these funds is in the form of dividends which have a
tax advantage through the dividend tax credit. There is also the potential for capital gains.
The price changes that lead to capital gains or losses on dividend funds are driven by both
changes in interest rates (interest rate risk) and general market trends (market risk). Price
changes in the preferred share component of the fund are driven by interest rate changes
while general upward or downward movements in the stock market most heavily affect the
common share component.
Recall that preferred shares rank ahead of common shares but below bondholders in the
event of bankruptcy or insolvency. Consequently, dividend funds are considered riskier than
bond funds but less risky than regular equity funds. Dividends received from a taxable
Canadian corporation get preferential treatment by way of the dividend tax credit
mechanism while dividends received from foreign corporations do not.
Comparing Risk and Return of Different Types of Mutual Funds

As explained above, different types of mutual funds are subject to different degrees of risk and
return. Figure 5.8 illustrates the risk-return trade-off between the different types of mutual funds.
FIGURE 5.8 RISK AND RETURN BETWEEN DIFFERENT TYPES OF MUTUAL FUNDS
Specialty Funds
Equity Funds
Dividend Funds
Return
Balanced Funds
Bond Funds
Mortgage Funds
Money Market Funds
Risk
Another factor that complicates comparisons between funds is that there is often no
attempt to consider the relative risk of funds of the same type. One equity fund may be
conservatively managed while another fund might be willing to invest in much riskier
stocks in an attempt to achieve higher returns.

Any assessment of fund performance should consider the volatility of a fund’s returns.
There are a number of different measures of volatility, but each attempts to quantify the
extent to which returns will fluctuate. From an investor’s standpoint, funds that exhibit
significant volatility in returns will be riskier than those with less volatility.

Chapter 5B
Segregated Funds
© CSI GLOBAL EDUCATION INC. (2011) 5B•1

5B
Segregated Funds
CHAPTER OUTLINE
Introduction
Key Features
Owners and Annuitants
Beneficiaries
Maturity Guarantees and Death Benefits
• How Maturity Guarantees Work
• Age Restrictions
• Reset Dates
• Death Benefits
Creditor Protection
Segregated Funds and Bankruptcy Law
Segregated Funds and Family Law
Bypassing Probate
Convergence with Mutual Funds
• A Growing Segment
• Need for Common Rules
5B•2 © CSI GLOBAL EDUCATION INC. (2011)

Regulation
• Reviews Conducted by CLHIA
• Solvency Monitored by OSFI
• Assuris’s Compensation Fund
Structure
Administration
• Unique Needs of Segregated Funds
• Buying and Selling Segregated Funds
Fees and Expenses
• The Cost of the Guarantees
• Sales Charges
Tax Considerations
• Effect of Allocations on Segregated Fund Net Asset Values
• Tax Treatment of Maturity Guarantee
• Tax Treatment of Death Benefits
• Interest Deductibility on Borrowing
• Tax Reporting on the T3 Slip
• Segregated Funds and RESPs
Disclosure
• Regulatory Requirements for Issuers
• Key Disclosure Documents
• Other Information Sources
• Advertisements and Marketing
• Innovations Related to Segregated Funds
© CSI GLOBAL EDUCATION INC. (2011) 5B•3

5B•4 CANADIAN INSURANCE COURSE • VOLUME 1
INTRODUCTION
Segregated funds have unique features that enable them to meet special client needs
such as maturity guarantee, death benefits and creditor protection. Unlike other types of
investment funds, segregated funds are insurance contracts and, therefore, mostly
exempt from the requirements of provincial securities laws.
In this chapter, you will learn about the key investment and insurance attributes of
segregated funds.
KEY FEATURES
LEARNING OBJECTIVES
• Define and explain the term IVIC.
• Explain the following terms as they apply to IVICs: Contract holder, Annuitant,
Beneficiary, Contract Date, and Maturity Date.
An IVIC is an “individual variable insurance contract” entered into between a contract holder and
a life insurance company. Maturity and death benefit guarantees are provided to contract holders
and beneficiaries under an IVIC. Purchasers of an IVIC hold an insurance contract that gives
them certain specified benefits based on the value of one or more specified segregated funds (or
groups of assets). A “segregated fund” is a pool of assets owned by the life insurance company
and held by the company separate and apart from other similar pools and its general assets. An
IVIC gives a purchaser the right to choose among various segregated funds.
Individual variable insurance contracts are often mentioned in the same breath as mutual funds
and other types of managed investment products. There are, in fact, many similarities. Segregated
fund contracts and other types of widely held investment funds all offer professional investment
management, diversification, ability to invest in small amounts, regular client statements and
other services including the opportunity to receive investment advice. These investment products
combine investments and related services into an integrated package. With segregated fund
contracts, investments and certain aspects of insurance contracts are combined.
Segregated funds have unique features that enable them to meet special client needs such as
maturity guarantee, death benefits and creditor protection. Unlike other types of investment
funds, segregated funds are insurance contracts regulated by provincial insurance authorities
and, therefore, mostly exempt from the requirements of provincial securities laws. Contract
holders who buy a segregated fund do not actually own the fund’s underlying assets. Instead,
their rights are based solely on the provisions of the contract itself.

FIVE B • SEGREGATED FUNDS 5B•5
Because it is a contract, the rights and benefits associated with holding a segregated fund are
more complex than the rights and benefits associated with holding a security. Essentially, a
segregated fund contract covers the following three parties:
1. The Contract holder: This is the person who purchases the contract (also known
as the policyowner).
2. The annuitant: This is the person on whose life the insurance benefits are based.
3. The beneficiary: This is the person who will receive the benefits payable under the contract
in the event of the death of the annuitant. A contract may have more than one beneficiary.
The maturity date of a segregated fund contract is an important date. It is normally set 10
years from the contract date and, by law, it cannot be less than 10 years. The maturity date is
a critical component of the contract because the maturity guarantee comes into effect on that
date, and no sooner. So, if an investor decides to redeem a segregated fund contract, say 8
years from the contract date, the investor would be paid the market value of the segregated
fund holdings, whatever the market value may be on the date of redemption. The maturity
guarantee would not get triggered until the maturity date.
OWNERS AND ANNUITANTS
When the contract is held in a registered plan, such as an RRSP, the Contract holder and the
annuitant must be the same person. When the contract is held outside a registered plan, the
Contract holder or owner of the contract does not have to be the person whose life is insured
under the contract; however, in most situations, the Contract holder and the annuitant is the
same person.
There are restrictions on whose life a Contract holder can base a contract. The general rule is
that the Contract holder, at the time that the contract is signed, must have an “insurable
interest” in the life of the annuitant. Otherwise, the proposed annuitant must consent in
writing to have his or her life insured.
In cases where the Contract holder and the person whose life is being insured are different
persons, the Contract holder may die before the annuitant. If that happens, the contract may
be transferred to a successor Contract holder. If no successor has been designated by the
original Contract holder, the contract becomes part of the Contract holder’s estate.
BENEFICIARIES
The segregated fund contract’s beneficiary is the person(s) or organization(s) entitled to

receive any maturity or death benefits payable under the contract. The designation of
beneficiaries can be either revocable or irrevocable. A revocable designation offers the
advantage of greater flexibility because the Contract holder has the freedom to alter or revoke
the beneficiary’s appointment. In the case of an irrevocable designation, changes to the rights
of a beneficiary are subject to the beneficiary’s consent.

A beneficiary should be designated at the time that the Contract holder completes the
application to establish a contract. A copy of the designation should be retained by the
Contract holder and reviewed annually to determine whether any changes are required.
The designation of an irrevocable beneficiary can be made in the segregated fund contract
itself or by a declaration filed with the insurer. It cannot be made in the Contract holder’s
will; if a beneficiary is named in a will, the beneficiary is considered revocable, even if the
will provision intends to appoint the beneficiary irrevocably.
A beneficiary designation made in a will is no longer valid if the will is revoked. Also, a will’s
provisions will be superseded if another designation is made after the date that the will was
signed. On the other hand, a beneficiary designation in a will replaces an earlier designation.
What follows applies to traditional life insurance policies and also to segregated fund
contracts/ IVICs.
It is important to consider the long-term implications of designating a beneficiary
irrevocably. Although it may work nicely in a situation that is well-defined and has a high
degree of certainty, things can and do change over time and a great situation could turn
adverse. For example, assume that Paula and Corey are happily married for the last eight
years, with two children under 6 years of age. Corey is a physician with a thriving practice
and purchases a $5,000,000 insurance policy on his own life and appoints Paula as an
irrevocable beneficiary. Ten years later, the two have problems in their marriage and go
through a bitter divorce. A year after the divorce, Corey marries Wanda and wants to change
the beneficiary designation on his $5,000,000 policy. Unfortunately, he cannot do so without
Paula’s consent and that is unlikely to be forthcoming given the acrimonious nature of their
breakup. If Corey had named Paula as beneficiary (but not irrevocably), then it would have
been a relatively simple matter of changing the beneficiary designation to Wanda.
Irrevocable beneficiary designations are most useful when the insured needs protection from
creditors and the intended beneficiary is not a spouse, child, grandchild or parent. For example,
Calvin is a successful fashion designer, age 35 and single. He has significant business debts but
wants to provide for an aging uncle, Tom, who looked after him in his childhood. He purchases a
$1,000,000 whole life insurance policy on his own life and names Tom as irrevocable
beneficiary. Eight years later, Calvin’s fashion business hits a wall and creditors come knocking.
They seek the $60,000 in cash value built up in the life insurance policy but cannot do so as
Calvin has named Tom as an irrevocable beneficiary. If, instead, Calvin had named Tom as a
revocable beneficiary, this protection would not have been available and Calvin’s creditors could
have seized the $60,000 cash value of the policy in payment of his business debts.
Beneficiary designations in favour of a spouse, child, grandchild or parent of the life
insured result in protection from creditors as soon as the beneficiary is named (similar to
the protection provided when an irrevocable beneficiary is designated). Creditor protection
will be covered in further detail later in this chapter.

MATURITY GUARANTEES AND DEATH BENEFITS
LEARNING OBJECTIVES
• Explain the age restrictions related to various investments.
• Analyze a variety of client-specific scenarios to determine the impact on the client of
the distinguishing features of segregated funds, including maturity guarantee, death
benefit and reset options.
Segregated funds alter one of the conventional principles of portfolio selection, namely the notion
that the older the client, the less exposure he or she should have to riskier long-term assets.
With the availability of maturity guarantees of up to 100%, along with death benefits, the
risks associated with capital markets become less of an investment constraint. Segregated
funds enable clients to invest in higher-growth asset classes, while offering assurance that the
principal amount of their contributions is protected, either fully or partially.
One of the fundamental contractual rights associated with segregated funds is the guarantee that
the beneficiary will receive at least a partial return of the funds invested in accordance with the
provisions of the contract. Provincial legislation requires that the guarantee be at least 75% after a
10-year holding period. Some sponsors of segregated funds top up the maturity guarantees to
100%. These guarantees – whether full or partial – appeal to people who want specific assurances
about the return of the principal amount invested and a limit on their potential capital loss.
For example, Sergei Yukovich deposited $150,000 in a segregated fund policy and named his
son, Vaslav, as beneficiary. The policy offers a 75% guarantee on death or maturity with a
minimum 10-year holding period. Five years later, Sergei dies in a skiing accident while
holidaying in Switzerland.
If we assume that the investments within the segregated fund policy are worth $200,000 at
Sergei’s death, Vaslav would receive $200,000. If, however, the investments have dropped in
value and are worth $140,000 at Sergei’s death, then Vaslav would receive $140,000 (which
is still greater than the 75% guaranteed amount of $112,500). Now, if we assume that the
investments have suffered a significant decline in value in the intervening five years and are
worth $100,000 at Sergei’s death, then Vaslav would receive the guaranteed amount of
$112,500, i.e., 75% of $150,000, the amount Sergei originally deposited.
If the policy had come with a 100% guarantee on death or maturity, then in the second
instance (i.e., where investments are worth $140,000 at death) and the third instance (i.e.,
where investments are worth $100,000 at death), Vaslav would have received the guaranteed
amount of $150,000.
A Contract holder may make withdrawals from a segregated fund contract during any time that
the annuitant is alive. Guarantees do not apply to amounts that are withdrawn or redeemed from a
segregated fund contract prior to the maturity date. The value of the guarantees would be reduced
by withdrawals and, as such, systems that track the ongoing value of the guarantees must be put
into place. Typically, when periodic deposits have been made, withdrawals will come from

the oldest units first. A partial withdrawal of units purchased on a particular date reduces
the guaranteed amount for the remaining units that were purchased at the same time.
Upon withdrawals from a segregated fund contract, the guarantees can be adjusted on a
dollar-for-dollar basis or on a proportional basis. Let’s look at an example.
An investor has deposited $25,000 in a segregated fund policy which purchased 2,500 units
at $10 each and comes with a 100% guarantee at death or maturity. Now two years later, the
investor wishes to withdraw $5,000 from the contract and the value of each unit has risen to $13.
So the investor would have to give up 384.615 units to get the $5,000 ($5,000 ÷ $13 per unit).
If the policy contract uses a dollar-for-dollar basis (also known as linear basis) for
adjusting the amount of the guarantee, then the guaranteed amount would be adjusted to
$20,000 ($25,000 initial deposit - $5,000 withdrawn).
If, however, the policy contract uses a proportional basis, then the adjusted guaranteed amount
would be different. The investor has sold 384.615 units and, therefore, 2115.385 units are left
(2,500 – 384.615). On a proportional basis, the adjusted guaranteed amount would be
$21,153.85 (initial deposit $25,000 × 2115.385 units remaining ÷ 2,500 units originally
purchased). As you can see, the investor in this situation benefits if the guarantee is adjusted
on a proportional basis. That, however, is not always the case.
Contract holders usually have the right to switch between various funds offered by the insurer;
however, the number of switches may be limited. For instance, some companies allow a certain
number of free switches per calendar year. A charge is levied for all switches made beyond
this amount. These transfers may affect the initial value and date of a policy and the
maturity guarantees may be reset at varying levels or with different maturities.
The death benefits associated with segregated funds meet the needs of clients who want
exposure to long-term asset classes and insurance that protects their beneficiaries if the client
dies. If the annuitant passes away, holdings in a segregated fund will bypass the fees and
delays of probate proceedings. For business owners and self-employed professionals,
segregated funds can also serve to shield their savings from creditors or lawsuits.
Because of the insurance benefits they offer, segregated funds are a more costly form of
managed investment as compared to an uninsured mutual fund. In recommending a
segregated fund to a client, the advisor should weigh the benefits and distinct features of
segregated funds against their added costs.
How Maturity Guarantees Work

Maturity guarantees, particularly those that offer full protection after 10 years, alter the
normal risk-reward relationship. With a maturity guarantee in place, a client can participate
in rising markets without setting a limit on potential returns. At the same time, subject to the
10-year holding period, he or she is assured that invested capital, i.e., principal amount, is
protected from loss.
Maturity guarantees must cover a term of at least 10 years. Almost all individual segregated
fund policies sold in Canada carry a 10-year term, although longer terms are permissible.

When a Contract holder makes deposits over the course of several years, it can complicate the
calculation of guarantees and maturity values. There are basically three types of guarantees:
• A deposit-based guarantee: When deposits under the segregated fund contract are
made at different times, such as regular monthly deposits, each deposit may have its
own guarantee amount and maturity date.
• A policy-based guarantee: This type of guarantee helps make record-keeping simpler.
It groups all deposits made within a 12-month period and gives them the same maturity
date. Insurers may also choose to group all deposits within a calendar year. For policy-
based guarantees, the first maturity date is generally 10 years after the contract was first
signed (not the month of the first deposit).
• The most generous type of policy-based guarantee bases all maturity guarantees on the
date that the policy was first issued. With this type of guarantee, there may be
restrictions on the size of subsequent deposits to prevent clients from making minimal
deposits at account-opening and much larger deposits several years later. Doing so
would effectively shorten the holding period required for the maturity guarantee and
increase the potential risk to the insurer.
Depending on the insurance company, maturity guarantees may be based on either the entire
portfolio of funds held by a client or on each fund. Where possible, a fund by fund guarantee is
generally considered better for the client because holding a fund that invests in a single asset
class, such as a Canadian equity fund, is inherently more risky than holding a balanced
portfolio diversified among domestic and foreign equities and fixed-income securities.
In historical terms, the risk of losing money in the North American stock markets over a
minimum 10-year holding period has been virtually non-existent. For example, in any 10-year
historical period, the S&P/TSX Composite total-return index has not had a negative return. The
rarity of negative 10-year returns has led many advisors and experts to conclude that the costs of
full (i.e., 100%) maturity guarantees exert an unwarranted drag on a client’s investment returns.
But the potential value of maturity guarantees should not to be dismissed outright. As the
performance of the Japanese market suggests, even the largest and most developed markets
are vulnerable to losses over a 10-year (or longer) period. The Nikkei (Japan’s most widely
watched index of stock market activity) peaked in December 1989 at 38,915 and was only at
9,709 in late March 2011, 21 years later.
To offer greater capital protection, many insurers have topped up the minimum statutory 75%
guarantee to a full 100%. The guarantee provisions are set out in the funds’ information folder.
A more recent trend is the introduction of segregated fund families that give clients a choice
between maturity guarantees of either 100% or 75%. This enables clients to choose not only the
underlying investments and money manager, but also the degree of protection that they prefer.
The 100% guaranteed funds have higher management expense ratios than the 75% guaranteed
funds and reflect the higher risks associated with offering full maturity guarantee after 10 years.
Some companies offer a 100% maturity guarantee on only a few of their funds.

Age Restrictions
Several insurance companies that offer 10-year maturity guarantees that exceed the statutory
requirement of 75% impose restrictions on who qualifies for the enhanced guarantee.
Depending on the age of the client and his or her requirements for death benefits, such
restrictions can be a crucial consideration in selecting a provider of segregated funds.
In most cases, the restrictions are based on age. A client who has reached a certain age might
be excluded outright from buying a company’s segregated funds. One insurance company, for
example requires that the individual on whose life the death benefits are based must be 80
years old or younger at the time that the policy is issued. Alternatively, the purchaser could
be subject to a reduced level of protection under the policy once he or she reaches a certain
age. For the industry as a whole, provincial insurance legislation does not specify a
maximum age limitation. For non-registered contracts, therefore, companies may set
maximum age limitations, such as age 90. Registered segregated fund contracts are subject to
the traditional rule, i.e., RRSP deposits/ assets must be withdrawn or converted into an
annuity or RRIF by the end of the year in which the Contract holder turns age 71.
Reset Dates
Although segregated fund contracts must have at least a 10-year term, they may be renewable
once the term expires. Whether they can be renewed or reset may depend on the annuitant’s age.
If renewed, the maturity guarantee on a 10-year contract would “reset” for another 10 years.
Many insurers issuing segregated funds have expanded the reset concept to include
greater flexibility in the form of more frequent reset dates. In some cases, holders of
segregated fund contracts may lock in the accrued value before the original 10-year
period has expired and, in doing so, extend the maturity date by 10 years.
Depending on the insurance company, the reset provisions may be initiated by the
policyowner or be an automatic feature of the policy. When resets are optional, there are
generally limitations on the number of resets per year. Resets provide additional flexibility
in investment strategy and financial planning.
The frequency of reset dates will vary according to the insurance company and are specified in
the information folder. Reset dates can range anywhere from daily to once a year.
The daily reset feature (generally set up on an automatic basis) benefits clients in either rising or
falling markets. In a rising market, when the net asset value of fund units is increasing, daily
resets enable Contract holders to continually lock-in accumulated gains. In a falling market
when
net asset values are declining, Contract holders are also protected because the guarantee is based
on the previous high. Daily resets are generally offered for contracts with maturity dates greater
than 10 years and are not available during the final 10 years of a contract. For instance, an
investor who is expecting to retire in 16 years could invest in a segregated fund contract with a
daily reset feature that would lock in market gains for the first 6 years of the contract.

Table 5B.1 provides a simplified example of how the daily reset feature works when the
market value of a fund’s assets is either rising or falling:
TABLE 5B.1 DAILY RESET VALUES
Accumulated Guaranteed Impact

Date value maturity value of reset
Jan. 2 $ 10,000 $ 10,000 None
Jan. 3 $ 9,900 $ 10,000 Protects against $100 market loss
Jan. 4 $ 10,125 $ 10,125 Locks in $125 market gain
Death Benefits
The basic principle behind the death benefits offered by a segregated fund is that the
beneficiary or estate is guaranteed to receive payouts equal to at least 75% of the original
premiums invested, excluding sales commissions and certain other fees. The basic amount of
the death benefit is equal to the difference, if any, between the market value of the fund
holdings and at least 75% of the original amount(s) invested.
Table 5B.2 illustrates the death benefits when the market value of the units held in the
segregated fund is below, the same as, or higher than the original purchase price. To simplify
the illustration, it is assumed that the fund has been held long enough that any deferred sales
charges are no longer applicable.
TABLE 5B.2DEATH BENEFITS
Guaranteed amount Market value at death Death benefit

$ 10,000 $ 8,000 $ 2,000
$ 10,000 $ 9,000 $ 1,000
$ 10,000 $ 10,000 None
$ 10,000 $ 11,000 None
As the table shows, death benefits are paid only when the market value of the fund holdings
is below the guaranteed amount. For example, when the market value at death is $9,000, the
beneficiary will receive a death benefit payment of $1,000. Therefore, including the $9,000
market value of the fund holdings, the total payment to the beneficiary is $10,000.
Death benefits can provide a great deal of reassurance to clients who want to participate in
the potential for higher returns offered by equities and long-term fixed-income funds but, at
the same time, are concerned about preserving the value of their investment for their heirs.
The death benefit enables these clients to pursue a long-term investment strategy while being
protected against sustaining a loss if death occurs during a losing period for the fund.

For example, without the protection afforded by segregated funds, the death of the annuitant
would trigger a deemed disposition at a loss if the market value at the time of death was below the
original amounts deposited. Assuming a 100% death benefit, holdings in the form of a segregated
fund are generally protected from any shortfall between the market value of the units held and the
original price of the units acquired. In this respect, segregated funds can be compared with other
guaranteed investments such as index-linked GICs or fund-linked notes.
Because of death benefits and flexibility regarding beneficiaries, segregated funds may
be very useful in estate planning.
However, death benefits commonly have other types of conditions or exclusions that may reduce
payouts to the beneficiary. The most common exclusion is based on age. Once the insured person
reaches a certain age, the beneficiary may have to accept a reduced percentage of benefits.
For example, one company’s guaranteed death benefits are based on a graduated scale
according to age. Annuitants who are younger than 77 years at the time of the deposit
qualify for 100% death benefits. The benefit declines to 95% at age 77, 90% at age 78, 85%
at age 79, and 80% for annuitants who are 80 or older.
When deposits have been made over a period of time and benefits vary according to the
client’s age, the death benefit is calculated according to a formula that factors in the amount
of deposits and the client’s age when they were made. Another restriction is based on a
combination of age and the length of time that the contract has been held.
Insurers also have the flexibility to offer death benefits in excess of 100% of the premiums
paid. For example, one insurance company offers a distinctive type of escalating death
benefit as part of its segregated fund package. This feature provides a death benefit equal to
at least the principal deposit plus an additional 4% simple interest per year.
CREDITOR PROTECTION
LEARNING OBJECTIVES
• Analyze a variety of client-specific scenarios to determine the impact on the client
of the distinguishing features of segregated funds, including creditor protection.
Segregated funds generally offer protection from creditors that is not available through
other forms of managed investment products such as mutual funds. Creditor protection is
available because segregated funds are tied to insurance contracts. As such, ownership of
the fund’s assets resides with the insurance company rather than the Contract holder. As a
matter of public policy, insurance proceeds generally fall outside of bankruptcy legislation.
Creditor protection can be a valuable feature for clients whose personal and/or business
circumstances could make them vulnerable to court-ordered seizure of assets to recover
debt. Owners/entrepreneurs, professionals or other clients who have concerns about their
personal liability are among those who might welcome the creditor protection offered by
a segregated fund.

FIVE B • SEGREGATED FUNDS 5B• 13
Assume, for example, that a self-employed professional, Samuel Gold, died and left a non-
registered investment portfolio of $300,000 and business-related debts of $150,000. If the
portfolio consisted of mutual funds, creditors would have a claim on half of the portfolio,
leaving only $150,000 for the surviving family members. Furthermore, the estate would be
subject in most provinces to probate fees based on the size of the estate. In provinces such as
Ontario and British Columbia, the probate fees would be more than $2,000.
If the portfolio consisted of segregated funds and Samuel had appointed his wife, Sarah, as
beneficiary, the full $300,000 would be payable directly to Sarah, the named beneficiary.
Creditors could claim nothing and Sarah would receive the proceeds promptly without
having to deduct a portion for probate fees.
Creditor-proofing does not apply under all circumstances. In order for the assets held in
the contract to be eligible for creditor protection, a beneficiary (other than the insured or
his/her personal representative) must be named.
Several provisions in the Uniform Life Insurance Act provide creditor protection to the
insured and beneficiary of life insurance contracts, and that extends to those who hold
segregated fund contracts.
1. “An insured may in a contract, or by a declaration other than a declaration that is part of a
will, filed with the insurer at its head or principal office in Canada during the lifetime of
the person whose life is insured, designate a beneficiary irrevocably, and in that event the
insured, while the beneficiary is living, may not alter or revoke the designation without
the consent of the beneficiary and the insurance money is not subject to the control of the
insured or of the insured’s creditors and does not form part of the insured’s estate.”
2. “Where a beneficiary is designated, the insurance money, from the time of the
happening of the event upon which the insurance money becomes payable, is not part of
the estate of the insured and is not subject to the claims of the creditors of the insured.”
3. “While a designation in favour of a spouse, child, grandchild or parent of a person
whose life is insured is in effect, the rights and interests of the insured in the insurance
money and in the contract are exempt from execution or seizure.”
Provisions 1 and 3 above offer the greatest extent of creditor protection as it (i.e., creditor
protection) begins to apply as soon as the designation is in effect whereas the protection
from creditors offered in 2 (where a beneficiary is designated) generally comes into play
only upon the death of the life insured. In the example of Samuel and Sarah mentioned
earlier, Samuel did the right thing by naming Sarah as the beneficiary of his segregated
funds portfolio because that protects the portfolio from Samuel’s creditors once Sarah is
named as beneficiary (Sarah being Samuel’s spouse and getting protection under 3).

SEGREGATED FUNDS AND BANKRUPTCY LAW
Under federal bankruptcy law, segregated funds are normally exempt from being included in
property to be divided among creditors. The federal Bankruptcy and Insolvency Act
specifically excludes from bankruptcy proceedings any property that is deemed exempt from
seizure under provincial law. For example, a bankruptcy trustee cannot change a beneficiary
designation to make the proceeds of the contract payable to the Contract holder’s creditors.
However, the creditor-proofing features of segregated funds are subject to a number of
limitations. The purchase of the segregated fund must be made in good faith and not with
the intent of evading legal obligations such as those arising from bankruptcy.
Claims for creditor protection may be subject to a successful court challenge by the bankruptcy
trustee if the purchase of a segregated fund is made in order to wilfully or fraudulently evade
a Contract holder’s debt obligations. Other types of challenges involving statutes other
than bankruptcy legislation are available in the event of fraud.
Under the federal Bankruptcy and Insolvency Act, the proceeds of a segregated fund may
be subject to seizure if it can be proven that the purchase was made within a prescribed
period before the bankruptcy. This will be the case even if the beneficiary is a family
member or if the beneficiary has been designated irrevocably. Generally, the proceeds of a
contract will not be protected from seizure if it was purchased within one year of the date
of bankruptcy. But if the client was legally insolvent at the time that the contract was
purchased, the segregated fund purchases could be challenged as far as five years back.
Because segregated funds allow new contributions to be made over time, a portion of the
segregated fund holdings might be protected, while new contributions or reinvestment of
fund distributions could be subject to seizure. The extent of the protected portion would
depend on whether the Contract holder’s status changed during the life of the policy.
SEGREGATED FUNDS AND FAMILY LAW
A person’s matrimonial obligations may also have an impact on an investment in a

segregated fund. Although insurance contracts do not normally form part of an estate, they
are nonetheless subject to family-law provisions designed to provide for the welfare of
family members or other dependants.
Because there is a cash surrender value belonging to a segregated fund contract – the
policy is redeemable for cash at any given time – it is considered matrimonial property. In
the common-law provinces, the cash surrender value is part of the total assets to be divided
between the two divorcing spouses.

BYPASSING PROBATE
LEARNING OBJECTIVES
• Analyze a variety of client-specific scenarios to determine the impact on the client of
the distinguishing features of segregated funds, including exemption from probate.
Segregated funds can help clients avoid the burden of costly probate fees that would
otherwise be levied against assets held in investment/mutual funds. The ability to bypass the
probate process can result in considerable cost savings and is one of the key estate planning
advantages of segregated funds.
These savings arise because the proceeds of a segregated fund pass directly into the hands
of the beneficiary.
One advantage of bypassing probate is the ease of transfer of funds to the beneficiary. Proceeds of
a segregated fund are payable immediately. There is no waiting period for probate to be
completed and payment would not be delayed over any dispute regarding settlement of the estate.
Saving on probate fees is not the sole financial advantage of bypassing probate. By passing
assets directly to the beneficiary via a segregated fund, the beneficiary also saves on fees
payable to executors, lawyers and accountants.
CONVERGENCE WITH MUTUAL FUNDS
LEARNING OBJECTIVES
• Describe the advantages/disadvantages of various life insurance investment

vehicles as compared to non-insurance investment vehicles.
A Growing Segment
Segregated funds have gained wider recognition in recent years and are a growing segment of
the investment fund industry in Canada. At the end of 2009, according to the Canadian Life and
Health Insurance Association (CLHIA) – a national industry trade group representing nearly all
issuers of segregated funds – an estimated $174 billion in segregated fund assets were held on
behalf of Canadian policyholders and annuitants and premiums from segregated funds of $28.2
billion represented 35.6% of total premium income of $79.1 billion.
This represents a huge leap from the end of 1995 when the industry held segregated fund
assets of $30.3 billion. Segregated funds were created in 1961 when insurance companies
used them to manage money for pension plans. During the mid-1960s, provincial regulatory
authorities began to allow insurance companies to issue segregated funds to individuals.

Along with welcoming new entrants, the late 1990s saw a period of innovation for the
segregated fund industry. New features, such as reset provisions that allowed Contract
holders to lock in capital gains and roll forward their 10-year maturity dates, increased the
ability of segregated funds to fit into a wide range of investment strategies.
On the product side, the number of segregated fund asset categories available for investment
has grown rapidly. Along with the traditional core categories, there now are segregated funds
that invest in riskier and more specialized areas such as small-cap equities and geographic
regions such as Asia. More recently, there has been an emerging trend towards offering
packaged portfolios of funds.
Need for Common Rules

The competitive environment for insured investment funds has been fundamentally altered
by industry developments that occurred in the late 1990s. Innovative products created by
both the insurance and mutual fund industries along with new marketing alliances between
the two have created a convergence between segregated funds and mutual funds.
It has become increasingly common for segregated funds to include brand-name mutual funds
as their underlying assets. In addition, recent years have seen the introduction of mutual funds
with capital-protection features that mimic the maturity guarantees offered by segregated funds.
On the distribution side, there is a continuing trend towards dual licensing of advisors that
allows them to sell insurance products and securities.
The convergence of products, distribution and marketing has encouraged the view among
regulators that coordinated efforts are needed to protect the interests of the investing public.
Progress towards harmonization occurred in May 1999 when the Canadian Securities
Administrators (CSA) and the Canadian Council of Insurance Regulators (CCIR) released a
joint study that compared the features of various segregated funds and mutual funds.
Recognizing that segregated funds and mutual funds have common features and serve many
similar needs, the insurance and securities regulators expressed the common goal of creating
a level playing field for the two products.
Table 5B.3 highlights some of the key similarities and differences between segregated funds
and mutual funds while Table 5B.4 lists the advantages and disadvantages of segregated
funds vis-a-vis managed investments.

TABLE 5B.3 SIMILARITIES AND DIFFERENCES BETWEEN SEGREGATED FUNDS

AND MUTUAL FUNDS
Features Segregated Funds Mutual Funds

Legal status Insurance contract. Security.
Who owns assets Insurance company. Fund itself, which is a separate legal
of fund entity.
Nature of fund units Units have no legal status, and serve Units are legal property which carry
only to determine value of Benefits voting rights and rights to receive
payable. distributions.
Who regulates Provincial insurance regulators. Provincial securities regulators.

their sale
Who issues them Mainly insurance companies, some Mutual fund companies.
fraternal organizations and mutual
fund companies (in partnership with
insurance companies).
Main disclosure Information folder. Prospectus.

document
How often valued Usually daily, and at least monthly. Usually daily, and at least weekly.
Redemption rights Right to redeem is based on Redeemed upon request.

contract terms.
Required financial Audited annual financial statements. Audited annual financial statements
statements and semi-annual statements that do
not require an audit.
Sellers’ Licensed life insurance agents. Registered brokers or dealers.

qualifications BC, Saskatchewan and PEI also
require successful completion of an
investment funds course approved
by the provincial Insurance Council.
Government None None

guarantees
Distribution Income and capital gains are Income and capital gains are
of income allocated to notional units distributed from existing units,
periodically, at least once a year. As causing net asset value to fall
a result, the net asset value of these by amount of distribution. If
units rises. distributions are reinvested, the
number of units held increases.

TABLE 5B.4 ADVANTAGES AND DISADVANTAGES OF SEGREGATED FUNDS VERSUS

MANAGED INVESTMENTS
Features Segregated Funds Mutual Funds

Death benefit Yes; guarantee that at the death of No such guarantee.
the annuitant, beneficiary will receive
at least a partial return (minimum
75%) of the funds invested.
Maturity guarantee Yes; guarantee that upon maturity No such guarantee generally available;
(generally a minimum ten-year however, a breed of mutual funds
holding period), Contract holder will called “protected funds” allows
receive a partial (75%) or full (100%) investors to benefit from potential
return of the funds invested, growth in the securities market while
regardless of the market value of the guaranteeing repayment of the
underlying investments at the time. principal amount invested
Protection from Creditor protection is available to No creditor protection available

creditors Contract holders because segregated
funds are tied to insurance contracts.
Valuable feature especially for self-
employed professionals and
business owners who want to shield
assets from creditors
Bypassing probate At death of the annuitant, proceeds No such bypass available

from a segregated fund pass
directly to named beneficiary and
do not have to go through the
expense and delay of probate.
Protection in event Assuris, a self-financing industry Mutual funds are separate entities from
of insolvency of organization, provides up to $60,000 the sponsor fi rm. The funds own their
issuer or 85% of the guaranteed amount, own assets, which are held separately by
whichever is higher, in compensation a third-party custodian. If sold by an
against any shortfalls in policy investment dealer, protection against loss
Benefits resulting from the insolvency of due to financial failure of the dealer is
a member fi rm (restricted to death available through the Canadian Investor
Benefits and maturity guarantees). Protection Fund (CIPF).
An Investor Protection Corporation
has been put into place by MFDA to
provide protection if a mutual fund
dealer becomes bankrupt.
Fees Significantly higher MERs levied Relatively lower MERs on mutual funds
on segregated funds to pay for the
guarantees and insurance component
Range of While the range of investments in Tremendous variety of investment

investments segregated funds has expanded in opportunities offered to an investor
available recent years, it still does not come in mutual funds.
close to the options available for
managed fund products

REGULATION
LEARNING OBJECTIVES
• Explain the role of Assuris in investment products offered by insurance companies.
• Describe the regulatory requirements for issuers of IVICs, including the role of
CLHIA IVIC Guidelines.
Most issuers of segregated funds are insurance companies, nearly all of which are federally
registered. To be an eligible issuer of segregated funds, a company or other organization must
be authorized by law to carry on the business of life insurance and be licensed by provincial
insurance regulators to sell contracts in the jurisdictions in which it wishes to sell funds. Along
with federally chartered insurance firms, other eligible issuers include fraternal organizations
that are qualified to sell life insurance and provincially chartered insurance companies.
Laws and regulations governing segregated funds are very similar in all provincial and
territorial jurisdictions across Canada. For the most part, segregated fund contracts are
subject to provincial legislation that governs all types of life insurance contracts of which
segregated funds are only one type. Each province and territory has accepted the CLHIA
guidelines as the primary regulatory requirements. Ontario, for example, has adopted the
CLHIA guidelines as regulations under the province’s Insurance Act.
Other provinces and territories generally apply the CLHIA guidelines as industry standards.
There are, however, some differences between jurisdictions. Quebec and Ontario, among
others, have special rules that govern the sale of segregated fund contracts.
Provincial regulators in the four Western provinces have delegated some licensing and
enforcement roles to provincial insurance councils. These councils consist of representatives
from various industry groups.
Federal insurance regulators do not regulate the sale of segregated funds. External
money managers of these funds are subject to provincial securities legislation if they are
registered as portfolio managers.
Reviews Conducted by CLHIA

Approval by provincial insurance regulators is required before a segregated fund can be
offered to the public. In carrying out their role, the regulators rely heavily on CLHIA.
Although CLHIA has no formal legal status as a self-regulatory organization, it plays a
critical role in supervising its members.
Applications to issue segregated funds must first be filed with CLHIA. The application
package consists of a completed application form, the proposed contract, information
folder, summary fact statement and financial statements.
After CLHIA completes an extensive review and gives its written approval, the application
and accompanying documents are forwarded to the regulators in the provincial or territorial

jurisdictions in which the applicant intends to sell the segregated funds. In most
instances, provincial regulators rely on the review conducted by CLHIA and do not
conduct their own additional review.
Solvency Monitored by OSFI

A federal regulatory body, the Office of the Superintendent of Financial Institutions
(OSFI), is responsible for ensuring that federally regulated insurance companies are
adequately capitalized under the requirements of the federal Insurance Companies Act.
Segregated fund contracts are subject to OSFI guidelines on guarantee provisions. These
rules are set out in OSFI’s guidelines for equity-linked insurance and annuity contracts with
guaranteed benefits.
OSFI’s key requirements for segregated fund contracts include:
1. The amount of the maturity guarantee payable at the end of the term of the policy cannot
exceed 100% of the gross premiums paid by the Contract holder. (This rule also applies
to contracts that carry reset features that allow the Contract holder to lock in gains and
set a new 10-year term to maturity.)
2. The initial term of the segregated fund contract cannot be less than 10 years.
3. There can be no guarantee of any amounts payable on redemption of the contract
before death or the contract maturity date.
When assets are not properly accounted for or liabilities are not paid, OSFI may take temporary
control of an insurance company, including its segregated funds, and manage the company’s
affairs. Under the federal Insurance Companies Act, the appointed actuary of the insurance
company must review, and monitor liabilities created by the issuance of segregated fund
contracts.
In 2001, OSFI instituted more stringent (i.e., higher) capital reserve requirements on insurance
companies so as to ensure that they could cover generous segregated fund guarantees being
offered. OSFI was concerned in this regard mainly because of the sharp decline in the securities
and capital markets after the “dot.com” bubble burst. This move by OSFI resulted in issuers
raising MERs on segregated funds and easing off on 100% guarantees. Sales fell, some issuers
decided to no longer offer segregated fund contracts and there was consolidation in the segregated
funds sector. In short, a regulatory change resulted in major market developments.
Assuris’s Compensation Fund

Generally, because the funds are segregated from the insurance company’s general assets, they
provide sufficient protection to Contract holders against corporate insolvency. But there is
an additional layer of protection in the form of an industry-financed organization,
Assuris (previously known as CompCorp).
Assuris is the insurance industry’s self-financing provider of protection against loss of policy
benefits in the event of the insolvency of a member company. Insurers licensed to write life
insurance business in Canada are required to be members of Assuris and to pay its levies.
It is financed by assessments levied on its members and is incorporated federally as a non-

profit organization. There are around 100 Assuris members.

Assuris’s membership includes nearly all entities that sponsor segregated funds in Canada
including all life insurance companies that are licensed to sell life insurance or health
insurance to the public. However, fraternal benefit societies are not members of Assuris.
Since 1990, when it first began providing coverage of segregated fund guarantees, it has
never had to make restitution to segregated fund Contract holders. For example, when
Confederation Life Insurance Company was ordered liquidated in 1994, the company’s
segregated fund contracts were transferred to other insurance companies that agreed to
assume Confederation’s obligations to Contract holders.
In the event of an insurer’s default, Assuris will top up any shortfall in the amount payable on
policies issued by its members. While the presence of Assuris provides an additional measure of
safety of capital to Contract holders, in practice this contingency fund has never been put to use.
The Assuris guarantee covers only the death benefits and maturity guarantees applicable to a
segregated fund contract. The assets of the funds themselves are not eligible for Assuris protection
because they are segregated from the general assets of the insurance company. As such, segregated
fund holders enjoy a built-in form of protection against an insurance company’s insolvency.
Assuris guarantees that the policyholder will retain up to $60,000 or 85% of the promised
guaranteed amounts, whichever is higher. For example, if a segregated fund policy has a
maturity guarantee of $80,000, then upon insolvency Assuris would cover as a policy benefit
$68,000, i.e., 85% of $80,000.
If a segregated fund policy provides a Guaranteed Minimum Withdrawal Benefit
(GMWB) option, i.e., an income benefit, Assuris protection is available as follows:
• In the savings phase, Assuris guarantees up to $60,000 or 85% of the promised

guaranteed withdrawal balance, whichever is higher.
• In the payout phase, Assuris guarantees up to $2,000 per month or 85% of the
promised guaranteed income benefit, whichever is higher.
GMWBs are discussed later in the chapter.
Also see Chapter 11, Professional Standards, for more information on Assuris.
STRUCTURE
While there are many similarities, segregated funds and mutual funds differ significantly in
terms of their legal structure.
Most open-ended mutual funds are structured as trusts and the remainder as corporations. In
addition to having to comply with securities legislation, the structure of a mutual fund is
either outlined in the declaration of trust at the time that the fund is established or governed
by the rules for business corporations. In both cases, the structure is one of ownership. In
contrast, segregated funds are contracts of life insurance, known as individual variable
insurance contracts (IVICs), between a Contract holder and an insurance company.
Unitholders do not own segregated fund assets and are non-participating policyholders. However,
the insurance company holds these assets apart from or “segregated” from the firm’s other assets.

Despite their legal structure, segregated funds are treated as trusts held on behalf of investors. If an
insurance company fails financially and has insufficient assets to fulfill its guarantees, the
assets of segregated fund holders would be dedicated solely to them and could not be
claimed by other policyholders or creditors. Since a segregated fund contract does not
represent ownership, segregated funds do not require the approval of investors to change
their management, investment objectives, or auditor or to decrease the frequency of
calculation of net asset values. For open-end mutual funds, such material changes would
require a vote by unitholders. Except in Quebec, segregated fund Contract holders are also
not entitled to attend company general meetings or to vote.
Because of their legal structure, segregated funds do not issue actual units or shares to
investors since this would imply ownership. Instead, an investor is assigned notional units of
the contract, a concept that helps measure a Contract holder’s participation and benefits in a
fund. This concept of notional units also makes it possible to compare the investment
performance of segregated funds with that of mutual funds.
ADMINISTRATION
LEARNING OBJECTIVES
• Explain the investment limitations of an IVIC.
Traditionally, the administration of segregated funds has been the responsibility of companies
that offer the funds. In general, these fund sponsors, who were once mostly life insurance
companies, have the choice of administering their funds in-house or appointing outside third-
party service providers.
With the entry of mutual fund companies and the growth of the segregated funds business,
the largely paper-based administrative processes for segregated funds have been under
increasing pressure to automate. As such, the challenge for insurers has been to match the
proliferation of products with efficient administration.
As with other areas of convergence, it would be natural to adapt the largely automated
systems that are in place for mutual funds to the segregated fund industry. There has also
been a trend for insurers to outsource administrative functions such as fund processing, client
record-keeping and asset valuation to mutual fund companies.
However, while many of the processes for mutual funds can be easily transferred to the business of
segregated funds, certain characteristics of insurance make segregated fund accounts unique. For
instance, purchases, transfers and withdrawals – while key functions for both mutual
fund and segregated fund investing – have more variables and demand more intricate
tracking systems in the case of segregated funds. In general, recent product growth in
segregated funds has outpaced the technical capabilities of existing administrative
systems, both for traditional insurance products and mutual funds.
The issue of administration is a complex one even for insurers, since the “insurance” associated
with segregated funds is not life insurance as it is usually understood. The unitholders of a

segregated fund are not the individual investors but the insurance contracts (i.e., IVICs)
that these individual investors own.
Unique Needs of Segregated Funds

Even when certain administrative requirements for segregated funds parallel those of
mutual funds, some important differences stemming from the regulations governing
these products remain. These differences fall under the areas of:
• investment management
• trustee services
• custodial services
• asset valuation
• investment limitations
INVESTMENT MANAGEMENT
A federally regulated insurance company may provide investment management for its own
segregated funds. However, because of regulatory limitations that existed before the
adoption of the Insurance Companies Act in the early 1990s, life insurance companies tend
to use portfolio-management subsidiaries or unrelated sub-advisors to provide investment
management for their segregated funds. In the case of funds-on-funds, external sub-advisory
services are accessed by other means since the segregated fund invests its assets directly in
existing, non-related proprietary funds. A segregated fund is managed by an external
portfolio manager or within the sponsor’s own investment department in a manner that
allows it to best meet its investment objectives.
TRUSTEE SERVICES
The role of a trustee is to administer the assets of a mutual fund on behalf of the investors.
Although segregated funds are treated as trusts – with assets held by the fund on behalf of
investors – their true legal status as insurance contracts means that segregated funds are
exempt from trustee requirements that apply to mutual funds held within RRSPs or other
registered plans.
In addition, the registration of segregated funds held in a brokerage account with a
securities dealer raises some issues relating to the role of the trustee. Usually, the securities
held by a client in an account with an investment dealer or broker are registered in the name
of the dealer and held on behalf of the client in nominee name. In terms of creditor-
proofing, the implications of this type of registration remain unclear.
CUSTODIAL SERVICES
The role of a custodian is to provide a layer of safety by maintaining investors’ assets apart from the
assets of the company. For holders of segregated funds, a significant degree of protection already
exists since the insurer is required to hold segregated funds’ assets separately from the general
assets of the company. As such, Contract holdershave priority over any other claimants against the
assets of the funds. Furthermore, if the assets of a fund are insufficient to satisfy
a Contract holder’s claim, he or she also has a claim against the general assets of the
insurance company for the remaining balance.

In part, because these safeguards for Contract holders’ assets already exist, an insurer is not required to
have a third-party custodian. Unlike mutual fund sponsors who must appoint a third-party custodian,
life insurance companies are permitted to act as custodians of their own segregated funds. Some
insurers choose this route while others appoint a custodian or sub-custodian.
ASSET VALUATION
The total assets of a segregated fund represent the market value of the fund’s holdings. Net
asset value represents the value of each “notional” unit (“notional” because units have no
independent legal existence and serve only to determine the value of the benefits to the
Contract holder based on the proportional interest of the Contract holder in the assets of the
segregated fund) and is used to determine the amount Contract holders would receive. Assets
must be valued at least monthly although, in most cases, they are valued on each day that the
Toronto Stock Exchange is open for business. (Assets such as mortgages, real estate and
derivatives are subject to different rules since monthly valuation may not be feasible.) Assets
are valued at the closing sale price (i.e., market value) of the securities held, less investment
management fees and other expenses. Transactions, such as purchases and redemptions, must
be reflected in the current or next calculation of net asset value.
INVESTMENT LIMITATIONS
Segregated funds have to abide by certain investment limitations stipulated by law. These
limitations deal, among other things, with publicly traded, transferable, liquid securities,
voting rights, and derivatives.
The sum of a segregated fund’s exposure to any one corporate entity may not exceed 10% of
the value of the segregated fund (including debt and equity exposures). Segregated funds may
not invest in more than 10% of class of securities of one corporate issuer (other than Canadian
government securities). They may not invest more than 10% of assets in illiquid securities.
Segregated funds may not invest in issuers in order to exercise control or management. As
the assets of each segregated fund are held in the name of the life company, the insider
reporting and takeover bid rules of provincial securities regulation apply.
Investment limitations on segregated funds with respect to derivatives are complex; different
rules apply to leveraged portfolios and unleveraged portfolios.
Buying and Selling Segregated Funds

Compared to other securities, segregated fund investing relies heavily on paper-based
processes. An investor’s rights, including the rules governing purchases and withdrawals,
are set out in each contract. Segregated fund contracts typically allow holders to withdraw
or purchase notional units at their most recent net asset value.
PURCHASES
To purchase units – technically, to make a deposit or premium payment – in a segregated
fund, an investor must first establish a contract with the insurer and provide details such as
date of birth, contact information, names of the annuitant and beneficiary, etc.
To initiate a transaction, a purchase order with a licensed insurance representative must include
the client’s signature and may be forwarded to the insurer or, in some cases, to the mutual

fund company on behalf of the insurer. The administration for many segregated fund
offerings is processed through Fund SERV, the same industry organization that provides
clearing and settlement services to mutual funds.
Potential Contract holders must receive disclosure documents and must sign an
acknowledgement that they have received these documents before signing the application
form. The completion and signing of an application form gives the investor – technically, the
Contract holder – the right to make deposits to a segregated fund(s) offered by the company.
Medical/health underwriting does not generally take place with segregated fund investments
(unlike the underwriting that occurs when a life insurance policy is applied for). As such,
people in poor health or otherwise uninsurable can invest in segregated funds.
The purchase price is based on the net asset value of the units at the close of business on the
day that the order is placed. For segregated money market funds, trades settle – i.e. proceeds
are debited or credited to the client’s account – on the day after the trade date. For other
types of segregated funds, settlement typically occurs three business days later, just as it
would for mutual funds.
MINIMUM DEPOSITS
The minimum deposit to a segregated fund may be the same as or similar to the minimum
requirements for mutual funds. However, some companies require a bigger initial
investment for segregated funds than for comparable mutual funds. For example, segregated
fund contracts of one insurer require a $5,000 initial deposit while the minimum investment
requirement for the underlying mutual funds is $500. Another insurer requires a $100,000
minimum deposit for its index guaranteed investment funds. However, periodic investment
plans for some segregated funds allow minimum investments for as low as $50.
WITHDRAWALS
Except in the case of locked-in plans, which are governed by provincial pension laws, the
policyowner of a segregated fund can withdraw or redeem some or all of the cash value of a
segregated fund at any time while the annuitant is alive. In non-registered plans, most
sponsors allow systematic withdrawals and lump-sum withdrawals from segregated fund
contracts. A minimum amount for these scheduled payouts may be required or a minimum
contract balance may have to be maintained. It is important to remember that withdrawals
will affect the value of the guarantees on the remaining deposits in a segregated fund.
A withdrawal is based on the net asset value of the units at the close of business on the day
that the withdrawal/redemption order is received. As with purchase orders, the settlement
date is set under the contract and settlement usually occurs a few days after the trade date.
TRANSFERS
Most insurers allow clients to transfer assets from one fund to another within the fund
family without penalty. In many cases, the number of these transfers is limited within a
calendar year. If the number is exceeded, a charge may be levied for further transfers.
Transfers may affect the initial value and date of a policy, and maturity guarantees may be
reset at varying levels or with different maturities.

FEES AND EXPENSES
LEARNING OBJECTIVES
• Explain “premium taxes.”
• Explain the insurance charges associated with an IVIC (Individual Variable
Insurance Contract).
• Describe the fees & expenses associated with various IVICs.
• Explain the various sales charge options and loads available and their impact on
the investment decision.
Like mutual funds, segregated funds offer the advantages of professional investment
management and portfolio diversification. Another similarity is that these benefits come at a
price. Management fees and expenses are deducted from fund assets and have a direct and
measurable impact on fund performance.
Along with investment management, many of the expenses related to the operation and
administration of segregated funds are similar to the costs of administering mutual funds that
do not have insurance features. These expenses include:
• Legal, audit, registration and bank fees and expenses.
• Administration, record keeping and accounting fees and expenses.
• Printing, filing and mailing costs, including documents prepared for regulators and
investors such as contracts, information folders and other reports.
• Taxes, including income, goods and services, sales and capital gains.
Premium taxes are levied on life insurance premiums by the various provinces with the
amount of tax levied varying between 2% and 4% (around 2% being more common).
These taxes are paid by the insurance companies directly and are another cost of doing
business. Mutual fund companies, of course, are not subject to provincial premium taxes.
The Cost of the Guarantees

In addition to these administrative expenses, segregated funds have added costs stemming
from their insurance components, namely the death benefits and maturity guarantees that
accompany these funds.
The shorter the term of the maturity guarantees on investment funds – whether they are
segregated funds or protected mutual funds – the higher the risk exposure of the insurer and the
cost of the guarantees. This inverse relationship is based on the premise that there is a greater
chance of market decline, and hence a greater chance of collecting on a guarantee, over shorter
periods. A Contract holder’s use of reset provisions also contributes to costs since resetting the
guaranteed amount at a higher level means that the issuer will be liable for this higher amount.

Assessing the true value of the insurance in segregated funds is a difficult issue. The
management expense ratios (MERs) for segregated funds are higher than for comparable
mutual funds. The cost of a full guarantee could be over 2% or 3% a year (and this would be
in addition to regular/ normal MERs).
One solution to the high cost of full guarantees is evident in a reversion to the practice of
guaranteeing only 75% of invested capital. The main argument for the lower guarantee is that
with either level of maturity guarantee, segregated funds still offer major benefits such as
creditor-proofing and the opportunity to bypass probate. With a 75% guarantee, the cost of
the insurance component becomes less onerous. One prominent fund company that offered
the same fund with different guarantees (i.e., 75% versus 100%) charged 5.79% MER for a
100% guarantee and 4.40% MER for a 75% guarantee while the underlying mutual fund
(without, of course, any guarantee) had a 2.69% MER.
Sales Charges
In addition to paying for insurance benefits, clients also pay sales commissions on
segregated funds, similar to the sales charges for mutual funds. These charges compensate
licensed advisors for selling a company’s products. The client may pay either a front-end
load or a deferred service charge (DSC). Segregated funds sold on a no-load basis, where the
sales commission is paid directly by the issuer to the advisor, are less common. As with
mutual funds, there are also trailer fees and switching fees.
TAX CONSIDERATIONS
LEARNING OBJECTIVES
• Explain “adjusted cost base.”
• Explain the taxation of maturity and death benefit guarantees.
• Describe taxation switches.
• Explain the taxation of an IVIC.
• Explain the valuation process for IVICs. Use examples to support your explanation.
Segregated funds are insurance contracts but are taxed as if they were trusts. The Income Tax
Act stipulates that assets of segregated fund contracts are deemed to be trusts whose assets
are separate from those of the insurance company that sponsors the funds. The insurance
company itself, which is the legal owner of the assets of the segregated fund, does not pay
taxes on income earned by the fund.
All of the fund’s net income – whether in the form of dividends, capital gains or interest – is
deemed to be income of the Contract holders. In taxable accounts, this income is taxable in
the current year. However, since the Contract holdersdo not own the fund’s assets, actual
distributions are not required. Instead, the amount of income deemed to have been earned by

each Contract holder is calculated using a procedure known as allocation. This involves
allocating a percentage of the fund’s total income to each unit according to the terms of the
segregated fund contract.
Most funds (but not all) allocate income to a Contract holder based on the number of units
held and the proportion of the calendar year during which those units were held. For
instance, a segregated fund contract held for six months of the year would be allocated half
of the per-unit allocations designated to a contract held for the full year.
Time-weighted allocations allow segregated funds to treat Contract holders more fairly in terms
of tax liability, regardless of when the contracts were purchased. In contrast, inequities may exist
for mutual fund holders, particularly in the case of equity funds, because of the common industry
practice of distributing all of the fund’s income at the end of the calendar year.
Mutual fund investors who buy a fund late in the year, but before the year-end distribution,
will receive the same distributions per unit as investors who held the fund for the full year.
Unlike purchasers of segregated funds, mutual fund investors do not have their distributions
pro-rated based on the percentage of the year that the fund was held. Mutual fund investors
who bought late in the year may be credited with capital gains that were earned before they
invested in the fund. This practice means that, in effect, the mutual fund unitholder is
required to make tax payments in advance.
Paying taxes on year-end distributions for mutual funds held for less than a full year is a
significant drawback for investors who wish to defer paying taxes for as long as possible.
Most segregated funds do not suffer from these seasonal tax distortions. Clients may invest in
segregated funds on a year-round basis without being subjected to premature tax liabilities.
Ordinarily, when a “switch” occurs between funds held in a non-registered account, a “sell”
transaction occurs first followed by a “buy” transaction, and a capital gain or loss must be
reported for income tax purposes on the “sell” transaction. However, investing within a
mutual fund corporation allows an investor to switch holdings from one “class” to another
without realizing a taxable capital gain at the time of the switch. This could provide
significant tax deferral benefits.
Effect of Allocations on Segregated Fund Net Asset Values

The different ways that income flows through to unitholders of mutual funds and segregated
funds is reflected in the net asset values (NAV) of these funds. With a mutual fund, net asset
values fall when a distribution is made. This is because income and capital gains are allowed
to accumulate inside the fund and are then paid out. Periodically (usually annually or
quarterly), the mutual fund makes distributions to existing unitholders and, each time, deducts
the value of the distribution from the fund’s assets. In turn, net asset values decline by the
amount of the distribution. Most distributions are reinvested in the fund and new units are
issued to unitholders. So although the NAV declines, each unitholder owns more units.
With most segregated funds, there is no decrease in the NAV when an allocation of
income is made. Instead, the segregated fund contract receives additional income that is
allocated to the existing units. In most cases, these allocations continue to be held in the
policy although they may also be redeemed by the Contract holder and received in cash.

Table 5B.5 illustrates the varying impact of distributions and allocations on the NAV of a
mutual fund and a segregated fund. For the purpose of this simplified example, assume that
the funds had identical holdings and income for the year.
TABLE 5B.5 EFFECT OF ALLOCATIONS ON SEGREGATED AND MUTUAL FUNDS
I II III IV V
Type of Number of Income Number of units Number of Units Value of
Fund units and per unit and NAV at and NAV after account
NAV, on earned year-end, flow-through after flow-
Jan. 2 during before flow- through and
full year through reinvestment
Mutual 100 units @ $20 $1.20 100 units @ $21.20 100 units @ $20, $2,120
fund = $2,000 = $2,120 plus six units from
reinvestment =
106 units @ $20
Segregated 100 units @ $20 $1.20 100 units @ $21.20 100 units @ $21.20 $2,120
fund = $2,000 = $2,120
For the mutual fund investor, a payout of $1.20 per unit means that the investor has income
of $120 for the year. Until the distribution is made, this income is reflected in an increase of
the unit price from $20 to $21.20 (column III). After this income is distributed to the
investor, the unit price returns to $20 (column IV). If the investor chose to have this income
reinvested in the fund, he or she would own six additional units of the fund. The total value
of the investment remains the same at $2,120. Alternatively, the investor could choose to
receive the distribution in cash.
The above example assumes that the segregated fund Contract holder held the fund for the
entire year, from January 1 to December 31. Since a segregated fund accrues income
throughout the year, the full $1.20 of income is allocated to the investor. If the investor held
the fund for only part of the year, the income allocation would be less than the full $1.20.
For example, holding the fund from July to December would entitle the investor to only
one-half of the income distribution.
Continuing from the above example, assume that an investor purchases the segregated fund
in September and holds it for the remainder of the year. Because the income allocation has
accrued for eight months already, the NAV at the time of purchase would reflect the
allocations since the beginning of the year. The calculation proceeds as follows:
Per month distribution = $1.20 ÷ 12 months = $0.10 per month
Distribution from January to September = 8 months × $0.10 = $0.80
The $0.80 represents the amount of the allocation earned by the fund during the eight months
from the start of the year which means that the investor would have bought in at a NAV of
$20.80 ($20.00 + $0.80) at the time of purchase instead of at an NAV of $20. When the
allocation is paid out at the end of the year, the investor would receive $0.40 per unit ($1.20 –
$0.80) representing the four months that the investor held the fund (September to December).

Therefore, the payout of $0.40 per unit means that the investor has income of $40 for the
year (100 units × $0.40).
At the end of the year, the NAV for the investor is also $21.20, the same as in the example
above. Therefore, the only difference in this example is that the investor receives allocations
only for the months that the contract was owned (September to December).
Mutual funds typically pay only once a year, near year-end. A mutual fund investor receives
the entire distribution at that time, regardless of whether the unitholder had owned the
mutual fund for the entire year or just since September.
A few principles flow from these examples:
1. Segregated funds’ NAVs are the same for all Contract holders at any given point in time.
2. The NAV at which an investor purchases a segregated fund varies depending on
when during the year the fund is purchased.
3. Income allocations do not reduce the NAV of a segregated fund.
4. Segregated fund allocations per unit are paid throughout the year.
For the segregated fund Contract holder, an allocation of $1.20 per unit means that the
Contract holder has income of $120 for the year. When this allocation occurs, there is no
change in the number of units owned by the Contract holder. Instead, the unit price of the
fund increases. While the Contract holder still owns 100 units, the unit price would now be
$21.20 instead of $20 (column IV). Not all segregated fund contracts handle a distribution in
this manner; some handle the distribution in the same fashion as a mutual fund.
In either case, the distribution is treated as income and taxable in the hands of the investor
(for non-registered contracts). In addition, it does not matter whether the distribution is taken
in the form of additional units or as a cash payout as this income is no longer reflected in the
unit price after the distribution is made. As previously discussed, all mutual fund unitholders
receive the same distribution – and accompanying tax liability – regardless of when they
bought into the fund.
One of the advantages of segregated fund contracts over mutual funds is that capital losses, as
well as gains, can be passed on to the Contract holder. This is not true of mutual funds.
Capital losses cannot be flowed through to mutual fund unitholders; they must be kept in the
fund and used in future years to offset capital gains.
Tax Treatment of Maturity Guarantee

Payments flowing from a segregated fund contract’s maturity guarantee are taxable. It must
be noted that consensus is lacking among tax experts as to whether the maturity guarantee
should be treated as a capital gain or as income, because different interpretations of the
provisions in the Income Tax Act are possible.
The amount of tax payable depends on whether the proceeds exceed the cost of the
contract. The proceeds of a contract are calculated as the market value of the segregated
fund holdings at redemption plus the value of any guarantee received. If the segregated
fund contract consists of more than one fund, each fund is calculated separately.

The cost of the contract, otherwise known as the adjusted cost base, consists of the original
amount deposited and any net income or capital gains (or capital losses) allocated to the
policy. (Capital gain allocations result from a fund’s trading activity, not from decisions
made by an individual Contract holder.)
If the proceeds of the contract are less than the adjusted cost base, income tax is payable on
the guaranteed amount. However, the Contract holder can use the difference between the
market value of the segregated fund holdings and the adjusted cost base as a capital loss. The
net effect is zero if the guarantee is considered to be a capital gain. If the guarantee received
is considered to be income, then the Contract holder must pay tax on the full amount but can
use only 50% of the capital loss declared. If the proceeds exceed the adjusted cost base, the
Contract holder is taxed on the difference.
The following examples illustrate the amount of tax payable under three different scenarios:
I. The maturity value exceeds the original cost of the contract.
II. The maturity value is less than the guaranteed amount.
III. A reset provision has been employed making the maturity guarantee higher than that
specified in the original contract. Resetting the maturity guarantee extends the policy
over a longer period. Even if the reset is used to lock in a capital gain, it does not
constitute a redemption and, therefore, does not trigger a taxable event.
Under each scenario, it is assumed that $100,000 was invested in a lump sum on a deferred
sales charge basis, with a 100% maturity guarantee, and that the policy was held long
enough so that no redemption fees are applicable at the time of the surrender of the contract.
Scenario I: Client redeems $100,000 deposit after 10 years for proceeds of $130,000.
The market value of the contract at maturity exceeds the adjusted cost base.
Tax consequences: 50% of the capital gain of $30,000 ($130,000 - $100,000) is taxable in
the year of redemption.
Scenario II: Client redeems $100,000 deposit after 10 years for proceeds of $95,000. Since
the market value at maturity is less than the adjusted cost base, the client also receives
$5,000 as the maturity guarantee.
Tax consequences: The maturity guarantee of $5,000 is treated as a capital gain, but it is offset by
the $5,000 capital loss incurred because the client’s $100,000 deposit is now worth only $95,000.
Scenario III: Client chooses to reset $100,000 deposit after five years, locking in the gain
in market value to $130,000 and extending the contract. Ten years after the reset date, the
contract matures at a market value of $110,000. The client receives a $20,000 maturity
guarantee, for total proceeds of $130,000.
Tax consequences: No capital gains tax liability is triggered at the time of the reset.
However, upon redemption (15 years after the original deposit), 50% of the capital gain
of $30,000 (proceeds at redemption less the original cost of $100,000) is taxable.
These are very simplistic examples as they assume there were no distributions paid by the issuing
company during the specified time period. In reality, distributions would likely be paid each year.
Tax is paid on these distributions in the year that they were made and, as such, the client

would not be taxed twice. The issuing company keeps track of these distributions and
the adjusted cost base is reported on the T3 slip.
Tax Treatment of Death Benefits

When the annuitant dies, the contract is terminated and the beneficiary receives death benefits. If
the Contract holder is not the same person as the annuitant, the contract remains in force when
the Contract holder dies, but the deceased owner is deemed to have disposed of the contract at
fair market value. This deemed disposition will normally trigger a capital gain or a capital loss.
However, if the Contract holder took advantage of the provision allowing his or her spouse to be
named as the successor owner, the contract can be transferred to the spouse at its adjusted cost
base, thereby deferring any capital gains tax liability. If the Contract holder and annuitant is the
same person, the gain or loss will be reflected on his or her terminal tax return for the year of
death. Similar to the taxation of maturity guarantees, consensus is lacking among tax experts as
to whether the death benefit should be treated as a capital gain or as income, because different
interpretations of the provisions in the Income Tax Act are possible.
Example: A client purchases a segregated fund contract for $100,000. The contract provides for
a 100% guarantee at death. Five years later, the client dies. At the time of the client’s death, the
market value of the segregated fund is $80,000. The death benefit payment would be $20,000.
Assuming the fund was held in a non-registered plan, the client would report a $20,000 gain, but
the client would also have an offsetting capital loss of $20,000. Because the fund declined from
$100,000 to $80,000, there would be no tax impact as the two would cancel each other out.
The tax treatment of death benefits can be very complicated. It is recommended that the
investor and the advisor clearly understand the tax implications of the contract by thoroughly
reading the information folder provided with the purchase of a segregated fund and
consulting a tax specialist if necessary.
Interest Deductibility on Borrowing

Similar to other income-generating investments, interest on money borrowed to
purchase segregated funds is tax deductible.
Tax Reporting on the T3 Slip

Depending on the type of fund and the composition of its investment returns, the allocations will
be in the form of capital gains, Canadian dividends, interest income or foreign-source income.
These allocations are reported annually on a T3 form by the fund issuer and, in turn, must be
reported by the Contract holder. The T3 form indicates the income, dividends and capital gains
earned during the year, based on the number of units and the length of time the units have
been held by the Contract holder. Since, for tax purposes, each type of income must be
declared separately on a tax return, they also appear separately on the T3 form.
Tax reporting on the T3 form includes capital gains or losses both by the fund itself and by
the individual Contract holder as of the date of surrender (redemption) of the contract. As is
the case with any type of investment fund, a switch from one fund to another in the same
fund family is a taxable event that will generally trigger a capital gain or loss. This type of
gain or loss is also reported on the T3 form.

Contract holderswill be subject to tax on capital gains that result from redeeming units or
switching from one segregated fund to another. The capital gain – if any – is the amount by
which the net proceeds exceed the adjusted cost base. The adjusted cost base is the sum of
the amount originally invested plus any income or capital gains allocated to the policy less
any capital losses. (A Contract holder is taxed on the difference between the proceeds and
the adjusted cost base. The adjusted cost base is affected by any distributions or allocations
made while the contract was held.)
Commission charges or acquisition fees – whether they are front-end, deferred or switching fees
– are reported separately on the T3 slip and can be claimed as a capital loss by the Contract
holder when the contract is surrendered. (This practice differs from that for mutual funds, where
commission charges are added to the adjusted cost base or deducted from the proceeds.) Usually,
since most segregated funds are purchased on a deferred-load basis, the commission is in the form
of a redemption fee payable at the time that the contract is surrendered.
Alternatively, if a commission was paid at the time of the initial purchase, this front-end load
would be deductible as a capital loss if the entire contract is redeemed. In the event of a partial
redemption, a proportional amount of the front-end load can be claimed as a capital loss.
Segregated Funds and RESPs

Very young people are not normally thought of as the type of clients who would benefit
from holding segregated funds. Nonetheless, segregated funds can be held in registered
education savings plans (RESPs) provided that the sponsor makes the necessary
administrative arrangements.
RESPs are government-subsidized savings plans that assist parents and other relatives in saving
for a child’s post-secondary education. Contributions to an RESP are not deductible for income
tax purposes and are not taxed upon withdrawal. Investment income accruing in the plan is
generally included in the income of the plan’s beneficiary on withdrawal. The 2007 federal
budget eliminated the maximum annual $4,000 RESP contribution limit and increased the lifetime
contribution limit to $50,000 per beneficiary. In addition, the federal government contributes 20%
of the first $2,500 of annual contribution in the form of a Canada Education Savings Grant
(CESG). RESPs have a maximum life of 35 years and, in most cases, the student beneficiary
begins to withdraw funds from the plan beginning at age 18.
By contributing to an RESP through a segregated fund contract that offers a 100%

maturity guarantee over 10 years, clients can invest in longer-term growth asset
categories with the assurance that their savings are protected from capital loss.
If the segregated fund policy has a reset feature that allows the maturity date to be rolled
forward, the client may have additional flexibility to lock in any capital gains that occur
during the earlier years of the RESP. The reset option is a more useful feature when the child
who is the plan’s beneficiary is eight years old or younger and will not need to draw funds
from the plan for at least 10 years.
If the child is older than eight years, a reset date could still be chosen that would extend the
date of the maturity guarantee past his or her 18th birthday. The child could still withdraw
funds before that maturity date but any withdrawals would not be protected by the 10-year
maturity guarantee provision.

DISCLOSURE
LEARNING OBJECTIVES
• List the requirements for providing audited financial statements.
• Explain the content and purpose of the Information Folder and the benefits it brings
to a client.
• Explain the requirements for reporting past performance in documentation
or advertisements to/for the consumer.
• Describe the disclosure requirements necessary when offering an IVIC and when they
must be given to the consumer.
The fundamental objective of the disclosure requirements that govern segregated funds is the
protection of existing and prospective Contract holders. Regulations and accompanying
guidelines are aimed at ensuring that Contract holders have all the information required to
make an informed purchase decision.
The governing principles of segregated fund disclosure are included in the guidelines developed
by CLHIA. These guidelines evolved from earlier ones set out by the Canadian Council of
Insurance Regulators (CCIR) and by CLHIA itself. The Canadian Institute of Chartered
Accountants has developed the standards for financial reporting that are part of these guidelines.
Regulatory Requirements for Issuers

Virtually all insurance companies that issue segregated funds are federally registered and regulated by
OSFI, with financial soundness or solvency of the companies being its prime concern.
Before an insurance company can issue a segregated fund contract, provincial regulators must
approve the sale of the contract. The first step towards obtaining this approval is to file a series of
documents with CLHIA. These documents consist of the draft contract, application form,
information folder and summary fact statement. After being reviewed for compliance by
CLHIA, the application and accompanying documents are forwarded to provincial insurance
regulators for approval.
A new information folder must be filed at the earlier of 13 months after the latest
information folder or 16 months after the latest audited financial statements. In addition,
material changes – changes that can be expected to have a significant impact on the potential
returns and risk of the fund – may require the process of approval to be repeated.
Key Disclosure Documents

Overall, the offering documents for segregated funds must disclose all the important facts
about the funds in concise and plain language. The key disclosure documents for a
segregated fund contract consist of:
• acknowledgment of receipt card

• application form
• contract
• information folder
• summary fact statement
• financial statements
• client statements
ACKNOWLEDGMENT OF RECEIPT CARD

Before a client signs an application for a segregated fund policy, he or she must receive a
copy of the information folder from the advisor. To prove that the information folder has
been delivered by the advisor, the issuer must receive a signed “acknowledgement of
receipt card” from the client.
APPLICATION FORM
The application form provides the insurance company with the information required to set up
the insurance contract and includes the names of the Contract holder, annuitant, beneficiary and
contributor (if, for example, it is a spousal RRSP) and the policy’s maturity date.
CONTRACT
A segregated fund contract must describe the benefits of the policy and identify the
benefits that are guaranteed and those that will vary according to the market value of the
fund’s assets. Included in a segregated fund contract is a warning to clients that the value
of the policy’s investments will fluctuate. The contract also states how often and when the
fund is valued, the fees and charges against the fund and how they are determined.
INFORMATION FOLDER
The information folder is the point of sale disclosure document for segregated funds and is
comparable to the prospectus for open-end mutual funds. It must be delivered to the
potential investor before the application for the segregated fund contract is signed. To
avoid any confusion with other marketing materials, the information folder must be
identified by the title “Information Folder” on its cover or the first “face” page inside the
cover. The key items of disclosure covered in the information folder include:
• Benefits guaranteed under the contract.
• Benefits under the contract that fluctuate with the market value of the assets of
the segregated fund supporting them.
• Method for determining the benefits related to the market value of the segregated fund.
• Redemption, surrender and maturity options.
• Method for determining the price of units on acquisition or transfer, including any
charges expressed in dollars and units or as a percentage of premiums.
• Options for acquiring or transferring units and the minimum dollar amount required
to make a purchase (either lump sum or periodic)

• Charges for withdrawals.

• Method for determining the value of the units.
• Statement of whether the insurer intends to market the segregated fund (IVIC)
continuously or whether it is a limited-time offer.
• Statement of the fund’s investment policy including an advisory that states that
Contract holders may request delivery of the segregated fund’s complete investment
policy and information on how it can be requested.
• Tax status of the fund and of Contract holders.
• Current management fees, as a percentage of the fund’s net assets.
• All other expenses that may be charged against the assets of the fund.
• A one-page executive summary of material facts about the fund.
If the segregated funds will be held in a registered plan, there are additional requirements for
various statements that must be included in the information folder. These requirements state that:
• Segregated funds (IVICs) are one of a number of different vehicles for the
accumulation of retirement income.
• Certain regular contractual benefits may need to be modified.
• Registered contracts may be more suitable for long-term holding periods.
• The prospective Contract holder should discuss fully all aspects of registration
with the insurer or agent before purchasing a registered segregated fund.
The information folder included with all real estate segregated funds must also stress the
long-term nature of the fund’s investments and their relative lack of liquidity. For example,
the information folder must state that the contract may only be redeemed on specified dates
and that it may be unsuitable for Contract holders who require a high degree of liquidity.
SUMMARY FACT STATEMENT

A prospective Contract holder must be given a copy of the summary fact statement at the
time that the information folder is delivered. The summary fact statement provides a snapshot
of the fund and includes a brief listing of its historical performance, investment policies and
its three largest holdings (guidelines call for disclosure of the three largest holdings only but
issuers commonly go beyond the minimum requirement).
FINANCIAL STATEMENTS
Audited financial statements must accompany the information folder and be provided
annually to Contract holders. Audited financial statements of each segregated fund, prepared
in accordance with generally accepted accounting principles, must contain a statement of
operations, statement of changes in net assets, statement of net assets, statement of
investment portfolio and the notes to the financial statements.

CLIENT STATEMENTS
Confirmation of purchases, sales or transfers is sent to clients as they occur. In addition,
summary statements are issued on a regular basis (usually semi-annually). A client statement
will show: changes in a client’s portfolio position including contributions and redemptions
that occurred since the previous statement, value of the Contract holder’s seg-fund holdings
and the unit value of each fund. Contract holders also receive an annual report that details the
investment management and performance of the funds.
Other Information Sources

Publications that track mutual fund prices normally include segregated funds in their listings.
Consequently, unit values for segregated funds are generally reported on a daily basis, along
with mutual fund values, in major newspapers across Canada. In addition, the performance of
segregated funds is listed in mutual fund tables included in newspapers (or on the newspapers’
websites) and is also available through various mutual fund software products.
Advertisements and Marketing

All types of communications are considered advertisements governed by CLHIA guidelines.
These guidelines have been approved by the Canadian Council of Insurance Regulators,
which represents regulatory agencies in provincial and territorial jurisdictions across Canada.
In addition to insurance companies, individual advisors are subject to CLHIA guidelines that
limit what they are allowed to communicate to their clients.
CLHIA guidelines are aimed at harmonizing advertising, disclosure and financial reporting
standards for segregated funds with those that securities regulators apply to mutual funds.
The definition of what constitutes a sales communication is very broad. It includes all
forms of advertising in any print, broadcast, online or other medium. The common theme
is that these communications are aimed at the public and are intended to solicit the sale of
segregated fund contracts.
Sales communications also include reports to Contract holders and any oral or written
communications used by a life insurance agent or insurance company to persuade
members of the public to purchase their services.
PROHIBITED PRACTICES
Insurance agents and sponsors face restrictions in how they represent segregated funds to clients. For
example, while it is appropriate to state a contract’s maturity and death benefits, there is a
prohibition against making any other representations about the future value of a contract.
Communications to clients and the public must also adhere to CLHIA guidelines that prohibit
unfair and deceptive sales practices. These include false statements or misrepresentations
regarding the terms, benefits and advantages of a contract; incomplete or otherwise misleading
comparisons with competing segregated fund contracts or other investment vehicles and any
unfair criticism of the contracts, services or methods of competitors.
Segregated fund contract advertisements must be expressed in plain language and be consistent
with the actual terms of the contract as listed in the information folder. Any citations by actuarial,
technical, medical or other professional authorities must be in a form that is comprehensible

to the public. In addition, this form must not change the meaning that these professional
authorities were trying to convey. It is also prohibited to give the appearance that statements have
an actuarial or other authoritative basis when they do not. When statistics or other authoritative
findings are cited in an advertisement, the source of that information must be disclosed.
DISCLAIMERS AND TESTIMONIALS

When an advertisement mentions any advantage of the contract, such as benefits payable
under the maturity guarantee or death benefits, it must also disclose any limitations,
exceptions or reductions in coverage. For example, any mention of death benefits would
also have to be accompanied by disclosure of any age-related reductions in benefits.
In addition, marketing documents or sales communications – whether printed or electronic –
must state that a description of the key features of the segregated fund is available in the
information folder. These documents must also contain a warning about the effects of market
fluctuations on an investment. The prescribed wording for this warning is: “Subject to any
applicable death and maturity guarantee, any part of the premium or other amount that is
allocated to a segregated fund is invested at the risk of the Contract holder and may increase
or decrease in value according to fluctuation in the market value of the assets in the
segregated fund.” Regulations allow this warning to be omitted in sales communications that
do not contain performance data and in communications where the warning would constitute
more than half of the sales communication.
When fees, commissions and other costs paid by the Contract holder are publicized, the
sales communication must disclose all applicable charges. Disclaimers in segregated fund
contract advertisements must be easy to locate and clearly visible. In written advertising,
disclaimers should be published in type that is at least eight points in size. In the case of
broadcast or other electronic media in which the disclaimer will be seen or heard, the
disclaimer must be visible or audible for “a reasonable period of time.”
When recommending segregated fund contracts as suitable for RRSPs or other registered
plans, insurance companies and advisors must mention the age at which the client must
convert the contract to an annuity or a registered retirement income fund (RRIF).
Sales communications are prohibited from touting immediate tax savings as the main
reason for investing in a segregated fund. Instead, the benefits should be described as being
longer term in nature. In addition, according to the guidelines, the sales communications
should advise the prospective client to discuss with his or her advisor and/or insurance
company all aspects of registering the plan before making any purchase decision.
Since segregated fund contracts are frequently marketed as being advantageous to older
clients, specific advertising guidelines have been put into place to help protect the interests
of these types of clients. Advertisements soliciting segregated funds as holdings for RRSPs,
for example, must address the fact that an older Contract holder may be required to convert
his or her contract before its maturity date. Accordingly, advertising communications are
required to indicate that a contract must be converted to a RRIF or annuity before the end of
the year in which the Contract holder turns 71.
According to CLHIA guidelines, testimonials used in an advertisement must be of a general
nature, be authentic and express the current opinion of the source of the testimonial. There must
be disclosure to the public of any direct or indirect payment in connection with the testimonial.

ADVERTISING PAST PERFORMANCE

A key area where disclaimers are required is the communication of past performance. In
advertising and any other communications to clients, it must be stated that past performance
is not indicative of future returns. This disclaimer can be found, for example, alongside
charts that illustrate the historic returns of a fund.
Illustrations of the prospective growth in value of a segregated fund contract must state that
the accumulated value can be used at maturity to provide an annuity or a death benefit. The
illustration must disclose the rate of growth assumed in calculating the illustration and the
extent to which any guarantees apply.
When past performance is advertised, it must be done so according to standard measurement
periods. For funds that are at least 10 years old, past performance must be reported for the
one-year total return and the three-, five- and 10-year compound annual returns. For funds
that have less than 10 years of history, past performance should be reported for as many of
the remaining standard periods (one, three and five years) as is applicable. Advertising of
returns for periods of less than one year is not allowed.
When rates of return are advertised for a certain period, reference should be made to any
provisions that might prevent Contract holders from redeeming their funds before the
expiry of that period. Similarly, when withdrawal privileges are advertised, the sales
communication must indicate any restrictions on withdrawals.
The reporting of standard performance data must be for periods that are deemed to be reasonably
current. CLHIA guidelines require that any returns reported be for periods ending in a
calendar month that is not more than three months before the initial date of publication of
the advertisement.
Performance comparisons with market benchmarks, price indexes or other investments are
permitted, subject to conditions aimed at ensuring that the comparisons are fair and
reasonable. The comparisons must be made for the same period. There must be disclosure of
any material differences between the portfolio of the segregated fund and its benchmark,
index or average and for any other points of comparison.
Innovations Related to Segregated Funds

In the past, segregated funds were the domain of insurance companies. Recently, the entry of
mutual fund companies and the growing popularity of segregated funds for investors have led
to significant product expansion in segregated funds. The result has been variations of and
enhancements to the basic structure of the traditional segregated fund contract.
GUARANTEED INVESTMENT FUNDS (GIF)

The first company to offer segregated funds that use brand-name mutual funds as their
underlying investments was Manulife Financial which launched its guaranteed investment funds
in January 1997. Manulife teamed up with a number of mutual fund companies to create a
product that brought well-known mutual funds under the umbrella of segregated funds.
The result was a product that combined known investment management from mutual fund
companies with the guarantees that have been traditionally offered by insurance companies
that issue segregated funds. As well as being popular with mutual fund companies (which
gained another avenue for marketing their products), this “fund-on-fund” structure has
proven attractive to investors because of the combination of investment and insurance.

GUARANTEED MINIMUM WITHDRAWAL BENEFIT PLANS

When clients near their retirement, losses in their portfolio can be particularly serious. Earlier
in the investment cycle, good years can balance off bad years, but in retirement the extra return
from later good years can be lost, since part of the portfolio has to be withdrawn for income.
To counter the risk of retirement funds being impaired by a few bad years at the wrong
time, insurance companies have developed guaranteed minimum withdrawal benefit
(GMWB) plans. Industry experts predict there is the potential for tremendous demand for
this product, particularly as the baby boomers approach retirement.
A GMWB is similar to a variable annuity.
With a variable annuity the amount of monthly payment to the annuitant varies according to
the value of the investments in a segregated fund into which premiums are placed. Many
variable contracts provide a “floor” below which benefits may not fall. The floor for benefits
is usually equal to 75% of premiums paid, regardless of what happens to the value of the
variable annuity fund.
With a GMWB:
• The client purchases the plan, and the GMWB option gives the plan holder the right to
withdraw a certain fixed percentage (7% is typical) of the initial deposit every year
until the entire principal is returned, no matter how the fund performs.
• At a minimum, clients receive their principal. The underlying investment account can
be based on a variety of indexes, funds, etc.
Under one plan, clients can buy the GMWB several years in advance of their withdrawals.
• In this case, the guaranteed amount can grow by 5% every year until withdrawals
begin. Every three years, throughout the term of the plan, if the underlying fund has
risen, the guaranteed amount is reset upwards. When the guaranteed amount increases,
the payment period is extended, and the regular payments may also be increased.
These plans have advantages besides guaranteeing principal repayment and the
possibility of sharing in the increased value of a mutual fund.
Example: If a client buys the plan several years before withdrawals begin, the guarantee
increases by 5% each year until withdrawals start, even if the fund decreases in value. During
this period, if the market rises, the three-year reset is in effect. This reset compounds the
value of the 5% increases in the guarantee.
If a client starts to take payments immediately after purchasing the plan, she will be
susceptible to earlier losses in the portfolio. In other words, she may never be able to
receive more than the principal repayment.
It is necessary to purchase the plan several years in advance of withdrawal, in order to
build up the guarantee. The bonuses come in those years regardless of the behaviour of the
underlying fund.
These plans are especially suitable for clients with 5 to 10 years to retirement, who cannot
afford significant losses in their portfolio during that time. These clients also want to be able
to share in the growth of selected financial markets.

FIVE B • SEGREGATED FUNDS 5B• 41
GMWB plans provide the potential for growth but with a guaranteed income floor that
provides a secure income stream as a base. The income stream can now also be assured for
the life of the investor. This provides further peace of mind, knowing that the investment can
provide income for life.
GMWB plans come with fees levied to manage the underlying mutual fund(s) and fees levied
to fund the GMWB guarantee. The investor may have to pay sales charges when depositing or
withdrawing from the contract depending on the sales charge option of the fund(s) chosen.
PORTFOLIO FUNDS
Portfolio funds, which invest in other funds instead of buying securities directly, allow
investors to hold a diversified portfolio of segregated funds through a single investment. The
responsibility for choosing or rebalancing the asset mix usually rests with the fund company.
Management expenses for portfolio funds are generally higher than for stand-alone
segregated funds and guaranteed investment funds, because the investor pays for the asset
allocation service, on top of the management costs for the underlying funds.
PROTECTED FUNDS
The emergence of protected funds marks one way in which the mutual fund industry has responded
to the popularity of insurance company segregated funds. Unlike segregated funds, protected funds
are legally structured as mutual fund trusts and are not governed by insurance legislation. An
important advantage of this structure for the mutual fund industry is that they can be sold by
registered mutual fund salespeople at bank branches and by independent financial advisors who do
not have life insurance licences. Also, investors and sellers of protected funds generally bypass the
more complicated administrative processes required for insurance purchases. The disadvantage is that
non-insurance products do not offer protection from creditors.
Protected funds provide many of the same benefits as segregated funds. They typically have
a maturity guarantee (usually ten years) and allow unitholders to reset the maturity value
without triggering an income tax liability. However, unlike all segregated funds, some
protected funds do not offer traditional death benefits. Instead of paying out the original
investment to a designated beneficiary or the investor’s estate on the death of the owner, the
company may allow the five-year guarantee to be transferable.

Chapter 6
Underwriting,
Issues and Claims

6
Underwriting,
Issues and Claims
CHAPTER OUTLINE
Introduction
The Duties of the Agent
• To Collect Information
• To Educate Clients on the Consequences of Providing Incorrect Information
• To Witness a Client Signature on an Application
Key Components of a Life Insurance Application
• Part I: Identification, Coverage, Beneficiary, and Eligibility
• Part II: The Non-Medical Application
• Applicant’s Signature
• The Agent’s Report
• The Consequences of Incomplete or Inaccurate Information in the Application
• Temporary Insurance Agreement (TIA) and Conditional Insurance Receipts
The Underwriting Process

• Submission of an Application by an Agent
• Preliminary Investigation
• Jet Underwriting
• Initial Review by an Underwriter
• Detailed Review of the Application
• Underwriting Guidelines

• Review of the Non-Medical Questionnaire
• Confirming Health Information
• Financial Underwriting
Factors that Affect the Level of Premium Rates
• Factors That Decrease Premium Rates
• Factors That Increase Premium Rates
Components of an Insurance Policy
• Main Provisions of an Insurance Policy
• Mandatory Life Insurance Provisions
• Other Life Insurance Provisions
• Accident and Sickness Insurance Provisions
• Disability Insurance Contract Provisions
Agent’s Responsibility in Delivery of the Insurance Contract
The Claims Process for Life, Disability, Accident & Sickness, and Group Insurance
• Life Insurance Claims
• Disability Insurance Claims
• Accident and Sickness Insurance Claims
• Group Insurance Claims
Role of the Agent in Settling a Claim
• Life Insurance Claims
• Disability Insurance Claims
• Accident and Sickness Insurance Claims
• Group Insurance Claims
• Federal Government Forms
• Provincial Government Forms
Pricing a Life Insurance Product
• Mortality Experience
• Morbidity Experience
• Investment Earnings
• Expenses and Taxes
Reinsurance

INTRODUCTION
The underwriting process begins with the life agent gathering pertinent client information.
The underwriter then assesses the risk presented in an application by comparing the
particulars of the medical, financial, and personal characteristics of the person to be insured
with the characteristics and patterns of standard risks.
In this chapter, you will learn about underwriting, issuance and claims processes, and the
roles of both the agent and the underwriter.
THE DUTIES OF THE AGENT
LEARNING OBJECTIVES
• explain the agent’s responsibility in collecting information as part of the
underwriting process;
• explain, using examples, the agent’s duty to educate the client about the consequences of
providing incorrect information during the application/underwriting process;
• explain the purpose of witnessing a client signature on an application;
• define what is meant by a legal signature.
To Collect Information
An agent’s principal duty, as laid out in the agent’s contract, is to solicit applications for
life insurance and related products. In doing so, the agent is required to ensure that the
application is complete, i.e., all the information needed to assess the applicant’s eligibility
for insurance has been obtained.
• The agent must read each question in the application to the applicant and accurately
record the applicant’s answers. It is not the agent’s responsibility to interpret an answer
or to coach the applicant in how to answer the questions.
• The agent must arrange to obtain any additional information required to assess the proposed life
insured’s eligibility for insurance. This responsibility may include arranging for a medical exam
of the proposed life insured, completing other forms, or obtaining additional pieces of
information. For example, if the proposed life insured is engaged in a potentially hazardous
activity such as flying a private airplane, the agent must get the proposed life insured
to complete and sign a form that provides the insurer with particulars of the proposed life
insured’s level of engagement in this activity. If the application is for key person life
insurance in a business, the agent may have to obtain the business’s financial statements
to help the underwriter justify the level of coverage requested in the application.

SIX • UNDERWRITING, ISSUES AND CLAIMS 6•5
• The agent must include a written report with the application that cites any relevant
information about the proposed life insured that may not have been included in the
answers to the questions on the application.
In summary, the agent is responsible for presenting a complete picture of the level of risk the
applicant presents, in terms of the proposed life insured’s health, financial situation, and lifestyle.
To Educate Clients on the Consequences of Providing

Incorrect Information
Once the life insurance application has been completed, the applicant must sign the
application. Just above the space for the signature is a printed notice that in signing the
application, the applicant is confirming the accuracy and truthfulness of the information
contained in the application. When the applicant signs the application, the agent must point
out that statement to make sure that the applicant understands that he or she is promising
that the information contained in the application is true, complete, and accurate.
To emphasize the importance of that commitment by the applicant, the agent should explain the
consequences of a material misrepresentation on the application. A material misrepresentation is
a misstatement of fact that affects the way the policy is issued, in that if the insurer had known the
truth, the insurer would have declined to issue the insurance contract as applied for or issued a
contract with limitations or restrictions on the coverage. The agent must explain to the applicant
that he or she might lose the insurance coverage if, within two years of the issue date, the insurer
discovers that a material misrepresentation was made on the application and takes steps to rescind
(i.e., cancel) the contract. In particular, the insurer might discover the misrepresentation during
the processing of a death claim that occurs during the first two years after the policy is issued. If
the misrepresentation was one that would have caused the insurer to decline to issue the policy or
to issue it on a more restrictive basis, the insurer could rescind the contract. The beneficiaries who
expected to receive the insurance proceeds will suffer financially if the benefits are not paid out.
The agent must make the applicant aware that even if the misrepresentation has no bearing on the
cause of death, the insurer can, under the provisions of the policy and life insurance law, rescind
the contract.
For example, Ralph, a life insurance agent, is taking an application from Wanda. The
application is for a life insurance policy and Ralph is explaining his company’s premium
rates for non-smokers and smokers. Ralph tells Wanda that if she confirms that she is a non-
smoker as defined in the application, she can save 20% off the premium rate.
Ralph reads the question in the application: “Have you smoked one or more cigarettes within
the last 12 months?” Wanda does smoke, although she does so only a few times a week.
Considering the savings in premium rates, she decides to answer “no” to the question. Ralph
notices a partially filled ashtray on Wanda’s coffee table, but does not want to upset her by
repeating the qualifying condition for non-smoker premium rates. Since she qualifies in every
other aspect, the insurer issues her a policy at non-smoker premium rates.
After two months, Wanda is diagnosed with an acute form of lung cancer and dies six
months later. While assessing the claim, the insurer discovers that Wanda was a smoker
and declines to pay the claim. The insurance was an important part of Wanda’s estate plan
and was intended to provide for her child’s education. Ralph should have made sure that
Wanda was aware of the consequences of misrepresenting her status as a smoker.

Assume that Wanda - instead of dying from lung cancer - fell down a flight of stairs a month
after the policy was issued, sustained serious head injuries and died soon after. The insurer
would be entitled to deny payment of death benefits to Wanda’s beneficiary even though the
cause of death has nothing to do with her being a smoker, i.e., the fact misrepresented.
To Witness a Client Signature on an Application

Once the agent has recorded the applicant’s answers on the application form, he or she must
present the form to the applicant to review and sign it. In signing the application form, the
applicant is confirming that the answers given on the application are true, complete, and
accurate. The agent then signs the application as witness to the applicant’s signature.
In signing as witness, the agent is confirming that the person who provided the answers is the
person to whom the information applies and that the person has read and signed the form.
DEFINITION OF A LEGAL SIGNATURE

There are four general purposes for signing documents. These are:
1. Evidence: A signature authenticates a document by identifying the signer with the
signed document. When the signer marks the document with his or her signature or
identifying mark, the writing becomes attributable to the signer.
2. Ceremony: The act of signing a document calls to the signer’s attention the legal
significance of the signer’s act and thereby helps prevent people from
undertaking engagements thoughtlessly.
3. Approval: In certain contexts defined by law or custom, a signature expresses the
signer’s approval or authorization of the matters contained in the document, or the
signer’s intention that the document should have legal effect.
4. Efficiency and logistics: A signature on a written document imparts a sense of
clarity and finality to the transaction; thereafter the document can be taken at its
face value as expressing the signer’s intentions.
KEY COMPONENTS OF A LIFE INSURANCE APPLICATION
LEARNING OBJECTIVES
• describe the key components of the life insurance application as they affect the
underwriting process, including medical information, financial information, product
selection, and the agent’s comments/report;
• explain, using examples, the consequences of incomplete or inaccurate information in
the application;
• define Temporary Insurance Agreement (TIA), explain how it affects the applicant,
and identify its limitations.

Part I: Identification, Coverage, Beneficiary, and Eligibility

A life insurance application is designed to provide the insurer with enough information:
• to identify and communicate with the parties to the proposed life insurance contract;
• to determine the kind of life insurance coverage requested;
• to identify the beneficiary of any benefits payable;
• to assess the proposed life insured’s eligibility for the coverage requested.
In addition to the information provided, the completed application includes the applicant’s
authorization for the insurer to obtain additional information about the applicant. The
following is a list of common items found on an insurance application.
IDENTIFICATION
Part I of the application calls for pertinent information about the applicant – and about the
life insured, if he or she is not the same person as the applicant. The applicant is the person
applying for the coverage. The applicant could be the life insured, or a third party who is
applying for insurance on the life of another person. The third party may be an individual or
an entity such as a corporation or a partnership.
Applicant information includes the applicant’s address, telephone number, and any other
information that allows the insurer to identify clearly who the applicant is and who the life
insured is. The life insured is identified by full name, address, sex, and age.
PROOF OF AGE
Although the life insured is not required to provide proof of his or her age when completing
the application, it is a good time to clearly establish the life insured’s age. It may not be
possible to provide adequate proof of age when a claim is being processed after the life
insured has died. The life insured’s age determines the premium rate for the insurance
coverage and, at some ages, whether the life insured is eligible for coverage at all.
COVERAGE
The application must clearly identify the kind of life insurance coverage being requested. Most
insurers have commercial names for their various plans. The commercial, rather than the generic,
name usually identifies the coverage requested. For example, a permanent life insurance plan
might be identified as the “Estate Planner” in the insurer’s marketing material.
In addition to the basic coverage, the applicant may also apply for other benefits, such as waiver
of premium or accidental death benefit, or additional coverage in the form of term insurance
riders. Coverage on a spouse and children can be part of the application as well. It is the agent’s
responsibility to identify clearly the type and extent of coverage being requested.
To reinforce the information about the coverage, the agent must complete the
premium calculation section of the application. The agent will write in:
• the total premiums for each type of coverage requested, based on the insurer’s premium
rate tables for the plan;
• the age of the person(s) to be insured;
• any policy fees or other premium charges.

PREMIUM PAYMENT OPTIONS

Unless the application is being submitted as cash on delivery (COD), which means that the
applicant pays the premium when the policy is issued and delivered to him or her, the application
records the method of premium payment that the applicant has chosen. The applicant may make
annual, quarterly or monthly payments in response to premium notices issued by the insurer,
or may elect a pre-authorized premium payment arrangement. Under this arrangement, the
applicant provides banking information and authorizes the insurer to make periodic withdrawals
(usually monthly) from the policyowner’s bank account to pay the premiums when they fall due.
Note: Most life insurance application forms allow for a conditional or temporary insurance
agreement when the applicant submits a payment for the initial premium with the application.
This arrangement provides some level of coverage during the underwriting process. The
temporary insurance agreement is explained in more detail later in this chapter.
BENEFICIARY
Once the policy has been issued, the beneficiary identified on the application form will be
the recipient of the death benefit proceeds when the insured person dies. The beneficiary
must be clearly identified and the beneficiary’s relationship to the applicant must be clear.
Many applicants designate “my estate” as the beneficiary. “My estate” means that the death
benefit proceeds will become part of the estate assets of the deceased person, and will be
included when probate fees are calculated on the estate value. They may also become subject
to the claims of any creditors of the deceased.
If the applicant does not want the proceeds to be subject to probate fees or accessible to
creditors, he or she must designate a named beneficiary.
OTHER INSURANCE IN FORCE

The purpose is to satisfy the insurer that the life to be insured is not applying for more insurance
coverage than is justified by his or her financial circumstances. The questions about other
insurance include queries about other life insurance acquired within the previous 12 months. The
questions may also be posed along with questions about the person’s occupation and job duties.
The agent may also be asked to estimate the annual income of the person to be insured.
The insurer does not want to issue too much life insurance on a proposed life insured’s life,
because people who seek out extremely large amounts of insurance may have critical
financial problems or may be considering suicide or homicide. In asking about the
applicant’s financial circumstances, the insurer is attempting to ensure that there are no
factors that will increase the mortality risk for the person whose life will be insured.
REPLACEMENT
The application contains a section to be completed by the applicant if the insurance being
applied for is intended to replace an existing life insurance policy on the life of the person
to be insured.

Common law provinces (i.e., provinces other than Quebec) require that anyone who induces
an insured to:
• let a policy lapse;
• surrender paid-up insurance or extended insurance for cash; or
• borrow substantially against a life insurance policy that contains provisions for cash
values and paid-up values;
in order to replace an existing contract must follow certain procedures so as to not be
considered guilty of committing an offence.
The agent must complete a replacement disclosure form that provides details about the
benefits of the policy to be replaced and compares the benefits of the existing policy to those
of the proposed replacement policy. The applicant must sign a disclosure form indicating
that he or she has received a copy of the completed form. Within three working days of
taking the application, the agent must send a copy of the disclosure form, signed by the
applicant, to the insurer whose insurance contract is going to be replaced.
The replacement question on the application form alerts the insurer who is being requested to
issue the new policy that it is replacing an existing policy. The issuing insurer is required by
law to make sure that a disclosure form is completed and that the insurer whose policy is
being replaced is notified in a proper and timely fashion.
FINANCIAL INFORMATION
If the insurance to be issued is on the life of a key person or principal in a business, the
insurer may ask the applicant to provide financial statements and income tax returns to
support the amount of insurance being applied for.
An excessive amount of insurance applied for under the circumstances may be a precursor
or inducement to suicide or homicide. The insurer is always aware that a relatively small
premium can generate a large death benefit payment.
SMOKING
Practically all insurers offer lower premium rates to non-smokers. A non-smoker is usually
defined as someone who has not smoked cigarettes, cigarillos, small cigars, or marijuana
within the previous 12 months. An applicant for non-smoker rates does not have to be
someone who has never smoked.
For those who qualify as non-smokers, the premium rates are significantly lower than
those for smokers. In fact, smoker rates might be considered as raised premium rates,
because the higher premium represents increased mortality risk for those who smoke.
DRUG AND ALCOHOL USE

The application for life insurance will usually contain questions about the proposed life insured’s
use of drugs such as marijuana, cocaine, LSD, or heroin. Keep in mind that substance abuse
could also include legally prescribed and obtained drugs such as Demerol and Prozac.
For alcohol use, the application focuses on how much is consumed, how often, and if
the applicant has ever received treatment or counselling for alcohol abuse.

If the applicant’s response to any of these questions is affirmative/positive (i.e., “yes”),

then the agent must gather more detailed information using a drinking/drug questionnaire.
HAZARDOUS ACTIVITIES
Even if the person to be insured works in a sedentary occupation that presents no unusual
risk, he or she may engage in activities outside of work that present unusual risks. Therefore,
the insurer will include questions on the application that address any of the proposed life
insured’s activities that might present a greater-than-normal level of physical risk.
Questions usually relate to recent activities such as:
• In the last 2 years, have you flown in an aircraft as a pilot or crew member or do you
intend to do so in the future?
• In the last 2 years, have you engaged in any hazardous activities such as motor racing,
underwater diving, ballooning, parachuting, skydiving, hang gliding, parakiting, ultra-
light flying, or mountain climbing?
If the response to either or both of these questions is affirmative, the agent must ask the
applicant to complete an additional questionnaire relating to the hazardous activity.
OTHER QUESTIONS
The questions in Part I may also include questions about whether the applicant has ever
been convicted of a criminal offence or has ever declared bankruptcy.
Part II: The Non-Medical Application

The insurer, through its underwriters, requires enough information about the person(s) to
be insured to assess the risk it is being asked to assume. The essential part of that
information is the current health status and medical history of the person to be insured.
Many life insurance applications are processed using a non-medical application (Part II of
the normal application form), which is a questionnaire administered/completed by the
agent rather than by a nurse or physician.
HEALTH HISTORY
The person to be insured responds to a series of questions about his or her height, weight,
age, and general state of health and about medical conditions or medical treatments received
within the last number of years. The health questions relate to illnesses or conditions that
may indicate that the person to be insured represents a high risk and is therefore not eligible
for life insurance coverage at the insurer’s standard premium rates.
Health questions are often organized according to when the condition may have occurred.
For example, the following series of questions may be included on the application form.
The first group of questions asks about conditions that may have occurred at any time
during the life of the person to be insured.

Have you ever been treated for or had any indications of: Yes No
AIDS, HIV infection or any other disorder of the immune system

Heart attack, chest pain, heart murmur
Stroke, irregular pulse, other disease of heart or blood vessels
Diabetes, elevated blood sugar
Haemophilia or other bleeding disorders
Cancer or tumour
Hepatitis or other liver disorder
Sexually transmitted disease
The next series of questions asks about conditions that have occurred in the last 5 years.
In the last five years… Yes No
Has an illness or injury prevented you from performing your normal

duties at your usual occupation for a period exceeding 2 weeks?
Have you been treated for or had any indication of:

High blood pressure
Peptic ulcer, ulcerative colitis, Crohn’s disease
Epilepsy, disorder of nervous system, depression, anxiety,
nervous breakdown
Arthritis, disease of muscles, paralysis
Tuberculosis, enlarged glands, jaundice Disorder
or disease of the joints, limbs or back (If female)
Hysterectomy, disorder of pregnancy

The next questions may focus on the preceding two years.
In the last 2 years, have you been treated for or had any
indication of: Yes No
Disorder of the eye, nose, throat, mouth

Skin diseases
Asthma, persistent cough, difficult breathing or hoarseness
Anaemia, thyroid disorder, goitre
Severe headaches, loss of consciousness
Persistent diarrhoea, fever
Persistent or undiagnosed pain
Urinary tract infection
Note how these questions are posed. “Have you been treated for or had any indication of…”
The person to be insured may be aware of or have been diagnosed with certain medical
conditions without pursuing treatment for those conditions. The onus is on the person to be
insured to disclose any condition of which he or she is aware, not just those for which he or
she has received some form of medical treatment.
The application may also pose a comprehensive question or questions such as:
• Have you any medical conditions, not already mentioned, for which you have
been investigated, under observation, or received treatment?
• Are you being investigated for any medical condition not already mentioned?
If the person to be insured gives a positive answer to any of the questions, he or she is
asked to provide details on the diagnosis, treatment and duration, including the names of
any attending physicians or medical facilities at which treatment was received.
FAMILY HISTORY
Since family history can indicate potential health problems and life expectancy, the
application may include a section on family history.
The questions posed relate to biological parents and siblings and include queries about
conditions such as:
• heart attack;
• high blood pressure;
• stroke;
• diabetes;
• cancer;
• kidney disease;

• retinitis pigmentosa;
• Huntington’s chorea;
• familial polyposis of the bowel;
• cystic fibrosis;
• muscular dystrophy;
• multiple sclerosis;
• any other hereditary disorder.
The person to be insured is asked to provide details if close family members have suffered
from any of these medical conditions.
PARAMEDICALS AND FULL MEDICALS

Depending on the age of the person to be insured and the amount of coverage applied
for, the insurer’s established underwriting requirements may include a paramedical
examination conducted by a nurse, or a full medical examination conducted by a
physician chosen by the insurer.
During a paramedical exam, the nurse asks a number of questions about the proposed life
insured’s medical history, similar to those listed on the non-medical questionnaire, and
records the answers on the paramedical exam form. The nurse will usually take a blood
pressure reading and a urine specimen for laboratory analysis, and may, depending on the
insurer’s underwriting requirements, also draw a blood sample for laboratory analysis.
A full medical exam is conducted by a physician and includes a questionnaire as well as a
medical examination, depending on the age of the proposed life insured and the amount of
coverage being considered. An electrocardiogram or an X-ray may be part of the assessment. The
physician may conduct more sophisticated tests, depending on the insurer’s assessment standards.
Applicant’s Signature
To complete the application, the applicant (and the person to be insured, if different from
the applicant) must date and sign the application form.
By signing the application, the applicant and the person to be insured:
• confirm that all of the answers given in the application are complete and true;
• acknowledge that they understand that any material misrepresentation may result in
any policy issued being voided by the insurer;
• authorize any physician, medical facility, insurance company, Medical Information
Bureau (MIB), or other organization, institution, or person that has information about the
health of the person to be insured to provide the insurer with health information
necessary to assess the risk;
• agree that the person to be insured will undergo any necessary examinations, X-rays,
electrocardiograms, blood profiles, or other tests required to assess the risk and
underwrite the application.

The Agent’s Report

The agent’s report gives the agent’s perspective on the purpose of the application and other
pertinent information about the financial status of the applicant and the person to be insured. The
agent must sign the report, confirming that he or she reviewed each of the questions on the
application with the applicant and the person to be insured, and that the application completely
records all the information provided by the applicant and the person to be insured in response to
the application questions. Finally, the agent confirms that, to the best of the agent’s knowledge,
the application provides all material information related to the coverage being requested.
The Consequences of Incomplete or Inaccurate Information in

the Application
The application for life insurance provides a picture of the life of the person to be insured
that allows the insurer to assess the mortality risk (that is, the likelihood that the person will
die within a certain period of time). The agent must do a thorough job of making sure that
the applicant answers each question and that each positive response to a question is
accompanied by a complete explanation.
For example, if the applicant mentions treatment for depression, the agent must record the
particulars of the treatment, including the attending physician, the length of the treatment,
and the medication prescribed. If an underwriter reviews an application that indicates that
the life to be insured was treated for depression and no explanation is provided, the
application may be returned to the agent for further details.
The insurer’s objective is to assess an application as quickly as possible before deciding whether to
accept the risk or decline it. If an application is delayed because of incomplete or inaccurate
information, the insurer may end up being vulnerable to a risk it might ultimately decline.
Example 1: Age Misstated in Application

While writing down George Marley’s responses to the questions on a life insurance application,
Aretha Agent did not quite hear George’s response to her question about his age. George was
not seeking a large amount of insurance ($100,000) and Aretha was in a hurry to get to another
appointment. She thought he had said that he was 35, when in fact he was 45. Once she had
asked all of the questions on the application, she requested George to sign the application
without offering him an opportunity to review it.
George was pleased at the low premium rate and gladly accepted the policy when it was
delivered to him. Three years later, he died in an accident. During the claim review, the insurer
discovered George’s correct age. The insurer reduced the death benefit to an amount that
applied to a 45-year-old at the premium rate that George had been paying. George’s family did
not receive the full benefit of $100,000 under the policy because Aretha Agent had not been as
careful as she should have been when she completed the application.
Example 2: Benefit Requested by Applicant Not Included in Policy Issued

James, an insurance agent, completed Mary Martin’s application for insurance and calculated the
premium to be paid under the policy. Mary requested the waiver of premium benefit and James
checked the box beside the listed benefit. When he calculated the premium, however, he forgot to
include the premium amount for the waiver of premium. The insurer processed the application
and approved the insurance. The policy was issued without the waiver of premium provision.
James delivered the policy by dropping it off at Mary’s offi ce. He did not take the time to
review the policy with her.

Mary accepted the policy without looking it over and stored it in a safe place. Within three months,
Mary suffered a disability that left her unable to work for a long period of time. She was having
difficulty paying her bills, including her life insurance premiums. She remembered that she had
requested a waiver of premium benefit and she contacted James. When James reviewed her
coverage, he realized that she was not paying the premium for the waiver of premium benefit.
He informed Mary that the benefit was not in force.
Mary was furious and contacted the insurer directly. The insurer reviewed the application and
noticed that the waiver of premium benefit had been requested, although it was not included in
the policy that was issued. The insurer was left with a serious problem to address. If James
had completed the application thoroughly and carefully, the problem would never have arisen.
This situation could likely end up being resolved in court.
Example 3: Agent Failed to Clarify Medical Terminology in Application

Raoul, a life insurance agent, met with Selma to discuss the purchase of life insurance. Raoul
was aware that Selma was relatively new to the country and her grasp of English was
rudimentary. Selma, a 40-year-old mother of two children under 10 years of age, agreed to buy
a $100,000 term insurance policy from Raoul and named her husband, Pancho, as the benefi
ciary. In the process of filling out Part II of the application form (the non-medical application),
Raoul asked Selma whether she had been treated for, or had any indication of, hypertension in
the last five years. Selma answered that question with a “No”.
The application was sent to the underwriter and a policy was issued to Selma. Six months
later, Selma had a massive stroke and died. Upon receiving a claim for the death benefit, the
insurer conducted an investigation and found out that Selma had been receiving treatment for
hypertension for over two years. The insurer denied the claim on the basis that a material
misrepresentation by Selma had taken place in completing the application for life insurance.
Pancho was understandably upset at the denial of the claim and asked Raoul for assistance.
In talking with Pancho, Raoul realized that Selma knew she had high blood pressure but she
did not know that hypertension is another word for high blood pressure. That is why she
answered the question on the application form about hypertension in the negative.
Raoul learned a crucial lesson – it is important to take some time and clarify the meaning of certain
questions, words and terms used in the life insurance application, especially medical terminology
and health-related questions that constitute a key section of the application, and even more so for
clients who do not have a strong grasp of the English language. If Raoul had spent a minute or two
clarifying to Selma that hypertension is high blood pressure, it is possible that the application may
have been rated and Selma would have had to pay a substandard premium; however, upon
Selma’s death, the policy proceeds would have been paid to Pancho without issue or delay.
In this situation, Raoul could be exposed to a lawsuit if Pancho decides to sue the insurer and
Raoul for non-payment of the policy proceeds and for not conveying or clarifying important
information to Selma during the completion of the application form.
Temporary Insurance Agreement (TIA) and Conditional Insurance

Receipts
A life insurance applicant can submit an application without including the initial premium. In
this case, the applicant asks the insurer to issue a policy, and the applicant accepts the policy by
paying the first premium. The policy coverage takes effect when the insurer issues the contract
and the agent delivers the contract to the applicant, provided that no change has taken place in

the insurability of the person to be insured between the date he or she completed the
application and the date the policy was delivered and the applicant paid the first premium.
Alternatively, the applicant may submit the first premium with the application. In this case,
the insurer, through its agent, issues a premium receipt. Most insurers provide temporary
coverage under the terms of the premium receipt. Since the applicant has submitted an
initial premium, the insurer agrees to provide some form of insurance coverage during the
time it takes to underwrite the application.
Insurers who receive a premium payment with an application may issue a conditional
insurance receipt or a temporary insurance agreement.
CONDITIONAL INSURANCE RECEIPTS

The conditional insurance receipt provides insurance coverage from the date of the application,
or the medical examination, if later, provided that the applicant is found to be an insurable risk.
For example, Rolf completes an application for $100,000 of term life insurance and pays the
first annual premium. The agent issues a conditional insurance receipt. On his way home
from the agent’s office, Rolf is involved in a traffic accident, he dies the next day. The
insurer receives the application for underwriting after Rolf’s death. The insurer underwrites
the application and concludes that a policy would have been issued as applied for. Since
Rolf had paid the initial premium, the insurer pays the death benefit to his beneficiary. If the
underwriter had concluded, however, that Rolf was not an acceptable risk, the insurer would
have declined the application and refunded the premium to Rolf’s estate.
The courts have not always accepted the notion of conditional coverage. Some courts have
held that, in spite of the written conditions of the conditional insurance receipt, once the
applicant has paid the initial premium, the life to be insured is considered covered until the
insurer notifies the applicant that coverage is terminated and returns the premium. Given that
interpretation, the insurer might have to pay the death benefit if an applicant, who would
otherwise have been uninsurable, dies before the insurer has had an opportunity to decline
the application and return the premium.
TEMPORARY INSURANCE AGREEMENTS

An alternative form to a conditional insurance receipt is the temporary insurance agreement. This
agreement provides insurance coverage for a specific amount and for a specific period of time.
The agreement specifies that the coverage under its provisions will end:
• on the date the insurer refunds the initial premium;
• a specified number of days after the insurer mails a notice of termination to the applicant;
• on the date coverage begins under the issued policy; whichever comes first.
The coverage provided under the temporary insurance agreement does not depend on the
successful underwriting of the full application. The agreement usually stipulates that the
coverage will take effect if the applicant can truthfully answer “no” to a few brief questions
relating to possible medical treatment the proposed life insured may have received in the
recent past. Such a question might state:

To the best of your knowledge and belief, have you, within the last two years, consulted
a physician for, or had treatment for: heart trouble, stroke, AIDS, or cancer; or had an
electrocardiogram for chest pain or for any other physical complaint?
The temporary agreement limits the amount of coverage that the insurer provides. It may be
the amount of coverage applied for in the full application, subject to a specific maximum
amount, such as $100,000.
THE UNDERWRITING PROCESS
LEARNING OBJECTIVES
• describe how an underwriter processes an application for life insurance received from
an agent, including medical information, Attending Physician’s Statement (APS),
inspection reports, data from the Medical Information Bureau, questionnaires about
hazardous sports and occupations, and financial underwriting.
The underwriting process begins when the insurance application is received by the insurer.
The process is complete once the underwriter makes a decision to offer insurance to an
applicant (life insured) or not.
Submission of an Application by an Agent

An agent, who has been contracted by the insurer and licensed in the jurisdiction in which
the application is completed, asks the applicant for his or her answers to the application
questions and fills in the application accordingly. If the applicant has paid the initial
premium, the agent also completes a premium receipt and delivers it to the applicant.
Depending on the information provided by the applicant and the amount of coverage
requested, the agent may request other information from the applicant or from other sources.
For example, the agent might ask the applicant to complete a questionnaire about hazardous
sports, if the applicant is involved in certain sporting activities. The agent might also request
an inspection report (described later in this chapter), depending on the amount of insurance
requested. If the application is for a large amount of insurance and/or the person to be
insured is above a certain age, the agent might arrange for a medical examination.
The agent is not qualified to assess the application, which, along with any other relevant
documents, is delivered to the agent’s office. After some preliminary work, the
documents are sent to the insurer’s underwriting office.
Preliminary Investigation
Once the application is received by the underwriting office, the first step in processing the
application is to make sure that the agent who signed and submitted the application is
licensed by the province in which the application was completed and that the agent has a
valid contract in effect with the insurer. An application cannot be processed if the agent
submitting it is not properly licensed.

Other preliminary activities include:

• reviewing the application to make sure that all the questions have been answered
and all required signatures have been obtained;
• ensuring that if the conditional insurance receipt has been detached, the first premium
has been submitted;
• searching the company records for other insurance in force or applied for on the life of
the person to be insured;
• initiating the Medical Information Bureau (MIB) request; (MIB is an association of over
500 U.S. and Canadian life insurance companies providing information and database
management services to the financial services industry. MIB’s core fraud protection
services protect insurers, policyholders and applicants from attempts to conceal or omit
information material to the sound and equitable underwriting of life, health, disability,
and long term care insurance.)
• ordering any other reports, such as an inspection report, depending upon the insurer’s
usual requirements for the age and amount requested.
Jet Underwriting
Most insurance companies operate a jet underwriting unit. The unit’s staff review
applications up to a certain amount and age. If the application is clear in all respects, the
unit has authority to approve the application and issue a policy. The goal is to complete
the underwriting process quickly, i.e., within 3 to 5 days.
Other applications are referred to the regular underwriting department.
Initial Review by an Underwriter

The underwriter’s review of the application usually begins with the information provided in
Part I of the application form. This part provides information that specifies:
THE APPLICANT, IF OTHER THAN THE PROPOSED LIFE INSURED

The underwriter is particularly interested in the relationship of the applicant to the person whose
life is to be insured. It is important to make sure that the applicant has an insurable interest in the
life to be insured, otherwise an insurance policy cannot be issued. An insurable interest means
that the applicant would suffer a loss if the person whose life is insured died. A loss could be
the loss of a spouse or child or a financial loss suffered by the death of a business partner or
key employee. In particular, the underwriter must be satisfied that non-family relationships
constitute an insurable interest. For example, if John Doe applies for a life insurance policy
on the life of Reg Everyman, then the underwriter must confirm that John Doe has an
insurable interest in Reg Everyman.
A contract is not void for lack of insurable interest if the person whose life is insured has
consented in writing to the insurance being placed on his or her life. For third-party
insurance involving a minor whose life is insured, a parent or legal guardian may sign the
application on behalf of a minor.

Insurable interest must exist at the time of the formation of the life insurance contract but does
not need to exist at a later stage. For example, Sunil and Susheel set up a business as partners
in a popular restaurant franchise. They purchase life insurance on each other’s lives naming
each other as beneficiaries, based on recommendations made by their business advisor. Five
years later, Susheel has a falling out with Sunil and leaves the business. The life insurance
policy that Sunil has on Susheel’s life remains valid even though Sunil no longer has an
insurable interest in Susheel’s life (by virtue of Susheel no longer being a partner in the
business). If Sunil deems it suitable to keep the policy in force, then that is his prerogative and
neither Susheel nor the insurer has any say in the matter.
THE LIFE OR LIVES TO BE INSURED

The application provides specific identifying information about the life to be insured, including:
• full name, address, and telephone number;

• age;
• sex;
• marital status;
• length of time at current address;
• occupation, current employer, and length of time with current employer
This information provides a “picture” of the proposed life insured that may help the underwriter
assess the other information in the application, or may lead the underwriter to seek additional
information on the proposed insured. For example, if the proposed insured has lived at his or her
current address for a short period of time or has been employed in his or her current job for a
short time, the underwriter may look more closely at information about the person’s lifestyle or
financial situation. For example, if the proposed life insured has had ten addresses in the last five
years, it indicates a possible issue with stability and continuity.
THE TYPES AND AMOUNTS OF COVERAGE APPLIED FOR

An essential part of the application is the selection of a plan of insurance, an amount of coverage,
and a method of premium payment. The underwriter will use his or her judgment to assess
the suitability of the plan for the life insured, the level of coverage that is reasonable, and the
likelihood that the policy will stay in force, given the method of premium payment.
For example, a $500,000 whole life insurance policy on an 18-year-old college student
who intends to have the policy paid up in 10 years and wants to pay premiums on a
quarterly basis will raise questions. The agent could be called upon to provide additional
information on the need for the plan of insurance.
THE BENEFICIARY
The underwriter should make sure that the name of the beneficiary and his or her relationship to
the proposed life insured is clear. Most designations, e.g., child, spouse, sibling or charitable
organization, are immediately apparent. Some, however, may warrant additional information. A
designation such as “John Doe, friend,” may have a valid purpose, but the underwriter may ask
for additional information to ensure that it’s legitimate and to easily identify the beneficiary in
the event of a claim. Insurable interest from a financial underwriting perspective must also exist,
i.e., the beneficiary must be in a position to demonstrate that he or she would suffer a pecuniary/
financial loss upon the death of the life insured. In the case of “John Doe, friend” beneficiary

designation, the underwriter may find that John Doe, a good friend, is financially dependent
on the life insured because he is severely disabled and unable to work. John Doe, therefore,
has an insurable interest in the life to be insured.
Detailed Review of the Application

The underwriter will then review other important information in the application.
SMOKING HABITS
The responses to these questions will determine if the person to be insured is considered a
non-smoker and is, therefore, eligible for non-smoker premium rates. The underwriter may
look for additional evidence of the individual’s smoking status, by reviewing the results of a
urinalysis if that test is a requirement for underwriting the application, given the person’s age
and the amount of insurance requested.
HAZARDOUS SPORTS OR ACTIVITIES

The underwriter reviews any positive responses to questions about the proposed life insured’s
participation or planned participation in activities such as scuba diving, hang gliding, or
parachute jumping, or his or her operation of an aircraft or involvement in a flight crew.
The underwriter will usually request a special questionnaire on these activities if the agent
has not already obtained one.
The proposed life insured’s participation in hazardous activities may cause the underwriter to:
• charge an extra premium to address the increased mortality risk;
• exclude coverage for a death occurring as a result of the proposed life insured’s
participation in these activities;
• decline the application.
All of these circumstances may have a bearing on the level of mortality risk that the person
to be insured presents. A poor driving record and the frequency and nature of any criminal
convictions will increase the mortality risk.
Travel to a foreign country or region with an unstable political or cultural environment could
also affect the classification of the proposed life insured’s mortality risk. For example, the
classification of an aid worker for an NGO (non-governmental organization) travelling and
working in parts of Africa could be affected.
INSURANCE HISTORY
Information about the amount of insurance currently in force (or currently applied for) with
any insurer on the life of the person to be insured helps the underwriter determine if the
proposed life insured is over insured.
The underwriter also needs information on whether the policy to be issued based on the
current application is intended to replace any life insurance currently in force on the
proposed life insured. The underwriter must make sure that the application complies with
all provincial regulations on adequate disclosure about replacement policies.

The underwriter has an obvious interest in the applicant’s responses to questions about any
previous insurance applications on the proposed life insured that have been declined, or
previous policies for which insurance has been offered on a restricted basis or at higher-
than-standard premium rates.
The applicant is also asked if he or she has applied for or received insurance benefits because of
ill health or injury. If the underwriter sees positive responses to any of these questions, he or she
then looks for corroborating information contained in the answers to other health questions.
AGENT’S REPORT
The application includes the agent’s statement, in which the agent can elaborate on the
circumstances of the application and any information that has a bearing on the assessment of
the risk being considered. The underwriter will rely on the comments to satisfy any potential
concerns raised by the information provided on the application, depending on the type and
quality of the business that the agent usually submits. The agent’s statement provides
information on:
• the length of time the agent has known the proposed life insured;
• how well the agent knows the proposed life insured;
• the agent’s impression of the proposed life insured’s financial worth;
• the agent’s assessment of the risk level presented by the applicant;
• the agent’s opinion on the appearance of the proposed life insured’s state of health;
• the applicant’s reasons for requesting the coverage.
Underwriting Guidelines
Insurers maintain tables that determine the type and amount of medical information that the
underwriter needs to assess the risk based on the age of the person to be insured and the
amount of insurance requested. The information contained in Part I, among other things,
will help the underwriter to judge if the normal standards should be followed or if more
stringent medical requirements are called for.
For example, a 30-year-old applying for $100,000 of life insurance might normally be assessed on
the basis of a non-medical application without any other tests. If the non-medical questionnaire
(Part II of the application) does not contain any adverse information about the proposed life
insured’s physical condition, the underwriter still has the option to order additional medical
information or tests based on the information presented in Part I of the application.

The following excerpt from an insurance company’s guidelines shows some

underwriting requirements of a life insurance application.
Age at Last Birthday Total of All Coverage Underwriting Requirements

41-45 Less than $99,999 Non-medical
$100,000 to $500,000 Paramedical, Blood profile

$500,001 to $1,500,000 Paramedical, Blood profile, ECG
$1,500,001 to $3,000,000 Medical, blood profile, ECG
More than $3,000,000 Medical, blood profile, ECG, X-ray,
inspection report
The table above provides an idea of the guidelines that an insurer might use to obtain an
appropriate amount of information about a proposed life insured, depending on the
individual’s age and the amount of insurance requested. An underwriter is not limited by
these guidelines. Depending on the information revealed in the application form, the
underwriter may ask for additional information on any application, including a statement
from an attending physician or inspection reports.
Review of the Non-Medical Questionnaire

The first source of health information on any application is the non-medical
questionnaire, usually known as Part II of the application. The non-medical report
provides the underwriter with information about:
• any medical conditions which the proposed life insured has been diagnosed as having,
or for which he or she has received treatment;
• the names and addresses of any attending physicians and the dates, reasons, and
results of any consultations;
• specifics concerning drug, alcohol, or tobacco use;
• family history of medical impairments and the cause of death of any deceased
family members.
Although underwriting guidelines may suggest only a non-medical application, the underwriter
may seek additional information, depending on the proposed life insured’s medical history.
A nurse who is engaged by the insurer to perform such exams conducts the paramedical
examination. The questions on the paramedical form follow the same pattern as the non-
medical application form. The nurse will also confirm the individual’s height and weight and
conduct tests such as blood pressure readings. The nurse may also collect urine and/or blood
samples, if called for by the guidelines.
The most extensive health questionnaire is found in the medical report. A physician completes
the report by recording the proposed life insured’s responses to questions about personal and
family health history. The physician also conducts a medical examination, which can include
blood pressure readings, heart and lung function monitoring, and other tests.

Confirming Health Information

In addition to the medical information in the non-medical, paramedical, or medical report,
the underwriter has other methods of confirming the information provided or of pursuing
sources of potentially conflicting information. The following is a list of some of them.
MEDICAL INFORMATION BUREAU REPORT

Most applications for life insurance include an authorization for the insurer to release personal
information about the life to be insured to the Medical Information Bureau (MIB). The MIB
receives and stores coded data based on information obtained from thousands of insurance
applications. It receives and stores information about unfavourable underwriting decisions and
noteworthy underwriting actions or investigations by member insurance companies. The MIB
releases appropriate coded information to insurers who are doing the underwriting.
During the underwriting process, the insurer sends identifying information about the
person whose life is being underwritten to the MIB. The MIB forwards any information it
has on file about that person, in code, to the insurer. Only the underwriters know how to
interpret the coded comments. The MIB reports on whether the applicant has applied to
other insurers and transmits any relevant health or personal information that may have
been gathered by other insurers as they assessed applications on the same person.
Most applications are subject to an MIB inquiry. If an insurer receives pertinent information
from that source, then it can gather additional information to confirm the MIB data. If the
insurance company receives any adverse information about an applicant from the MIB, it
cannot use that information alone to decline an application. The insurer must seek other
information to corroborate the MIB data or findings.
For example, if an application has been submitted with a non-medical report, as called for in
the guidelines, and the MIB reveals that the applicant has been declined for insurance with
another company for medical reasons, the underwriter can request a full medical
examination to get a clearer picture of the proposed life insured’s current medical condition.
ATTENDING PHYSICIAN’S STATEMENT (APS)

Another tool that the underwriter can use to confirm health information is an
attending physician’s statement. However, ordering this statement and waiting for
a response can significantly delay the processing of the application. An APS is
usually ordered when:
• a specific illness or injury has been mentioned on the application;

• the amount of insurance is beyond a certain amount, say, $1 million;
• information from the MIB is unfavourable;
• the proposed life insured is elderly according to the insurer’s mortality tables
The underwriter follows guidelines on which types of medical history warrant further
investigation and which types do not. For example, a report of dizziness, heart palpitations,
or elevated blood pressure usually requires an APS. Conditions such as ulcers, anaemia, or
indigestion that occurred some years before and have not recurred recently might not
warrant an APS.

HISTORY STATEMENT
A history statement is a special form of APS that the underwriter might order to obtain a
detailed history on the treatment of a specific health condition mentioned by the person to be
insured. Health conditions that might trigger a request for a history statement include nervous
disorders, cancer, diabetes, and heart conditions.
The underwriter may order a history statement:
• if there are contradictions in the health information provided on the application and
the information obtained from other sources;
• if the proposed life insured has recently had a series of medical appointments;
• if the proposed life insured has recently been admitted to hospital.
SPECIALIZED MEDICAL QUESTIONNAIRE

The underwriter can also request a specialized medical questionnaire. This form of APS
poses questions on the symptoms and treatment of a specific medical condition. For
example, if the applicant has reported episodes of epilepsy, the underwriter might request
a specific physician’s report on the history and treatment of that particular condition.
LABORATORY RESULTS
Laboratory tests provide another source of information for the underwriter. However, the
underwriter should order tests only when required to do so by the guidelines, because of the
expense and the delay in obtaining results. Among the various tests used are:
• Electrocardiogram: this test records the electrical forces produced by the heart and
can detect a disease or abnormality of the heart.
• Urinalysis: this test detects the presence of protein, sugar, blood cells, drugs, or nicotine in
the urine. It is one way to confirm whether the applicant suffers from hypertension or
diabetes, or whether the applicant smokes or uses certain drugs associated with drug abuse.
• Blood chemistry profile: this is a group of laboratory tests that identify possible
chronic and acute disease in a blood sample. The standard blood profile includes 15
to 18 components relating to liver function, kidney function, glucose, blood lipids,
serum proteins, and HIV antibodies.
• Saliva sample: this test can reveal the presence of nicotine, cocaine, or HIV antibodies.
INSPECTION REPORT
An inspection report is another investigative tool available to the underwriter. The
inspection report is a report prepared by a consumer-reporting agency that contains
information about the applicant.
The information gathered includes details of the applicant’s personal life, activities,
occupation, and financial status. As with other investigative tools, the insurer limits the use
of inspection reports, based on the age of the proposed insured and the amount of coverage
requested. The report is usually used in relation to financial matters, but the underwriter can
use it to obtain other information about the applicant, such as health information, to clarify
any discrepancies in the information that the underwriter has received from other sources.

SPECIAL QUESTIONNAIRES
There are a variety of special questionnaires that insurers have developed to uncover
additional information about personal factors that may have a bearing on the mortality risk
presented by the applicant.
For example, the proposed life insured’s leisure activities might include scuba diving,
automobile racing, or parachuting, activities that are associated with a greater-than-normal
mortality risk. If the application reveals that the proposed life insured participates in a
hazardous activity, then the underwriter can ask the proposed life insured to complete a
questionnaire on the frequency and level of participation. Someone who has parachuted once
in the last year presents a different level of risk from someone who skydives weekly.
Financial Underwriting
Financial underwriting seeks to confirm that the amount of insurance requested is
reasonable and has been requested for a legitimate purpose. A legitimate purpose is the
future protection of the applicant’s business or family. Resolving financial problems,
particularly if the proposed life insured is in poor health or contemplates suicide, is not
a legitimate purpose.
An underwriter considers a range of financial information about the prospective life
insured for both personal life insurance and business insurance.
Personal life insurance is usually purchased by individuals for the benefit of those who have
a direct financial interest in the life of the proposed life insured. The insurance proceeds are
usually earmarked for income replacement, family needs and expenses, and the payment of
income taxes owing at death.
Business insurance addresses the needs of a business. The proposed life insured may be a
partner, shareholder or key person in the business. The insurance proceeds are geared to
keeping the business operation going by providing funds to the business or funds to the
surviving business associates who can purchase the deceased’s interest from his or her heirs.
In both situations, financial underwriting is conducted to make sure that the amount
of insurance requested is appropriate to the circumstances.
INFORMATION ON THE APPLICATION FORM

The life insurance application is an important source of financial information about the proposed
life insured. In considering the proposed life insured’s financial circumstances, the underwriter
is attempting to verify that the amount of insurance requested is appropriate. For example,
the underwriter will consider the following information about the proposed life insured.
Information gathered about

proposed life insured Reason for gathering information
Current age To estimate years of future employment
Occupation and current income To estimate future income potential
Amount of insurance in force To compare existing coverage to the need for expanded
coverage
Information gathered about

proposed life insured Reason for gathering information
Amount of requested coverage To assess the relationship of both existing and requested
insurance coverage to the estimated need
Cost of the requested coverage To compare it to the applicant’s ability to pay the premiums
Relationship of the insured to the To verify that there is an insurable interest justifying the
proposed beneficiary amount of coverage requested
Relationship to other family members To confirm that the proposed life insured’s status as wage
earner justifies the amount of coverage requested; i.e., the
proposed life insured is a substantial income contributor
to the family and that the beneficiaries rely substantially on
the income of the proposed life insured.
Net worth To verify that the amount of insurance requested is
appropriate to satisfy income taxes falling due at death
INFORMATION FROM THE AGENT

The agent is a valuable source of information about the applicant’s financial status when
the underwriter has concerns about the amount of insurance requested. For example, if the
amount of life insurance requested is large, the underwriter may ask the agent to submit a
letter explaining the purpose and need for the life insurance and the method for determining
the amount of coverage. The underwriter may also ask the agent for information that
confirms the information in the application form.
INSPECTION REPORTS
The underwriter can ask for an inspection report to get an objective assessment of the proposed
life insured’s financial status. The underwriter can ask the inspection company to find out about:
• liens or loans on property owned by the proposed life insured;
• bankruptcies;
• credit history;
• outstanding lawsuits;
• criminal records;
• other debts.
The inspection company may also interview the proposed life insured’s lawyer, tax
advisor, or accountant to verify or obtain information about the applicant’s finances.
INFORMATION FROM THE PROPOSED LIFE INSURED OR APPLICANT

Underwriters may also contact the proposed life insured or applicant directly to clear up any
inconsistencies in the information provided on the application. For example, the underwriter
may want to clarify an inconsistency between the reported occupation and the amount of
earned income or to ask if the applicant or proposed life insured has income sources or
personal assets that justify the amount of coverage requested.

TAX STATEMENTS AND RETURNS

Tax forms are another reliable source of information, since there are severe penalties for
fraudulent statements made on a tax return. Tax returns can provide valuable information about:
• earned income;
• interest and dividend income;
• alimony received or paid;
• business, farm or investment income or loss;
• capital gains or losses on property;
• government benefits received.
FINANCIAL QUESTIONNAIRES
The underwriter may also ask the proposed life insured to complete and sign a financial
questionnaire that provides details about his or her net income and net worth. This is
another way in which the underwriter attempts to justify the amount of insurance
requested by considering the potential loss of income to the proposed life insured’s family
if he or she dies, or the potential tax liability to the estate based on the current and
potential value of the assets owned by the proposed life insured.
BUSINESS FINANCIAL STATEMENTS

If the proposed life insured owns a business, the underwriter may request financial statements
relating to the business. The underwriter may want to assess the condition of the business if the
amount of insurance is large and the underwriter is concerned that the reason for acquiring the
insurance is to save a foundering business. Another reason is to make sure that the amount of
insurance relates to the true financial loss to the business if the proposed life insured dies.
The underwriter may examine financial statements for several years to get a sense of the
business’s history and to assess:
• the profit or loss of the business over a few years;
• the performance of the business in its sector;
• the financial obligations of the business;
• future plans for the business.
The underwriter may request the following documents:
• Statement of owner’s equity: this is a financial statement that explains any changes in
the business owner’s equity from one period to the next. The underwriter uses this
information to estimate the value of the proposed life insured’s interest in the business.
• Balance sheet: this provides a statement of the business’s financial condition on a
certain date. The statement identifies the assets, liabilities, and owner’s equity. It
gives the underwriter information on the size of the business assets and liabilities,
particularly if the liabilities are large or are due for payment in the near future.
• Income statement: this provides information on profits or losses over periods of time.
The information demonstrates the financial health of the business and reveals any
history of net business losses.

• Statement of cash flows: this indicates the amount of cash received, or paid out, in the
operating, investing, and financing activities of the business. Smaller and smaller cash
flows over a few accounting periods may indicate that the business is struggling.
• Annual reports: these are reports issued every year by an incorporated company to
its shareholders. They contain audited financial statements that report business
activity for the fiscal year. This is another valuable source of information that gives
the underwriter a perspective on the business’s financial condition.
An important aspect of underwriting is to determine if the applicant can afford to pay the
premiums for the proposed life insurance contract. Life insurance companies have
established guidelines that underwriters can apply to assess the applicant’s ability to pay the
premiums. Two methods are:
• Factor tables: these show the amount of insurance, expressed as multiples of a

person’s salary or income, that an insurer will normally approve in each age range. The
tables are guidelines only. If the underwriter feels that the proposed life insured’s
occupation gives the person a good chance of earning higher amounts of income, then
the underwriter may approve a larger amount of insurance, despite the applicant’s
current earnings level. For example, a physician or lawyer at the beginning of his or her
career has the potential to earn a larger income than that shown on the application form.
• Percentage-of-income-rule: the underwriter may use percentages to determine the
amount that the applicant can spend on insurance. The percentage varies depending on
the applicant’s level of income and the kind of insurance applied for.
Ultimately, underwriting affects the health of the insurer’s own business. A life insurance
company will be profitable only if the new life insurance plans that it issues remain in force for
long enough to recover the costs of issuing them and the commissions paid to writing agents.
FACTORS THAT AFFECT THE LEVEL OF PREMIUM RATES
LEARNING OBJECTIVES
• identify the factors that contribute to an increase or decrease in premium rates.
Factors That Decrease Premium Rates

Most insurers establish premium rates based on standard risks as well as lower rates for
preferred risks.
Insurers assess the risk presented in an application by comparing the particulars of the
medical, financial, and personal characteristics of the person to be insured to the
characteristics of standard risks. If a proposed life insured’s profile shows characteristics that
are significantly better than average, he or she is considered a preferred risk. An applicant
who falls into the category of “preferred risk” may qualify for a lower premium rate than
someone who qualifies as a standard risk.

The most common preferred premium rates apply to non-smoking applicants. For most
insurers, a non-smoker is someone who has not smoked a cigarette or used tobacco products
within the previous 12 months.
Factors That Increase Premium Rates

The underwriter uses a numerical rating system, derived from actuarial studies and the
insurer’s experience, to assess each risk. The underwriter assigns a numerical value to each
medical and non-medical factor revealed on the application based on its expected impact on
mortality. The numerical value is a net value representing better or worse characteristics.
Under this rating system the base number is 100. The rating is reduced (giving the applicant
a credit) for better-than-standard characteristics and increased (giving the applicant a debit)
for worse-than-standard characteristics.
For example, if a proposed life insured has a history of ulcerative colitis, the underwriter
might assign a value of +50. If no other factors affect the rating, the proposed life insured
will be assigned a mortality rating of 150, which is the proposed life insured’s predicted
percentage of standard mortality.
Insurers also consider the proposed life insured’s age and build as part of the medical
risk assessment. Most insurers establish upper age limits beyond which they will not
issue life insurance. Age is the most important factor in assessing risk.
Build is the shape of a person’s body, including the relationship of height

to weight. To evaluate the risk that the person’s build represents, the
underwriter refers to a chart that indicates average weights for various
heights for men and women, along with the mortality values associated
with deviations from the standard parameters . For example, the average weight for
a 6-foot tall male might be 180 lbs. At 270 lbs, a proposed life insured might be assigned a
value of +25.
If a proposed life insured is assessed as a sub-standard risk based on these evaluations, the
insurer may decline the application or offer insurance at a greater-than-standard, i.e., higher,
premium rate.
In establishing substandard risk premium charges, the insurer recognizes that the
mortality associated with certain patterns or characteristics will remain constant,
increase with age, or decrease with age.
Insurers charge substandard premiums based on a table rating, charging a flat extra
premium, or combining these methods.
TABLE RATING METHOD

The table rating method is generally used to calculate substandard premium rates for people with
medical conditions whose mortality risk increases with age. The table divides substandard risks
into groups according to their numerical ratings. The extra mortality for each substandard group
is expressed as a percentage added to standard mortality. So if a substandard group has a 25%
greater-than-standard mortality, the percentage rating will be 125% and the insurance coverage
will be offered to the proposed life insured at a premium rate that reflects this increase.
For example, Jane Thompson, age 45, applied for a $100,000 term life insurance policy,
after being on medication for several years to control her cholesterol levels. The standard
premium for this policy is approximately $50 a month; however, she has been given a
percentage rating of 130% so her premium will be $65 a month. $50 x 130% = $65.
FLAT EXTRA PREMIUM METHOD

Under the flat extra premium method, a specified extra dollar amount per $1,000 of insurance is
added to the standard premium. This method is generally used in cases involving extra mortality
that is considered to be constant or decreasing with age. The amount of the extra premium per
thousand is assessed based on the nature of the impairment. For example, the insurer may charge
an extra premium of $2 per thousand for a mild impairment and $5 per thousand for a more
serious condition. The flat extra may be charged on a temporary or permanent basis, depending
on the type and nature of the medical condition.
A temporary flat extra premium may be charged for a condition for which the prognosis is
positive. Several insurers levy temporary flat extra premiums if the life insured has recent or
multiple convictions for DUI/DWI (Driving Under the Influence/Driving While Intoxicated);
these premiums generally disappear 2 to 5 years from the date of a conviction. A permanent
flat extra premium might be applied to proposed life insureds who participate in hazardous
sports or occupations. For instance, a firefighter may be charged a permanent flat extra
premium, given the hazardous nature of that occupation.
COMBINATION METHODS
A combination of a flat extra premium and a table rating is generally used when the mortality risk
is expected to increase for a certain period and then decrease after a certain period. For example,
if the proposed life insured has suffered an acute illness, but has showed no recent symptoms, the
insurer may offer a table-rated premium to recognize the substandard risk and a temporary flat
extra that will disappear if the prognosis is that the condition will improve over time.
COMPONENTS OF AN INSURANCE POLICY
LEARNING OBJECTIVES
• define the key components of an insurance policy;
• list and explain the main provisions of an insurance policy.
All the provinces except Quebec have similar legislation in place that regulates insurance contract
provisions and the application of those provisions. The basis of each province’s legislation pertaining
to life insurance is the Uniform Life Insurance Act, drafted in 1921 by the Association of
Superintendents of Insurance, the Canadian Commissioners on Uniform Legislation, and the
Canadian Life Insurance Association. The Uniform Life Insurance Act has been adopted by all
of the provinces, except Quebec, and integrated into each of their insurance acts. In addition to
life insurance regulations, each province has a set of regulations for products that fall under the
definition of accident and sickness plans. Those provisions are addressed later in this chapter.

The life insurance acts of each province (except Quebec) define life insurance as:
“An undertaking by an insurer to pay insurance money, on death; or on the happening of
an event or contingency dependent on human life; or at a fixed or determinable future
time; or for a term dependent on human life, and, without restricting the generality of the
foregoing, includes, accidental death insurance, but not accident insurance; disability
insurance; and an undertaking entered into by an insurer to provide an annuity or what
would be an annuity except that the periodic payments may be unequal in amount and
such an undertaking shall be deemed always to have been life insurance.”
The provincial insurance acts apply to life insurance, insurance riders and benefits, disability
insurance, and annuities. Although the life insurance acts include disability insurance in the
definition of life insurance, accident and sickness regulations also include provisions for
disability insurance products.
Although contract law covers oral agreements, the provincial acts require that all insurance
policy contracts be written. The provincial acts also specify that:
• the application;
• the policy;
• any document attached to the policy when issued; and
• any amendment to the contract agreed upon in writing after the policy is issued,
constitute the entire contract. In other words, the completed application and supporting
documents form part of the insurance contract.
Many insurers include a copy of the application in the policy contract when they give the
contract to the insured person. Even if the application is not included with the policy
contract, it is still part of the contract. If any dispute arises between the insurer and the
insured concerning the contract, all the documents specified in the insurance act are
considered part of the contractual agreement.
Even if a copy of the application, including health questions, is not enclosed with the
insurance policy, both parties can rely on the responses in the application to defend their
positions. However, neither party can rely on verbal statements or documents that are not
part of the contract to dispute any statements written in the documents that, by law,
constitute the entire contract.
For example, a policyowner cannot assert that his or her life insurance policy should have
been issued for twice as much death benefit as the policy describes, according to an illustration
produced by the agent. The illustration is not part of the contract and the application is the
relevant document in determining the amount of insurance applied for and to be provided.
Main Provisions of an Insurance Policy

Insurance policies are the property of the owner, but they are “intangible property”, i.e.,
they have no value in themselves, like a building or a car. Instead, they represent a benefit
due to the owner when a certain event occurs. Each policy must contain specific provisions
that lay out the rights and benefits of the owner and the obligations of the contracting
parties in forming and maintaining the agreement.

For example, the owner is obliged to provide full and truthful information about the person
whose life is insured. The owner is also obliged to pay all premiums as a condition of keeping the
contract provisions in effect. The insurer is obliged to provide the benefits when a claim occurs.
To protect the rights of the contracting parties, the uniform insurance acts of the provinces
define provisions that must be contained in the policy contract. Beyond those mandatory
provisions, insurance companies also include provisions that describe the limits of the
coverage and the manner in which the contract will be administered.
The uniform insurance acts contain provisions relating to life insurance policies and accident
and sickness insurance contracts. Disability insurance contract provisions are specified
mainly in the part of the insurance acts that deals with accident and sickness insurance.
Mandatory Life Insurance Provisions

In addition to specifying the documents that constitute a life insurance policy, the
provincial acts specify the provisions that must be contained in the policy. The provisions
found in a life insurance contract have been extensively covered in Chapter 2 and some
provisions are also covered in Chapter 11.
A representative section of a provincial insurance act stipulates that:
“An insurer shall set forth the following particulars in the policy :
1. The name or a sufficient description of the insured and the person whose life is
insured.
A life insurance policy usually contains a cover page that identifies the person or
entity that is applying for insurance and the person on whose life the policy has been
issued. For third party contracts, the insured and the life insured are different entities.
For two-party contracts, the insured and the life insured are the same person.
2. The amount, or the method of determining the amount, of insurance money

payable, and the conditions under which it becomes payable.
For many life insurance policies, the amount of death benefit will be shown on the
cover page, or the particulars page, as a single amount to be paid upon the death of the
life insured. There are other life insurance contracts under which the benefit to be paid
depends on the length of time that the policy has been in force, or upon the value
accruing from the premium contributions paid under the policy.
3. The amount, or method of determining the amount, of the premium and the period
of grace, if any, within which it may be paid.
For traditional plans of life insurance, such as whole life or level term insurance, the
premium is calculated when the policy is issued and recorded on the particulars page of the
policy. The premium amount is guaranteed not to change while the policy remains in force.
4. Indication of whether the contract provides for participation in a distribution of

surplus or profits that may be declared by the insurer.
Participating life insurance policies are clearly identified as such on the specifications
page of the policy that describes the benefits provided by the policy. The dividend
option selected at issue may also be shown.
5. The conditions upon which the contract may be reinstated if it lapses.

The provincial life insurance acts specify that if a contract lapses, the policyowner can
apply for reinstatement within two years after the date it lapsed. Reinstatement was
covered in detail in Chapter 2.
6. The options, if any,

a. of surrendering the contract for cash;
b. of obtaining a loan or an advance payment of the contract money;
c. of obtaining “paid-up or extended insurance.”
Other Life Insurance Provisions

In addition to specifying the provisions that must appear in a life insurance policy, the provincial
insurance acts also contain provisions that stipulate the rights and obligations of the policyowner,
the life insured, and the insurer under the policy contract. Most insurers include provisions in
their insurance contracts relating to these rights and obligations. They usually include other
provisions that are not necessarily required under the law but which address generally accepted
practices. These provisions have been covered in Chapter 2 and include:
• 10 day right of rescission

• entire contract
• incontestability
• misstatement of age and sex
• settlement options
• non-forfeiture options and the automatic premium loan
• ownership provisions and assignment
• beneficiary designations
• suicide
Accident and Sickness Insurance Provisions

The provincial insurance acts contain a separate section on the regulation of accident and
sickness insurance. Although many of the regulations regarding mandatory contract
provisions are similar to life insurance contracts, there are some differences. According to the
provincial acts, accident insurance is
“Insurance by which the insurer undertakes, otherwise than incidentally to some other
class of insurance defined by or under this Act, to pay insurance money in the event of
an accident to the person or persons insured, but does not include insurance by which
the insurer undertakes to pay insurance money both in the event of death by accident
and in the event of death from any other cause.”
This definition distinguishes accident insurance from the accidental death benefits that
are available as optional coverage under life insurance plans.
Sickness insurance is insurance by which the insurer undertakes to pay insurance money
in the event of sickness of the person insured but does not include disability insurance.
The provisions of this section do not include regulations for accidental death insurance
and disability insurance that are included in the uniform insurance acts.
MANDATORY PROVISIONS
The insurance acts set out the following statutory conditions that are deemed to be part of every
accident and sickness policy, whether the policy contract includes them in its provisions or not.
• The insurance contract must specify the term of the insurance or the method of
determining the day upon which the insurance commences and terminates.
• Provisions relating to exceptions or reductions to the coverage must be identified in
the policy.
• The documents that form the contract are specified.
• The insurer can waive a condition in the contract only in writing; the waiver must be
signed by the insurer.
• The insurer must, upon request, provide an insured or claimant with a copy of
the application.
• Only written statements made by the insured in the application, or other written
statements submitted as evidence of insurability can be used by the insurer to defend a
claim or avoid a contract.
• If an insured person changes occupations to one that is more or less hazardous than
that stated in the contract, the effect of the change must be described in the contract.
• The relation of earnings to benefits payable under one or more contracts must be taken
into consideration, so that the person insured does not receive more than the loss in
earnings he or she has sustained.
• The procedure by which either the insured, or the insurer, can terminate the contract
and receive a refund of (or refund, in the insurer’s case) any excess premiums paid
must be specified.
• The procedure by which a claimant must provide notice and proof of claim to the
insurer must be specified. Notice must be in writing and delivered to the insurer not
later than 30 days from the date the claim arises. Proof of claim must be provided
within 90 days from the date the claim arises. A claim will not be invalid for failure
to comply with these requirements if notice and proof are given as soon as possible
and not later than one year from the date the claim arises.
• The insurer must furnish forms for proof of claim.
• The insurer has the right to examine the person insured as often as it reasonably
requires while the claim is pending. If the person insured dies, the insurer can
require an autopsy, subject to applicable laws relating to autopsies.
• An insurer must pay claims within 60 days after receiving proof of a claim,
unless the claim is for loss of time. Initial benefits for loss of time must be paid
within 30 days after the insurer has received proof of claim and after that, at
the intervals stated in the policy, but not less frequently than every 60 days.
• A legal action against an insurer to recover a claim under the policy must
be started not more than one year from the date that the insurance money
became payable.
FORMATION OF THE CONTRACT

According to the provincial acts, the insurer takes on the risk of having to pay a claim where an
accident and sickness policy has been delivered to the insured, even if the initial or renewal
premium has not been fully paid. The insurer must provide written notice to the person
insured that the contract is not in effect. The contract is terminated ten days after the written
notice is issued.
ADDITIONAL ACCIDENT AND SICKNESS PROVISIONS

The provisions included in an A & S policy have been extensively covered in Chapter 3
and include:
• Incontestability
This provision is similar to the provision in life insurance policies, with the exception
that the insurer may take action to rescind a contract after the first two policy years if
the disability that led to the rescission started within the first two policy years.
• Misstatement of age
• Pre-existing conditions
Under this provision, if, after a policy has been in force continuously for two years,
the insurer finds out that the insured suffered from a disease or physical condition
prior to the issue date of the policy, the insurer cannot use this fact to deny a claim.
• Payment of benefits
The insurer may pay an amount not exceeding $2,000 to a relative by blood or marriage
of the person insured, or any other person appearing entitled to the amount by reason of
having incurred expenses related to the person insured. This provision, known as the
“facility of payment” provision, discharges the insurer to the extent of the amount paid.
• Accident
The accident provision may include an accidental means clause or an accidental results clause.
An accidental means clause requires that not only the results, but also the means
causing an accident, must be accidental. An unexpected death or injury from an
intentional act would not be covered under an accidental means clause.
For example, if a young man insured under an accident policy plays “chicken” with a fast-
approaching freight train, misjudges his timing, and is hit by the train, and the policy
contained an accidental means clause, the insured’s accident would not be covered.
Under an accidental results clause, the same accident would most likely be covered,
because the death resulting from the young man’s deliberate actions was an accident.
EXCLUSION CLAUSES IN ACCIDENT BENEFIT CONTRACTS

Exclusions under accident policies usually include losses resulting from such
causes as suicide, drugs, poison, gas, or fumes. Some policies will exclude
coverage for death or injury while the insured is under the influence of
alcohol.
Disability Insurance Contract Provisions

An injury or accident is defined as an accidental bodily injury sustained
while the policy is in force. Sickness is defined as an illness or disease that
first manifests itself while the policy is in force, and includes both physical
and mental illnesses. An injury or sickness suffered before the effective
date of the policy is not covered under the policy terms.
Disability insurance contracts contain many of the provisions described in
the section above. In addition there are contractual provisions that address
the circumstances and conditions under which benefits are payable. These
provisions have been covered in Chapter 3, and include:
• Prior earnings
The prior earnings clause may offer alternative measures to determine the level of the insured’s earnings. The first is usually
the monthly average for the 12-month period immediately before the disability started. The second is the highest average
monthly earnings for any 24 consecutive months in the 60 months before the disability started. The insured will be allowed
to use the higher calculated amount to determine the level of prior earnings.
• Excluded income
The contract defines earnings as compensation for work performed by the insured such as salary, wages, commissions, or
fees. Passive income, such as interest and dividends on
investments, does not constitute earnings for the purpose of determining a disability benefit.
• Minimum residual benefit in the first six months

Under this provision, the insured receives either 50% of the total disability monthly benefit or the actual residual benefit
calculated based on the earnings loss, whichever is greater.
• Recurrent disability
If the insured suffers a total or residual disability within six months of recovering from a previous total or residual disability,
and the cause of both disabilities is the same, the current disability will be considered a continuation of the previous
occurrence. Consequently, the insured will not have to satisfy another elimination period before he or she begins receiving
benefits.
• Renewability options
• Defining total disability
• Partial disability benefits
• Qualification period
• Elimination period
• Waiver of premium

• Cost of living adjustment
• Exclusions
AGENT’S RESPONSIBILITY IN DELIVERY OF THE INSURANCE

CONTRAC
LEARNING OBJECTIVES
• explain, using examples, the agent’s responsibilities in delivery of the insurance contract,
including right of rescission, proof of delivery, and any change in the health of the insured.
The agent plays an important role by helping applicants complete an insurance application
and providing any other information that the insurer requires for underwriting the
application. The agent’s role is just as important after the insurer has reached its
underwriting decision. The agent is responsible for conveying the insurer’s decision to the
applicant and, if the decision is positive, for delivering the policy contract.
The agent’s duties in communicating with the applicant vary, depending on the
circumstances. Consider the agent’s role in the following situations.
Example 1: Agent White has taken an application from Harold Innis. Although Harold
completed all of the application documents, he chose not to pay the initial premium with the
application. The insurer underwrites and approves the application and issues a policy, which it
sends to Agent White’s agency offi ce for delivery to Harold. Agent White immediately contacts
Harold and arranges an appointment to deliver the contract. During the appointment, Agent
White makes it a point to complete the following tasks:
1. First, he reviews the contract provisions in detail with Harold and answers several
questions that Harold asks.
2. Next, he asks Harold if his health has changed in any way since the date he made
the original application or the date of any medical examination, if later.
3. When Harold confirms that his health is unchanged, Agent White asks for and
receives Harold’s payment for the full first premium.
4. Since Harold has chosen to pay premiums on a monthly basis, Agent White also has Harold
complete an authorization for automatic premium withdrawals from Harold’s bank account.
5. Agent White then asks Harold to sign and date an acknowledgement that he has
received the policy and accepted its delivery.
6. Finally, Agent White points out the “ten-day free-look provision,” under which Harold
could return the policy for cancellation and receive full refund of any premiums paid,
within ten days of the delivery of the contract, if he changes his mind.

After the appointment, Agent White immediately submits Harold’s signed policy delivery
acknowledgement, the premium payment, and the withdrawal authorization to his agency
office to complete his responsibility in the policy delivery process.
Consider a number of changes in the circumstances and their effect on the agent’s duties.
1. What if Harold wants to keep the policy, but does not want to pay the initial premium
until he or she has had an opportunity to inspect the policy provisions more carefully?
In this case, Agent White must retrieve the policy and not leave it with Harold, unless
Harold signs a form that stipulates the conditions under which he has retained the policy
in his possession. The form should specify clearly that the contract has been left with
Harold for inspection only and that the contract has not taken effect. It should also
specify a limited number of days within which Harold must decide to keep or return the
policy. The form should specify the requirements for full delivery of the contract, that
the policy will only take effect once the full first premium is paid and provided that
Harold’s insurability (that is, his health) has not changed since the date of the
application or the medical examination, if later.
2. What if Harold insists that the coverage described in the policy contract is not the
coverage he wanted?
Under these circumstances, Agent White would retrieve the policy and return it to the
insurer. He will certainly want to clarify the coverage that Harold is seeking. It may be
that Harold has changed his mind about the type and amount of coverage he needs.
Depending on the insurer’s instructions, Agent White may take an entirely new
application, or ask Harold to complete a policy change request to specify the coverage
to be considered. Agent White must make it clear to Harold that no insurance coverage
is in effect and that no coverage will take effect until a new or revised policy has been
issued and delivered. As with the original policy, delivery is complete when Harold
pays the full first premium, provided that his health has not changed in the meantime.
3. What if Harold’s health has changed?

Agent White must retrieve the policy and return it to the insurer for a review of the
circumstances. Agent White must make it clear to Harold that no coverage is in effect
and that, given the change in his health, the insurer might decline to issue insurance of
any kind, or issue insurance on some basis other than standard premium rates.
4. What if Harold refuses to take delivery of the policy?

The applicant has the right under the ten-day free look offer to return the policy and receive
a full refund of any premiums paid. Agent White should have Harold convey that decision
in writing by noting his decision on the policy delivery acknowledgement, and signing it.
Example 2: Agent Green has accepted payment of an initial premium from Amanda Addison. After
Amanda reviews and signs the application, Agent Green hands her a receipt acknowledging a
temporary insurance agreement. The insurer receives the application and after underwriting it,
approves the issue of a policy exactly as applied for. The policy is forwarded to Agent Green’s
agency offi ce for delivery to Amanda.

Agent Green contacts Amanda to arrange for delivery of the contract. Under these
circumstances, the Uniform Life Insurance Act provides that “where a policy is issued on the
terms applied for and is delivered to an agent of the insurer for unconditional delivery… it shall be
deemed, but not to the prejudice of the insured, to have been delivered to the insured.”
Since Amanda has paid the full fi rst premium and the policy has been issued as requested,
Amanda is covered under the terms of the policy. Agent Green is busy and so is Amanda.
Therefore, Agent Green mails the contract to Amanda and considers his job complete.
What important considerations has Agent Green ignored?

1. What if Amanda receives the policy and either has questions about the product she has
bought or does not think that the policy provides all of the benefits she applied for?
It is Agent Green’s responsibility to do everything he can to review the policy with
Amanda in person. In the process, he can review the reasons why Amanda purchased
the coverage and can make sure that Amanda is comfortable with the benefits specified
in the contract. If Amanda is well informed about her policy and reminded of the
reasons she acquired it, chances are she will keep it in force.
2. What if Amanda’s circumstances have changed and she does not want to keep the policy?
If Agent Green simply mails the policy to Amanda or drops it off at her home or workplace,
Amanda may take advantage of the ten-day free look and return the policy for a full refund
of her premium. Agent Green’s responsibility in this situation is to arrange a personal
interview with Amanda and remind her of the reasons she applied for the policy. He may be
able to convince her that the policy is an important part of her financial planning, or work
with her to have the policy reissued to address her changed circumstances.
3. What if Amanda’s health has deteriorated to the point that she no longer qualifies as a
standard risk?
This is a particularly difficult situation confronting both Agent Green and the insurer. The
Uniform Life Insurance Act provides that, among other conditions, a policy contract does
not take effect unless “no change has taken place in the insurability of the life to be insured
between the time the application was completed and the time the policy was delivered.”
It is Agent Green’s responsibility on behalf of the insurer to deliver the policy in

person and confirm that Amanda’s health has not changed. If Agent Green is
concerned that there has been a change in Amanda’s health, he cannot deliver the
policy, but must return it to the insurer with an explanation. It is the insurer’s
responsibility to deal with these new circumstances.
Example 3: Agent Blue knew there would be a problem with Sam Stockwell’s life insurance
application. As she completed the application with Sam, Agent Blue realized that the
underwriters would pay close attention to Sam’s health history. After a subsequent medical
on Sam and a follow-up attending physician’s statement, the insurer declined to issue a
standard policy and instead issued a policy with a lower face amount, without the waiver of
premium benefit provision that Sam had requested and at a substandard premium rate.

The policy was issued, along with an amendment to be signed by Sam, confirming his acceptance of
the modified provisions. It is up to Agent Blue to contact Sam to explain the insurer’s offer. She
telephones Sam to let him know that the policy could not be issued as applied for. Sam is
unhappy with the decision and informs Agent Blue that he is no longer interested in doing
business with her or her company. Agent Blue returns the policy to the insurer as undeliverable.
1. What could Agent Blue have done differently under these circumstances?
At the time she was completing the application with Sam, Agent Blue could have advised
Sam that, considering his medical history, it was possible that the insurer might not issue
a standard policy contract. Under circumstances in which a proposed life insured’s health
history indicates the possibility that the insurer may decline the application, many insurance
companies will consider a trial application. This type of application allows the insurer
to obtain enough preliminary information about the applicant’s insurability to make an
informed decision to decline to issue any insurance or to propose a plan of insurance
with a premium rate higher than standard rates. If Agent Blue had anticipated the
insurer’s reaction, perhaps she could have prepared Sam to consider the insurer’s offer
of coverage at substandard (i.e., higher) premium rates.
2. What should Agent Blue do to have Sam consider the insurer’s offer?
Agent Blue could arrange for a personal appointment with Sam to review the offer in
person. Again, if Agent Blue had prepared Sam, the conversation about a substandard
policy might be less strained. She must review the terms of the offer with Sam and
remind him that insurance is an important part of his financial planning needs. Although
she cannot discuss with Sam the particulars of the health information that the insurer
used to arrive at its decision, she can encourage him to discuss any concerns he may
have with his personal physician.
Many insurers will, if given a written authorization by an applicant, provide the proposed
life insured’s personal physician with the rationale for its underwriting decision based on
the medical information it received. Agent Blue must make sure that Sam has enough
information to make an informed decision about taking or refusing the coverage.
3. What steps must Agent Blue take if Sam decides to take the coverage?
If Sam decides to take the policy, he must confirm that he understands and accepts the
modified coverage by signing an amendment that provides details about the coverage
offered by the insurer. Agent Blue is responsible for explaining the terms of the
proposed coverage, including the higher premium rate. She must also have Sam sign the
form, witness his signature, and collect the full first premium. Finally, she must forward
the premium payment and the amendment form to the insurer through her agency office.
4. What steps must Agent Blue take if Sam refuses to take the coverage?
Agent Blue must have Sam provide a written acknowledgement to that effect. She will
return the acknowledgement and the contract to the insurer through her agency office.

THE CLAIMS PROCESS FOR LIFE, DISABILITY, ACCIDENT &

SICKNESS, AND GROUP INSURANCE
LEARNING OBJECTIVES
• describe the claims process for life, disability, accident & sickness, and group insurance.
The fundamental purpose of any insurance product is to provide a financial benefit when an
event occurs that was specified in the insurance policy, such as a death or accident. Every
insurer attempts to conduct a fair and thorough claims review in order to pay the policy
proceeds promptly, while making sure that each claim is valid and is actually covered under
the policy provisions. Provincial regulators have established regulations that provide some
security for the interests of the insured and the insurer.
The Uniform Life Insurance Act provides that:
“Where an insurer receives sufficient evidence of,
a) the happening of the event upon which insurance money becomes payable;
b) the age of the person whose life is insured;
c) the right of the claimant to receive payment; and
d) the name and age of the beneficiary, if there is a beneficiary;
it shall, within 30 days after receiving the evidence, pay the insurance money to the
person entitled thereto.”
Life Insurance Claims
HAPPENING OF THE EVENT

For life insurance claims, the “event” is the death of the life insured. The Uniform Life Insurance Act
makes it clear that the insurer must receive sufficient evidence of the death of the life insured. In most
cases, the procedure is straightforward. The beneficiary or personal representative (the estate executor
or administrator) for the insured person who has died notifies the insurer of his or her death and
completes the claim requirements. The insurer must comply with a valid claim by making the claim
payment within 30 days. Sometimes, however, the claims procedure is not routine. The Uniform Life
Insurance Act provides some remedies for those occasions.
Lack of Proof of Death

Sometimes it is not evident that the life insured has died, although the policy is in force and the
beneficiary would be entitled to any benefits. Under these circumstances, the Uniform Life
Insurance Act allows the insurer to take some action to resolve the claim. If there is some
indication that the life insured has died, but no positive proof is available, the insurer or the
claimant can apply to the courts for a declaration as to the sufficiency of the proof of death. For
example, if the insured person was last seen swimming alone and has not been seen since, his or her
body may not be recovered. Although it is most likely that the insured person has drowned, there is
the chance that he or she is still alive. It is up to the claimant to prove that the insured

person has died. The insurer may refuse to pay the claim until it has received absolute
proof of the insured’s death. Once the court declares that the life insured has died, the
insurer can then settle the claim.
If the person whose life is insured disappears, but there is no evidence that he or she has died,
and the claimant applies for benefits, the Uniform Life Insurance Act allows a court to make a
declaration about the death of the life insured. The claimant can apply for such a declaration
once the life insured has not been heard from for seven years. If the court makes a declaration,
based on a balance of probabilities, that the life insured is dead, the insurer can pay the benefit
under a court order and be discharged from any other liability. If the insured person later turns
up, the insurer can demand that the beneficiary return the death benefit.
Suicide
Most policies stipulate that if the life insured commits suicide, while sane or insane, within
two years (sometimes one year) after the date the policy was issued, or the date it was
reinstated after having lapsed, the insurer’s liability is limited to the total of the premiums
paid under the policy. It is up to the insurer to prove that the life insured committed suicide
and suicide must be proved as the cause of death to the exclusion of any other cause.
Accidental Death
If the life insured was covered under an accidental death benefit, the claimant must prove that
the insured’s death was accidental. Some accidental death benefit provisions require the
claimant to show that both the cause and the effect of the death were accidental.
If the life insured died in a train wreck for example, then both the cause and the effect were
accidental. If the life insured fell from a balcony while performing hand stands on a railing,
while the effect is accidental, the cause may not be considered accidental.
The insurer will decline payment of an accidental death benefit under other extenuating
circumstances. Death by inhalation of a noxious substance such as sniffing glue may be
excluded. Accidental death during the commission of a criminal act may also be excluded.
MISSTATEMENT OF THE AGE OF THE LIFE INSURED

The Uniform Life Insurance Act contains provisions for situations in which it is discovered that
the life insured’s age was misstated on the application. Once a claim is presented to the insurance
company, the claim’s examiner may ask for proof of age, particularly if there is some conflicting
information between the age reported on the claimant’s statement or death certificate and that
shown in the company’s records. The Uniform Life Insurance Act provides that if the life
insured’s age has been misstated, the insurance proceeds will be increased or decreased to the
amount that would have been provided for the same premium at the correct age.
Furthermore, the Act provides additional protection for beneficiaries of a life insurance
policy, if the coverage would never have been provided because the life insured’s true age
exceeded the age limit for the coverage. The Act makes it clear that the insurer can, within
five years of the issue date and during the lifetime of the insured person, void a policy that it
would never have issued if it had known the life insured’s true age. Within those five years,
the insurer has 60 days from the time it discovers the error to the time it voids the contract.

THE RIGHT OF THE CLAIMANT TO RECEIVE PAYMENT

Beneficiary or Estate As Claimant
Often, the beneficiary designated by the policyowner claims the proceeds and, having
confirmed his or her identity, receives the payment. For example, if the policy names Blair
Benedict, spouse of the life insured, as beneficiary, and Blair prepares and signs a claim
form, and the insurer confirms that Blair is the beneficiary noted on its records, then the
insurer will pay the proceeds to Blair.
The policyowner may designate “my estate” as the beneficiary of a policy on his or her life. In
that case, when the life insured dies, his or her personal representative will apply for the
proceeds, which will be paid to the representative as “executor or administrator of the estate of
the deceased.” The personal representative is usually the executor of the life insured’s estate.
The insurer will usually ask for a copy of the deceased’s probated will to confirm the
claimant’s right to act on behalf of the life insured’s estate. The claims examiner may review
the terms of the will to see if the life insured has made any declaration under the will to
appoint another person as beneficiary. In fact, some insurance companies ask for a copy of
the will, even if a natural person has been named as beneficiary, to satisfy itself that the life
insured has not made any declarations in the will about the disposition of the policy proceeds.
If the deceased did not have a valid will, then the insurer will ask for letters of
administration so that it can legitimately pay proceeds to a claimant declared by the
courts to be a valid administrator of the deceased’s estate. There may be other potential
claimants for the policy proceeds, and if their claims have been duly registered with the
insurer, the insurer must recognize them and distribute the policy proceeds accordingly.
What if “Blair Benedict, my spouse” is the beneficiary named in the policy, but Blair Benedict is
no longer the deceased life insured’s spouse? Is Blair still considered to be the beneficiary,
particularly if the life insured has remarried? If the policyowner did not register a new beneficiary
designation with the insurer, then the beneficiary of record can claim the proceeds. It is the name of
the beneficiary that gives the designation legitimacy, not the relationship. For example, Harry and
William were once partners and William took out a policy on Harry’s life under which “William,
partner” was named beneficiary. When Harry dies, William can claim the insurance proceeds, even
though the partnership may have been dissolved long before Harry’s death.
Third Party As Claimant

What if a third party has a legitimate claim to some or all of the policy proceeds, but
notification of that party’s status as beneficiary has not been registered with the insurer?
What is the insurer’ liability in such cases? Under the provisions of the Uniform Life
Insurance Act, if the insurer pays the insurance claim according to the documents it
possesses at the time of payment, it is fully discharged from any additional liability towards
any claimants of whom it has no knowledge. Those unknown claimants must then pursue
their claim against the party that received the claim proceeds.
Parties other than the beneficiary may have a claim against the proceeds of the life insurance
policy. Since the life insurance policy is a piece of property, the policyowner has the right
to assign some or all of the rights under the policy to a third party. The assignment may be a
collateral assignment to secure a loan or an absolute assignment to give or dispose of the
entire interest in the life insurance policy. In either case, the assignment affects the rights of
a beneficiary to the extent necessary to accommodate the rights and interests of the assignee.
However, the assignee must register his or her interest with the life insurance company before the

insurer is obliged to acknowledge that interest. Insurers usually acknowledge an assignment,

but “make no guarantee as to its sufficiency or validity.” If an assignment is registered, the
insurer will abide by its directions until it (the insurer) is released.
For a collateral assignment, the assignee is entitled to a portion of the policy proceeds to the
extent of his or her interest. For example, the XYZ bank has a collateral interest of $10,000
in Brenda’s $100,000 whole life policy. If Brenda dies while the assignment is still in effect,
XYZ bank is entitled to $10,000 of the proceeds and the beneficiary is entitled to the
remainder of the benefit.
An absolute assignment is a transfer of ownership of all rights, title, and interest in the policy
from one policyowner to another. Usually, when an absolute assignment takes place, the assignee
changes the beneficiary designation, since the existing beneficiary will most likely not have a
relationship with the new owner. Since an absolute assignment delivers every “right, title, and
interest” in the policy to the assignee, the assignment will include the right to the policy proceeds
on the life insured’s death. The insurer, in order to protect all interested parties, may require the
consent of the assignor and assignee before any dealings with the policy take place.
The life insured’s creditors may register a claim against the proceeds of the life insurance
policy. In this instance, the Uniform Life Insurance Act steps in to protect the beneficiaries’
rights. The Act provides that “where a beneficiary is designated, the insurance money, from the
time of the happening of the event upon which the insurance money becomes payable, is not
part of the estate of the insured and is not subject to the claims of the creditors of the insured.”
Confirming the Identity of the Beneficiary

If a natural person has been appointed beneficiary, then the insurer must confirm that the person
claiming the proceeds has a legitimate right to those proceeds. The beneficiary designation may
be straightforward. For example, if the designation is “Blair Benedict, spouse of the insured,”
then as long as Blair Benedict is alive, has reached the age of majority, and can prove that he or
she is the individual so designated, then the insurer can pay the policy proceeds to Blair Benedict.
If, however, the beneficiary designation is “children of the life insured,” it becomes more
difficult to identify all of those who are entitled to claim the policy proceeds. Did the
policyowner intend that only children living at the time the policy was issued were to benefit?
What about the rights of any children born to the policyowner after the policy was issued? It
is important for the agent and the insurer to make sure that the beneficiary designation is clear
and that the insurer can identify those who are entitled to claim the proceeds. Nowadays, with
many people marrying more than once in their lifetime, there may be step-children and half-
children along with adopted children and biological children. And both spouses may be in the
same situation, making things even more complicated. That’s why it’s better to specifically
name the beneficiaries instead of using a catch-all phrase such as “my children”.
If the insurer acknowledges that a claim is valid, but cannot resolve issues concerning rights
to the proceeds, the Uniform Life Insurance Act allows the insurer to pay the proceeds into
court and be discharged from any further liability. The courts will then sort out the conflicts
concerning entitlement to the policy proceeds.
If the beneficiary dies before the life insured, the insurer can pay the policy proceeds to the
life insured’s estate, unless a contingent beneficiary was appointed. However, the insurer
must have been formally notified that another beneficiary has been appointed before that
beneficiary’s claim can be acknowledged.

If the beneficiary is a minor, the insurer must generally pay the proceeds into court, and the
court determines how the proceeds are to be disbursed. The Uniform Life Insurance Act
provides that anyone who has attained the age of 18 years has the capacity of a person who
has reached the age of majority and can give a valid release to the insurer upon receipt of the
claim proceeds. At that time, the insurer will have no further obligations to the beneficiary.
OTHER DETAILS OF THE LIFE INSURANCE CLAIMS PROCESS

Once the insurer has received all of the required documents to pay the life insurance claim,
it has 30 days in which to make payment. Some insurers pay interest on the claim proceeds
from the time it receives full proof of claim until it pays the proceeds. Many insurers
calculate and pay interest from the date of death to the date the proceeds are released. The
interest rate used is usually similar to that for current short-term investments.
Proceeds are usually paid in the province where the contract was made. Many policies, however,
stipulate that “all amounts payable by the company will be payable at any office of the company in
Canada.” The contract will usually specify that proceeds are payable in Canadian dollars.
These provisions make clear which jurisdiction’s regulations apply in determining the
payment of the proceeds and the currency in which the proceeds are paid.
If a contract is issued in a Canadian province, then the insurance laws of that province
apply to the contract. If someone who does not live in Canada applies for the policy
proceeds, the laws of the province of issue apply to the claims process and the proceeds are
payable in Canadian currency. The beneficiary cannot claim the proceeds in the currency
of the country in which he or she lives.
At the same time, the Uniform Life Insurance Act allows the insurer to pay policy proceeds in
accordance with the laws of the jurisdiction in which the beneficiary resides. For example, if
a policy was issued in British Columbia, then the uniform act of British Columbia would
regulate the claims process. If, however, the beneficiary lives across the border in Seattle,
Washington, payments to the beneficiary would be made as per the laws of Washington state.
Those laws might dictate the age of majority, for example, or the extent of a trustee’s rights to
act on behalf of the beneficiary.
If the beneficiary designation stipulates that a trustee of the beneficiary is to receive the
policy proceeds, the insurer does not have to confirm that the trust agreement is valid. A
payment by the insurer to a trustee discharges the insurer to the extent of the payment.
The Uniform Life Insurance Act specifies limits for the payment of legitimate claims and
the length of time allowed for legal action over a life insurance claim. Once a claim has
been validated, if the insurer does not pay the proceeds within 30 days, the claimant can
apply to a court to have the proceeds paid into court. The court can then determine the
manner in which the proceeds will be paid.
The Uniform Life Insurance Act also places limits on how long a claimant can pursue a claim
for life insurance proceeds. Once claim requirements have been submitted, a claimant has one
year in which to launch a suit to recover the insurance money, if the insurer has failed to pay
the proceeds within that time. In addition, a claimant cannot launch a suit to recover insurance
proceeds from an insurer more than six years after the death of the life insured.

Disability Insurance Claims

The disability insurance claims process differs from the life insurance claims process
because the person insured is alive and usually able to communicate with the insurer to
provide information and make himself or herself available for medical examinations.
HAPPENING OF THE EVENT

The “event” is the onset of the disability of the insured. The disability policy provisions
determine whether the disabled insured is entitled to receive benefits under the policy. The
first step in the claims process begins when the insured notifies the insurer of his or her
disability. The insurer provides an official claim form that the insured must complete,
providing details of the claim. The form usually includes a section to be completed by the
doctor who is attending the insured during his or her disability.
The insurer will normally request that the insured and the attending physician complete the
claim form as soon as the claim notification is made. This allows the insurer to establish a
claim file and begin the claim assessment, even though payments are not scheduled to begin
until the end of the elimination period. The claim form completed by the insured includes an
authorization, allowing the insurer to obtain medical information about the insured.
DETERMINING ELIGIBILITY
The insurer must first confirm that the policy is in force and that the insured is eligible to make a
claim. Then it must determine, based on the information in the claim form, whether or not the
insured is disabled under the provisions of the policy. The nature of the illness or injury may be
apparent from the information provided by the insured and the attending physician or the insurer
may require additional information on the extent of the insured’s disability.
For example, if the insured has been hospitalized from the trauma of an automobile accident
and has suffered some major injuries, the claim is likely valid (unless the insured caused the
accident intentionally, say, with suicide as a motive). The claims examiner might seek some
additional information, such as a police report of the accident, to provide background on the
circumstances. It would be relatively straightforward to confirm the disability and that it is
covered under the terms of the policy.
On the other hand, a claim for a nervous disorder might be more difficult to assess. If the insured
is hospitalized and under constant care, the extent of the illness is apparent. If the insured is
not hospitalized and there is no specific diagnosis, such as “bi-polar” disorder, it might be
more difficult for the claims examiner to confirm that the insured is truly disabled and
unable to perform the duties of his or her occupation.
The claims examiner has some alternatives in assessing the claim. He or she can order
additional reports from the attending physician to get more detail on the insured’s symptoms
and the physician’s prognosis. The insurer can request that the insured undergo an
examination by a physician or psychiatrist selected by the insurer. Another alternative might
be an independent investigation by an inspection company or an investigative service to
obtain information about the insured’s lifestyle or conduct.

ADMINISTERING BENEFITS
Once the insurer is satisfied that a valid claim exists and the elimination period has been
satisfied, it is up to the claims examiner to begin administering disability payments. The
examiner will begin making monthly benefit payments in the amount specified in the policy
at the end of the first month that payments are due. The examiner will usually include another
claim form with the first claim cheque, to be completed by the insured and the attending
physician, confirming that the insured continues to be totally disabled.
The insurer will monitor the claim while the insured’s disability continues. For short periods
of disability, such as six months, the claims process might be routine. For longer disability
periods, the examiner must consider the details of the coverage provisions. Does the policy
provide residual or partial disability benefits? If so, when do these benefits first become
available? A claimant who has been disabled for a period might return to work with a
reduced work schedule or a reduction in earned income. If the insured’s contract does not
include partial or residual benefits, then the claim is finished. If these benefits are included,
then the insurer has to consider the claimant’s ability to perform the duties of his or her job
(partial disability) or the reduction in earnings he or she is experiencing (residual disability).
The claims examiner will continue to monitor the claim by seeking attending physician’s
reports and statements from the claimant on how many regular work duties he or she can
perform, or how much income the claimant is able to earn currently compared to his or her
earned income before the onset of the disability. If the insurer is satisfied that the claimant
qualifies for partial or residual benefits, claim payments will continue.
DEFINITIONS OF TOTAL DISABILITY

Some policies define total disability as the inability of the insured to perform the duties of
his regular occupation over a certain period of disability, e.g., two years, and then the
inability to perform the duties of any occupation for which the insured is suited by reason
of education, training and experience after that initial period has expired. The claims
examiner will keep that definition in mind as the claim continues.
For example, Ella has been a police officer for ten years. Because of the stresses of her
career, she suffers a nervous breakdown and is unable to perform the duties of a police
officer. Ella is insured under a disability income policy that contains a “dual” definition of
total disability. During the first two years of her disability, Ella would be considered disabled
if she were unable to perform all of the important duties of her occupation. After two years,
Ella would be considered disabled if she were unable to perform the duties of an occupation
for which she was suited by reason of education, training or experience. For two years, Ella
was unable to resume her duties as a police officer. After that time, the insurer reviewed her
claim and apprised her of the way in which total disability was now defined. Ella was offered
a position with a private investigation firm in which she could apply her knowledge and
training. Ella accepted the position and the insurer discontinued claim payments.
MISSTATEMENT OF THE AGE OF THE INSURED

For disability insurance plans, if the age of the person insured has been misstated, the insurer
can increase or decrease the monthly income to the amount that would be provided at the
correct age, or adjust the premium according to the correct age.

Since the amount of disability income benefit is based on the insured’s actual earnings, the
insurer might not want to allow a significant increase in the benefit if the insured’s age has been
overstated. The insurer may choose to reduce the premium and refund any excess amounts paid.
THE RIGHT OF THE CLAIMANT TO RECEIVE PAYMENT

In assessing a claim, the insurer must determine whether the claimant has a valid claim,
not necessarily based on his or her disability, but on the validity of the coverage itself.
The first consideration is the status of the coverage. Is the policy in force?
Next, has the insured reached the age limit for the coverage?
The insurance policy may also contain an exclusion for any disability caused by certain
conditions. For example, if the insured has a history of back problems, the insurer could
have excluded from the policy any disability resulting from a back problem.
The insurer can refuse a claim resulting from an undisclosed condition that pre-dated the policy’s
issue date. This right is restricted to claims occurring in the first two years the policy is in force.
OTHER CONSIDERATIONS
The disability insurance contract contains a waiver of premium benefit that takes effect after
a certain period of disability. The waiting period for commencement of this benefit may be
three to six months, depending on the insurer. The claims examiner initiates the waiver
benefit as part of the ongoing assessment process.
A third party, such as the insured’s employer, may be named in the policy. The claims examiner
must ensure that claim payments are made to the right party. Some plans call for payments to be
made to the employer; others pay the benefits directly to the disabled employee.
Special types of disability insurance require additional processing by the claims office. In
addition to confirming that a disability claim for business overhead insurance is valid, the
claims examiner must determine the amount of the claim to be paid. To do that, the
examiner requires confirmation of the amount of the eligible business expenses incurred
during the period of disability. The source of the information might be revenue statements
that provide information about the business’s regular expenses. Just as the examiner requires
regular statements from the claimant and the attending physician, appropriate financial
statements are required on a regular basis in order to calculate the amount of the benefit.
Disability buy-out plans require a careful review of the circumstances surrounding the disability
and a determination of the “trigger date” – the date on which the benefit payment is due based
on the length of time that the insured has been disabled. The claims examiner must carefully
consider the interests of the insured and the owner of the policy and make the payment
accordingly. For example, the disability buy-out plan is most likely a financing instrument for a
buy-sell agreement. The policy provisions should clearly identify the recipient of any claim
payments. Normally, the recipient is the policyowner, not the insured person.

Accident and Sickness Insurance Claims

The uniform insurance acts contain a section relating to accident and sickness insurance.
Although many of the provisions relating to accident and sickness insurance are similar to
those for life insurance, there are some differences. The claims examiner must recognize the
differences during the claims process.
The claims process for accident and sickness insurance follows the same pattern as that for life and
disability income claims. The claimant must formally notify the insurer of the claim and provide
sufficient proof of the sickness or accident. Proof may be in the form of an attending physician’s
statement or a physical examination by a physician chosen by the insurer.
NOTICE OF CLAIM AND CLAIM PAYMENT

The claimant is obliged to notify the insurer in writing no more than 30 days after the
accident occurs or the sickness begins. Proof of claim must be submitted to the insurer within
90 days. The insurer must pay claims within 60 days of receiving the proof of claim, unless
the claim is for loss of time. Loss of time benefits must be paid within 30 days after the
insurer has received proof of claim and, after that, at intervals no less frequently than 60 days.
EXCLUSIONS AND EXCEPTIONS

In assessing the claim, the examiner must first confirm that the policy is in force and that the
claimant is eligible to submit a claim. Then the examiner considers the policy provisions and any
exclusions or exceptions that might apply to the claimant’s policy contract. If, for example, the
contract excludes coverage for a sickness resulting from colitis, then the examiner will look at
the cause of the sickness to confirm it is covered under the terms of the policy.
Pre-existing Conditions
The examiner considers the date on which the sickness began. If its onset predates the date
the policy was issued, the examiner will look at the application to see if the condition was
revealed on the application. If not, the insured may have withheld information that was
essential to the assessment of the insurance risk.
If the misrepresentation was material and the policy has been in force for less than two years, the
insurer can deny liability for the claim and take action to rescind the contract. After the policy
has been in force for two years, the examiner cannot deny a claim for a pre-existing condition
unless it can be proven that the insured committed fraud in withholding the information.
Change of Occupation
Some accident and sickness policies contain a provision that allows the insurer to adjust the
benefits payable if the insured has taken up a more hazardous occupation after the policy issue
date. The adjustment will be based on the amount of coverage available at the same premium
level to an insured in the more hazardous occupation. If the claimant has assumed a less
hazardous job, then the insurer will maintain the same level of benefit, but reduce the premium.
Overinsurance
Accident and sickness policies may contain a provision that reduces the benefits payable
under the plan if the insured is overinsured.

As part of the claim assessment, the claimant will be asked if the claim is also being considered
under another insurance plan. If other coverage is in force under which the claim will be
considered, the examiner will review the insured’s application to see if the other coverage was
mentioned. If not, the examiner will take steps to reduce the benefit payable under the claim.
Group Insurance Claims

Insurance products that are offered on an individual basis can also be offered under a group
insurance scheme. The uniform insurance act provisions that apply to individual policy
contracts apply to life, disability, and accident and sickness coverage offered through a group
contract. An important difference in the claim process for group benefits is that the claimant,
or the claimant’s beneficiary, usually deals with the group administrator, or the company’s
Human Resources Department when submitting the claim.
GROUP LIFE INSURANCE

The life insured will be issued a group certificate that specifies the current level of life insurance
coverage. The amount of life insurance is usually a multiple of the life insured’s salary.
The group claim process follows the same procedures as for individual life insurance. The group
claims department requires a claimant’s statement from the beneficiary and official confirmation
of the life insured’s death. Since most group life insurance coverage is issued without evidence
of insurability, a close investigation of an early death claim may not take place.
GROUP DISABILITY INSURANCE

Many organizations self-insure for short-term disability. The employer continues to pay the
employee’s salary if the employee suffers a disability lasting several weeks. The employer
usually requires a physician’s statement disclosing the nature of the employee’s disability.
If the employee remains disabled after the short-term disability period has elapsed, the
claim will be referred to the group claims department of the insurer for adjudication. Group
claims administration for long-term disability claims follows the same pattern as individual
disability income claims. The insured and his or her physician must submit regular written
reports on the status of the insured’s medical condition.
The group contract will define total disability for the purposes of assessing a claim.
Typically, total disability is defined as the inability to perform the essential duties of the
insured’s regular occupation and the inability of the insured to find gainful employment in
any other occupation. After a certain period of total disability, such as two years, the
definition of total disability commonly becomes an inability to engage in any occupation for
which the insured is reasonably suited by education, training, and experience.
GROUP ACCIDENT AND SICKNESS INSURANCE

A wide range of employee benefits is included in this category. Supplementary health care
benefits not covered under provincial health care plans can include the cost of semi-private
hospital accommodation, private duty nursing care, physiotherapy, coverage for prescription
drugs, vision and hearing care, and dental care. The group claims administrator usually
assesses any claim based on the employee’s claim history for the benefit and the limitations
stipulated within the policy.

The claims process requires submission of written evidence to the claims administrator that
the insured has incurred an expense under the group accident and sickness plan. Some claims
procedures are streamlined. For example, an employee insured under a prescription drug plan
may be issued a pay-direct drug card to present to the pharmacist when having a prescription
filled. The pharmacist will register the purchase electronically to claim the insured portion of
the prescription cost. The employee pays only the portion of the prescription cost that is not
covered under the plan.
Vision and hearing care benefit claims require written proof of the cost incurred by the
employee. Group plans offering vision and hearing care limit the frequency and the amount
of benefits. For example, plans may limit the amount payable in any 12-month period for
eyeglasses and contact lenses.
Dental plan claims start with a dentist’s statement that specifies the treatment provided and
identification of the treatment, according to the provincial schedule of fees. The plan usually
pays for covered treatments to the limit of the provincial fee schedule for the procedure. The
level of coverage provided under the plan is laid out in detail in the employee’s group benefit
booklet. Some plans provide coverage for basic dental services. Other plans provide coverage
for more sophisticated procedures, such as crowns. For a procedure such as a crown, most
plans require that the dentist provide a detailed list of the procedures involved in the
treatment and the cost of each procedure before the treatment is approved under the plan.
ROLE OF THE AGENT IN SETTLING A CLAIM
LEARNING OBJECTIVES
• describe the role of the agent in settling a claim for life, disability, accident &
sickness, or group insurance;
• state and explain the insurer’s requirements for a death claim;
• explain the role of the agent in liaising with the estate of an insured, including
the accountant and the lawyer for the estate;
• list the applications that must be filed for payment of government benefits to a claimant.
For individual life and disability plans, the agent’s role begins when the policy is issued, continues
while the policy is in force, and does not end when a claim occurs. The agent can anticipate
(and avoid) any potential problems by making sure that the application process is properly
and thoroughly conducted. That means that when a policy is issued:
• the application for the insurance contains complete, true, and accurate information
about the life to be insured;
• any beneficiary is clearly identified on the application or on any subsequent
beneficiary appointment made by the policyowner;
• the policyowner and the life insured understand the terms and conditions of the coverage.
After issue, the agent continues to have an important role in the claims process by continuing
to communicate with the policyowner and monitoring any changes in the policyowner’s

circumstances that call for a change to the coverage. By conducting regular reviews
with the client, the agent can help the client assess his or her insurance needs and make
appropriate changes to the insurance coverage.
Life Insurance Claims

Once an agent receives notice that one of his or her clients has died, the first step is to
review the client’s records and any financial planning analysis that was conducted with the
client and his or her family. It is important to determine:
• the type and amount of life insurance;
• the type of retirement savings plans and amount of funds in them, including registered
and non-registered policies;
• the type of group insurance coverage, if any, on the deceased’s life, particularly life
insurance coverage;
• the status of the client’s Canada Pension Plan coverage.
While the deceased’s family is dealing with the loss of a loved one, the agent can help by
offering condolences and providing information and assistance that the family may need
concerning the deceased’s insurance coverage.
PROOF OF DEATH
The agent can advise the family on the appropriate proof of death for the insurer. For policies
that have been in force for a long time, an acceptable proof of death may be the original or a
certified copy of the funeral director’s statement. If the death benefit is very large, the insurer
may require a provincial death certificate. The agent can help the family file the appropriate
documents with the provincial authorities. If the life insured has died within two years of the
policy issue date, the insurer will probably also require an attending physician’s statement.
This document provides specific information about the cause of death. In cases of violent
death, the insurer may request a copy of the coroner’s report or any police report.
WORKING WITH THE BENEFICIARIES

After the death of an insured person, the agent can serve as an information link between a
family representative, most likely a lawyer, and the claims examiner. The agent cannot
guarantee or approve a claim payment, but he or she can help the process along by following
up with the claims examiner and the family representative. At some point, the insurer may
decide to decline a claim. If that happens, the agent must let the insurer communicate its
decision directly to the family representative.
In most cases, a claim payment is approved. While obtaining the evidence of death, the agent
can help the beneficiary complete the claimant’s statement. If the beneficiary is a person (rather
than a corporate entity or the insured’s estate), he or she can complete the claimant’s statement.
In some cases, a trustee is appointed to represent a beneficiary such as a minor or a disabled
individual. The agent can help by providing the insurer with copies of any trust agreement that
confirms the trustee’s authority to act on the beneficiary’s behalf.
If the beneficiary is the life insured’s estate, the insurer may require a copy of the probated will, if
one exists. Otherwise, the insurer may require a copy of the letters of administration for an
intestacy (dying without a will). In most cases, a lawyer, working on behalf of the heirs of the

person who has died, makes the necessary submissions to the court to obtain these approvals.
The agent can explain to the family why these procedures are necessary and reassure them
that the claim will be handled efficiently, once the documentation is complete. He or she can
also confirm that the insurer will pay interest, which accrues on the death benefit amount,
during the time it takes to resolve the claim.
A knowledgeable agent can anticipate the insurer’s requirements. As much as possible, he or
she can speed up the process to get the claim approved and paid. The agent usually delivers
the death benefit cheque personally to the beneficiary.
FINANCIAL PLANNING
In many cases, the death benefit is payable in a lump sum to a beneficiary. The agent’s role
at this point is to continue the financial planning process with the surviving family
members. The agent can offer advice on investing the claim proceeds. The financial needs
planning that the agent conducted while the deceased was alive may have included
establishing an investment plan to look after the survivors’ needs. The claim proceeds could
be earmarked for the children’s education, maintaining the family’s lifestyle, or providing
current or retirement income for the surviving spouse.
If the estate is the beneficiary, the terms of the will may dictate the distribution of the claim
proceeds. The agent can continue to provide insurance and financial planning advice to the
estate beneficiaries, including helping them set up appropriate investments that are funded by
the life insurance proceeds.
Example: Continuing Financial Planning Process Upon Client’s Death

Andrea was shocked when she heard that her long-time client Duncan had passed away suddenly.
As a life insurance agent and fi nancial planner, she had helped Duncan and his family defi ne their
fi nancial goals and select insurance and fi nancial products to address those goals.
Duncan was the principal in a small, incorporated Canadian business and one of three
shareholders in the business. Duncan, his wife Deana, and their three teenaged children lived
in a comfortable home, on which they still had a mortgage.
Once Duncan and his family had identifi ed their fi nancial objectives, Andrea had helped them establish
an insurance portfolio to address both the family’s and the business’s insurance needs. Andrea had
worked with Duncan’s lawyers to create a buy-sell arrangement with the other two shareholders for his
interest in the business and to set up an insurance program to fund the agreement.
Andrea had also coordinated the issue of a term insurance policy to pay off the outstanding
mortgage and other debts. At the same time, she had helped Duncan and Deana purchase
permanent life insurance to pay the income tax that would fall due when they died, to fund the
children’s education, and to ensure a retirement nest egg for the surviving spouse.
After paying her respects to Duncan’s family, Andrea set about helping Deana and her children
claim the life insurance proceeds. Since Andrea had helped the family prepare a comprehensive
fi nancial plan, the insurance proceeds were already earmarked for investments.
Andrea contacted the company’s lawyer and provided complete information on the insurer’s
requirements for disbursing the proceeds to the corporation for the purchase of Duncan’s
shares. She also met with the company’s tax accountant to confi rm that the corporate
insurance proceeds were disbursed in the most tax-effi cient way.

Duncan’s RRSPs were to be transferred to Deana. Andrea provided advice to the family’s
lawyer on the documentation required to complete this transaction. Andrea also helped the
family claim government death benefits, particularly the CPP death benefit, CPP survivor’s
pension and CPP children’s benefit.
Andrea’s service to Duncan’s family will continue for a long time as she helps Deana address the
fi nancial consequences of the changes in her life. The children are ready to begin their own
fi nancial planning and Andrea can provide valuable assistance to a family she knows well.
ROLE OF THE AGENT IN LIAISON WITH THE ESTATE

The agent provides information and coordinates the payment of benefits under an insurance
policy. The agent has a thorough knowledge of the insurance product in question and can
explain any of its provisions to the insured’s representatives and beneficiaries. In matters of
law and taxation, the agent is unlikely to have specialized knowledge. He or she will confer
with the estate’s lawyer and tax accountant to offer advice and service relating to insurance
and to explain the processes for claiming benefits.
The agent should not attempt to provide detailed tax advice or legal advice to clients. For
example, the agent should not try to complete the income tax returns after the death of an
insured person. The returns may include the deceased’s final return, return for “rights or things,”
etc. Filing these returns and providing specific advice must be left to the tax specialist.
Similarly, any submissions concerning the deceased’s estate must be left to the executor and the
estate’s legal counsel. Although the agent may have a wealth of experience and knowledge in these
matters, he or she generally does not have the authority or knowledge to administer an estate.
An agent’s role is analogous to a building contractor’s. He or she does not perform the
framing, the plumbing, or the electrical work, but does provide a focal point for planning
and directing the jobs that need to be done.
Disability Insurance Claims

Unlike a life insurance claim that requires evidence of the death of the life insured, a
disability claim requires proof of a disability and ongoing monitoring of the claimant to
verify his or her continuing disability.
WORKING WITH THE CLAIMANT

Once the agent learns that an insured has suffered a disability, he or she should
review the insured’s records to determine information such as:
• the provisions of the insured’s disability income coverage,
• when it was issued,
• the benefit amount,
• the elimination period.
The agent must ensure that the claimant is aware of the extent of the benefit provisions of
the policy and how the claims process works.

Since the claimant has only a limited amount of time to notify the insurer (30 days), the
agent should deliver a claim form to the insured as soon as possible. A claim form consists
of a claimant’s statement that provides particulars about the nature and onset of the
disability and a physician’s statement that provides information about the diagnosed
illness or injury, the treatment prescribed and the prognosis.
The agent should encourage the claimant to submit the claim form as quickly as possible, even
if the elimination period has not been satisfied. Early notification gives the insurer more time to
assess the adequacy of the claim information and to ask for additional assessments, if necessary.
The sooner the insurer receives the claim form, the sooner it can make a decision. If the claim is
approved, benefits can begin within 30 days after the end of the elimination period.
Unless the illness or injury is so severe that the insured is likely to suffer a lengthy
disability period, the insurer may ask for an additional claim form to be submitted each
month (or other specific period, for example each quarter) confirming that the insured
remains disabled. The agent can make sure that the claimant receives the claim form on a
timely basis and also follow up with the attending physician to ensure that the physician has
received the request for current information and will fulfil the request promptly.
LIAISON BETWEEN INSURER AND INSURED

Sometimes the claim assessment is not favourable, or the insurer requests additional proof of
disability, such as an independent physician’s examination of the claimant. The agent can
help in this situation by encouraging the claimant to cooperate to obtain a resolution. The
agent can also provide the insurer with his or her insights on the claimant’s appearance and
symptoms. In some situations, the claims examiner should communicate directly with the
claimant, particularly when a claim is denied. The agent should not attempt to interpret or
explain the insurer’s reasons for the denial.
For some types of disability income coverage, in addition to claim information, the claimant
must provide financial information. The agent can help speed this process as well. If, for
example, a policy contains a residual disability benefit, the insurer needs confirmation of the
insured’s pre-disability income and post-disability earned income.
RESIDUAL BENEFITS
The agent should make sure that the claimant understands how the residual benefit operates.
In most cases, the level of pre-disability earned income is measured over more than one year,
so the claimant needs to assemble documentation that may not be readily available. If the
claimant’s accountant becomes involved, the agent can explain the operation of the residual
benefit to the accountant and the kind of information that the insurer requires to establish an
earnings base for calculating the residual benefit.
After the insured returns to work, the agent can explain the kind of financial information
that will confirm the claimant’s current earnings and work with the claimant and his or her
accountant to obtain it. If the insured is self-employed, or a partner or a principal shareholder
in a business, the insurer may need financial statements and accounting information that
require an accountant’s expertise. In these cases, the agent can act as an intermediary
between the insurer and the claimant’s accountant.

BUSINESS OVERHEAD EXPENSES

If the insured has a business overhead expense policy, the insurer will require detailed
financial statements about the claimant’s regular monthly business expenses in order to
determine the level of benefits. Again, the agent can work with the claimant’s accountant to
deliver the information promptly, so that the claim can be administered efficiently.
DISABILITY BUY-OUT PLANS

Claims under disability buy-out plans are even more complicated to administer. In addition to
confirming the insured’s disability, the insurer must monitor the claim until the trigger date
(claim payment date) has been reached. The claim must be paid under the policy provisions in
concert with the buy-sell arrangement. The process usually requires the involvement of the
company’s lawyer, accountant, and other partners or shareholders. The agent can
coordinate the claim process, leaving the financial and legal details to the specialists.
Example: Leona was a partner in a consulting services business. Ellen, an insurance agent and
fi nancial planner, had helped Leona develop a fi nancial needs analysis for her personal and
business objectives. Among other initiatives, Ellen helped Leona set up disability insurance
plans to address her personal and business needs. Leona’s disability plans included:
• a personal disability insurance plan that provided $5,000 a month to age 65, with an
elimination period of 30 days;
• a business overhead expenses plan that paid up to $4,000 per month for business expenses incurred
while Leona was disabled, with an elimination period of 30 days and a benefit period of 12 months;
• a disability buy-sell agreement to be funded with disability buy-out insurance that would come
into effect after Leona had been disabled for 12 months, since Leona’s efforts were vital to
the business’s success.
Five years after this insurance program was put in place, Leona was diagnosed with cancer.
Her treatment involved a major operation and a regimen of radiation and chemotherapy. As
soon as she became aware of Leona’s condition, Ellen started the claim process by helping
Leona complete the claim form.
Ellen contacted the attending physician’s support staff to explain the purpose of the physician’s
statement and the need for regular reports. She submitted the completed claim form to the insurer
and followed up to make sure that the claims examiner had enough information to make a fair
assessment. The claim was approved. When the fi rst claim instalment was issued, Ellen delivered
the cheque to Leona in person, along with another claim form for completion.
Next, Ellen turned her attention to the business overhead expense plan. She contacted the
company accountant and explained the kind of information that the insurer would require to
determine the benefit amount. The accountant agreed to provide regular monthly fi nancial
statements and Ellen coordinated their submission to the insurer. The claims examiner was
able to assess the claim promptly and initiate monthly payments to the company.
As Leona’s treatment progressed, Ellen realized that her disability might continue to a point at
which the disability buy-out plan would be needed. After consulting with Leona, Ellen contacted
the other business associates and the company’s legal counsel to discuss the provisions of the
contract. The implications for Leona and her associates were serious. Once Leona’s disability
continued beyond one year, the disability buy-out agreement would become effective. The
benefit under the disability buy-out plan would be payable as well.

After 10 months of treatment, Leona was able to return to work on a part-time basis while her
doctors continued to monitor her condition. Ellen reviewed the residual disability provision of
Leona’s personal disability insurance plan with Leona and the company accountant. At Ellen’s
direction, the accountant provided detailed information about Leona’s pre-disability earned
income and the income that Leona was able to earn part-time.
Leona’s treatment fi nished and eventually her doctors advised her that she was free of cancer.
She was able to resume her career on a full-time basis. The buy-out policy was not exercised
and remained in effect as the means of funding the disability buy-sell agreement.
Accident and Sickness Insurance Claims

In most cases, accident and sickness claims require little if any involvement on the part of the
agent. Insurers provide standard claim forms for medical expenses, dental procedures, and
drug prescriptions. In most instances, claim payments for covered services are handled
efficiently when the insured submits a properly completed claim form.
The agent can make himself or herself available to answer any questions about the terms
of various plans so that the purchaser can make an informed decision. Once purchased,
accident and sickness plans operate in a straightforward way.
Group Insurance Claims

As with accident and sickness insurance, the agent’s role in claims service for group insurance
benefits is limited. In most instances, the agent will work with the insurer’s group sales
representative to prepare a proposal for group insurance. Companies with group insurance plans
in place can establish their own group insurance administration functions or defer to the insurer’s
services for new member enrolments, premium assessments, and claim reporting.
For life, disability, and accident and sickness group coverage, the insurer, through the
employer, provides a booklet to each employee explaining the benefits. The employer,
generally through its Human Resources department, will provide claim forms and
information services to each employee about the group coverage. Human Resources will
communicate with the insurer as required to address any problems and exceptions.
The agent who sold the group plan may continue to be the agent of record. As such, he or
she may become involved in any controversial claims to negotiate a resolution. The agent
of record will be the contact point for any negotiations between the employer and the
insurer about changes in the group coverage or the cost of renewal premiums.
Federal Government Forms

The federal and provincial governments provide Canadians with a variety of benefits.
These include death benefits, disability benefits, retirement pensions and sickness benefits.
In order to receive these benefits, one must apply to the proper government agency.
HRSDC (Human Resources and Skills Development Canada) provides information
and application forms/kits on its website at http://www.hrsdc.gc.ca/en/home.shtml
Also, Service Canada (http://www.servicecanada.gc.ca/en/about/index.shtml) offers “single
window” access to a wide range of Government of Canada programs and services for citizens

through hundreds of points of service located across the country, and through call centres and
the Internet. Service Canada’s goal is to provide Canadians with one-stop, personalized
service they can access however they choose – by telephone, Internet, or in person.
Provincial Government Forms

For Workers Compensation benefits, each province provides application forms for insurance/
disability benefits payable as a result of an employee’s job-related accident or sickness.
PRICING A LIFE INSURANCE PRODUCT
LEARNING OBJECTIVES
• describe the relevant factors in developing and pricing a life insurance product,
including mortality costs, administration costs, and expenses.
For every insurance product it issues, an insurer must set the premium rates at a level that will
guarantee the payment of the promised benefits whenever a claim occurs. Since claims against
an insurance policy can occur many years after it was issued, the methods of determining
premium rates must be rigorous and based on credible estimates of future claims.
At the same time, the insurer must factor in administration costs, expenses, and profits. An
insurance company cannot expand its business without the capital resources obtained from
profitable products. Since paid premiums are not paid out as claims immediately, the revenues are
invested and the investment earnings used to offset the estimated mortality costs and expenses.
Mortality Experience
The basis for any set of life insurance premiums is the mortality assumptions that the
insurer makes about anticipated claims. The insurer obtains estimates of mortality from
published mortality tables.
Mortality tables have been developed over the years based on the statistics that insurers have
accumulated about deaths occurring over time for each age group. The reliability of these
statistics is a function of a statistical premise called the Law of Large Numbers. This
statistical theory states that the more times we observe a particular event, the more likely it
is that our observed results will approximate the actual probability that the event will occur.
To provide an example of this premise, assume that of one million individuals aged 35 who
are alive at the beginning of the year, 20,000 (or 2%) will die before the end of the year. If a
large group of 35-year-olds is observed for several years, the Law of Large Numbers dictates
that, on average, 2% will die each year. In any one year the actual number dying may be
more or less than 2%, but on average, that is a statistically reliable number.
Given that premise, a life insurer can offer insurance to a group of 35-year-olds and charge each
of them a large enough premium to make sure that there is enough money to pay the death
benefit owing. For example, if the insurer has one million life insureds, each aged 35, it could

charge each of them 2 cents for each dollar of insurance and be guaranteed to have enough
money to pay death claims for each of the life insureds who die during the year. Although
no insurer will have exactly one million 35-year-old life insureds, the ratio of those 35-
year-old policyowners alive at the beginning of the year to those who die during the year is
on average a constant number.
If the number of life insureds aged 35 is 10,000 at the beginning of the year, then statistically,
200 of those individuals will die during the year. Insurers quote premium rates based on $1,000
of insurance. Therefore, if each 35-year-old is charged $20 for each $1,000 of insurance he or she
buys, there will be enough money to pay all of the death claims occurring during the year.
Since the mortality rate at younger ages is relatively low, the premium rate charged at
younger ages is also relatively low. As a group of life insureds ages, however, the premium
required of the group each year increases, for two reasons: (a) the size of the group has
decreased and (b) the number dying each succeeding year will be larger.
For example, a group of one million 35-year-olds, after 40 years, may be reduced to
500,000 people who are now 75 years old. During that year, perhaps 300,000 of those
75-year-olds will die (60%). For each $1,000 of insurance, the insurance company
would have to ask for a premium of $600. At older ages, the cost of insurance becomes
prohibitive and many in the group might not be able to afford to retain the insurance
coverage. That is why few term insurance policies are kept in force beyond age 65 or 70
(with the exception of Term-to-100 policies).
To address this issue, insurers developed the level premium system. This is the normal method of
establishing premium rates for most life insurance policies with guaranteed benefits. In the
example above, the group of 35-year-old insureds would be charged the same amount of premium
each year. The premium would be larger than $20 per thousand at the youngest age
and much less than $600 per thousand at age 75. Let’s assume that the premium charged is
$150 per thousand. The insurer would have more than enough money to pay the insurance
benefits for the 35-year-olds who die during the year. Those extra funds are used to establish
a reserve to pay the claims occurring in later years when a premium of $150 would not be
sufficient to pay all of the claims.
Since mortality experience is different for men and women of every age group, mortality
tables contain different data for males and females. Insurance companies modify the
statistics based on their experience for different blocks of policies. Most insurers establish
separate mortality expectations for smokers and non-smokers. Non-smokers have a longer
life expectancy and, beginning at a certain age, insurers establish premium rates for non-
smokers that are much lower at each age than those for smokers.
For example, a premium rate table for a life insurance product may show a combined smoker/
non-smoker rate to age 18 and then record separate smoker and non-smoker rates for people over
18. Many insurance companies offer preferred premium rates for proposed life insureds under a
certain age who qualify because of their medical condition, habits, and lifestyle.
Morbidity Experience
While mortality tables document statistics about life expectancy, morbidity tables document
statistics on the likelihood that individuals at each age will become disabled. For disability
insurance and accident and sickness products, insurers can set adequate premium rates by

examining morbidity tables that project the number of individuals at each age who will suffer a
disability. The insurer can anticipate its claim costs and set premium rates accordingly.
As with life insurance products, insurance companies have developed a level premium method
for disability income and accident and sickness products. Some disability income plans offer a
non-cancellable premium rate, which means that the insurer cannot adjust the premium even if
it receives an unusually large number of claims for that group of policies. For most disability
income and accident and sickness products, however, an insurer reserves the right to
adjust premiums for a particular block of policies if it receives a larger number of claims
than it anticipated when it set the premium rates.
Projecting morbidity experience is not as straightforward as mortality experience. For example, a life
insurance death benefit is a specific amount payable upon death. A disability income benefit is not
certain, since a disability can last several months or several years, and a disability can recur after the
claimant has recovered. Costs for accident and sickness benefits can escalate depending not only on
the number of claims, but also on the increased costs of medical and dental services.
Investment Earnings
With the level premium system and regulatory requirements for establishing reserves,
insurance companies use their reserve funds to earn investment income. Those investment
earnings are used to increase the reserve and decrease the amount of premiums owing for
each age group. Since most life insurance policies are in force for many years before a claim
is made, the reserve funds can remain invested for a long time.
Investment earnings over the long term can have a dramatic effect on premium costs because
they benefit from the effect of compound interest. For example, if $1,000 is invested at a
simple interest rate of 5%, each year the $1,000 is invested, the investor will receive 5%.
After 20 years, the investor has earned $1,000 and has a total of $2,000. If, however, the
interest earnings are added to the amount invested, the amount earns interest on the interest.
After 20 years, the fund will be worth $2,650.
In establishing premium rates, the insurance company makes estimates about the investment
returns it can expect to make on its premium reserves. Since these estimates must be projected
over many years, insurance companies make conservative assumptions. The insurer must
ensure that it will have enough funds to pay claims many years in the future.
Expenses and Taxes

While mortality assumptions and investment return projections are important elements
in developing adequate premium levels, insurers must consider other factors that will
reduce its revenues and its ability to maintain adequate reserve levels.
Commissions
Most insurance companies sell their insurance products through agents to whom they pay
commissions. Those commissions are usually a percentage of the premium payable for each
policy the agent sells. Some commission scales pay a level amount of commission over the life
of the policy, such as 20%, depending on the type of product. Other commission programs pay
commissions only in the first few policy years. A commission plan might pay 65% of the first
year premium, with a sliding scale of reducing percentages over the next four years that the policy

remains in force. Thereafter, the agent might receive a small percentage of the premium
as a service incentive.
Many insurance companies that deal with managing general agents/agencies (MGAs) and
independent brokers also establish bonus schemes. For example, if an agent works through
an MGA, the agent might receive a commission of 65% of the first year’s premium. The
MGA might receive an override of 120% of the commission. That amount might change,
depending upon the number and size of insurance policies being put in place through the
general agent’s operation with one insurance company. These commission programs might
end up paying more than the total premium in the first policy year.
Commissions and overrides fall dramatically in subsequent years, so the initial deficit is
recouped quickly – if the policy remains in force. The insurer knows that a certain percentage of
the policies sold in any year will lapse in the short term. If a policy lapses within the first 12 to
24 months, the contract with the agent may allow the insurer to recoup some portion of
the commissions and overrides paid to the agent and the general agent. Not all of the
insurer’s commission payments may be recovered, however. The costs of underwriting
and issuing the policy will not be recovered if the policy lapses.
Operating Expenses
An insurance company incurs other costs, no matter how much business it sells or retains in
force, including operating costs for administration, information technology systems, salaries
and benefits, head office, and sales premises.
Taxes
Insurance companies in Canada are subject to federal and provincial government taxes. Each
province levies a premium tax on life insurance and disability income plans that ranges from
2% to 4%, depending upon the province in which the premium is paid.
Insurance companies are subject to corporate income taxation. Financial institutions, including
insurance companies, are also subject to a “large corporations tax” imposed by the federal
government on taxable capital employed in Canada. Some of the provinces levy a capital tax
on taxable capital employed in the province. In addition, the federal government imposes an
investment income tax on life insurance companies that taxes the investment income
accruing to fund life insurance policies that is not otherwise taxed in policyowners’ hands.
Net Premiums and Gross Premiums

To deal with expenses and taxes and to provide a certain level of profit, insurance
companies add a “loading” to the net premium to calculate the “gross premium.”
The net premium is the amount that the insurance company charges in order to provide the
policy benefits. In calculating the net premium, the insurer makes assumptions about
mortality expectations, investment earnings, and the rate at which its in-force policies will
lapse. The loading is an amount calculated by the insurance company to provide for
commissions, expenses, and taxes. The gross or total premium charged to the policyowner is
the sum of the net premium, plus the loading.

REINSURANCE
LEARNING OBJECTIVES
• explain how reinsurance works;
• explain why insurance companies use reinsurance.
Reinsurance is a tool that is used to share or transfer risks for insurance products, including life
and disability and individual and group plans. While insurance companies make conservative
projections to ensure that all benefits will be paid, there are limits to the amounts of insurance
each company can issue and while assuming all of the risk. Large companies with substantial
reserves can withstand unanticipated or large claims. Smaller companies may not have
sufficient reserves to cope with claims over certain limits. These companies may also be
attempting to increase market share by offering competitively priced products.
As a solution to these limitations, insurance companies may reinsure part of the insurance
risk they assume. They negotiate with a reinsurance company to transfer a portion of the
risk for a portion of the premium.
For example, ABC Insurance Company has introduced a new life insurance product with
competitively priced premiums and is marketing the product aggressively. The company
expects to receive individual applications that exceed the amount of insurance it feels that it
can adequately guarantee. ABC enters into a reinsurance agreement with XYZ Reinsurance
Company. Under the terms of the agreement, XYZ will automatically assume the risk for the
new life insurance product for insurance amounts in excess of $100,000. That means that for
every insurance policy issued for face amou`nts in excess of $100,000, ABC will retain the
insurance risk up to $100,000 and reinsure with or cede to XYZ the excess risk. ABC
compensates XYZ through a yearly renewable term premium schedule.
Some agreements are made on a coinsurance basis. This means that the reinsurance company
receives part of the premium and part of any reserve of any policy issued for a particular product
line. The reinsurance company may assume insurance risks exceeding a certain amount, or the
ceding and the reinsuring companies may agree to share a portion of every policy issued.
Life insurance companies may also negotiate reinsurance arrangements for specific risks. When an
insurer receives an application for a large amount of insurance, in addition to underwriting the
application, it will approach reinsurance companies to offer to cede a portion of the risk.
Depending on the size of the risk, a reinsurance company may agree to assume all of the risk
or assume only some of the risk and cede a portion to other reinsurance companies. This
transaction is known as a retrocession and may involve several insurance companies.
For example, ABC Insurance Company receives an application for a $5 million life
insurance policy. First, it takes steps to underwrite the application on a COD basis (in
other words, it has not received an initial premium). The underwriting process will be
rigorous, with a close assessment of the overall insurability of the person to be insured
and a careful review of the proposed life insured’s financial background and prospects.

As the underwriting review proceeds, ABC contacts one or more reinsurance companies and
offers them an opportunity to accept a portion of the risk. Most reinsurers ask to review the
underwriting documentation before accepting or declining to reinsure the risk. If the
reinsurance company accepts the risk, once the policy is issued, the ceding company
establishes a schedule to pay the reinsurance premiums as long as the policy remains in
force. If a claim occurs, the reinsurance company will most likely participate in the claim
assessment process to protect its interests and to confirm that the claim is valid.
If an insurance company underwrites an application and decides to decline to issue a policy,
the underwriter, with the proposed life insured’s consent, may contact one or more reinsurance
companies to offer them an opportunity to accept the risk. This is known as “shopping” a case.
The reinsurance company reviews the underwriting documentation and either declines the
risk or offers to insure the risk – usually at a higher-than-standard premium rate.
Any offer of insurance will be communicated to the applicant, who may choose to accept
the offer. If an offer is made and accepted, the ceding insurance company issues a policy.
Once it is in force, the company establishes a schedule to pay the reinsurance premium to
the reinsurance company.

Chapter 7
Taxation

7
Taxation
CHAPTER OUTLINE
Introduction
Canada’s Tax System
• Taxation Year
• Calculation of Income Tax
• Types of Income
• Calculating Income Tax Payable
The Tax System and Insurance Products
• Life Insurance as Property
• Life Insurance as an Investment Product
• Life Insurance as a Segregated Fund Product
• Life Insurance as a Registered Retirement Savings Plan
• Investment Income Tax
• Provincial Premium Tax

Tax Planning
• Tax on Dividends
• Tax-Deductible Items Related to Investment Income
• Capital Gains and Losses
• Capital Losses
• Tax Loss Selling
• Taxation of Interest Income
• Taxation of Life Insurance
• Taxation of Disability Insurance
• Tax-Free Savings Account (TFSA)
Registered Education Savings Plans (RESPs)
• Canada Education Savings Grant
• Low and Middle-Income Families
• Canada Learning Bond
• Withdrawals from an RESP
• Time Limits
• Major Benefit
Recommending Independent Tax Advice to a Client
Using Insurance to Solve a Tax Problem
• For Individuals and Families
• Business Situations
Using Insurance Policy as a Tax-Planning Tool
Appendix A

INTRODUCTION
Life insurance is a unique product in many ways. The amount paid to a beneficiary when an
insured person dies is not subject to income tax. However, if a life insurance policy is cashed
in at any point other than the death of the insured person, it is treated much like any other
property that is sold.
Because permanent life insurance includes an investment component, it is subject to provisions
of various sections of the Income Tax Act. In this chapter, you will be provided with a general
explanation of federal and provincial tax requirements as they relate to various sources of
investment income, and a description of the taxation rules specific to insurance products.
CANADA’S TAX SYSTEM
The federal government imposes income taxes by federal statute (the Income Tax Act, or
ITA). All Canadian provinces have separate statutes that impose provincial income tax on
residents of the province and on non-residents who conduct business or have a permanent
establishment in that province.
Canada imposes an income tax on income from foreign sources earned by Canadian
residents, as well as the Canadian income earned by non-residents. Companies incorporated
in Canada under federal or provincial law are usually considered Canadian residents and are
subject to Canadian taxes, as are foreign companies with management and control in Canada.
Taxation Year
All taxpayers must calculate their income and pay tax on it every year. Individuals use the
calendar year for these calculations as do professionals and personal service corporations
(January 1 to December 31). Corporations may choose any fiscal year, as long as the period is
consistent from one year to another. No corporate taxation year may be longer than 53 weeks. A
change of fiscal year-end may be made only with the approval of the Minister of Finance.
Calculation of Income Tax

Calculating income tax involves four steps:
• calculating income from all sources including income from employment,
business, or investments;
• taking allowable deductions to arrive at net income and taxable income;
• calculating the gross or basic tax payable on taxable income;
• claiming applicable tax credits and calculating the net tax payable.
Once total income has been determined, a number of prescribed deductions may be used
in calculating net income and taxable income. For individuals, these include Registered
Pension Plan contributions and Registered Retirement Savings Plan contributions,
childcare expenses, certain net capital and non-capital losses of other years, etc.

SEVEN • TAXATION 7 •5
Types of Income
There are four general types of income. Each is treated differently under Canadian tax laws:
EMPLOYMENT INCOME
Employment income is taxed on a gross receipt basis. This means that an individual
employee, unlike a business, cannot deduct the costs incurred in earning income. However,
employees may deduct certain employment-related expenses such as pension contributions,
union dues, and childcare expenses.
BUSINESS INCOME
Business income comes from the profit earned from producing and selling goods or
rendering services. Self-employment income falls into this category. Unlike property
income, business income requires activity on the part of the recipient. It is taxed on a net
income basis. Canadian controlled private corporations (CCPCs) have access to the small
business deduction, which can reduce their overall tax rate.
INCOME FROM PROPERTY

Dividend and interest income, royalties, and rental income are examples of income from
property. Income derived from company pension plans, Canada Pension Plan (CPP) and
Registered Retirement Income Funds (RRIFs) is also included in this category. This type of
income is passive since the property owner rarely does anything other than own the income-
producing property. Individuals may deduct reasonable expenses such as property taxes,
repairs and maintenance, and, in certain circumstances, financing costs on the acquisition of
the property (such as interest paid on a margin loan). Only net income is subject to tax.
CAPITAL GAINS AND LOSSES

Both corporations and individuals are subject to taxes on capital gains. A capital gain or loss
results when a capital property is disposed of at a price greater or less than its original cost.
Costs of disposition are also included in arriving at a capital gain or capital loss.
Calculating Income Tax Payable
TAX RATES
Basic tax rates are applied to taxable income. The following rates of federal tax
(excluding tax credits) apply to individuals in 2011:
TABLE 7.1 FEDERAL INCOME TAX RATES FOR 2011
Taxable Income Tax

$41,544 or less 15%
More than $41,544 but not more than $83,088 22%
More than $83,088 but not more than $128,800 26%
More than $128,800 29%

PAYMENT OF INCOME TAX

Employers are required to withhold income tax on salaries and wages and remit this amount
to the government on their employees’ behalf. Some individuals, and all corporations, pay
their taxes by instalments.
THE TAX SYSTEM AND INSURANCE PRODUCTS
LEARNING OBJECTIVES
• list the federal and provincial tax requirements as they apply to life insurance products.
Several sections of the federal Income Tax Act apply to life insurance products, including
not only insurance products that pay a benefit on the death of an insured person, but also
annuities, RRSPs, and segregated fund products.
Life Insurance as Property

The amount paid to a beneficiary when an insured person dies is not subject to income tax.
The proceeds, or death benefit, of a life insurance policy are one of the few remaining
sources of funds that enjoy this special tax-free status.
However, Section 148 of the Federal Income Tax Act deals with the calculation of federal income
tax on dispositions of life insurance policies that have a cash value or investment value. If a
disposition of a life insurance policy occurs, the Income Tax Act treats the policy as an
investment owned by the policyholder, and taxes the return or earnings on the policy as income to
the policyholder. Life insurance is exempt from tax as it is meant to benefit someone other than
the life insured at the time of death. This tax exempt status is lost if the policyholder does
anything with the policy prior to the payment of a death benefit that directly or indirectly benefits
the policyholder, other than a policy loan from the insurer or collateral assignment of the policy.
The return is calculated as the amount of the policy’s cash value that exceeds the cost of
the premiums, less the net cost of pure insurance (NCPI), less any dividends received. For
tax purposes, the insurance premium is divided between the cost of pure insurance and the
investment in a cash value or reserve. The portion of the premium cost that contributes to
the investment return is deducted from the investment return itself and the difference is
considered to be taxable income.
Income tax may become due on a life insurance policy if the policyholder withdraws a
portion of the cash surrender value, surrenders the policy for full cash surrender value, or if
it is transferred to a third party (absolutely assigned or sold). A life insurance policy is a
piece of property and is deemed to be disposed of for its fair market value when it is
transferred to a third party, even if the transferor receives no consideration.

SEVEN • TAXATION 7•7
Life Insurance as an Investment Product

Because life insurance is in some ways an investment product, it is subject to the taxation
provisions of other sections of the Income Tax Act. The Income Tax Act stipulates that the
accumulation of interest-bearing investments is taxable, even when the returns are kept within
the investment (allowed to accrue) and not paid to the investor. Canada Savings Bonds are an
example of an investment product that is taxed in this fashion. Holders of compound interest
savings bonds receive a tax slip each year showing the amount of money they must report as
earned interest for the tax year. Certain life insurance products are taxed in a similar way.
Annuities are similar to interest-bearing investment products such as Canada Savings Bonds.
The Income Tax Act requires that the insurance company issue a tax slip each year, showing
the amount of interest earned during the year under any “unregistered” deferred annuity (also
known as deferred income annuity or DIA or guaranteed income annuity or GIA). A deferred
annuity is one under which the policyholder makes one or more premium contributions that
earn interest; the plan begins paying an annuity at some point in the future. (By contrast, an
immediate annuity is one under which annuity payments begin as soon as the policyholder
makes the requisite deposit.)
Life insurance policies that build cash values in excess of a certain level are also subject to
annual taxation. These policies are considered non-exempt from annual taxation of their
earnings. For example, an endowment at age 65 is a kind of life insurance policy that is subject to
annual taxation of its earnings growth because of the size of its investment returns. However, a
whole life insurance policy with premiums payable for the life of the insured is considered
principally a life insurance policy and is not subject to annual taxation on its growth.
Participating life insurance policies that pay dividends allow the policyholder to retain
declared dividends on deposit with the insurer, to accumulate with interest. The interest
earned each year must be reported as interest income by the policyholder.
The Income Tax Act allows for the deduction of certain costs incurred by the investor in
funding an investment. For example, an investor may deduct the interest cost of a loan that is
used to fund an investment. If a policyholder takes out a loan against his or her life insurance
policy and uses the loan amount to fund an investment, the interest payable on the loan is
considered a tax-deductible expense.
Life Insurance as a Segregated Fund Product

Segregated funds are, in many respects, the life insurance industry’s version of the
investment industry’s mutual funds. Life insurance plans that use segregated funds as the
investment component are subject to specific tax provisions, in addition to the provisions
that relate to life insurance plans in general.
Briefly, the returns of the segregated fund are allocated to policyholders as though the
policyholders had invested directly in the investment portfolio. If a segregated fund accrues
interest, dividends, capital gains, or capital losses, these are allocated to each investor in
proportion to his or her investment in the fund. When the policyholder disposes of the plan,
the amount by which the cash value exceeds the cost is taxed as a capital gain, i.e., only 50%
of the gain is taxable. Any loss incurred is considered a capital loss for income tax purposes.

Life Insurance as a Registered Retirement Savings Plan

The Income Tax Act allows life insurance products to be registered as retirement savings
plans, subject to the income tax provisions concerning RRSPs. Life insurance RRSPs are
usually deferred annuities or individual variable annuity contracts (IVICs) such as segregated
funds or index-linked deferred annuities. The premium contributions are tax-deductible to the
limits allowed under the Income Tax Act. The value of any payments out of the plan is
taxable as ordinary income.
Investment Income Tax

The Income Tax Act taxes the investment income that insurers earn to fund life insurance
policy benefits. This tax is payable by the insurance company. However, it can be considered
an indirect tax on policyholders since it affects the premium charged by the insurer.
Provincial Premium Tax

Each province levies a tax on the life insurance premiums paid by its residents during the
year. The life insurance company pays the tax, but the cost is passed along to
policyholders by the insurer factoring it in when establishing premium rates.
TAX PLANNING
LEARNING OBJECTIVES
• explain the Capital Gains Tax;
• explain the tax implications of dividends;
• identify the types of interest costs that have tax implications;
• explain and interpret the potential tax consequences of disability benefits.
Proper tax planning should be a part of every investor’s financial strategy. The minimization
of tax, however, should not be the sole objective of the strategy nor should tax considerations
dominate other elements of a proper financial plan. It is the after-tax income or return that is
important. Choosing an investment based solely on a low tax status does not make sense if the
result is a lower after-tax rate of return than the after-tax rate of return of another investment
that is more heavily taxed. The government provides tax incentives to encourage individuals
to invest in higher risk vehicles that should benefit the economy over the long term. Investor
risk tolerance needs to be balanced with the desire to reduce tax.
Although all investors want to lighten their individual tax burden, the time and effort
spent on tax planning must not outweigh the rewards. The best tax advantages are usually
gained by planning early and reviewing the plan regularly. Reasonable time is required
for most plans to work and to produce the desired results.

The tax authorities do not condone tax evasion, but tax avoidance by one or more of
the following means is legitimate:
• full use of allowable deductions;
• conversion of non-deductible expenses into tax-deductible expenditures;
• postponing the receipt of income;
• splitting income with other family members under certain conditions;
• selecting investments that provide a better after-tax yield.
Because taxes play a significant part in the overall financial plan and can affect the choice
of investments, investors need to keep abreast of the ever-changing rules and
interpretations of tax law. The Canada Revenue Agency (CRA) can provide copies of
regulations and rulings upon request. Contact the local tax office for more information or
visit http://www.cra-arc.gc.ca/ menu-e.html
Tax on Dividends
DIVIDENDS FROM TAXABLE CANADIAN CORPORATIONS

As of 2006, Canadian dividends are categorized as either “eligible” or “non-eligible”. Eligible
dividends are those received from public corporations or Canadian controlled private
corporations (CCPCs) on which the full corporate tax rate has applied. Non-eligible dividends
are those received from Canadian controlled private corporations that have paid tax at the small
business rate (in 2011, it is 11.0%, on the first $500,000 of active business income).
Individual taxpayers can benefit from the preferential tax treatment on dividends received
from taxable Canadian corporations. For eligible dividends in 2011, the taxpayer is
required to gross-up the amount of the dividend by 41% and claim a dividend tax credit of
16.44%. For non-eligible dividends, the taxpayer is required to gross-up the amount of the
dividend by 25% and claim a dividend tax credit of 13.33%. Most provinces have revised
their tax regimes to reflect the federal changes although the combined tax rates vary from
province to province (combined federal and provincial dividend tax rates range from
15.9% to 30.7% for eligible dividends and 27.7% to 39.7% for non-eligible dividends).
For example, at the federal level, if an individual receives an eligible dividend of $160, it
would be reported for tax purposes as $225.60 [$160.00 + ($160.00 x 41%) = $160.00
+$65.60]. The additional $65.60 is referred to as the gross up and the $225.60 is known as
the taxable amount of dividends.
The taxpayer calculates total income, net income and taxable income using the $225.60
amount, and can then claim a dividend tax credit of:
16.44% of the taxable amount of dividends or
23.18% of the actual dividend received
For example:
$225.60 × 16.44% = $37.09 or $160 × 23.18% = $37.09
The taxable amount of dividends and the amount of the federal dividend tax credit is shown
on the T5 form sent annually to the investor.

Stock dividends and dividends that are reinvested in shares are treated in the same manner as
cash dividends. Table 7.2 illustrates the gross-up and credit of taxable Canadian dividends.
Note: The eligible dividend gross-up will be reduced to 38% in 2012. The dividend tax credit rate will
also change to 15.02% in 2012.
TABLE 7.2 ELIGIBLE DIVIDEND GROSS-UP AND CREDIT CALCULATIONS - 2011
A Canadian resident who is in a 29% federal tax bracket receives $1,000 of eligible dividend income
from a taxable Canadian corporation. Depending on the province of residence, the investor’s after-
tax dividend income is calculated in the following manner.
Dividend Income $ 1,000.00
Step 1 Gross-up dividend income by 41% . . . . . . . . . Gross-up (41% of $1,000) $ 410.00

Taxable Amount $ 1,410.00
Step 2 Calculate federal tax Federal tax (29% of $1,410) $ 408.90
Step 3 Calculate federal tax credit Federal tax credit

(16.44% of grossed-up amount) (16.44% of $1,410) $ 231.80
Federal tax payable
($408.90 minus $231.80) $ 177.10
Residents of All Provinces except Quebec

Federal tax payable $ 177.10
Step 4 Calculate provincial tax
(Provincial tax rate: 11.16% - Ontario)
11.16% of $1,410 (prov. tax payable) $ 157.36
Less: provincial dividend tax credit

6.4% of $1,410 $ 90.24
Provincial tax payable $ 67.12
Total taxes payable
($177.10 + $67.12) $ 244.22
Net dividend income
($1,000.00 - $244.22) $ 755.78
AFTER-TAX YIELD OF INVESTMENTS

Dividends from taxable Canadian corporations (but not foreign corporations) are subject to
substantially less tax than interest income. Depending on the tax rate and province of
residence, capital gains tax can be somewhat higher or lower than the tax on Canadian
dividends. The federal dividend tax changes of 2006 were designed to eliminate any double
taxation of dividends and make the tax incentive for dividend and capital gain investing
equal. Many provinces are phasing in changes with the aim of achieving tax neutrality
between dividend income and capital gains. Moving money from interest-bearing
investments into dividend-paying Canadian securities will probably reduce an individual’s
overall taxes and increase the after-tax yield of the investments.

Table 7.3 illustrates that at the highest marginal tax rate of 29%, more tax ($32.10) is payable on
$1,000 of dividend income compared to $1,000 of capital gains. Table 7.4 illustrates that at a
marginal tax rate of 22%, the difference favours dividend income by a tax savings of $31.60 (i.e.,
$110.00 capital gains tax - $78.40 dividend tax). In both cases, there is a substantial difference
between the tax owed on interest income and the tax owed on capital gains or dividends.
TABLE 7.3 COMPARISON OF TAX CONSEQUENCES OF INVESTMENT INCOME

IN A 29% TAX BRACKET - 2011
Interest Eligible Dividend Capital

Income Income Gains
Income Received $ 1,000.00 $ 1,000.00 $ 1,000.00
Taxable Income $ 1,000.00 $ 1,410.00 $ 500.00
(Grossed up by 41%) (50% of $1,000)
Federal Tax (29%) $ 290.00 $ 408.90 $ 145.00
Less Dividend Tax Credit
(16.44% of $1,410) $ 231.80
Federal Tax Owed $ 290.00 $ 177.10 $ 145.00
TABLE 7.4 COMPARISON OF TAX CONSEQUENCES OF INVESTMENT INCOME

IN A 22% TAX BRACKET - 2011
Interest Eligible Dividend Capital

Income Income Gains
Income Received $ 1,000.00 $ 1,000.00 $ 1,000.00
Taxable Income $ 1,000.00 $ 1,410.00 $ 500.00
(Grossed up by 41%) (50% of $1,000)
Federal Tax (22%) $ 220.00 $ 310.20 $ 110.00
Less Dividend Tax Credit
(16.44% of $1,410) $ 231.80
Federal Tax Owed $ 220.00 $ 78.40 $ 110.00
TAX ON FOREIGN DIVIDENDS

Individuals who receive dividends from non-Canadian sources usually receive a net amount
from these sources, as taxes are usually deducted at source. These investors may be allowed
a deduction from the Canadian income tax they would otherwise have to pay. The allowable
credit is either the foreign tax paid or the Canadian tax payable on the foreign income,
whichever is less, subject to certain adjustments.

CAPITAL DIVIDENDS
A private corporation may choose to pay a dividend out of its capital dividend account
(CDA), which is largely composed of the non-taxable portion of the net capital gains realized
by the corporation since 1971 and the proceeds from life insurance policies net of adjusted
cost base. The dividend is not included in the investor’s income when it is received and has
no effect on the adjusted cost base of the shares on which the dividend was paid.
TAX ON INTEREST
Taxpayers are required to report interest income annually on investment contracts acquired
after 1989. This includes investments such as Canada Savings Bonds (CSBs), Guaranteed
Investment Certificates (GICs), and Treasury Bills. The tax is calculated on an annual accrual
basis, regardless of whether or not the cash is actually received. The term investment contract
is specifically defined in the Income Tax Act, and includes virtually all debt obligations, as
well as certain annuity and insurance contracts.
Tax-Deductible Items Related to Investment Income
CARRYING CHARGES
Tax rules permit individuals to deduct certain carrying charges for tax purposes.
Acceptable deductions include:
• interest paid on funds borrowed to earn investment income (although interest paid
on money borrowed to contribute to an RRSP is not deductible);
• fees paid to investment counsel for certain investment advice;
• fees paid for the administration or safe custody of investments (administration and
trustee fees for self-directed RRSPs and RRIFs are not deductible);
• safety deposit box charges;
• fees paid to have someone prepare your tax return if you have income from a
business or property.
Note: There are conditions imposed on most of these deductions.
INTEREST ON BORROWED FUNDS

Taxpayers may deduct the interest paid on funds borrowed to purchase securities provided that:
• the taxpayer has a legal obligation to pay the interest;

• the purpose of borrowing the funds is to earn income; and
• the income produced from the securities purchased with the borrowed funds is not
tax-exempt.
CARRYING COSTS ON EQUITY INVESTMENTS

Part of the carrying costs of preferred shares with a fixed dividend rate may not be allowed as a tax
deduction if the carrying costs are larger than the grossed-up amount of the preferred dividend.

Carrying charges on common shares are, for the most part, tax-deductible, even for non-
dividend-paying growth securities, since earnings may later rise and dividends may be
paid in future.
In other words, the ability to deduct carrying costs depends on the income potential of
the investment.
Capital Gains and Losses

Investors and their advisors should have a general understanding of capital gains and losses
when developing an investment strategy.
Basically, a capital gain arises from the disposition of a capital property for more than its cost
(in other words, the selling price is higher than the original cost of the property). Property can
be tangible or intangible, real or personal, and usually consists of stocks, bonds, real estate,
art, business ownership, etc. Capital property is property that, if sold, will lead to a capital gain
or loss. For tax purposes, however, the calculation may be complicated because:
• additional costs are often involved in the purchase and sale of property,
such as commissions;
• the past value of certain properties on which capital gains are calculated is difficult
to determine; for example, real estate that has been held for several decades.
Although actualized or deemed capital gains result in additional tax for investors, only part of
a capital gain is taxable as a result of the 50% capital gains inclusion rate. Capital property can
increase or decrease in value to any degree without tax consequence as long as the property is
held and not disposed of in whole or part.
Generally, CRA treats share dispositions as capital gains or losses. However, if the
taxpayer’s investment activities indicate that the taxpayer is in the business of trading
securities to realize a speculative profit, CRA may consider any gains as ordinary income
and, therefore, fully taxable (or, equivalently, losses as fully deductible).
In assessing whether trading is speculative, CRA considers:
• short periods of ownership;
• a history of extensive buying and selling of shares or quick turnover of securities;
• special knowledge of, or experience in, securities markets;
• substantial investment of time spent studying the market and investigating
potential purchases;
• financing share purchases primarily on margin or some other form of debt;
• the nature of the shares (particularly speculative, non-dividend-paying shares).
Although none of these factors alone may be sufficient to characterize a taxpayer’s trading
activities as a business, several factors in combination may be sufficient to do so. In every
instance, the particular circumstances of the disposition are evaluated before a determination can
be made. Taxpayers may choose to have all gains and losses on the sale of Canadian securities
treated as capital gains or losses during their lifetime, provided they are neither a trader, nor a
dealer in securities, nor a non-resident. CRA interprets a dealer or trader in securities to be an
individual who participates in the promotion or underwriting of a particular issue of shares or

who is considered by the public to be a dealer in shares. In general, an employee of a corporation

engaged in these activities is not a dealer. If, however, such an employee engages in insider
trading to realize a quick gain, he or she would be considered a trader of those particular shares.
TAX ON DISPOSITION OF SHARES

The general rules of capital gains taxation — the proceeds of disposition (POD) minus the
adjusted cost base (ACB) plus any costs of disposing of the property are included in income at a
specified rate (currently 50%) — apply to the sale of preferred shares and common shares.
Example: An investor buys 100 ABC common shares at $6 and sells the 100 shares at $10 two
years later. In the year of sale, the investor’s tax liability would be as follows:
Proceeds of Disposition: (100 x $10) $ 1,000.00
Less Adjusted Cost Base:

(100 x $6) + $17 purchase commission + $25 sales commission $ 642.00
Capital Gain $ 358.00
Taxable Capital Gain ($358 x 50% inclusion rate) $ 179.00
Investors who receive stock dividends or who subscribe to dividend reinvestment plans (DRIPs)
must declare them as income in the year the dividend is paid. Investors should keep a record of
stock dividends and reinvestments, because these amounts increase the adjusted cost base of the
investment. When the stock is sold, the higher adjusted cost base will reduce any capital gain.
VALUING IDENTICAL SHARES

The adjusted cost base of shares sold is generally calculated as the purchase price plus any
commission expense. However, investors often own shares of the same class that were bought
at different times and different prices. When a taxpayer owns identical shares, the average cost
method is used to calculate the adjusted cost base of the shares. The cost base of all such stock
is summed and divided by the number of shares held to produce an average cost for each share.
Example: An investor buys:

200 ABC common shares at $6 each in January of Year 1
100 ABC common shares at $9 each in June of Year 2
When the investor sells any ABC common shares, the cost base used will be the average
cost, or $7 per share calculated as follows:
200 x $6 = $ 1,200.00
100 x $9 = $ 900.00
Total cost = $ 2,100.00
$2,100 ÷ 300 = $ 7.00 per share

TAX ON DISPOSITION OF DEBT SECURITIES

For tax purposes, debt securities include bonds, debentures, bills, notes, mortgages, and similar
obligations. (Canada Savings Bonds and provincial Savings Bonds do not generate a capital
gain or loss because they do not fluctuate in value and either mature or are redeemed at par.)
If the seller of a debt security is in the business of trading securities, the proceeds from the
sale must be included in the seller’s business income, which is taxed as regular income.
However, the sale or redemption of a debt security by someone who is not a dealer or trader
often produces a capital gain or capital loss.
Capital gains and losses on debt securities are determined as the proceeds of disposition
minus the adjusted cost base and any expenses associated with the disposition. If, at the
time of disposition, a debt security has accrued interest owing, it is not included in the
capital gains calculation. Interest due at the date of sale is income to the vendor and may
be deducted from interest subsequently received by the purchaser.
Example: An investor buys a $1,000, 10% bond, at par, and has to pay accrued interest of
$80 at the time of purchase.
Principal amount $ 1,000.00

Plus : Accrued interest $ 80.00
Total cost $ 1,080.00
The buyer includes, as investment income for the year of purchase, net interest income of
$20 from the bond ($100 interest for the year less $80 accrued interest paid to the seller).
When the buyer later sells the bond, the adjusted cost base is $1,000, not $1,080.
Alternatively, the seller of the bond includes for the year of sale investment income of $80
accrued interest that was received at the point of sale and any other interest received from
owning the bond during the year. On the same tax return, the proceeds of disposition of $1,000
are used to calculate a capital gain or loss.
Capital Losses
Capital losses are calculated in the same manner as capital gains, but are deducted from
income instead of added to income. In most cases, they can be deducted only from capital
gains. However, two additional factors involved in capital losses should be kept in mind.
WORTHLESS SECURITIES
When a security loses all its value, the security holder must fill out a CRA form that states that
the security is worthless, so that the holder may declare a capital loss for tax purposes. This tax
rule does not apply to instruments that have an expiry date, such as warrants, rights, or
options. Capital losses for expired securities may be claimed without the owner having to
sign a declaration.

An exception to the rule above occurs when a security becomes worthless because the
underlying company becomes bankrupt or insolvent. In this situation, the taxpayer is deemed
to have disposed of the security for nil proceeds.
SUPERFICIAL LOSSES
A special type of loss results from the sale and purchase of the same security within a
limited period of time. A superficial loss occurs when securities sold at a loss are purchased
within 30 days before or after the sale and are still held at the end of 30 days after the sale.
Superficial losses are not considered to be capital losses and are therefore not tax-deductible. The
tax advantage may not be totally lost; it may just be deferred. Tax rules for superficial losses
apply not only to trades made by an investor who realizes a capital loss, but also to trades made
by the investor’s spouse or common-law spouse, or by a corporation controlled by the investor.
Example: An investor buys 100 XYZ shares at $30 and sells the shares at $25 on May 1. He
incurs a $500 capital loss ($3,000 – $2,500). Normally an allowable capital loss of $250 (50%
of $500) would be deductible against other capital gains. However, the capital loss would be
considered a superfi cial loss if the investor purchased 100 XYZ shares on any day in April or
May and owned them on May 31 of the same year.
Although superficial losses are not deductible for tax purposes, in most cases the taxpayer
eventually receives the tax benefit of the superficial loss when the investment is sold. The
amount of the superficial loss is added to the adjusted cost base of the property, thereby
reducing the ultimate capital gain.
If the shares were acquired at $25 before May 31, the loss of $5 per share would be added to
the cost of each XYZ share (100 in this example) owned on May 31. By so doing, the potential
future amount of the capital gain is reduced.
If later, 100 XYZ is sold at $40 per share, the capital gain is calculated as follows:
Proceeds of disposition (100 × $40) $ 4,000.00
Less Adjusted Cost Base
Cost of acquiring shares (100 × $25) $ 2,500.00
Commission on purchase $ 45.00
Superficial loss (100 × $5) $ 500.00
Total Adjusted Cost Base $ 3,045.00
Add
Commission on sale $ 60.00 $ 3,105.00
Capital gain $ 895.00
Taxable capital gain ($895 x 50% inclusion rate) $ 447.50

Tax Loss Selling

A decision to hold or sell a security should be based on the investor’s expectations for that
security. However, in some circumstances, taxes may also be a consideration. For example,
an investor may own shares for which the market price has declined with little potential for
appreciation in the foreseeable future. By selling the shares (generally done towards year-
end), the investor creates a capital loss which can be used to reduce capital gains from other
securities. Proceeds from the sale can then be re-invested in more attractive investments.
When a tax loss sale looks advantageous without breaching investment principles,
taxpayers should consider the following factors:
• if the taxpayer plans to buy the securities back at some point, the timing of the sale
and repurchase must be scheduled to avoid a superficial loss;
• for tax purposes, the settlement date (usually three business days after the transaction
date) is the date on which the ownership is transferred. This is an important tax rule for
investors to remember when selling securities near the end of a calendar year. For
example, an investor who sells a stock on the last day of December does not incur a
capital loss for the taxation year in which the sale occurred. The loss would apply to the
next taxation year since the settlement date would be in early January.
Taxation of Interest Income

Interest earned from investments is taxed as regular income at the investor’s marginal tax rate.
Unlike dividends and capital gains, it is not tax-advantaged in any way. Accrued interest must be
declared annually on the taxpayer’s return, whether or not it is actually received.
For example, Canada Savings Bonds may accrue compound interest. The interest is not paid
until the CSBs mature or are redeemed. However, the appropriate amount of interest must be
declared as income each year. Instruments such as Treasury Bills, that are sold at a discount
and redeemed at par, are considered to earn interest, not capital gains.
Taxation of Life Insurance

Life insurance is a unique product in many ways. In its simplest form, life insurance is a tool
that can create an instant estate, i.e., a lump-sum payment of cash is made at a time when it is
needed most. Another special aspect of life insurance is that the amount paid to a named
beneficiary when an insured person dies is not subject to income tax or probate fees.
If a life insurance policy is cashed in (in whole or part) at any point other than the death of
the insured person, however, it is treated much like any other property that is sold. If the
owner realizes a gain, the gain will be taxable.
Although there are several technical nuances that can have small effects on the calculation of a
policy gain on disposition, the general approach for polices issued before December 2, 1982 is:
Taxable policy gain = proceeds of disposition – adjusted cost base
Stated in another way:

Taxable policy gain = cash surrender value – (all premiums paid - all dividends declared)

If a policyholder surrenders a policy that has been in force for 10 years and the cash
surrender value is $5,000, the annual premiums paid $500, and the dividends declared
totalled $1,000, the taxable policy gain would be:
$5,000 POD – ($5,000 - $1,000) ACB = $1,000 Taxable Policy Gain
The full $1,000 would be subject to tax, not a reduced amount (50%) as is the case with
capital gains. The policyholder would report the $1,000 gain on his or her tax return in the
year the policy was surrendered.
In the case of policies issued after December 1, 1982, the adjusted cost base (ACB) of the
policy is further reduced by the net cost of pure insurance (NCPI) protection provided by the
policy. NCPI is calculated by multiplying the amount of pure risk (the difference between the
death benefit and the policy’s cash surrender value) in the policy by a prescribed mortality
factor (based on 1969-1975 mortality tables developed by the Canadian Institute of
Actuaries). The amount of pure risk is technically called the net amount at risk.
For example, if the policy in the previous example had been issued after December 1, 1982
and the total NCPI for the years the policy had been in force had been $1,000, the taxable
gain upon surrender of the policy would be:
$5,000 – ($5,000 - $1,000 - $1,000) = $2,000
The NCPI calculation results in a lower ACB for post-December 1, 1982 policies.
Consequently, more of the surrender value of the policy would be taxable compared to an
identical policy issued prior to December 2, 1982.
There are basically two types of policies from a tax standpoint – exempt policies and non-exempt
policies (see Chapter 2). The savings element (investment build-up) within an exempt policy
is ordinarily not subject to income tax. It is therefore important when owning permanent
life insurance to ensure that the policy always meets the exemption test.
The exemption test is a complex mathematical formula developed by the Canada Revenue
Agency (CRA) representing the actuarially determined, maximum policy reserve required to
fund the death benefit of a 20-pay, endow-at-age-85, permanent life policy. Such policies
were deemed to be primarily for the purpose of providing death benefits rather than deferring
investment returns from tax. The exemption test is referred to as the Maximum Tax Actuarial
Reserve (MTAR).
Since accrual taxation rules were introduced in 1982, life insurance companies and advisors go
to great lengths to ensure that a policy meets the criteria of an exempt policy on an annual basis.
This means that the policy’s main purpose is to provide benefits at death and not to provide
lifetime investment benefits. If a policy fails the exemption test, the policyholder is given a
grace period within which to bring the policy back to exempt status. For example, if an
unexpected increase in dividends results in the policy failing the exemption test, then the
policyholder may need to withdraw enough funds from the policy to restore its exempt status.
Note: Endowment life insurance pays the face value of the policy either at the insured’s death
or at a certain age or after a number of years of premium payment. Premiums for an
endowment life policy are generally much higher than those for a whole life policy.
A non-exempt policy is one in which the savings or investment portion exceeds a certain limit
in relation to the amount of insurance protection. Investment returns on non-exempt policies

are accrued for tax purposes and a policyholder must pay tax on the accrued income periodically
(every year for policies acquired after 1989, and at least every three years for policies bought
before 1990). When a life insured who is also the policyholder under a non-exempt policy dies,
previously untaxed accrued income must be included in taxable income on the final tax return.
Taxation of Disability Insurance

The taxation of income from a disability insurance contract was covered in Chapter 3 on
individual disability and accident and sickness products and also in Chapter 4 on group
insurance products. The general tax rule applied is that if the premium is tax-deductible, any
benefits received will be taxable. The employer is entitled to deduct as a business expense
any group insurance premiums paid. If the employer pays part or all of the employees’ LTD
premiums, then any LTD benefits paid to the employees are taxable.
Because the difference between a tax-free disability benefit and a taxable disability benefit
can be substantial, advance planning can ensure maximum benefit for both employer and
employees. If the employer chooses to pay 50% of the cost of group benefits, the plan could
be structured so that the employee pays the premiums associated with group life insurance,
weekly indemnity, and LTD coverage to receive tax free benefits. The employer would pay
the premiums for the prescription drug, dental, and extended health coverages; the payments
made on these items are reimbursements and not taxable to the employee.
Tax-Free Savings Account (TFSA)

In the 2008 federal budget, the government introduced the new Tax-Free Savings Account
(TFSA) that, starting in 2009, allows Canadians to set up to $5,000 a year aside in eligible
investments and have those savings grow tax-free throughout their lifetimes. Contributions to a
TFSA are not deductible for income tax purposes but investment income, including capital gains,
earned in a TFSA are not taxed, even when withdrawn at any time for any purpose. Unused
TFSA contribution room can be carried forward to future years and the amounts withdrawn
can be paid back into the TFSA starting in the next year without reducing contribution
room. Neither income earned in a TFSA nor withdrawals affect eligibility for federal
income-tested benefits and credits such as the Guaranteed Income Supplement and the
Canada Child Tax Benefit. In the 2009 federal budget, TFSAs were designated as a
separate category of deposits insurable by CDIC (Canada Deposit Insurance Corporation).
REGISTERED EDUCATION SAVINGS PLANS (RESPS)
LEARNING OBJECTIVES
• explain the tax benefits available through a Registered Education Savings Plan.
Registered Education Savings Plans (RESPs) are designed to make saving for postsecondary
education more attractive. RESPs are usually established by parents or grandparents to help
finance a child’s (or grandchild’s) education. The lifetime contribution limit per beneficiary

is $50,000 with no annual limit on contributions. A penalty tax of 1% per month is imposed
on excess contributions.
RESPs may include mutual funds, segregated funds, stocks, bonds, and cash deposits.
Contributions to an RESP are not tax-deductible, but the interest, capital gains, and dividends
accumulate tax-deferred until the child enters a postsecondary institution and starts receiving
educational assistance payments (EAPs) from the plan. [EAPs are amounts paid from an RESP to
an eligible beneficiary to assist with education-related expenses at the post-secondary level.]
Canada Education Savings Grant

The federal government encourages saving for education by making matching contributions
to RESPs through the Canada Education Savings Grant (CESG). It contributes 20% of the
first $2,500 of annual contribution in the form of a CESG. The CESG is available for
beneficiaries under the age of 18 to a plan maximum of $7,200 per beneficiary.
Low and Middle-Income Families

The following enhancements to the CESG program are available for low and middle-
income families:
• The CESG matching rate is 40% on the first $500 and 20% on the next $2,000
contributed per child per year for families in the lowest federal income bracket (less
than $41,544 per year). Therefore, the maximum government contribution will be
$600 a year per child [($500 × 40%) + ($2,000 × 20%)].
• For families earning between $41,545 and $83,088 a year, the CESG matching rate
will be 30% on the first $500 and 20% on the next $2,000 contributed per child per
year for a maximum of $550 [($500 × 30%) + ($2,000 × 20%)].
• For families earning more than $83,088, the maximum CESG will be $500 a year per
child ($2,500 × 20%).
CESG ENHANCEMENTS TO LOW- AND MIDDLE-INCOME FAMILIES
RESP Contribution Family Income (’000s)

<$41,544 $41,545-$83,088 >$83,088
First $500 contribution $200 $150 $100
Additional $2,000 contribution $400 $400 $400
Total CESG on first $2,500 $600 $550 $500
Canada Learning Bond

For parents in the lowest federal tax bracket receiving the National Child Benefit Supplement,
the Canada Learning Bond (CLB) program is also available. The CLB is provided for children
born after December 31, 2003 who are beneficiaries of an RESP. The CLB program begins with

a $500 contribution to the RESP and continues at the rate of $100 per year through the 15 th year
as long as the parents remain entitled to the NCBS. This could add up to an additional $2,000 of
RESP contributions. The CLBs are deposited directly to the RESP each year based on the parents’
tax return information. It is not necessary for the parents to make contributions to the RESP to
receive the CLBs. If the child named in an RESP does not continue education after high school,
the CLB must be returned to the Government of Canada.
Withdrawals from an RESP

A family-plan RESP allows for the listing of multiple beneficiaries, as well as multiple and
joint contributors, as long as the contributors and beneficiaries are related by blood or
adoption. The beneficiaries can share the funds in any proportion, as long as each
beneficiary receives no more than $7,200 in government grant money.
Once a child begins attending an eligible post-secondary program and starts withdrawing
funds, the growth component of the educational assistance payments are taxable as “other
income” with no distinction regarding dividends, foreign income, interest income, or capital
gains. The return of capital (ROC) component of plan payments is not taxable, since it was
not tax-deductible when contributed. However, since most postsecondary students have little
or no taxable income, the tax burden is usually very low.
If there are no beneficiaries who want to pursue post-secondary education, the government
grant must be repaid (without interest). Plan contributors can transfer up to $50,000 of
RESP income to their RRSPs or spousal RRSPs if they have contribution room available
and as long as the RESP has been in existence for at least 10 years. If no RRSP contribution
room remains, the investment income can be withdrawn at the contributor’s marginal tax
rate plus a 20% tax penalty. The original capital portion can be withdrawn tax-free since it
was not deductible when contributed.
Time Limits
The 2008 federal budget increased RESP time limits by 10 years. The number of
contribution years after a plan is entered into went up from 21 years to 31 years. The
deadline for plan termination moved up from the 25th anniversary of the plan to the 35th
anniversary of the plan. The contribution age limit for family plan beneficiaries also went
up from 21 years of age to 31 years of age.
To provide more flexibility for a beneficiary to access RESP savings, the budget also allowed
a six-month grace period for receiving EAPs from the plan. Under this measure, an RESP
beneficiary is eligible to receive EAPs for up to six months after ceasing to be enrolled in a
qualifying post-secondary program.
Major Benefit
The major benefit of an RESP is the tax-deferred compounding of returns. Although the
government grant is more heavily advertised, it is actually less valuable. Parents who can
afford to do so would do better to accelerate contributions to attain the plan limit of $50,000
as soon as possible rather than delaying contributions to maximize the CESG.

For example, annual contributions of $5,000 will yield government grants of only $5,000
($500 annual maximum CESG 10 years for maximum funding of $50,000), whereas annual
contributions of $2,000 for 18 years will yield the maximum government grant of $7,200
($400 per year 18 years). However, if contributions earn an 8% return and withdrawals
begin when the student is 21 years old, the accelerated contributions (with the
corresponding CESGs) will have grown to about $185,000, whereas the gradual
contributions (with the greater total CESGs) will only grow to about $113,000.
RECOMMENDING INDEPENDENT TAX ADVICE TO A CLIENT
LEARNING OBJECTIVES
• using client-specific data, identify situations in which a life agent should recommend
that a client seek independent tax advice.
Example 1: Dealing with Testamentary Trust Issues

Alicia, a life insurance agent and financial planner, has a long-time client called Grant. Over the years,
Alicia has helped Grant establish a life insurance program to protect his family if he died prematurely or
became disabled. The insurance plan addressed questions of debt such as mortgage loans, and
financial planning issues such as providing for his children’s education and saving for Grant and
his wife’s retirement. All of the issues were straightforward and the potential problems were well
within Alicia’s knowledge as a trained financial planner.
Recently Grant asked Alicia for her advice in dealing with a financial planning concern. Grant
was a capital beneficiary of a testamentary spousal trust that was established on his father’s
death. Under the terms of the trust, the trust assets were used to provide an income to Grant’s
mother during her lifetime. His mother has recently died and Grant was advised that as sole
beneficiary of the trust, he was entitled to receive all of the trust property. The trust’s principal
assets consisted of $1 million worth of blue-chip stocks that his father had acquired over a 50-
year period. The trustee of the spousal trust told Grant that the trust was being wound up and all
of the assets were being transferred to Grant.
Grant asked Alicia questions such as:
• Is any tax owing on the property being transferred to him?
• What was the value of the shares when he received them from the trust?
• If he receives the shares and then decides to sell them, what are the tax consequences?
• If Grant retains the trust property and sets up a trust for the benefit of his wife and children,
what are the tax implications, if any?
As a knowledgeable generalist, Alicia knows that Grant must consider a number of taxation
issues, currently and in the future. For example, as a capital beneficiary, would Grant receive
the trust property at its cost base? How would the cost base of the shares be determined?
Grant’s father had acquired the shares over a long period, including acquisitions before 1972,
when the capital gains tax was introduced.

It is clear to Alicia that Grant needs the services of a tax specialist to address these and related
issues. Alicia can help Grant integrate his newly acquired assets into his estate plan, but Grant
needs expert tax advice in dealing with this situation.
Example 2: Dealing with Taxes at Death

Edwin and Edwina enjoyed a long life together as husband and wife. Edwin died fi ve years
ago and left Edwina “everything” in his will. They had three children, Ellen, Edward, and
Edgar, all of whom were married and had their own families. All the property held by Edwin at
his death was transferred to Edwina without any tax implications, i.e., transferred at cost.
Now Edwina has died, and the children have approached the family’s life insurance agent, Errol,
to report her death and claim the life insurance proceeds of a joint-last-to-die policy that Errol had
written on Edwin and Edwina’s life some years ago. Since Errol is familiar with the estate, the
family has asked him to help calculate the “death taxes” owing on Edwina’s estate.
Errol knows that the estate assets are subject to probate fees and that the estate assets will have to be
reviewed one by one to determine the amount of income tax payable before the assets can be
transferred to the children. Since the children clearly have little if any knowledge of the taxation
issues surrounding the disposition of the estate, Errol recommends that the children seek
expert tax advice to settle the taxation issues. The children ask Errol to recommend someone.
He gives them a list of tax accountants to contact. They contact one and begin the process of
determining the tax requirements and filing the appropriate tax returns.
Example 3: Dealing with Complex Tax Issues Regarding a Self-Directed RRSP

Morley’s self-directed RRSP is a mess. The trust company that administers his RRSP has told him that
he has added investments to the RRSP that are not qualified for RRSP purposes and he must remove
them from his plan. Morley has also been depositing cash, investments and contributions in kind
into his RRSP and he really has no clear idea of the tax rules and regulations. For instance, a
transfer of investments to an RRSP can trigger a capital gain; yet, a capital loss cannot be
claimed on such transfers.
Josephine is Morley’s life insurance agent. Some years before, she took an application on
Morley’s life to insure a home mortgage. At the time, she and Morley discussed the need for a
comprehensive financial plan, but Morley has avoided the matter until recently. Now he asks
Josephine to help him resolve the problems with his self-directed RRSP.
Josephine knows the tax rules concerning self-directed RRSPs but she is concerned about the
particular problems that Morley has created with his indiscriminate RRSP deposits, transfers,
and withdrawals. After reviewing the plan, Josephine tells Morley that he should consult a tax
expert to get the best advice on the most cost-effective way of resolving the tax issues.

USING INSURANCE TO SOLVE A TAX PROBLEM
LEARNING OBJECTIVES
• using client-specific data, identify situations in which insurance can be used as a
strategy to address and resolve tax issues;
• using client-specific data, identify business situations in which insurance can be used
as a strategy to address and resolve tax issues.
For Individuals and Families

Example 1: RRSP Benefits for a Single Person
Emeril is a divorced parent of two teenaged children. He is in his early forties and is a
successful business owner. Since his mid-thirties, he has been making the maximum
contribution to his RRSP each year. He plans to continue making maximum contributions to the
RRSP which will be his principal source of retirement income.
During a review of his financial plan, his financial advisor, Jacques, asks Emeril how he intends to
direct the payment of the proceeds from his RRSP if he were to die before he retired, or shortly after
he began to receive a retirement income from the accumulated value in his RRSP. Jacques explains
that upon Emeril’s death, the RRSP will be considered disposed of and the entire value will be
included as ordinary income in his fi nal tax return. If Emeril wants to pass the RRSP value to his
children, the tax owing would deplete that value by as much as 50%.
Emeril is well off financially and while he plans to receive an income from the RRSP when he
retires, he wants to preserve as much of its value as possible to pass along to his children,
particularly if he dies soon after retiring.
Jacques recommends that Emeril apply for life insurance to address the tax problem. He could apply for
an appropriate amount of insurance (i.e., close to the estimated value of his RRSP) and appoint his
estate as beneficiary. If he dies before he retires, his estate will receive the death benefit and his
children can use the proceeds to pay the tax owing on the value of the RRSP. All of the funds
from the RRSP can then be distributed to his children.
If he chooses to receive an annuity from the RRSP upon retirement, he could select a straight
life annuity. Annuity payments would cease upon his death and there would be no taxes
payable. The insurance proceeds paid to his estate could be distributed to his children.
Example 2: Using an Exempt Life Insurance Contract

Ingrid is concerned that her investments are generating taxable income each year. As her investments
grow, the amount of taxable income she is required to report for income tax purposes grows as well.
Since she is earning an income that places her in the highest income-tax bracket, the marginal tax rate on
her investment income also falls within the highest tax bracket. She is particularly concerned that she has
to report earnings growth on her GICs, even though the interest earned remains in
the investment to compound. She asks her advisor, Jason, if there is any way that she can
reduce the amount taxable on her investments.

Jason is helping Ingrid develop a financial plan. He notes that she is contributing the maximum amount to
her RRSP. She also holds sizeable non-registered investments that yield unrealized capital gains,
dividend income, and interest. Although she does not have to pay tax on the unrealized capital gains, the
liability for tax will significantly increase and need to be paid at some point in the future.
Jason notes that Ingrid’s life insurance program is not sufficient to cover her financial planning
needs. After performing an insurance needs analysis, Jason recommends that Ingrid should
buy $250,000 of life insurance. Since her insurance needs are permanent, he recommends a
permanent life insurance plan.
Jason also recommends that Ingrid consider purchasing a universal life insurance (U/L) policy.
Under a universal life insurance policy, Ingrid could tailor her life insurance premiums to pay for
the insurance over a specific period of time. At the same time, she could invest her premium
payments in her choice of investments that would provide a competitive rate of return.
Jason points out that as long as Ingrid maintains the accumulating value in her policy below a
certain level to keep it tax-exempt, any investment returns will be tax-free. In any event, the
life insurance benefit is tax-free. Ingrid chooses a premium payment plan aimed at paying up
her universal life policy within 25 years. She also chooses a conservative mutual fund for the
investment account portion of the U/L policy.
Example 3: Taxation of Estate Assets and Joint-Last-to-Die Insurance

Olive and Oliver, a married couple, have recently reviewed their financial status with their
financial planner, Marion, and asked her to establish a financial and estate plan. They are
growing older and they want to make sure that the assets they have accumulated over the
years will be transferred in an orderly fashion to their children Opal and Orris. In addition to
a principal residence that has no mortgage, the couple owns a cottage that has grown in
value from $100,000 to $200,000 over the years. They also own two rental properties along
with a number of investments including stocks, bonds, and GICs.
Marion discusses the income tax implications of transferring their assets to the children when
they die. Up to 50% of the value of their assets could be lost in income tax. The tax owing could
amount to $250,000.
Marion informs the couple that the income tax cannot be avoided. They could dispose of the
assets before they died, but they would still be required to pay income tax on any capital gains
realized. Marion suggests that they consider using life insurance to counteract the effects of tax
on the value of their estate. Life insurance of $250,000 could be made payable to the estate
with the proceeds used to pay the income taxes due.
Olive and Oliver are concerned about the cost of $250,000 of life insurance on each of their
lives. Marion suggests that they consider a joint life insurance policy with proceeds payable
upon the second death. She explains that upon the first death, the assets could be transferred
without income tax consequences to the surviving spouse. Only on the survivor’s death would
the assets be considered disposed of at their fair market value for income tax purposes.

Business Situations
Example 1: Funding a Buy-Sell Agreement While Maintaining Small Business Status
Barron’s Brooms Inc. manufactures curling brooms. It is a CCPC. All its shareholders are Canadian
residents. Barron’s Brooms qualifies as a small business corporation under the Income Tax Act. As
such, it is entitled to a favourable income tax rate on the first $500,000 of income earned in each tax
year (commonly referred to as the “small business deduction”).
The principal shareholders of the company want to establish a buy-sell agreement under which the
surviving shareholders will purchase the shares of a deceased shareholder on his or her death. A
Barron’s Brooms share has been valued at $1,000. Each shareholder’s interest has been valued at
$1 million. The shareholders realize that they must find a way of funding the buy-sell arrangement,
other than with company assets, when a shareholder dies. They have considered establishing a
sinking fund derived from business earnings.
Since the shares qualify as shares of a small business corporation, disposition of the shares is
eligible for the $750,000 capital gains exemption.
The shareholders are aware that to retain the company’s status as a small business corporation, at
least 90% of the value of the corporate assets must be actively used in the business. They are
concerned that as the sinking fund grows, its value will not be considered an active business asset
and the company might lose access to the capital gains exemption.
The solution to this problem may be found in the use of life insurance to fund the buy-sell agreement. Life
insurance is not valued at its death benefit but at its cash value. As long as the other assets of the
company are invested in the active business, the insurance policy will not affect the company’s status as a
small business. On the death of a shareholder, the life insurance proceeds can be paid to the corporation
to purchase the deceased person’s shares from his or her estate.
Although the proceeds of the policy become an asset of the corporation, until they are paid out, the
life insurance policy continues to be valued at its cash value and not its death benefit. If the value of
the active business assets represents 90% or more of the total assets of the business, the addition of
the death benefit to the company coffers will not compromise that position. Consequently, access to
the $750,000 capital gains exemption should continue to be available on the disposition of the
deceased’s shares of the qualifying small business.
Example 2: Funding a Buy-Sell Agreement without Depleting a Company’s Resources

Accurate Accounting Inc. is a CCPC, owned by its principal shareholders Tom, Dick, and Mary. All
three are chartered accountants who contribute their services to the business on a full-time basis.
The company has 6 full-time employees.
Tom, Dick, and Mary have negotiated a buy-sell agreement whereby, on the death of one of
them, the corporation will purchase the deceased person’s shares from his or her estate. They
are now trying to decide on the most efficient way of providing the funds to purchase the shares.
If they fund the purchase from the general assets of the company, it could represent a significant
blow to the company’s resources, particularly at a time when the contribution of one of the active
participants is no longer available. However the share purchase is funded, the payment to the
deceased’s estate is considered a refund of paid-up capital and a taxable dividend.
The corporation can purchase life insurance on the lives of each shareholder to fund the share
repurchases. Using life insurance as the funding vehicle also allows the corporation and the
deceased shareholder’s estate some flexibility in addressing the taxation of the capital gain
resulting from the disposition of the shares.

Tom, Dick, and Mary each contributed $25,000 as paid-up capital when the company was first
established. Each of them received 25 shares with a value of $1,000. Each shareholder’s total
share value is $750,000. The corporation purchases insurance of $750,000 on each of their lives
for which the corporation is the beneficiary.
If Tom dies, there would be a deemed disposition of his shares at their fair market value. In his fi nal tax
return, the disposition must be reported as a capital gain of $725,000 ($750,000 proceeds of disposition -
$25,000 adjusted cost base). Tax must be paid on 50% of the taxable capital gain of $362,500 ($725,000
capital gain x 50% capital gain inclusion rate) unless it can be sheltered by the lifetime capital gains
exemption. Tom’s estate will acquire the shares at a cost base of $750,000. The corporation will pay
Tom’s estate $750,000 from the proceeds of the life insurance policy.
Upon Tom’s death, the corporation will collect the insurance proceeds. Because the insurance
proceeds are paid tax-free, the corporation can pay for the repurchase of the shares from Tom’s
estate by declaring a capital dividend which is not taxable.
Life insurance also allows some flexibility in planning for the taxation of the capital gains from the
share disposition. Tom’s estate sells the shares to the corporation. While the estate receives the
full value of the shares, for income tax purposes, the dividend is not considered proceeds of
disposition. Effectively the shares are disposed of at no value. Since the cost of the shares to the
estate equals their fair market value, the estate realizes a capital loss. Under the provisions of the
Income Tax Act, Tom’s executors can apply the loss against his final return, thereby allowing for a
deferral of the taxation of the share disposition.
The taxation rules surrounding the deemed disposition of shares of a Canadian small business
corporation upon the death of a shareholder are complex. Using life insurance as a funding method
to purchase the shares adds to the complexity. Life insurance, however, does give the executors of
the deceased shareholder’s estate and the surviving shareholders flexibility in deciding if taxes owing
on the share disposition will be paid in the deceased’s final return, in the estate tax return, or deferred
and taxed in the hands of the surviving shareholders when they dispose of the shares. See Appendix
A for further information.
Example 3: Choosing Group Life Insurance

Precious Bracelets Inc. produces elegant bracelets that it sells worldwide. The company has
been in business for fi ve years and its growth in earnings and staff has been impressive. The
company intends to implement a group plan for its employees offering life, disability, and
extended health and dental insurance.
An important consideration for the company and its employees is the tax consequences for premiums and
benefits under each type of coverage. The company needs to determine who should pay the premium for
each type of coverage to have the smallest level of taxation on the employer and the employee.
For group life insurance, the death benefit is tax-free, whether the employer or the employee pays the
premium for the insurance coverage. If the employer pays, the premium for the life insurance coverage is
a deductible expense for the employer and a taxable benefit to the employee. If the employees pay, the
premium is not tax-deductible. Precious Bracelets decides to pay for the group life insurance benefit.
The group plan will also include extended health benefits, including a dental plan and a drug plan.
Employer premium contributions for this type of coverage are tax-deductible by the employer and are
not a taxable benefit to the employees. Employee premium contributions are tax-deductible by the
employee as a medical expense tax credit. Medical expenses paid for under the plan are not
deductible by the employee under the medical expense tax credit. Precious Bracelets decides to pay
the premium for this part of the group coverage.

The company also wants to implement a short-term disability benefit program. It will pay a
disabled employee an income benefit equal to two-thirds of the employee’s salary, for a period
of seventeen weeks, with benefits to begin two weeks after the onset of a disability. If Precious
Bracelets registers this plan with Human Resources and Skills Development Canada, it will
benefit by a reduction in Employment Insurance Premiums, part of which it can pass along to
each employee. In addition, employer premium contributions are tax-deductible. The premiums
paid by the employer are not a taxable benefit to the employee. If the employer pays the
premiums, however, benefits paid under the plan are a taxable benefit to the employee.
Precious Bracelets decides to pay the premiums for the short-term disability plan.
Finally, the Company intends to include a long-term disability plan under the group insurance package.
Benefits under the plan will begin when short-term disability benefits expire and will continue until the
employee recovers, dies, or reaches retirement age. If Precious Bracelets pays the premiums, they are tax-
deductible to the employer, but are not a taxable employee benefit. Disability income benefits, however,
would be taxable to the employee. If the employee pays the premiums, the amounts are
not tax-deductible by the employee. Benefits under the plan, however, would be received tax-
free. Precious Bracelets decides to set up the plan so that the employees pay the premiums.
USING INSURANCE POLICY AS A TAX-PLANNING TOOL
LEARNING OBJECTIVES
• using client-specific data, demonstrate the use of an insurance policy as a tax-planning tool.
Example 1: Use of Life Insurance by Couple to Transfer Assets at Death to Children

Luke and Laura Lucky, a married couple, are reviewing their finances as part of a planning
process they are conducting with their advisor. They are discussing the following:
• The Luckys jointly own a principal residence that is valued at $300,000. There is no mortgage.
• They have two children, both in their early twenties, who have completed their education.
While both live at home right now, they have begun promising careers and plan to move
away from home shortly.
• Both Luke and Laura are employed in large corporations and earn salaries in the $60,000
range. Their respective companies have defined benefit pension plans. Pension benefits
are in the form of joint-and-last-survivor payments.
• Their pension plans provide a pension income calculated at 2% per year of service based on an
average of the best three years of earnings. They both contribute 5% of salary to the pension
plans. Neither has set up an RRSP because they feel that the pension plans, together with OAS
and CPP benefits, will provide them with a comfortable income in retirement.
• Both Luke and Laura hold conservative investments in Canada Savings Bonds and
Guaranteed Investment Certificates. They each have about $50,000 invested.
• Laura also has an interest in three rental properties that she owns jointly with her younger
sister, Lana. The properties are held in a trust that was set up by their parents. Laura and
Lana are income beneficiaries of the trust. When Laura and Lana die, the properties are to
be sold and the proceeds donated to their parents’ favourite charity.

The couple is reviewing plans to transfer assets to the children when they die. They ask their
advisor if their estates will face a large tax bill and if they should buy insurance to pay for any
taxes that will come due.
CONCLUSIONS
When the last one of them dies, their property will be considered disposed of at fair market
value with any capital gains or other income to be reported in the final tax return. Consider
the nature of the assets that Luke and Laura hold.
• The house that they own is their principal residence. As such, it is not subject to
taxation upon its disposition or deemed disposition at death.
• Their pension plans provide for a joint-and-last-survivor pension. That means that upon the
death of one of them, the pension will continue to the survivor until his or her death. After
that, no additional benefits will be paid. The income from the pensions will be taxable to the
recipient as received. However, there is no income tax owing when they die.
• All their investments produce interest earnings that are taxable each year. When they
die, the principal amounts held in the investments can be passed to the children, with no
income tax owing.
• Laura’s interest in the trust ceases when she dies. There is no residual benefit to pass
along to her heirs and no amount that is taxable.
Although the couple may choose to acquire life insurance to pay for burial expenses, or to
provide additional funds to pass along to their beneficiaries, they have no reason to acquire
insurance to address a tax issue upon their deaths.
Example 2: Use of Life Insurance to Transfer Assets of Single Individual at Death to Next Generation
William Barrie is a successful software developer who works as a self-employed consultant
for a number of companies. He is single and lives in a condominium that he bought for cash.
He enjoys life and travels as much as possible between consulting jobs.
Aside from his work, William has two passions. He acquires houses, which he renovates
and then rents out, and he is an avid art collector. In both cases, the value of his
acquisitions has grown considerably.
William has a brother, Albert, and a sister, June, with whom he is very close. Neither is as
successful financially as William. They are both married and each of them has two children.
As he grows older, William is sure that he will remain single for life. Because of his regard
for his family, he wants to pass along his assets to his nieces and nephews.
He has reviewed his affairs with an advisor and begun to plan for the transfer of his assets when he dies.
William is in his early forties and in good health. His advisor outlines the income tax provisions that will
apply upon his death for the property that he owns. Given his circumstances, he is not concerned about
taxes, since his holdings consist of rental properties and rare art. He feels that there are enough assets in
the estate to take care of any income tax that might fall due when he dies.

CONCLUSIONS
William may have not fully considered how much the imposition of income taxes might deplete
the value of his estate and the size of the inheritance he wants to pass along to his family.
• His art collection consists of assets that are taxable property. The amount by which the fair
market value exceeds the original cost of each item is a capital gain and 50% of that gain
is taxable on his final tax return. As the value of each piece of artwork increases, so does
the size of the capital gain that must be reported in the final tax return.
• William’s rental properties will generate two types of income. First, there is the capital gain,
assuming that the value of each property and the land on which it sits increases. Second,
if he has claimed capital cost allowance on the rental properties, when the properties are
considered disposed of on his death, his executors must calculate a recapture of the total
capital cost allowance claimed (i.e., any amount by which the original cost of the rental
property exceeds the undepreciated capital cost) and bring it into income.
• The assets in his estate are not considered liquid. For example, works of art may not be
easily and quickly saleable. While rental property can always be sold, if the overall real
estate market is in a “down” phase, his executors might have to sell the properties at
distress prices if funds are needed to pay the income tax owing when he dies. In
addition, he might want to pass along the property he owns, rather than having his
assets sold and the capital distributed to his beneficiaries.
Under the circumstances, a reasonable amount of life insurance becomes a valuable planning
tool to make sure that most of his assets can be passed along to his nephews and nieces in a
well-planned and tax-effective manner.
Example 3: Use of Life Insurance by Small Business Owners to Fund a Buy-Sell Agreement
Eric, Theo, and Pavel are the owners and sole shareholders of an architectural design business.
The trio began working together shortly after graduating and they have built a thriving business
that continues to grow each year. While they all participated in the design work initially, only Theo
continues to work on projects every day. Eric and Pavel deal with prospective customers and
negotiate new contracts. Two years ago, they incorporated the business, which now has 25
employees who perform drafting or architectural design work.
As part of the incorporation process, the shareholders worked with an advisor, Monica, and a lawyer,
Nora, to formally incorporate the business and issue shares. Each of the three contributed $25,000 and
received 250 shares. The value of each share was set at $100 arbitrarily, but Monica and Nora
recommended that they value the business and the shares on a regular basis. Today the value of each
share is $2,000 and expectations are that the value will increase to $5,000 in the next two years.
All three are married and have started a family. Each of them realizes that his share interest
in the business is the most important asset he has. All of their energies have been focused
on the business and they have not spent any time acquiring investments.
Recently, Theo was involved in an automobile accident. Although he was not seriously injured, he
missed a few days of work. The business associates became concerned about what would happen if
one of them were to die. How would the deceased’s family benefit from his interest in the business?

Monica recommends that the shareholders establish a buy-sell agreement under which the surviving
shareholders will agree to purchase the deceased’s shares from his estate. With the help of Nora and
their accountant, Eliza, the three set up an agreement that specifies a method for valuing the shares and
the way in which the surviving shareholders will acquire and pay for the deceased’s shares.
As part of the agreement, Monica recommends that they set up life insurance to provide the
funds to pay for the deceased’s shares. This seems to be the best way to generate the
necessary funds. The only other funds available are the business assets, and most of the
financial resources are tied up in design projects.
Eric, Theo, and Pavel purchase life insurance on each other’s lives and feel that the
agreement has solved a potentially serious problem for their business.
At the same time, Monica has begun to help them develop personal financial plans. She considers the
nature of the business and the shares. The business operates in Canada and the three shareholders are
Canadian residents. All of the business assets are active assets. She concludes that, for income tax
purposes, the business is a Canadian-controlled private corporation/qualified small business corporation.
For planning purposes, each shareholder’s interest is eligible for a $750,000 capital gains exemption if he
disposes of the shares or if his associates upon his death acquire them. Since the
shares are to be purchased with insurance proceeds, each one feels that any income taxes owing at
the time of his death will be addressed by the insurance and the capital gains exemption.
CONCLUSION
Although Eric, Theo, and Pavel expect that when they die, their families will receive fair
market value for their shares, they should consider the effect on the value of their individual
estates. For income tax purposes, the shares will be considered disposed of at death for their
fair market value. Any excess of that value over the cost of the shares is a capital gain and
50% of the gain is taxable in the deceased shareholder’s final tax return.
Since the shares are held in a “qualifying small business corporation,” the $750,000 capital
gains exemption can be applied to reduce the total taxable capital gain. The value of the shares,
however, is growing and in spite of this tax advantage, the deceased’s executors may be
faced with a large income tax liability.
Although the executors can expect a cash payment for the value of the shares, a large part of
it may be required to pay the income taxes owing. The deceased’s family may not receive
enough financial support to continue to live the lifestyle they have enjoyed. Personal life
insurance owned by each of the shareholders on his life is worth considering as an important
part of the estate and tax plan.
All three of them must consider the income flow that would no longer continue to their
family. They must decide what percentage of their income they would like to have replaced if
they died. There must be enough insurance in place to pay any outstanding taxes and final
expenses but also enough to provide a continued income source to their survivors.
Having a funded buy-sell agreement in place only takes care of part of the picture. Their
spouses would receive fair value for their husband’s shares and not have to worry about
running the business on a day-to-day basis. They must look at their whole picture and
determine other requirements for the insurance such as, education, providing an emergency
fund and paying other final expenses. Their insurance agent must do a complete financial
needs analysis to determine what their insurance needs are.

APPENDIX A
Under a corporate-owned share redemption, for policies in effect prior to April 27, 1995,
the estate of a deceased shareholder could reduce its taxable capital gain to nil by declaring
a capital loss equal to the amount of tax-free capital dividends received from the
corporation (through its capital dividend account) upon redemption of the shares.
Note: A capital dividend account is a notional tax account that contains tax-free surpluses
accumulated by a private corporation. Among its main holdings are the untaxed one-half of
capital gains realized on the disposition of capital assets and the proceeds of life insurance
policies (net of the adjusted cost base of the policies). These amounts can be distributed as
capital dividends free of tax to the shareholders.
Stop-loss rules introduced under the Income Tax Act are designed to limit the capital loss
that an estate can claim. These rules have resulted in different strategies being pursued to
keep corporate-owned share redemption plans tax effective. As a direct consequence, the tax
burden is being shared, and in many cases, more equitably between the deceased
shareholder’s estate and the surviving shareholders.
Assume, for instance, a corporation with two shareholders, Adam and Brent, who each own
50% of the corporation. Assume Adam dies. The ACB of Adam’s shares is $100 and the FMV
(Fair Market Value) at death is deemed to be $500,000. The corporation is worth $1,000,000.
Under the pre stop-loss rules scenario, the consequences would have been as follows:
Deemed proceeds at Fair Market value to Adam $ 500,000

Less Adjusted Cost Base of Adam’s shares $ (100)
Capital gain for Adam $ 499,900
Upon acquisition of the shares from Adam’s estate:

Proceeds of redemption $ 500,000
Less Paid-Up Capital $ (100)
$ 499,900
Capital dividend declared $ 499,900
Amount taxable to Adam’s estate zero
Proceeds of disposition $ 500,000
Less deemed dividend to estate $ (499,900)
Deemed proceeds of disposition $ 100
Less ACB of Adam’s shares to estate $ (500,000)
Capital loss to estate (carry back to Adam’s fi nal return) $ (499,900)

In essence, Adam’s entire interest in the corporation worth $500,000 would be shielded from
tax because the allowable capital loss (50% of the capital loss) would be carried back to
offset the taxable capital gain (50% of the capital gain).
Under current stop-loss rules, Adam’s estate would not be able to carry back $499,900 to
Adam’s final tax return; instead, only one-half of the capital loss would be eligible for carry
back, i.e., $249,950. As such, Adam’s capital gain of $499,900 would be reduced by the
capital loss carried back of $249,950 thereby requiring the final tax return to declare net
capital gain of $249,950 (50% of which would become taxable if it could not be sheltered by
the lifetime capital gains exemption).

Chapter 8
Retirement

8
Retirement
CHAPTER OUTLINE
Introduction
Retirement Planning and the Importance of Pensions
• The Six Steps in Retirement Planning
Government-Sponsored Pension Plans
• Old Age Security (OAS)
• The Guaranteed Income Supplement (GIS)
• Allowance
• Allowance for the Survivor
• Provincial Guaranteed Annual Income Supplement
• Canada and Quebec Pension Plans
Employer-Sponsored Registered Retirement Plans
• The Evolution of Employer-Sponsored Pension Plans
• Registered Pension Plans
• Defined Benefit Pension Plans
• Defined Contribution Plans (Money Purchase Plans)
• Hybrid Plans
• Maximum Pension Benefit
• Normal Form of Pension
• Guarantee Period

• Early Retirement Considerations
• Contribution Limits
• Registered Pension Plans: Regulatory Climate
• Priorities, Objectives and Constraints in Establishing a Pension Plan
• Tax Rules Applicable to Retirement Income
• Individual Pension Plans (IPPs)
• Retirement Compensation Arrangement (RCA)
• Supplemental Executive Retirement Plans (SERPs)
• Salary Deferral Arrangements
• Deferred Profit-Sharing Plans (DPSPs)
• Group Registered Retirement Savings Plans (Group RRSPs)
Registered Retirement Savings Plans (RRSPs)
• The Importance of RRSPs
• Advantages of an RRSP
• Disadvantages of an RRSP
• Earned Income
• Contributions to an RRSP
• Types of RRSPs
• Qualified Investments for RRSPs
• Non-Qualified Investments for RRSPs
• Maturing an RRSP – Partial Withdrawals and Deregistration
• RRSPs and Inheritance
• Spousal RRSPs
• Using RRSP Funds to Assist First-Time Canadian Home Buyers
• Lifelong Learning Plan
• Locked-In RRSPs
• Retiring Allowances for Employees
Registered Retirement Income Funds (RRIFs), Life Income Funds (LIFs)
and Locked-In Retirement Income Funds (LRIFs)
• Registered Retirement Income Funds (RRIFs)
• Life Income Funds (LIFs)
• Locked-in Retirement Income Funds (LRIFs)

Annuities
• Straight Life Annuities
• Life Annuities with a Guaranteed Payout Period
• Factors Affecting a Life Annuity’s Payout
• Fixed-term (or Term-certain) Annuities
• Deferred Annuities
• Other Types of Annuities
• A Split Annuity Program
• Withdrawal Rights and Market Value Adjustments
• Structured Settlement Annuities
Advantages of Income-Splitting Between Spouses
• Paying Salary (or Profits) to Family Members
• Splitting Investment Income among Family Members
• Splitting Retirement Income
• CPP Income Sharing/Assignment between Spouses
• Payment of Expenses by the Higher-Income Spouse
Retirement Income Needs Analysis: An Example

• Retirement Budgeting
• Estimating Income and Expenses
• Meeting the Shortfall
• Assessment and Required Action

EIGHT • RETIREMENT 8• 5
INTRODUCTION
Your role as an advisor does not end when your client signs a policy contract. Your clients will
be looking to you for other financial advice. Many clients want advice on their retirement and
they may ask for your help in establishing goals for retirement as well as advice on how to meet
those goals. This chapter describes government- and employer-sponsored retirement plans as
well as personal savings that can be used to help fund a client’s retirement.
PLANNING AND THE IMPORTANCE

OF
LEARNING OBJECTIVES
• explain the importance of the retirement planning process;
• list the steps in the retirement planning process.
The Six Steps in Retirement Planning

As life expectancy climbs and more people retire earlier, the costs of retirement will increase
dramatically. Social factors such as the decline of close family relationships and the aging of
the labour force all focus attention on the importance of retirement planning and pension plans.
Without a retirement plan in place, your clients will not be able to reach their retirement goals.
Very few people plan to fail, but many people fail to plan. As an advisor, you must determine
where your clients are now, where they want to go and most importantly how to get them there.
The best way to do this is to follow a series of steps in creating a retirement plan.
1. Identify the client’s retirement goals and estimate how much money is
needed to achieve these goals.
2. Determine the client’s current financial status or net worth.
3. Calculate the client’s likely annual expenses during retirement.
4. Establish a savings and investment plan to meet the retirement needs.
5. Integrate the investment plan with tax planning to take advantage of possible
tax savings and implement the strategies.
6. Monitor the plan and make changes as required.

GOVERNMENT-SPONSORED PENSION PLANS
LEARNING OBJECTIVES
• describe Old Age Security (OAS), including its source, the benefits provided, the
“clawback” provision, and the 2000 changes;
• describe the Canada Pension Plan, including contributions to the plan, the age for receiving
benefits, the benefits provided, and penalties for choosing to receive pension benefits early.
Old Age Security (OAS)

The Old Age Security Act came into force in 1952, replacing legislation from 1927 requiring the
federal government to share the cost of provincially-run, means-tested old age benefits.
The Act has been amended many times. Among the most important changes have been:
• the drop in age of eligibility from 70 to 65 (1965);

• the establishment of the Guaranteed Income Supplement (1967);
• the introduction of full annual cost-of-living indexation (1972);
• quarterly indexation (1973);
• the establishment of the Spouse’s Allowance (1975);
• payment of partial pensions based on years of residence in Canada (1977);
• the inclusion of Old Age Security in international social security agreements (ongoing);
• the extension of the Spouse’s Allowance to all low-income widows and
widowers aged 60 to 64 (1985);
• maximum of one year of retroactive benefits (1995);
• the ability for an individual to request that their benefits be cancelled (1995); and
• the extension of benefits and obligations to same-sex common-law partners (2000).
OAS is a monthly benefit payable to all Canadians or legal residents (including
landed immigrants), who are aged 65 and older, and who meet certain residence
requirements. The program is financed from general federal tax revenues, and the
benefits are adjusted four times a year to reflect increases in the Consumer Price
Index (CPI). Payments do not go down, however, if the cost of living falls.
ELIGIBILITY CONDITIONS
To qualify for an OAS pension, a person must be 65 years of age or over, and
1. must be a Canadian citizen or a legal resident of Canada on the day
preceding the application’s approval; or
2. if no longer living in Canada, must have been a Canadian citizen or a legal resident of
Canada on the day preceding the day he or she stopped living in Canada.

EIGHT • RETIREMENT 8•7
A minimum of 10 years of residence in Canada after reaching age 18 is

required to receive a pension in Canada.
Canada has signed reciprocal social security agreements with many countries that allow social
security benefits to be portable upon immigration. Service Canada has posted information sheets
about these agreements on its website; the countries included range from Barbados to the
United States. A person who has lived in one of these countries or contributed to its social
security system may qualify for a pension from that country, or from Canada, or from both.
FULL OAS PENSION

The amount of a person’s pension is determined by how long he or she has
lived in Canada, according to the following rules:
1. A person who has lived in Canada, after reaching age 18, for periods that
total at least 40 years, may qualify for a full OAS pension;
2. A person who has not lived in Canada for 40 years after age 18 may still qualify
for a full pension if, on July 1, 1977, he or she was 25 years of age or over, and
• lived in Canada on July 1, 1977; or
• had lived in Canada before July 1, 1977, after reaching age 18; or
• possessed a valid immigration visa on July 1, 1977.
In such cases, a person must have lived in Canada for the 10 years immediately prior to
approval of the OAS application. Absences during this 10-year period may be offset if, after
reaching the age of 18, the applicant lived in Canada before those 10 years, for a period of
time that was at least three times the length of absence. In this case, however, the applicant
must also have lived in Canada for at least one year immediately prior to the date of the
application’s approval. For example, an absence of two years between the ages of 60 and
62 could be offset by six years of residence after age 18 and before reaching age 55.
PARTIAL OAS PENSION

A person who cannot meet the requirements for the full OAS pension may qualify for a partial
pension. A partial pension is earned at the rate of 1/40th of the full monthly pension for each
full year lived in Canada after his or her 18th birthday. Once a partial pension has been
approved, it may not be increased as a result of added years of residence in Canada.
ABSENCES FROM CANADA

Canadians working outside Canada for Canadian employers, such as the armed forces and banks,
may have their time working abroad counted as residence in Canada. To qualify, the person
must have returned to Canada within six months of ending employment or have turned
65 years old while still employed. Both proof of employment from the employer as well
as proof of physically returning to Canada, if only for one day, must be provided. Under
certain conditions, this provision may also apply to spouses and dependents and
Canadians working abroad for international organizations.

APPLYING FOR OAS BENEFITS

Since OAS pensions are not paid until the individual has applied and the application has been
approved by the federal government, applicants should apply six months before they become
eligible for the OAS pension. They must provide proof of their age and legal residence status.
Pension benefit payments normally begin a month after the applicant meets the age
and residence requirements. If the applicant makes a late application, payments may
be made retroactively for up to 12 months.
PAYMENT OF OAS BENEFITS TO RECIPIENTS OUTSIDE CANADA

Once a full or partial OAS pension has been approved, it may be paid indefinitely outside
Canada, if the pensioner has lived in Canada for at least 20 years after reaching 18 years of
age. Otherwise, payment may be made only for the month of a pensioner’s departure from
Canada and for six additional months, after which payment is suspended. The benefit may
be reinstated if the pensioner returns to live in Canada and meets all conditions of eligibility.
If he or she lived or worked in a country that has a social security agreement with
Canada and is considered to meet the 20-year residence requirement, he or she
can receive the payments indefinitely.
TAXATION OF OAS BENEFITS AND THE PENSION CLAWBACK

Like most other retirement income, basic OAS pension is taxable income. OAS payments
are considered a social benefit, and under the Income Tax Act, higher-income Canadians
must repay all or part of the social benefits they receive in any year.
Essentially, an individual with a net income of more than $67,668 (for 2011) must repay a portion
of their OAS payments. The total amount of OAS that an individual repays is 15% of the amount
by which that person’s net income (including OAS) exceeds $67,668. In other words, for every
dollar of income above $67,668, 15 cents of OAS income must be paid back.
For example, if a person’s net income in 2011 was $75,000, then repayment would be 15% of
$7,332 ($75,000 – $67,668) or $1,100. The full OAS pension is eliminated when a pensioner’s
net income is $109,764 or more. This provision is often referred to as the clawback.
The Guaranteed Income Supplement (GIS)

The government pays the basic OAS pension to everyone who meets the age and
residency requirements, regardless of income. Lower-income OAS recipients who
qualify under an income test are eligible for an additional pension called the
Guaranteed Income Supplement (GIS). The GIS, which was introduced in 1967,
was originally designed as a temporary measure to help low-income seniors until the
CPP was fully functioning, but has become a permanent government benefit.
There are two basic rates of payment for the GIS. The first applies to single pensioners – including
widowed, divorced or separated persons – and to married pensioners whose spouses or common-
law partners do not receive either the basic Old Age Security pension or the
Allowance. The second applies both to legally married couples and couples living in common-law
relationships, where both spouses or common-law partners are pensioners. The GIS single rate
is higher than the GIS married rate. However, each spouse or common-law partner in a couple

is entitled to a benefit, so the combined benefits for a couple are higher than
those for a single person.
As of the 2nd quarter of 2011, the maximum monthly GIS benefit was $665.00 for a
single pensioner and $439.13 each for married pensioners. Like OAS, GIS
benefits are adjusted quarterly to reflect increases in the Consumer Price Index.
OAS recipients with no other income or a very limited income may be eligible for the GIS.
The amount of the supplement depends on the pensioner’s marital status and income. The
income does not include possessions, savings, investment assets, a home or property, or
the OAS pension, but does include income such as private pension income, employment
income, Employment Insurance benefits, CPP/QPP benefits, interest, dividends and rents.
If the pensioner is married or living common-law, the partners’ combined income is

taken into account to determine GIS eligibility. The GIS is income-tested and reduced
by 50 cents for every dollar of other income individuals receive. There is an exemption
for employment earnings to encourage labour market participation. The exemption used
to be 20 per cent of earned income up to $2,500, providing a maximum exemption of
$500. The 2008 federal budget fully exempted the first $3,500 of earnings.
Unlike the OAS pension, the GIS is not subject to income tax. The GIS is not payable outside
Canada beyond a period of six months, regardless of how long the person has lived in Canada.
Allowance
The Allowance (formerly known as the Spouse’s Allowance) provides money for
low-income seniors who:
• have a spouse or common-law partner (same sex or opposite sex) who receives or is
entitled to receive the Old Age Security pension and the Guaranteed Income Supplement;
• are 60 to 64 years old;
• are Canadian citizens or legal residents at the time the Allowance is approved
or when they last lived here;
• have lived in Canada since age 18 for at least 10 years.
The maximum Allowance is the sum of the OAS pension plus the GIS pension at the married
rate. As of the 2nd quarter of 2011, the maximum monthly Allowance was $965.98.
Allowance for the Survivor

The Allowance for the Survivor (formerly known as the Widowed Spouse’s
Allowance) provides money for low-income seniors who:
• are 60 to 64 years old;
• are Canadian citizens or legal residents at the time the Allowance is approved
or when they last lived here;
• have a spouse or common-law partner who has died;
• have lived in Canada after reaching age 18 for at least 10 years.

Benefits are payable until age 65 or until the person remarries. The maximum
monthly benefit, as of the 2nd quarter of 2011, was $1,070.78.
Allowance and Allowance for the Survivor payments are recalculated four times a
year to reflect increases in the Consumer Price Index. Individuals can apply
whenever their income reaches the qualifying range. Recipients must reapply each
year. These benefits are not considered as income for income tax purposes.
TABLE 8.1 SUMMARY OF BENEFITS
Maximum Monthly Benefit

Type of Benefit as of 2nd quarter of 2011
Basic OAS Pension $ 526.85
Guaranteed Income Supplement (Single person) $ 665.00
Spouse/common-law partner of:

Non-pensioner $ 665.00
Pensioner $ 439.13
Allowance recipient $ 439.13
Allowance
Regular $ 965.98
Survivor $ 1070.78
Government pension benefits are subject to change. For latest rates and amounts,
please visit http://www.servicecanada.gc.ca/eng/isp/oas/oasrates.shtml
Provincial Guaranteed Annual Income Supplement

Many provinces have established income-tested guaranteed annual income plans to provide
basic income in addition to that available under the federal Old Age Security program. Each
province or territory provides the difference between the maximum combined OAS/GIS
benefit and a somewhat higher income level set by the province or territory.
To obtain the maximum supplement, pensioners must qualify for the maximum OAS pension,
the maximum GIS pension, and the province’s or territory’s maximum provincial supplement.
For example, the Ontario GAINS (Guaranteed Annual Income System) program provides
monthly payments to qualifying pensioners on top of the federal OAS and GIS payments.
The maximum GAINS payment per month in the 2nd quarter of 2011 is $83 per person.
No application is necessary. If a person meets the eligibility requirements, benefits
will be determined automatically based on information the Ministry of Revenue
receives from Human Resources and Skills Development Canada and information
provided on the person’s annual income tax return.

Canada and Quebec Pension Plans

The Canada Pension Plan (CPP) was created by legislation in 1965 as a national social
insurance system providing retirement, disability and survivor benefits. The legislation allowed
individual provinces that provided a comparable pension plan to opt out of the federal plan. In the
same year, legislation in Quebec established the Quebec Pension Plan (QPP). The two plans,
which went into effect in 1966, are closely coordinated, and contributions to the CPP/QPP are
portable from one province to another. For both programs, same-sex common-law partners have
the same benefits and obligations as opposite-sex common-law partners.
Unlike contributions to a conventional pension plan, contributions to the CPP/QPP do not go

into an account to accumulate until the contributor retires. Instead, the plans are run on a
pay-as-you-go basis. This means that contributions made by today’s workers are used to fund the
CPP/QPP payments of today’s pensioners. Any accumulated CPP/QPP surplus is to be used as a
reserve for contingencies, but the reserve has been falling in recent years due to higher benefit
payouts, an aging population, declining fertility rates and increased claims for
disability pensions. As a result, there will probably be changes to the CPP/QPP in
future. Proposals for changing the plan include:
• increasing the required contributions;
• reducing benefits to recipients;
• clawing back payments after a certain income level (as with the OAS);
• raising the retirement age.
The first change has already been implemented to keep the CPP/QPP on a sound
financial footing. Benefits are also going to be actuarially reduced further (starting in
2012) for those who opt to take them before age 65.
Service Canada delivers the Canada Pension Plan program benefits, the Canada
Revenue Agency (CRA) collects the contributions and the CPP Investment Board
manages the investment of funds that are not required to pay current benefits.
The Régie des rentes du Québec administers the Quebec Pension Plan. The Quebec
Department of Revenue collects the contributions and turns them over to the Régie, which
keeps what it needs to pay current benefits and administration costs. The remaining funds
are deposited with the Caisse de dépôt et placement du Québec for investment.
PARTICIPATION IN THE CPP/QPP

Participation is compulsory for almost all Canadian workers and self-employed
persons between 18 and 65 who earn more than the year’s basic exemption (YBE).
The YBE for 2011 is $3,500. Neither employees nor self-employed persons may
contribute in any year in which they earn less than the YBE.
Employees or self-employed persons who continue working past 65 and up to 70 may
continue to contribute to the CPP/QPP, and delay receiving pension benefits until they turn
70. Employers whose employees regularly work outside Canada or Quebec may enroll
these employees as a group to continue their coverage during their absence from Canada.
Workers not covered by CPP or QPP include casual and migratory employees,
exchange teachers and members of a religious order under a vow of poverty.

CPP/QPP CONTRIBUTIONS
CPP/QPP contributions are based on earnings from employment or self-employment
only. Earnings on which contributions must be paid are those above the YBE and below
the year’s maximum pensionable earnings (YMPE). The YMPE for 2011 is $48,300.
An employee and an employer each contribute 4.95% of an employee’s earnings above the
YBE, subject to CPP/QPP maximums. The maximum employer-employee contribution for 2011
is $2,217.60 [or 4.95% of ($48,300 – $3,500)]. Self-employed taxpayers contribute the full 9.9%
of earnings up to the maximum limit of $4,435.20 [or 9.9% of ($48,300 – $3,500)].
Taxpayers who earn more than $48,300 a year may not make additional contributions
above the maximum limit. Excess contributions are refunded. Once a contributor has paid
into the CPP/ QPP, he or she has the irrevocable right to a pension based on his or her
years of contribution. The pension is paid out even if the contributor leaves Canada.
Retirement benefits, disability benefits and survivors’ benefits are available under CPP
and QPP. All benefits must be applied for. CPP/QPP benefits, except for death
benefits, are recalculated annually to reflect increases in the Consumer Price Index.
Employee and employer contributions are treated as non-refundable tax credits for income tax
purposes. All benefits paid under CPP/QPP are taxable income for the recipient.
CPP/QPP RETIREMENT BENEFITS
Eligibility
CPP and QPP contributors may choose to receive a monthly retirement pension for life beginning
at the age of 65, whether or not they have retired from regular employment. Contributors can
apply to receive their pensions between the ages of 60 and 65 but the amount of pension is
reduced by 0.5% for each month by which the recipient is under the age of 65. This reduction
affects the pension throughout the remainder of the pensioner’s life. For those who start the
pension at age 60, the monthly payment is 30 percent lower than if they had waited until they
turned 65. The penalty will rise to 0.6% a month over 5 years starting in 2012 so the maximum
reduction by 2016 will be 36% - 0.6% x 60 months (see Note below). The increase in the monthly
factor (monthly reduction) will be phased in as follows:
2012: 0.52; 2013: 0.54; 2014: 0.56; 2015: 0.58; 2016: 0.60
For example, assume that Vladamir turns 63 in 2013. He wants to receive his CPP
payments early. His CPP pension benefit would have been $500 a month at age 65,
but he will receive $435.20 a month instead. He will lose 0.54% a month for 24
months, so his pension will be reduced by 12.96% ($500.00 - $64.80).
A contributor may postpone applying for the pension until age 70. After age 65, the
amount of pension is increased by 0.5% for each month by which the recipient is over
65, to a maximum of 30%. This increase is payable throughout the life of the pensioner.
The amount of increased pension will be 0.7% a month over 3 years starting in 2011 so
the maximum increase by 2013 will be 42% - 0.7% x 60 months (see Note below). The
increase in the monthly factor (monthly increase) will be phased in as follows:
2011: 0.57; 2012: 0.64; 2013: 0.70

Note: In December 2009, the passing of Bill C-51 resulted in several changes to the CPP
including adjustments in benefit payments for those taking CPP early or late (the threshold age
being 65) to restore actuarial fairness, elimination of the work cessation test, changes to drop-out
rules, and mandatory contributions for early CPP benefit recipients who continue working.
The requirement to stop working or have a substantial reduction in earnings in order to get early CPP
benefits has been eliminated. So, an individual may continue to work while collecting CPP benefits
early. Likewise, the individual (and the individual’s employer) would have to continue contributing to
CPP until age 65. The additional contributions made after opting to take early benefits would result in
higher retirement benefits through what is known as Post-Retirement Benefit. The PRB will be added
to an individual’s CPP pension even if the maximum pension amount is already being received.
These provisions are designed to make the transition to retirement smoother and more seamless.
Almost all contributors are entitled to the general drop-out provision, which allows them to exclude
a portion of their zero or low earnings from the calculation of their retirement benefit. The drop-out
rules have been adjusted so that more years (up to 8 years) of low income or no income due to, for
example, taking care of family members or children, pursuing higher education or coping with
involuntary job losses would be “dropped” from the calculation of CPP benefits, thus resulting in a
higher amount of benefits than without the drop-out provision.
Benefit Payments
The amount of retirement pension is 25% of a contributor’s average monthly pensionable
earnings during the period when he or she was contributing to the plan. Pensions are
available to persons who have contributed to the CPP/QPP in at least one calendar year.
In 2011, the maximum monthly CPP/QPP retirement benefit payable to a 65-year-old

is $960.00, calculated by taking the average YMPE over the past five years (2007 to
2011), dividing by 12, and multiplying by 25%.
[($43,700 + $44,900 + $46,300 + $47,200 + $48,300) ÷ 5] ÷ 12 × 0.25 =
($230,400 ÷ 5) ÷ 12 × 0.25 = $46,080 ÷ 12 × 0.25 = $3,840 × 0.25 = $960.00
Therefore, the maximum monthly amount of retirement pension is $960.00.
Adjustments to the CPP/QPP Contributory Period

The provisions of CPP/QPP are based on a contributory period for each
individual. The contributory period begins:
• on January 1, 1966, or
• the day a contributor turns 18,
and ends:
• the month before the pension begins,
• the month of the contributor’s 70th birthday, or
• the month the contributor dies,
whichever comes first.

This period is important, because it helps determine certain benefit payouts to contributors.
The following adjustments to the contributory period may be made:
a) Any month in which a CPP/QPP disability pension was paid may be

excluded from the contributory period.
b) 15% of the lowest-earning years in the contributory period before age 65 may
be dropped (this will increase to 16% in 2012 and 17% in 2014). This
provision can compensate workers for periods when they were not working,
because of unemployment, illness or attendance at school.
c) Periods when the contributor stops working or his or her earnings are lower
while raising children under the age of seven may be excluded.
d) Low earning months after the age of 65 may be excluded.
Eliminating these periods increases the amount of the pension.
CPP/QPP DISABILITY BENEFITS

A contributor’s disability must be a physical or mental impairment that is both severe
and prolonged. Severe disability means that the contributor cannot pursue regular
gainful employment and prolonged disability means that such disability is likely either
to be of indefinite duration or to result in death.
Eligibility
A contributor becomes eligible for a CPP disability pension if he or she meets all of
the following conditions:
• he or she is considered disabled, according to CPP legislation;
• he or she has earned a specified minimum amount and contributed to the CPP
in four of the last six years OR contributed to the CPP for at least 25 years and
made valid contributions to the Plan during three of the last six years;
• he or she is under 65.
To be considered to have contributed sufficiently to the Québec Pension Plan, a
person must have:
• contributed for at least 2 of the last 3 years in his or her contributory period
• contributed for at least 5 of the last 10 years in his or her contributory period
• contributed for at least half of the years in his or her contributory period, but
not less than 2 years
Benefit Payments
The CPP/QPP disability pension consists of a flat-rate component and an earnings-related
component. The latter is equal to 75% of a retirement pension calculated as if the contributor
had reached 65 in the month when the disability pension became payable. The maximum
monthly disability benefit for 2011 is $1,153.37 for the CPP and $1,153.34 for the QPP.

Disability pensions begin four months after the month in which the person became disabled,
and they are payable every month until the beneficiary recovers from the disability, reaches
65 or dies. When the recipient of a disability pension reaches 65 or takes early retirement
between the ages of 60 or 64, the pension is automatically converted to a retirement
pension. The four-month waiting period is waived if the disability occurs within five years of a
previous disability. The first payment begins in the month following the date of disability.
A disabled contributor’s unmarried and dependent children under 18, or between

18 and 25 (under 18 only for QPP) who are attending school full-time, are also
eligible to receive monthly benefits. In 2011, the monthly benefit for each child is
$218.50 under CPP and $69.38 under QPP.
CPP/QPP DEATH BENEFITS, SURVIVOR BENEFITS AND CHILDREN’S BENEFITS

A lump-sum death benefit, a survivor benefit and children’s benefit are provided to the estate or
the survivors of a CPP contributor who has died. To qualify, the deceased must have contributed
to the CPP for at least three years. If the CPP contributory period was longer than nine years, the
contributor must have made contributions in one-third of the calendar years in the contributory
period, or 10 calendar years, whichever is less. The death of a QPP contributor gives entitlement
to survivor benefits if the deceased contributed to the QPP for at least one-third of the period
during which he or she could have contributed and at least three years OR for 10 years.
Death Benefits
Following the death of a qualified CPP/QPP contributor, a lump-sum death benefit is payable
to his or her estate. If there is no estate, the person responsible for the funeral expenses, the
surviving spouse or common-law partner or the next of kin may be eligible, in that order. The
amount payable under the CPP is equal to six times the actual retirement pension
the contributor was receiving or would have received, to a maximum of $2,500.
The QPP death benefit is a lump-sum payment of $2,500. The death benefit
payable under the QPP may be paid to the person responsible for the funeral
expenses, up to the amount of such expenses but not exceeding $2,500,
provided the application is filed within 60 days of the contributor’s death. If no
application is filed within 60 days, the benefit is paid to the contributor’s estate.
Survivor Benefits
Under the CPP, following the death of a qualified contributor, the spouse or a common-law
partner who lived with the contributor and was represented as the contributor’s partner may
apply for a surviving spouse’s pension. As of July 2000, same-sex partners also qualified for
CPP survivor benefits for a contributor who died on or after January 1, 1998. On March 1, 2007,
the Supreme Court of Canada ruled in Canada (Attorney General) v. Hislop that the federal
government’s current legislation governing same sex pension benefits was unconstitutional. The
legislation only allowed CPP survivor benefits to same-sex partners widowed after January 1,
1998. This specific date was chosen by the federal government in 2000 when it enacted new
laws to extend pension benefits to same-sex couples. The Supreme Court declared that
allowing benefits only to same-sex survivors whose partners had died after 1998 was
unconstitutional. However, the Court limited benefits to those whose same-sex partners passed
away after 1985 (the date that section 15 of the Charter of Rights and Freedoms providing
equality rights was enacted) and limited back payments to a period of 12 months.

Under the QPP, a pension is paid to a spouse married or in a civil union, provided that he or
she never legally separated from the contributor. If the contributor was not married, not in a
civil union or separated at the time of death, a pension can be paid to a common-law spouse
who lived with the contributor in a conjugal relationship for at least three years before the
contributor’s death or for at least one year if they had a child (by birth or adoption) together.
A surviving spouse does not lose entitlement to the deceased spouse’s pension upon remarriage. If
a spouse has been widowed more than once and is, thus, eligible for more than one survivor’s
pension, the higher (or highest, if there are more than two) of the amounts will be paid.
CPP Survivor Benefits

The amount a surviving spouse or common-law partner will receive depends on:
• whether the spouse or common-law partner is also receiving a CPP disability
or retirement pension;
• how much, and for how long, the contributor has paid into the plan;
• the spouse or common-law partner’s age when the contributor dies.
If the survivor is: The benefit is:
Age 65 or over Equal to 60% of the deceased contributor’s retirement

pension, if the surviving spouse or common law partner is
not receiving other CPP benefits.
Between the ages of 45 and 64, OR Made up of a flat-rate benefit plus 37.5% of the deceased
is under age 45 and has at least one contributor’s pension, if the surviving spouse or common
dependent child or is disabled law partner is not receiving other CPP benefi ts.
Between the ages of 35 and 45, and Made up of a flat-rate benefit plus 37.5% of the
has no dependent children, and is not deceased contributor’s pension.
disabled
Reduced by 1/120th for each month the surviving
spouse or common law partner’s age is less than 45 at
the time of the contributor’s death. This reduction
applies for as long as the pension is paid.
Under age 35, not disabled, with Not paid until the spouse or common law partner
no dependent child reaches age 65 or becomes disabled.
QPP Survivor Benefits

The amount of a surviving spouse’s pension varies according to the following factors:
• the contributions that the deceased made to the Plan;
• the surviving spouse’s age;
• whether the surviving spouse supports dependent children of the deceased person;
• whether the surviving spouse is disabled;
• whether the surviving spouse is already receiving a retirement or a disability pension.

Children’s Benefit
If a qualified contributor to the CPP/QPP dies leaving unmarried dependent children,
monthly benefits are also payable to those children. The children must be under 18, or
between 18 and 25 (under only 18 for QPP) and attending school full-time. In 2011, the
monthly benefit for each child is $218.50 under CPP and $69.38 under QPP.
CPP/QPP CREDIT SPLITTING UPON DIVORCE OR SEPARATION

The Canada Pension Plan recognizes that in a legal marriage or common-law
relationship, both spouses or common-law partners share in the building of their
assets and entitlements. Among these are Canada Pension Plan pension credits.
When a relationship ends, the Canada Pension Plan pension credits which the
couple built up during the time they lived together can be divided equally between
them. This division is called “credit splitting”.
Credits can be split even if one spouse or common-law partner did not pay into
the Canada Pension Plan.
Under the CPP/QPP, pension credits earned during a marriage or common-law relationship
may be split between two spouses after divorce or separation, if they have lived together for
at least 12 consecutive months. To be recognized as de facto spouses in Quebec, the QPP
specifies that the spouses must have lived as a couple for a certain period of time - one year
if they have a child or three years if they do not have any children. These credits are used to
calculate future CPP/QPP benefits. Credit splitting between former spouses or common-law
partners means that for the period they lived together, CPP/QPP credits can be “equalized.”
Splitting CPP/QPP credits can make a former spouse eligible to receive CPP/QPP benefits
for which he or she would not otherwise qualify or increase the amount of the benefit a
former spouse receives. There is no application deadline for splitting pension credits if a
marriage ends in divorce or a legal annulment. If the division of credits involves a common-
law relationship, the former partners must apply within four years of their separation.
ASSIGNMENT OR SHARING OF CPP/QPP RETIREMENT PENSIONS

Spouses in an ongoing relationship can apply to share their CPP/QPP retirement pension
payments, as long as both are at least 60 and receive a CPP pension. This may result in tax
savings. If only one spouse has been a CPP contributor, they can share that one pension.
The assignment of a retirement pension redistributes a couple’s CPP/QPP retirement pension or

pensions. The amount of pension that each receives depends on the amount of time the couple
has lived together and their respective contributory periods. The overall household pension
amount will not change, but the tax payable by the partners may change. Up to 50% can be
redistributed by each partner. However, both spouses must agree to redistribute their pensions.

Example: Peter and Karen have been married for 20 years and both have been contributing
to the CPP for 30 years. Peter is in a higher tax bracket than Karen. Peter receives $600 a
month in CPP pension and Karen receives $300 a month in CPP pension.
This is how CPP pension sharing would work for Peter and Karen:
Peter gets $600 a month in CPP. Since he and Karen have been married for 2/3 of their
contributory period, $400 (2/3 of $600) of Peter’s CPP is available for sharing.
Karen gets $300 a month in CPP. Since she and Peter have been married for 2/3 of their
contributory period, $200 (2/3 of $300) of Karen’s CPP is available for sharing.
So, $600 is available in total for CPP pension sharing and each would get 50% or $300 as a result.
After the pension sharing:
• Peter would get CPP of $500 [$300 from sharing + $200 based on the CPP contributory period
(10 years) prior to marriage]
• Karen would get CPP of $400 [$300 from sharing + $100 based on the CPP contributory period
(10 years) prior to marriage]
PORTABILITY OF CPP/QPP BENEFITS

Both the CPP and QPP plans are portable. If a CPP contributor moves to Quebec,
his or her record of earnings and contributions is merged with the QPP. The reverse
situation applies to QPP contributors who move elsewhere in Canada.
STATEMENT OF CONTRIBUTIONS
Once a year, a CPP/QPP contributor may ask for a Statement of Contributions or the Statement of
participation in QPP from Service Canada. If a person is 30 years of age or older, the CPP Statement
gives an estimate of how much that person’s monthly retirement pension could be at age 65 based on
average earnings since age 18, if earnings continue at the same level until age 65. CPP/QPP
contributors should periodically check their statement for accuracy and completeness.
TABLE 8.2 SUMMARY OF CPP AND QPP BENEFITS -

MAXIMUM MONTHLY BENEFIT - 2011
CPP QPP
Retirement Pension (Age 65) $ 960.00 $ 960.00
Disability Pensions
1) Contributor’s Pension $ 1,153.37 $ 1,153.34
2) Child’s (children) Pension $ 218.50 $ 69.38

MAXIMUM MONTHLY BENEFIT - 2011 – Cont’d
CPP QPP
Survivor Benefits
1) Death Benefit (maximum lump sum) $ 2,500.00 $ 2,500.00
2) Survivor Benefits
i) Age 65 and Over $ 576.00 $ 576.00
ii) Age 45 to 64 $ 529.09 $ 793.34
iii) Under age 45
a) not disabled, no child $ 529.09 * $ 470.98
b) not disabled, with child $ 529.09 $ 762.35
c) disabled $ 529.09 $ 793.34
* Between the ages of 35 and 45 where survivor has no dependent children and is not disabled, the CPP
survivor benefit is reduced by 1/120 of the amount for each month the surviving spouse or common law
partner’s age is less than 45 at the time of contributor’s death.
CPP/QPP benefits are subject to change. For latest rates and amounts, please visit
http://www.servicecanada.gc.ca/eng/isp/pub/factsheets/rates.shtml
http://www.rrq.gouv.qc.ca/en/retraite/rrq/regime_chiffres/pages/regime_chiffres.aspx
CHANGES TO THE OLD AGE SECURITY PROGRAM AND THE CANADA PENSION PLAN
The following changes to the Old Age Security program and the Canada Pension
Plan took effect on July 31, 2000:
1. Same-sex, common-law partners have the same benefits and obligations as

opposite-sex, common-law partners.
2. The programs called Spouse’s Allowance and Widowed Spouse’s Allowance
are called the Allowance and Allowance for Survivor.
3. Common-law couples, whether opposite-sex or same-sex, are defined as two people
who have been living together in a conjugal relationship for at least one year. Common-
law partners must sign a declaration and provide evidence such as tax returns, wills or
joint bank accounts to prove that they live together in a common-law relationship.
Under the QPP, the Régie des rentes du Québec considers applications for a surviving
spouse’s pension for same-sex spouses if the death occurred on or after April 4, 1985.

EMPLOYER-SPONSORED REGISTERED RETIREMENT PLANS
LEARNING OBJECTIVES
• differentiate between defined benefit plans and defined contribution plans;
• describe how a defined benefit plan works, including funding the plan, the payments
received, and legislative restrictions on the maximum amount a person can receive;
• describe how a defined contribution plan works, including funding the plan, tax benefits,
payments received, legislative restrictions on the maximum amount that can be contributed
each year, and how investment options may be provided for the employee;
• describe other types of employer-sponsored registered retirement plans, including
Individual Pension Plans, Deferred Profit-Sharing Plans and Group RRSPs.
The Evolution of Employer-Sponsored Pension Plans

When employer-sponsored pension plans were created, the money used to pay
pensions did not come from investments. When an employee retired, the employer paid
a percentage of his or her former salary from company revenues. Over time, however,
pension expenses increased to the point at which they became a financial burden to
employers. Companies began to set aside money to be invested for the benefit of
retired employees. Eventually, governments-imposed pension funding requirements on
employers to protect workers from an arbitrary cut-off of their pension privileges.
Today, pension plans are an integral part of the financial system. Trust
companies, insurance companies and pension investment firms are among the
largest traders of securities on behalf of pension funds. For example, the Ontario
Teachers Pension Plan is responsible for investing $107.5 billion in assets.
Registered Pension Plans

A registered pension plan (RPP) is a trust, registered with CRA, established by
an employer to provide pension benefits for its employees when they retire.
There are two main types of registered pension plans:
1. A defined-benefit plan provides a set level of pension income after retirement. Although
the pension benefit at retirement is known, the contributions required to fund the benefit
are not known. The benefit may be a flat dollar amount or a certain percentage of income
earned for each year of pensionable service. However, the plan member knows what his
or her benefits will be (in current dollar terms) when he or she retires.

2. In a defined-contribution plan, the worker’s contributions to the plan are known, but
the final benefit is not known. A defined-contribution plan pays whatever level of
pension the amount in a member’s account will buy at retirement, often in the form of an
annuity. The pension is not predetermined. It depends on how much the employer and
the employee contribute, the earnings on those contributions, and how good a pension
those accumulated contributions and earnings will buy at retirement. Defined-
contribution plans are also referred to as money purchase plans.
Up to specified dollar limits (which will be discussed later) and if made within
specified time limits, employer and employee contributions are tax-deductible.
Employer contributions to either type of plan must be made within the taxation year,
or up to 120 days after the end of the taxation year. Employee contributions must
be made by December 31 in the year a deduction is to be claimed.
Until recently, most Canadian workers who were covered by a pension plan had a defined-
benefit plan. However, tax and accounting rules have complicated the administration of such
plans, prompting many employers to switch to defined-contribution plans. With a defined-
contribution plan, the employer does not need to be concerned with the future funding of an
employee’s pension. Employers starting an employee pension plan today usually choose a
defined-contribution plan, because it is simpler to administer and poses little risk.
Employees in a defined-contribution plan have a choice in how their money is
invested but if they make the wrong choice, they suffer the consequences.
Defined-Benefit Pension Plans

There are three types of defined-benefit plans:
1. Flat benefit plans
2. Career average plans
3. Final average plans
FLAT BENEFIT PLANS

This is the simplest type of defined-benefit plan. The monthly pension is a specified number of
dollars for each year of service. For example, a formula of $75 per year of service, after 30 years
of service, would produce a pension of $2,250 a month ($75 × 30 years). This type of pension is
common among unionized employees, where wage levels are generally uniform.
Advantages
• The formula is easy to understand.
• The plan is normally funded entirely by the employer, and the level of benefits is
usually increased as a result of ongoing employee-employer negotiations.
• The pension paid is in addition to OAS and CPP/QPP benefits.

Disadvantages
• The flat benefit plan does not differentiate between the earnings levels of plan participants.
• The amount paid by the plan is established in terms of today’s dollar values. If
the pension amount is not regularly increased by negotiation, the pension
payable at retirement would be eroded by inflation.
CAREER AVERAGE PLANS

The pension is calculated as a percentage of an employee’s earnings over the course of his or her
career (while in the plan). Employees may contribute a fixed percentage of their salary (such
as 5%) to this type of plan. Employer contributions required to fund the defined benefit
vary according to factors such as investment yield, mortality and employee turnover.
For example, an employee may accumulate a career average pension of 2% of

earnings for each year of service while in the plan. If the employee has 30 years of
service and average monthly earnings of $4,000 over the 30 years, the pension
payable at retirement would be $2,400 a month (2% × $4,000 × 30 years).
Advantages
• Career average plans are easily integrated with CPP/QPP benefits. (When an
individual receives a pension from one plan, this may affect the benefits that person is
entitled to receive from another plan.) Integration with CPP/QPP may be achieved
through a direct or an indirect reduction method. The indirect reduction method, which
is more common, usually consists of two contribution or benefit rates – a lower rate for
incomes below the yearly maximum pensionable earnings (YMPE), and a higher rate
for incomes above that level. For example, the pension amount per year of service may
be 1.3% of earnings up to the YMPE level, and 2.0% of earnings above that level.
Under the direct reduction method, contributions or benefits are lowered by an amount
equal to a portion or the total amount of CPP/QPP contributions or benefits.
• The plan gives equal weight to the employee’s earnings throughout his or her career.
• Many employers improve career average plan benefits by updating the base
year in the pension formula. For example, if the base year is moved forward to
2008, all service before 2008 will be based on 2008 earnings, rather than on
the actual salary received when the service was performed.
Disadvantage
• Like the flat benefit plan, the pension payable at retirement may be eroded by
inflation, if the base year of the plan formula is not regularly updated.
The 2007 federal budget included a phased retirement arrangement. Beginning in
2008, an employee is entitled to receive a partial pension income (up to 60% of their
accrued pension) from a defined benefit registered plan while continuing to work part-
time and earn future pension benefits. This measure only applies to employees who
are 55 years of age and over and entitled to an unreduced pension.

FINAL AVERAGE PLANS

In a final average plan, like a career average plan, the pension is based on the employee’s
length of service and average earnings. However, instead of calculating the earnings over the
employee’s career, final average plans use only certain years of service. The pension
may be based on the average of the best five consecutive years of earnings in the
employee’s last 10 years of employment, or the average of the best three consecutive
years of earnings in the employee’s last five years of employment.
Using the best average years is preferable to using the last few years, if the employee
experiences a drop in earnings close to retirement. Employees often contribute a
percentage of their salary to final average plans. The employer’s costs are variable.
Advantages
• Final average plans are easily integrated with CPP/QPP benefits.
• By providing a pension based on earnings near retirement, these plans

provide better protection against inflation, at least up to retirement.
Disadvantage
• If the contributor’s earnings decline as retirement approaches, he or she may receive a
lower pension payment than that calculated using the career average method.
Career average and final average plans are very popular, and are used for many
Canadian workers registered in pension plans.
Defined-Contribution Plans (Money Purchase Plans)

In this type of plan, the money manager provides a list of possible investments in which
pension contributions can be invested. Each employee chooses investments that meet
his or her risk tolerance and long-term retirement goals. Often, employees contribute a
percentage of their salary to the plan and the employer matches it.
ADVANTAGES
• The regulations for money purchase plans are not as onerous as those for
defined-benefit plans.
• Employees can usually direct the funds to their choice of investment vehicles.
• This type of plan is easy to understand and easy to administer, and has fixed
annual costs, so it is especially popular with small businesses.
• The employer’s responsibility and risk is limited.
DISADVANTAGES
• The final pension amount is unknown until retirement.
• The final pension may be much smaller than expected, if the investments
chosen have not performed well.

• Members retiring under practically identical employment circumstances

may receive substantially different pensions.
INVESTMENT OPTIONS PROVIDED BY EMPLOYER

Before offering a defined-contribution plan, employers should consider the
investment framework of the plan:
• The employer must offer a sufficient number and variety of investment

options (fixed-income, equity, balanced portfolio).
• The performance of the investments must be compared to appropriate benchmarks.
In providing a defined-contribution plan, employers minimize their future risk by placing the
onus of actual investment selection on the individual plan member. However, employees have
varying degrees of investment knowledge and experience, and may hesitate to ask for advice.
By law, the sponsor of a defined-contribution plan is a fiduciary in relation to the plan member.
This means the employee should be able to look to his or her employer for investment advice.
Therefore, while employers are not required to provide investment education, it is a prudent
move, because it demonstrates a desire to help employees reduce their risk exposure.
Hybrid Plans
Hybrid plans involve elements of both defined-benefit and defined-contribution plans.
One common arrangement is a defined-benefit plan, accompanied by a money purchase
vehicle for additional voluntary contributions. Hybrid plans may also provide a pension that
takes the greater amount of a defined-benefit plan and the pension that may be purchased
by a defined-contribution plan. The defined-benefit plan has a formula that pays out a
percentage of final earnings, and the employee also contributes to a defined-contribution
plan. The plan that would pay the employee the largest pension is paid out.
Maximum Pension Benefit
DEFINED-BENEFIT PLAN
The pension benefit used to be 2% of the recipient’s best three-year-average
earnings, multiplied by the number of years of service up to a maximum of
$1,722.22 for each year of service. While the 2% is still used, the maximum dollar
amount was $2,333 in 2008, $2,444 in 2009, $2,494 in 2010 and $2,552 in 2011.
The maximum amount of pensionable income that could be taken into consideration
when funding an RPP used to be $86,111 (based on $86,111 × 2% = $1,722.22). For
2011, it is approximately $127,600 (based on $127,600 × 2% = $2,552).
DEFINED-CONTRIBUTION PLAN
There is no maximum pension under a defined-contribution plan. The value of the
pension is based on the amount that can be purchased by the total accumulation
of contributions plus earnings at the time of retirement.

Normal Form of Pension

This is the form of payment defined in the plan that will be paid unless the employee chooses
another form. If the member has a spouse, in most provinces, the pension is reduced to 60% after
one spouse dies. This is referred to as a joint-and-last-survivor pension and must be paid in most
jurisdictions if the employee is married, unless both the employee and the spouse sign a waiver.
Guarantee Period
Pension payments can be guaranteed for the life of the contributor or for a minimum payment period,
such as 10 years. Some registered pension plans are insured, and a life insurance company
guarantees that stipulated benefits will be paid in the future. Ontario, for example, has set up
the Pension Benefits Guarantee Fund to protect the pension benefits of workers
in case of an employer/pension plan sponsor becoming insolvent.
Early Retirement Considerations

Although most pension plans pay money on a periodic basis after the contributor retires, there
are exceptions. Some individuals are entitled to a small pension payment and pension legislation
may allow the commutation of the pension (that is, the pension payable periodically is converted
into a lump sum and paid out). This saves the employer from having to administer the pension for
the employee, and allows the employee either to use the cash immediately or place the money
with another financial institution where the employee already has invested some funds.
When a member of a pension plan leaves an employer before retirement, he or she

must transfer the commuted value of the pension to a locked-in retirement account
(LIRA) or locked-in RRSP. Ordinarily, a locked-in plan does not allow the money to
be withdrawn before retirement, unless the money is:
• transferred to another locked-in RRSP;
• transferred to an employer-sponsored pension plan;
• used to purchase a life annuity.
Contribution Limits
In the following formulas, compensation is generally defined to include salary,
wages and other employment earnings.
DEFINED-BENEFIT PLAN
Combined employer/employee contributions are set at a level recommended by
a qualified actuary to ensure that the plan is adequately funded. The Minister of
National Revenue must approve the actuarial recommendation.
Employee current service contributions are restricted to the lesser of the following amounts:
• 9% of the employee’s compensation for the year, or

• $1,000, plus 70% of the employee’s pension adjustment (see below) for the year.

DEFINED-CONTRIBUTION PLAN
The combined employer/employee contributions cannot exceed the lesser of
the following amounts:
• 18% of the employee’s current year compensation; or
• the money purchase plan contribution limit set by the government for the year.
The annual maximum contribution limit was $21,000 in 2008, $22,000 in 2009,
$22,450 in 2010 and is $22,970 in 2011.
PENSION ADJUSTMENT (PA)

The pension adjustment (PA) is the amount of contributions made by, or the value of benefits
accrued to, a member of an employer-sponsored retirement plan for a calendar year. The
pension adjustment enables an individual to determine the amount he or she can contribute to
an RRSP, without exceeding the annual contribution limit for all plans combined.
The pension adjustment for a defined-benefit plan participant is determined by

the following formula:
(Benefit Entitlement × 9) – $600
The multiple of 9 is used to equate the expected benefits from a defined-benefit plan to
those of a defined-contribution/money purchase plan. The federal government has
determined that contributions of 18% of earnings over an individual’s career should be
sufficient to provide a pension of 2% of pre-retirement earnings per year of service. The
Maximum Pension Benefit for defined-benefit plans is $2,552 in 2011. This – using the
multiple factor of 9 – is equal to the contribution limit for Money Purchase Plans of $22,970
($2,552 × 9) or maximum pensionable earnings of $127,600 (based on $127,600 × 18% =
$22,970). The 2% rate is considered an appropriate limit for tax-assisted retirement saving.
The benefit entitlement in the formula is specified in the pension plan document
and is the approximate amount of pension accrued in the year, based on current
pensionable earnings. Employee contributions are not included. The amount
calculated using the formula cannot be negative.
The pension adjustment for a defined-contribution plan is the aggregate of
employer and employee contributions to the plan.
Under a deferred profit sharing plan (DPSP), the PA is the amount of the
employer’s contributions.
PAST SERVICE PENSION ADJUSTMENT (PSPA)

Employers who offer defined-benefit plans may upgrade them by, for instance,
crediting an individual with additional post-1989 pensionable service or amending
the plan to retroactively increase the benefit formula (say from 1% of earnings to
1.5% of earnings) for years of pensionable service after 1989.
When this happens, an employer may make additional contributions to an employee’s plan to
provide increased benefits. The difference between the pension adjustment under the old plan
and that under the revised plan is called the past service pension adjustment (PSPA).

A PSPA is required to maintain the overall limit on tax-assisted retirement savings of 18% of
income by reducing an individual’s RRSP contribution room by the amount of the PSPA.
PENSION ADJUSTMENT REVERSAL (PAR)

PAR is used to restore an individual’s RRSP room when a member terminates their
membership in a registered pension plan or deferred profit sharing plan (DPSP). The
key element in determining if an individual is eligible for a PAR is membership. A PAR
is calculated when membership is terminated and not when employment is terminated.
For example, two members terminate their employment on November 1, 2011. Employee A
transfers his/her benefits to a locked-in RRSP on December 17, 2011 and employee B decides to
leave his/her entitlement in the plan until he/she retires. Employee A has terminated membership
and is therefore entitled to a PAR for the year 2011. Employee B still has an entitlement to
benefits under the plan and therefore is still a member and not eligible for a PAR.
In a DPSP or money purchase pension plan, the PAR is the amount of the employer
contributions that are unvested at termination of membership. In a defined benefit
pension plan, the PAR is generally the difference between:
• the PAs and PSPAs earned to termination of membership, and
• the commuted value of benefits.
REPORTING REQUIREMENTS
Employers and pension plan administrators are required to calculate and report a plan
member’s pension adjustment on the employee’s T4 by the end of February each year.
Using this information, CRA calculates the individual employee’s RRSP contribution room and
notifies the employee. Because of the timing of this reporting, a taxpayer’s RRSP contribution
room for a year is determined by his or her pension adjustment for the previous year.
PSPA and PAR amounts are also reported by employers to CRA on specified
information slips - PSPA on T215 and PAR on T10. Plan administrators must also
file annual information returns for pension plans by the end of April each year, as
well as actuarial reports for defined-benefit plans.
Registered Pension Plans: Regulatory Climate

Government regulations affect the benefit security and taxation of registered pension plans.
Registered pension plans must be registered under one of the provincial pension benefits acts, if the
plan covers employees in a province that has passed such legislation, or the Pension Benefits
Standards Act, if the business is under federal jurisdiction. The acts regulate benefit security,
including funding requirements, benefit entitlement, investments, disclosure and audits.
Pension plans must also be registered federally with CRA under the Income Tax Act. This
registration allows employer and employee pension contributions to be tax-deductible up to
certain maximums, and exempts the pension plan’s income from taxation.
Plans for employees in all provinces except Prince Edward Island and for employees
under federal jurisdiction must comply with the provisions of the applicable Acts.
Pension legislation has not been enacted in PEI.

Some pension benefits acts were first enacted many years ago when economic and social
circumstances were different from the way they are today. Since then, job mobility,
inflation, increases in life expectancy, inequities between pension plans and other factors
have forced governments to revise their pension benefits acts. Whereas pension plans
were once considered a benefit to long-service employees for services rendered, today
they are generally considered to represent employees’ deferred wages.
Changes to legislation have affected, among other things, pension eligibility, vesting, portability
and mandatory survivor pensions. Vesting is particularly important; this is the employee’s right to
employer contributions made on his or her behalf while the employee is enrolled in the plan.
TABLE 8.3 KEY ASPECTS OF PENSION BENEFITS STANDARDS ACT (PBSA)
Pension Benefits Standards Act, 1985 (An Act respecting pension plans organized and
administered for the benefit of persons employed in connection with certain federal works,
undertakings and businesses)
Under this Act, the federal government supervises private pension plans covering federally
regulated areas of employment including banks, airlines, interprovincial and international
transportation, and telecommunications. Provinces have their own pension benefits legislation
and many provisions in the provincial acts are similar to those in the PBSA. For the latest
details, a pension specialist should be consulted.
Eligibility for Membership

Full-time employees: 24 months of continuous employment
Part-time employees: 24 months of continuous employment and earnings equal to 35% of
YMPE in each of two consecutive calendar years after December 31, 1984
A pension plan may provide, in respect of employees who are engaged to work on a full-
time basis, that membership in the plan is compulsory, except for employees who, because
of their religious beliefs, object to becoming members of the plan.
Vesting of Benefits (the point at which a terminating employee is eligible for the pension
earned by the employer’s contribution to the date of termination)
Two years’ membership
Minimum Pension Benefit Credit

In the case of a defined benefit plan, where
a) a member retires,
b) a member ceases to be a member,
c) a member dies, or
d) the whole or part of the plan is terminated,
the member’s pension benefit credit shall be not less than the aggregate of the member’s
required contributions together with interest.

TABLE 8.3 KEY ASPECTS OF PENSION BENEFITS STANDARDS ACT (PBSA) -- Cont’d
Marriage or Common-Law Partnership

A pension benefit payable to the spouse, former spouse or former common-law partner of a
member or former member or to the survivor of a deceased member or former member shall
not terminate by reason only that the spouse, former spouse, former common-law partner or
survivor marries or enters into a common-law partnership.
Mandatory Survivor Benefits after Retirement (continuation of pension to a surviving

spouse after death)
A pension benefit that commences to be paid on or after January 1, 1987 to a member or former
member of a pension plan who has a spouse or common-law partner at the time the pension
benefit commences to be paid shall be in the form of a joint and survivor pension benefit.
A pension benefit may be reduced by reason of the death of either spouse or common-law
partner, to an amount not less than 60 percent of the amount of the pension benefit that would
have been payable in respect of the member or former member had the death not occurred.
Pre-Retirement Death Benefit

The survivor, if any, is entitled to that portion of the pension benefit credit to which the
member would have been entitled on the day of death if the member had terminated
employment on that day and had not died.
A pension plan may provide that a survivor may, after the death of a member or former
member, surrender, in writing, the pension benefit or pension benefit credit to which the
survivor is entitled under this section and designate a beneficiary who is a dependant of the
survivor, member or former member.
Portability of Pension Benefit Credits

If a member, before becoming eligible to receive an immediate pension benefit, ceases to be a
member of a pension plan or dies, the member or the survivor is entitled:
a) to transfer the member’s pension benefit credit or the survivor’s pension benefit credit,
whichever is applicable, to another pension plan, if that other plan permits,
b) to transfer the member’s pension benefit credit or the survivor’s pension benefit credit, whichever
is applicable, to a retirement savings plan of the prescribed kind for the member or survivor, or
c) to use the member’s pension benefit credit or the survivor’s pension benefit credit, whichever
is applicable, to purchase an immediate or deferred life annuity of the prescribed kind for the
member or survivor.
Pensionable Age
The earliest age (taking into account the period of employment with the employer or the
period of membership in the pension plan, if applicable) at which a pension benefit is payable
to the member under the terms of the pension plan without the consent of the administrator
and without reduction by reason of early retirement.
Early Retirement
Notwithstanding the pensionable age specified by a pension plan, members of the plan shall be eligible,
commencing ten years before pensionable age, to receive an immediate pension benefit based on
the period of employment and salary up to the actual retirement date, but a plan is not required to
provide an immediate pension benefit commencing earlier than ten years before pensionable age.

Priorities, Objectives and Constraints in Establishing a Pension Plan

When establishing a pension plan, employers must consider the following:
COMPARABILITY WITH PEER GROUP PLANS

Usually, employers want to establish a pension plan that is competitive with those of
other employers in the same sector or industry. To do so, they must identify their
own peer group, set an objective (average, above average, top quartile) and survey
the key features of the peer groups’ plans.
ADEQUATE RETIREMENT INCOME

Employers want to ensure that employees receive an adequate retirement income.
To do this, they must develop employee profiles to determine their anticipated
retirement needs and set total income targets, taking into account income from all
sources and existing government and corporate programs.
EQUITY
The pension plan should be internally equitable. Within various employee groups,
functions and levels, an employer must ensure that pension benefits are fair, that is,
similar benefits are provided for employees who do similar work.
CONSIDERATION FOR SPECIAL EMPLOYEE CIRCUMSTANCES

Employers may consider special employee circumstances and include optional elements
to address such circumstances. For example, a newly introduced plan might:
• waive eligibility requirements for long-service employees;

• give credit for service before the plan takes effect;
• offer a different benefit formula for executives, or for hourly and salaried employees;
• offer continued pension accrual during periods of total disability;
• subsidize early retirement, perhaps by offering a percentage reduction instead
of an actuarial reduction.
ADMINISTRATIVE SIMPLICITY
The best plans are relatively simple to administer and include a program of
effective communication to help employees understand the plan’s provisions.
POPULARITY
Employers will want to check a proposed pension plan for any unsatisfactory elements,
review for any major gaps and poll employee attitudes to determine satisfaction.
PRACTICALITY
Costs are a prime consideration when determining a plan. The plan must be within
budget and, in a public company, acceptable to shareholders. The plan should be
tax-effective and must satisfy legal requirements.

Tax Rules Applicable to Retirement Income
PENSION PAYMENTS
Pension income from the following sources is fully taxable in the recipient’s hands:
• OAS payments (but not GIS payments);
• CPP or QPP payments;
• employer pension plan payments;
• pension income received from a foreign country (such as Social Security
payments from the United States).
LUMP-SUM PAYMENTS OR WITHDRAWALS FROM RRSP

Lump-sum payments from RRSPs are taxable in the recipient’s hands, unless transferred either
into another RRSP or into an acceptable annuity, in which case, the annuity payments are taxable
as received. Lump-sum cash withdrawals from an RRSP are subject to withholding tax by the
financial institution unless the proceeds are directly transferred to another RRSP.
CPP/QPP CONTRIBUTIONS
Contributions made to CPP and QPP up to stipulated limits are non-refundable tax
credits for the year in which they were made. Any payment over the limit is refunded.
Individual Pension Plans (IPPs)

An individual pension plan (IPP) is a registered pension plan structured for one
person, established by a person’s employer or an owner-manager of a small
business conducting business through a corporation.
IPPs are defined-benefit plans and, therefore, specify a certain level of pension payments
to the plan holder. The employer is responsible for making annual contributions. Most
IPPs are non-contributory. Setup and administrative costs, while tax deductible, are high.
An IPP permits higher tax-deductible (by the employer) contributions than those allowed
under an RRSP. As the member of the IPP gets older, the level of contributions required to
fund the plan increases, as there are fewer years for the funds to accumulate. Compared to
an RRSP, the increase in retirement savings provided by an IPP can be substantial.
Contributions must be calculated by an actuary based on the age of the employee, benefit
formula, earnings history and mandated actuarial assumptions.
There are two types of IPPs:

• a connected person plan for owner-managers who own more than 10% of any class of
the shares of the company or who do not deal at arm’s length with the plan sponsor;
• a non-connected person plan for those who are not shareholders or who own
less than 10% of the shares.
IPPs are often used to attract or retain senior management personnel. IPPs are not available
to partners, sole proprietors or to self-employed individuals who have no employees.

Based on actuarial projections and the high costs of setting up and administering
such plans, IPPs are mainly attractive to those between 40 and 60 years of age who
earn more than $124,722 a year. An IPP plan holder may contribute at the most
$600 to his or her own RRSP or a spouse’s RRSP.
Unlike RRSP funds, which may be withdrawn at any time, IPP funds must remain
locked in. As retirement approaches, the IPP plan holder may transfer the funds to a
locked-in RRSP and thereby further defer tax until age 71, when the locked-in
RRSP must be used to purchase an annuity or a Life Income Fund. An RRSP
provides more options than an IPP when an employee leaves a company or retires.
While IPPs may provide greater benefits and higher contribution limits, they are complex, costly
to set up and expensive to administer. Owner-managers who are interested in this option should
explore their appropriateness with an advisor who has specialized knowledge in this area.
Retirement Compensation Arrangement (RCA)

A retirement compensation arrangement (RCA), as set out in the Income Tax Act, allows employers to
pre-fund retirement benefits without using a registered pension plan. With an RCA, there are no
specified contribution limits like with IPPs and RPPs. CRA has even accepted RCAs funded with
contributions over $10 million. Since the RCA is not registered with the CRA as a registered pension
plan, it does not affect the employees’ ability to contribute to an RPP or RRSP.
Like IPPs, RCAs are often used for:

• owners of privately held corporations who want to build up funds for retirement;
• corporate executives with salaries of more than $100,000;
The RCA is a taxable trust set up by an employer to hold funds for the employee’s retirement. The
investments in an RCA arrangement are governed by the trust agreement, not the Income Tax
Act. A wide range of investments may be included in the RCA trust, including tax-exempt life
insurance, stocks and bonds, mutual funds and deferred annuity contracts.
The employer pays tax (that is refundable when the money is eventually paid out) at:
• 50% of all contributions made to the RCA during the year;
• plus 50% of the returns (income and capital gains) earned for the year;
• minus 50% of the benefits paid out during the year.
Each year, the custodian of the RCA sends CRA the 50% refundable tax, along with
a report summarizing the accounting of that tax. The tax is refunded when retirement
payments made to the employees are greater than the income earned inside the
RCA trust. The refundable tax account with CRA is non-interest-bearing.
Costs to set up and administer an RCA include the legal cost of setting up the trust, the
cost of filing the annual trust tax return, and the services of the RCA custodian. Generally
speaking, experts suggest the use of an IPP before considering an RCA, mainly because
of the 50% refundable tax that has to be paid upfront in the case of an RCA.
An RCA may be considered by CRA to be abusive and re-characterized as a

salary deferral arrangement (see below).

Supplemental Executive Retirement Plans (SERPs)

Once employees reach a certain level of income ($124,722 in 2011), they have maximized their
tax-assisted savings under the RRSP. Moreover, when their income reaches $127,600 (in
2011), they have reached the maximum benefit under a defined-benefit plan and the maximum
contribution limit on a defined-contribution plan. In spite of increases in statutory retirement
savings limits, the actual dollar amounts have not kept pace with inflation and wage increases.
Some employers have responded to these ceilings by establishing either defined-benefit SERPs
or defined-contribution SERPs for senior executives and key employees.
A SERP is an employer-provided retirement benefit that provides an employee who

is already a member of the registered pension plan with an additional benefit that
increases the employee’s overall retirement benefit, beyond the maximum RPP
limits. SERPs are not registered, therefore the employer does not receive a tax
deduction for the contribution until the employee actually receives the benefits.
SERPs may be funded through RCAs, letters of credit or insurance arrangements.
From an employer’s perspective, the biggest advantage of implementing a SERP is the ability to
retain and attract top executives and key employees. For employees, the benefit of a SERP is that
it can help fund a retirement plan that more accurately reflects their high salary. Consider
this — according to growinggap.ca, an initiative of the Canadian Centre for Policy Alternatives,
“Canadians will work full-time in 2011 to earn an average wage of $42,988. But by 2:30 pm on
January 3 (the first working day of the year), the 100 best-paid CEOs of public companies in
Canada will have already pocketed that average Canadian wage... Canada’s best-paid 100
CEOs earned, on average, 155 times more than Canadians earning an average income.” These
CEOs, for instance, would be prime candidates for “top hat” plans like SERPs.
CRA may treat “unreasonable” SERP benefits (i.e., benefits considered more generous than
those provided under the underlying RPP) as a salary deferral arrangement for tax
purposes. This would subject the employee to tax each year on the future benefits promised
under the SERP as opposed to being taxed when the benefits were ultimately paid out.
Salary Deferral Arrangements

CRA considers a salary deferral arrangement as an arrangement under which an employee
postpones receiving salary or wages to a later year. The deferred salary or wages must be
declared as employment income in the year in which the employee earns the amount. That
removes most of the incentive for deferring the payment of salary and wages.
A number of plans are excluded from the salary deferral arrangement rules under
the Income Tax Act. Payments under the following plans will be treated in
accordance with their own rules and not the salary deferral rules:
• registered pension plans;
• disability or income maintenance insurance plans administered by an insurance company;
• deferred profit sharing plans;
• employee profit sharing plans;
• employee trusts;
• group sickness or accident insurance plans;
• supplementary unemployment benefit plans;

• plans for providing education or training (sabbaticals);

• plans established to defer the salary of a professional athlete;
• plans under which a taxpayer has a right to receive a bonus or similar payment
for services rendered by the taxpayer in a taxation year to be paid within three
years following the end of the year;
• prescribed plans or arrangements.
The salary deferral arrangement rules allow certain exceptions:
• Self-funded leave of absence arrangements (sabbaticals) are excluded from
income if they provide for deferrals of up to one-third of salary for six years or
less to provide for a leave of absence of at least six months (three months if the
leave is to allow the employee to attend school full-time).
• Bonus arrangements with payment deferred for three years or less are excluded,
provided the employer accepts the loss of deductibility that occurs after 180 days.
• Retiring allowances - that, within limits, may be transferred on a tax-free basis

to an RRSP - are excluded.
Deferred Profit-Sharing Plans (DPSPs)
WHAT IS A DPSP?
A deferred profit sharing plan (DPSP) is a trust usually held by a trust company and
registered with the Canada Revenue Agency. A DPSP may be set up for all employees or
for one or more classes of employees, such as senior executives or office workers.
ADVANTAGES AND DISADVANTAGES OF DPSP
Advantages
• Employer contributions are deductible to specified maximum limits.
• The trust governed by the plan is tax-exempt.
• For the employer, there are no locking-in or funding requirements.
• For the employee, a two-year maximum vesting period is imposed.
• Employer contributions are tied to a profit formula, to create an
incentive for key employees.
• Tax-deferred rollover is possible of one spouse’s DPSP to other spouse’s registered plan(s)
• Partial withdrawals from vested funds are possible.

• A DPSP can be used as a fund which key employees could use to purchase the company
that employs them when the current owner(s) holding controlling interest retires or dies.

Disadvantages
• Beneficiaries under a DPSP cannot borrow from it, nor can their rights to it be
surrendered or assigned.
• There are some restrictions on the investment of assets held.
• Contributions to a DPSP are reported as a pension adjustment and, therefore,
reduce the amount that employees can contribute to an RRSP in the following year.
ESTABLISHING A DPSP
To become a member of a DPSP, a person must be employed by an employer that offers such a
plan. Although all types of commercial enterprises, including public and private companies,
partnerships and sole proprietorships, may establish a plan for their employees, many do not.
An employer that establishes a DPSP makes cash contributions to the plan out of business
profits on behalf of each employee who is a member of the plan. The contributions and
earnings accumulate in the plan tax-free until withdrawn by plan members upon their
retirement or earlier, once the contributions vest with (that is, belong to) the employee.
A deferred profit sharing plan cannot be registered with CRA if a beneficiary under
the plan is an individual who is (or is related to) a specified shareholder, that is, an
individual who owns more than 10% of the voting shares of the company.
To establish a DPSP, the employer must enter into a trust agreement with an independent
trustee. Normally a trust company acts in this capacity; otherwise, a minimum of three Canadian
residents must be designated as trustees. Under the latter arrangement, if the employer is not
a public company, at least one trustee must be neither a shareholder nor an
employee of the employer.
ROLE OF THE TRUSTEE

The trustee of a DPSP sets up a trust fund and individual accounts for each DPSP member and
at each calendar year-end issues statements showing the value of each account. The trustee
files tax returns and issues cheques and tax forms, acting upon the employer’s instructions.
REGISTERING THE DPSP

The trustee registers the DPSP with the Canada Revenue Agency, provided that
the plan meets the following requirements:
• For years after 1990, a plan can permit contributions to be made at the employer’s
discretion, or to be contingent on a prerequisite such as employee performance,
without requiring the employer to make a minimum contribution. The amounts
payable by the employer are normally calculated by reference to profits (e.g., 5% of
profits) as defined in the plan. The text must clearly provide, however, that
contributions will be subject to the maximum contribution limits (stated below).
• Also, the employer may not make a contribution in any year in which it does
not have a profit or accumulated profits (i.e., retained earnings).
• The plan must specify the effective date and eligibility of employee-participants.

• The plan must provide that contributions will be allocated exclusively to the participants.
• The vesting schedule for contributions must be defined. Each contribution must irrevocably
vest with the employee within 24 months of the date that the employee becomes a
beneficiary (providing that the employee is still a member of the plan at the time).
• The plan must define the normal retirement age, death and termination
benefits, and how payment of vested amounts is to be made.
• Provisions must be made for amendments to or termination of the plan.
QUALIFIED INVESTMENTS FOR A DPSP

Qualified investments for DPSPs are similar to those for RRSPs, with a few
major differences designed to prevent a DPSP from holding the employer’s debt.
The investment in a single year by the plan in equity shares of the contributing
employer or in a corporation with whom the employer does not deal at arm’s
length is limited by a defined formula.
CONTRIBUTIONS TO A DPSP
Employer Contributions to a DPSP

A DPSP is not accepted for registration unless the plan:
• prohibits contributions to the plan by an employee;
• restricts the aggregate of contributions made by an employer for each employee in a
calendar year to the amount required to be contributed under the plan as registered; this
amount must not exceed the lesser of: 18% of each member employee’s salary or
wages paid in the year by the employer to the employee; or half the limit for money
purchase plans (DPSP limit - $11,225 in 2010, $11,485 in 2011);
• provides that amounts allocated by a trustee under the plan to an employee vest
irrevocably within two years after the employee first becomes a beneficiary under the plan;
• limits by a defined formula the investment per year by the plan in equity
shares of the contributing employer or a corporation with whom the
employer does not deal at arm’s length.
Employer contributions may be made up to 120 days after the employer’s fiscal year-end.
Employee Contributions to a DPSP

Since 1991, employee contributions to a DPSP have not been permitted.
PAYMENTS AND WITHDRAWALS FROM A DPSP

All payments received by an employee from a DPSP (other than his or her own
contributions deposited before 1991) are taxable as ordinary income, with the exception, in
certain circumstances, of accumulated capital gains on employer shares transferred to the
plan. The employee pays no tax on the amounts the employer contributes to the DPSP on
the employee’s behalf until the employee receives payments from the plan.

Payments from a DPSP may be made to members in full or in part at any time, once
contributions vest with the employee. However, if an employee leaves the company or
dies, the employer must pay all vested amounts to the employee or the employee’s
estate within 90 days. Mandatory payments from a DPSP must begin within 90 days
after the employee’s retirement or 71st birthday, whichever comes first.
DPSP payments may be made to the employee as:
• a lump sum (either cash and/or stock);
• periodic payments over a maximum of ten years;
• an acceptable (that is, meets CRA’s conditions) life annuity.
What is the tax status of funds withdrawn from a DPSP?

While funds remain in a DPSP, they are not taxed. However, DPSP funds cannot be transferred,
assigned or used as collateral for a loan. Since employee contributions made before 1991 to
the plan were not tax-deductible, any payments from the plan contributed by an employee are
tax-free. However, all other withdrawn funds (employer contributions and earnings on both
employer and employee contributions) are taxable as income at the time of withdrawal.
When DPSP funds are withdrawn, can tax be deferred?

To shelter funds withdrawn from a DPSP from taxes, the funds must be transferred
directly from the DPSP to:
• an RPP or RRSP (without affecting contribution limits); or
• another DPSP (with a minimum of five beneficiaries).
What is the employee’s tax position if investments are transferred to the employee as a single
payment on withdrawal from a DPSP?
If investments in a DPSP, such as stocks, are transferred “in specie” (in kind) to the
employee as a single payment, the capital gain is not taxed as a DPSP benefit to the
employee, but is deferred until the employee subsequently disposes of the stocks.
Therefore, if an employee has a choice of receiving $1,000 in cash out of the DPSP as a single
payment or stock with a fair market value of $1,000, but an adjusted cost base of $800, the
employee is better off to choose the latter, since the employee has converted $200 from a
DPSP benefit to a capital gain ($1,000 – $800). The $800 would have to be reported as income,
while 50% of the capital gain is taxable when the employee disposes of the stock.
Group Registered Retirement Savings Plans (Group RRSPs)

Group RRSPs are similar to individual RRSPs. An employer sponsors and administers a
group RRSP, usually, as an alternative to a registered pension plan. Employers will often
match an employee’s contributions to the group RRSP, as an employee benefit. Although
both employee and employer contributions are deductible from taxable income, employer
contributions are considered additional earnings of the employee.
Group RRSPs are not governed by pension legislation, but by tax legislation. Employer
contributions are vested immediately. Employee and employer contributions can be withdrawn
at any time, unless the plan locks in employer contributions until the employee leaves or retires

or fulfils some other condition. Group RRSPs usually offer employees lower
management fees on mutual funds and at-source income tax reduction based on
contributions made. They also serve as a form of disciplined savings for retirement.
EMPLOYER AND EMPLOYEE CONTRIBUTIONS

Total RRSP contributions are limited to the lesser of:
• 18% of earned income in the previous year;
• the RRSP dollar limit for the year,
minus any pension adjustment for the previous year and past service pension
adjustment for the current year.
The total contributions to a group RRSP and individual RRSP of an employee
must be within the employee’s RRSP contribution limit.
INVESTMENTS
The employer may choose the fund manager and investment options that are
available, which may include the employer’s own shares, and the employee may
choose where his or her money will be invested from among those options. Small
employers may leave everything up to the employee once they make the contribution.
The employee bears the risk or reaps the reward of any particular investment choice.
SETTLEMENT OPTIONS
When an employee retires, he or she may use the funds in the account to purchase
an annuity, may withdraw them in a lump sum, or may transfer the funds to a RRIF.
The employer may offer an early retirement subsidy through a retiring allowance, all
or a part of which may be eligible to be deposited to the group RRSP.
REGISTERED RETIREMENT SAVINGS PLANS (RRSPS)
LEARNING OBJECTIVES
• describe the primary advantage of a Registered Retirement Savings Plan
(RRSP) over other investments held outside an RRSP;
• describe the role of an advisor in assisting a client in selecting investments for an RRSP;
• describe the benefits of an RRSP, including annual contribution maximums,
current and future tax implications, and who can contribute;
• explain the differences between registered and non-registered products;
• identify sources that qualify as “earned income” for RRSP purposes;
• describe the RRSP “carryforward” provision and the alternative minimum tax
provisions when the carryforward is used;
• identify the types of investments that can be held inside an RRSP;

• explain the foreign content rule for RRSPs;

• explain the effect of a pension adjustment on RRSP contributions;
• explain the advantages of income splitting through spousal RRSPs;
• explain how RRSPs may be used to finance buying a home for a first-time
buyer and the repayment provisions required;
• describe a Retiring Allowance;
• explain how to establish a self-directed RRSP and the advantages of doing so;
• describe the process for transferring money accumulated in a registered
pension plan to a locked-in RRSP when an employee leaves an employer;
• describe the options available to an RRSP holder upon retirement, including the
purchase of an annuity, or a RRIF;
• describe the tax implications of early RRSP redemptions and the death of the RRSP owner.
The Importance of RRSPs

An RRSP is an individual retirement savings plan that has been registered with
the Canada Revenue Agency. It generally permits tax-deductible contributions to
the plan. Income earned within the plan is exempt from tax until the owner starts
to receive payments from the plan or makes withdrawals.
The federal government introduced RRSPs in 1957 as an incentive for working
Canadians to save for retirement. By deducting RRSP contributions up to available
limits, taxpayers lower their taxable income and, therefore, pay less tax.
Interest income, dividends and capital gains derived from the assets of an RRSP
are free of tax until the funds are withdrawn. At that time, they are taxed as
regular income. Thus an RRSP provides its owner with:
• an immediate income tax deduction for the year that contributions are made;
• a tax shelter for income and capital gains realized from the assets of the RRSP
during the life of the plan.
As an advisor, you should educate your clients on RRSPs. You must know the allowable
investments to make in an RRSP. You must know your clients’ risk tolerance and financial
goals and objectives. Ask your clients when they plan to retire and how long they expect to
be in retirement: the answers will help you recommend the most appropriate investment
products. Many clients know exactly how they are going to invest, while others look to you
to make recommendations. In either situation, you must educate your clients so they can
make the best possible decisions for both their personal and family situation. You should
give your clients options to choose from and let them make an educated decision.
Some clients will say, “I don’t want to be involved; do what you think is best.” That is
fine, as long as the client is aware of the implications of what they are saying. Many
clients want nothing to do with managing their money and “leave it to the professionals.”
Your job is to uncover their goals and objectives, assess where your clients are today
and where they want to be in the future, and give them solutions to close the gap.

Advantages of an RRSP
• It provides a medium for investing and compounding returns on tax-sheltered dollars.
• It helps individuals build up retirement savings funds and a larger estate

through the compounding of tax-deferred income and capital gains.
• The plan holder does not have to do the bookkeeping for investment income
and capital gains earned by the assets of the plan over its life.
• It is not affected by a job transfer or the loss of employment to the same degree as many
employer pension plans. With increased job mobility and a lack of portable pensions,
taxpayers can lose the benefits of private pension plans, as they change jobs over the years.
• It can provide additional funds for an early retirement or an extended period

of absence from work.
• It defers income tax to later years, when the plan holder is, presumably, in
a lower tax bracket.
• It provides an opportunity to split retirement income (using both contributor and
spousal RRSPs) and reduce the effective tax rate on a couple’s combined income.
• Under new legislation brought in by the federal government in 2008, RRSPs (and RRIFs)
issued by all financial intermediaries will be protected from seizure by creditors. To curb the
potential for abuse, any RRSP contributions in the last 12 months prior to bankruptcy will
not be protected; this “recovery” provision may not apply in all provinces.
Disadvantages of an RRSP
• If funds are withdrawn from an RRSP, the plan holder pays income tax (not capital
gains tax) on the proceeds withdrawn. Therefore, ideally, an RRSP holder should
make sure that other funds are available for emergencies before setting up an RRSP.
• When funds are withdrawn from an RRSP, a portion to cover tax must be withheld at
source by the financial institution and remitted to CRA or Revenue Québec.
• The RRSP holder cannot take advantage of the dividend tax credit on
eligible dividend income.
• Capital gains earned outside an RRSP are subject to income tax on only 50%
of the gain, whereas in an RRSP, 100% of capital gains are taxable, as all
RRSP funds are fully taxable as income when withdrawn.
• If the plan holder dies, all payments from the RRSP to the plan holder’s estate
are subject to tax as income of the deceased, unless they are inherited by the
spouse or, under certain circumstances, a dependent child or grandchild.
• If the plan holder receives payments from a registered life annuity, the entire
amount is taxed as income, whereas if the annuity is not registered, the recipient
may separate the “interest” and “return of capital” portions of the annuity
payments and pay tax only on the interest portion.

• If a whole life insurance policy is registered as an RRSP, the policyholder may not take out policy
loans from the issuing insurance company, and the policy cannot be used as collateral.
• The assets of an RRSP cannot be used as collateral for a loan.

• The plan holder may not borrow from the plan except through the Home
Buyers’ Plan and Lifelong Learning Plan.
Earned Income
A definition of earned income is essential to understanding RRSPs. Earned income for most
employees is essentially the same as salary. It includes all income earned by an individual from
Canadian sources, with certain exceptions such as investment income (interest, dividends and
capital gains), pension benefits, withdrawals from RRSP/RRIF and payments from a DPSP.
The following items are considered as earned income:

• gross Canadian salaries and wages, including bonuses;
• commissions;
• allocations from employee profit-sharing plans;
• net business/self-employment income;
• net rental income from real property;
• taxable spousal and child support payments received;
• royalties from a published work or an invention;
• supplemental unemployment benefits (but not EI benefits);
• research grants (net of related expenses);
• disability payments received under the CPP
or QPP. Earned income is reduced by:
• deductible alimony, maintenance and child support paid out;
• most deductible employment-related expenses, such as union dues or travelling expenses;
• rental losses.
Contributions to an RRSP
The maximum annual tax-deductible contribution to RRSPs that an individual may
make is the lesser of the following amounts:
a) 18% of the previous year’s earned income;
b) the RRSP dollar limit for the year (see below);
Minus:
c) the previous year’s pension adjustment (PA) and the current year’s past
service pension adjustment (PSPA).
Plus:

d) the taxpayer’s unused RRSP contribution room at the end of the immediately preceding
taxation year (essentially the difference, since 1991, between what the taxpayer has
contributed and the maximum allowable contribution from year to year).
THE RRSP DOLLAR LIMITS

The RRSP Dollar Limit for 2010 is $22,000 and for 2011 is $22,450.
To be tax-deductible, RRSP contributions must be made in the taxation year or
within 60 days after the end of the year.
For example, in 2010, Mohsin had earned income of $60,000 and a pension adjustment
(on his 2010 T4 slip) of $4,400. He had no past service pension adjustment, no unused
RRSP contribution room and no previous RRSP over contributions. What is his
maximum tax-deductible contribution to an RRSP for the 2011 tax year?
Compare: a) 18% of $60,000 = $10,800

And b) 2011 RRSP Dollar Limit of $22,450
The lesser amount is $ 10,800
Subtract: 2010 pension adjustment $ 4,400
Contribution: $ 6,400
Mohsin can deduct up to $6,400 for the 2011 taxation year for amounts contributed
to RRSPs in 2011 or within the first 60 days of 2012.
FOREIGN PROPERTY RULE

There used to be a limit on the amount of assets that could be held in foreign
investments of 30% of the book value of all assets held within the RRSP.
This Foreign Property Rule was eliminated in the 2005 federal budget to widen
the scope of investment opportunities for retirement savings.
CARRY-FORWARD OF UNUSED RRSP CONTRIBUTION LIMITS

(UNUSED RRSP CONTRIBUTION ROOM)
For 1991 and subsequent years, every individual’s unused RRSP contribution limit (i.e., unused
RRSP contribution room) for a year may be carried forward to following years indefinitely.
A substantial contribution to an RRSP in one year, to extinguish accumulated contribution room,

used to expose the individual taxpayer to alternative minimum tax (AMT) provisions because of
a sharp reduction in taxable income. However, the 1998 federal budget removed RRSP
contributions and rollovers from the AMT tax base, retroactive to 1994. The change was made
because, during the economic restructuring of the 1990s, many individuals were receiving large
severance packages that were being rolled over into RRSPs. The large RRSP contributions
triggered the AMT. Since retirement savings were important to Canadians, and limitations on
RRSP contributions were already in place, the government decided that it would be appropriate
to remove this preference from the AMT tax base.

THE USE OF OVERCONTRIBUTIONS TO AN RRSP AND THE “CUMULATIVE EXCESS AMOUNT” (CEA)
Before the 1995 federal budget, taxpayers could make an overcontribution of up
to $8,000 to an RRSP without penalty. This amount has been reduced to $2,000.
This $2,000 amount is cumulative.
Overcontributions made before the 1995 budget do not have to be withdrawn.
Instead, they are automatically allocated against regular RRSP room in subsequent
years to avoid the 1% penalty tax (see below).
Although there is no tax deduction for the amount of the overcontribution, the excess
amount is permitted to accumulate tax-free investment income while it remains within the
plan. The excess contribution will be taxable when it is eventually withdrawn (even
though a tax deduction was never allowed), but there may be an overall benefit if the
amount is retained and tax-deferred investment income is compounded over a long
period. A taxpayer should determine whether or not making an overcontribution fits with
his or her investment policies before undertaking such a long-range plan.
Overcontributions may become tax-deductible if the taxpayer cannot make a full contribution
in one or more years after making the overcontribution. At this point, all or part of the
overcontribution may be deemed to be the regular RRSP contribution which the taxpayer
would normally have been entitled to make and, therefore, become tax-deductible.
A penalty tax of 1% per month is assessed on the cumulative excess amount

(CEA) in the plan, until the excess is withdrawn.
CEA = total undeducted RRSP contributions after 1990 – (member’s unused RRSP
contribution room + $2,000)
THE USE OF LUMP-SUM PAYMENTS TO AN RRSP

Lump-sum transfers from Registered Pension Plans (RPPs), Deferred Profit Sharing Plans
(DPSPs) and other RRSPs can be made to an RRSP, tax-free, without affecting the regular
tax-deductible contribution limits, if they are transferred to the individual’s RRSP directly
(from one organization or financial institution to another organization or financial institution).
Types of RRSPs
There are two basic types of RRSPs: managed RRSPs and self-directed RRSPs.
MANAGED RRSP
In a managed RRSP, the plan holder may, for instance, invest in one or more
segregated funds or mutual funds, and the investments are held in trust under the
plan; the plan holder is not required to make any further investment decisions.
Mutual fund companies, banks, trust companies, life insurance companies, credit
unions and investment dealers offer a wide selection of plans whereby the RRSP
holder may purchase units of various funds. To qualify as acceptable investments
for an RRSP, the funds must be registered with Canada Revenue Agency.

The most prevalent types of managed RRSPs include the following:

• Guaranteed Plans: Assets are invested in guaranteed instruments at a fixed rate of
interest for a specific term (such as one to five years). Chartered banks, credit unions and
trust companies all offer guaranteed plans. If the issuer is a member of the Canada
Deposit Insurance Corp. (CDIC), the principal and interest in the guaranteed plan is
insured up to $100,000. For insurance purposes, guaranteed RRSPs are covered
separately from personal deposit accounts (where the insurance limit is also $100,000).
• Savings Accounts: Funds are invested in interest-bearing deposits with

interest accruing regularly, sometimes even daily.
• Income Funds: Funds are invested in portfolios of generally low-risk
bonds and/or mortgages, providing income and security of capital.
• Equity Funds: The funds are made up of common stocks.
• Balanced Funds: The assets are held in equities and income
securities in varying proportions.
• Life Insurance Company Plans: They offer interest-bearing and market-based
fund RRSPs through deferred or accumulation annuities. With a market-based
fund RRSP, contributions are invested in a segregated fund.
SELF-DIRECTED RRSP
A self-directed RRSP is a retirement savings plan registered under the Income Tax Act whereby the
administration and custody of the assets is handled by an approved corporation. The holder of
a self-directed plan assumes responsibility for all investment decisions. These plans have become
popular with people who like to participate in the management of their own investments.
Administrators of self-directed RRSPs charge an annual administration fee, plus any

specified transaction charges. The administration fee is not tax-deductible. No margin
transactions (purchase of securities on credit) are allowed in self-directed RRSPs.
The holder of a self-directed plan receives confirmation of transactions as well as a

periodic statement which summarizes his or her transactions, income earned,
expenses charged and value of current holdings.
A Qualified Custodian Is Necessary

With a self-directed RRSP, the plan holder pays the custodian or issuer of the plan a
stipulated annual fee, and usually some specified transaction charges as well. Buy
and sell orders are entered through the broker(s) of the plan holder’s choice.
Administration Fees are Payable

Administration fees for self-directed RRSPs vary considerably.
• Many levy a flat annual fee (such as $125).
• Others charge a minimum annual fee (such as $100) and allow a specified number
of transactions per year at no additional charge. Above this limit, a set fee is levied
for each transaction (in addition to regular brokerage commissions).

• Some charge lower fees for plans that hold only mutual funds (as opposed
to individual stocks and bonds).
• Many waive the fees entirely if holdings are above a specified level (such
as $25,000, $50,000 or $100,000).
Clients interested in starting a self-directed RRSP should shop around before opening a
plan. Plans offered by banks, trust companies, investment dealers and other issuer firms
should be investigated to determine which is best suited for an individual’s requirements.
Transfer of Assets to a Self-Directed RRSP

Contributions to a self-directed RRSP may take the form of marketable securities
and assets other than cash. The value of such securities and assets for tax purposes
is the market value on the date the trustee receives the assets in the plan.
If securities are transferred to a self-directed RRSP, the transfer has the
following tax consequences:
• The transfer of assets is classified as a deemed disposition.
• If the market value of the transferred assets is higher than the original cost
price, the plan holder is deemed to have realized a taxable capital gain.
• If the market value of the transferred assets is lower than the original cost
price, the plan holder’s loss for tax purposes is deemed to be zero.
• If a debt security is contributed between the dates on which interest is paid, the amount of
the contribution will include all interest accrued to the date of transfer. This accrued interest
must be included in the contributor’s taxable income for the year the contribution is made.
As a self-directed RRSP makes the plan holder responsible for investment decisions, it is
best suited for knowledgeable individuals who are comfortable making their own investment
decisions. It is of value to a person with both time and ability who feels he or she can
“outperform” a managed RRSP over a period of years. The plan holder should also
compare the size of the proposed self-directed RRSP with the annual administration
fee to determine if the plan is (or will be) large enough to be economically viable.
Qualified Investments for RRSPs

The following are qualified investments for RRSPs:
• money on deposit in a bank or similar institution;
• bonds, debentures and similar obligations guaranteed by the Government
of Canada, a province, a Canadian municipality or a Crown Corporation
(including Canada Savings Bond issues and Treasury Bills);
• shares and debt obligations of Canadian public companies;
• shares of foreign public corporations listed on a prescribed stock exchange
outside Canada (or on NASDAQ in the United States);
• foreign government bonds with investment grade ratings;

• debt obligations of corporations whose stocks trade on an eligible foreign stock exchange;
• debt obligations of the European Bank for Reconstruction and Development

and the International Finance Corporation, and securities issued under Ontario
or New Brunswick community development legislation;
• GICs issued by a Canadian trust company;
• certain annuities issued by Canadian companies;
• units of a mutual fund trust or an insurance company pooled fund;
• the purchase of exchange-traded rights, warrants and options (including
call and put options) on securities that qualify for an RRSP;
• the writing of exchange-traded covered calls on securities that qualify for an RRSP;
• a mortgage or interest in a mortgage or a pool of mortgages secured by real property
located in Canada. Canada Revenue Agency allows certain non-arm’s-length
mortgages, including a mortgage on the beneficiary’s own residence under prescribed
conditions. Also allowed are interests in mortgage-backed securities, which are pools
of NHA-insured first mortgages on Canadian residential properties (guaranteed by
CMHC), and shares in most Canadian mortgage investment companies.
• shares, bonds, debentures or similar obligations issued by certain

cooperatives or credit unions and shares of certain investment corporations;
• certain life insurance policies;

• bankers’ acceptances (these are short-term promissory notes issued by
corporations and guaranteed by banks thereby increasing the negotiability of
the instrument and lowering the cost of borrowing);
• limited partnership units listed on a Canadian stock exchange;
• certain shares in the capital stock of a small business corporation, prescribed
venture capital corporations or specified co-operative corporations;
• investment-grade gold and silver bullion coins and bars, and certain certificates
based on financial institutions’ precious metal holdings (added to the list of
qualified investments for RRSPs in the 2005 federal budget);
• the 2007 federal budget extended eligibility to any debt obligation that has an
investment grade rating and that is part of a minimum $25 million issuance, and
any security (other than a futures contract) that is listed on a designated stock
exchange. For this purpose, a designated stock exchange will include any stock
exchange that is currently identified as a prescribed stock exchange.

Non-Qualified Investments for RRSPs

The following investments are not qualified for RRSPs:
• shares and debt obligations of private corporations, unless certain prescribed

conditions are met;
• real estate (although Real Estate Investment Trust units are qualified investments);
• commodity and financial futures contracts;
• listed personal property, such as works of art, jewellery, rare manuscripts and stamps.
The acquisition or retention of non-qualified investments in an RRSP results in tax

being levied on the plan holder. If a non-qualified investment is acquired, the fair
market value of the investment, at the time it was acquired, is included in the plan
holder’s income for the taxation year in which the investment was made.
When the non-qualified investment is sold, the plan holder may deduct the lesser of:
• the amount brought into income;

• the proceeds of the disposition in calculating taxable income for the year.
This deduction, however, reduces the maximum amount deductible for
contributions to an RRSP in the year the non-qualified investment is sold.
If a qualified investment is acquired by an RRSP, but later becomes a non-qualified
investment, it is subject to a special tax. In this case, it will not be included in the income of
the plan holder. However, the RRSP will be subject to a tax of 1% of the cost of the security
at the end of each month the security is retained. It is the responsibility of the plan holder,
not the plan issuer, to comply with all qualifications, regulations and restrictions.
Maturing an RRSP – Partial Withdrawals and Deregistration

Maturing an RRSP means winding up the plan and arranging to receive income from
the accumulated RRSP funds. While an RRSP may be matured at any time, it must
be matured by the end of the year in which the plan holder turns 71. The 2007 federal
budget raised the age from 69 to 71, with some transitional provisions.
When a plan holder matures a plan, he or she has certain options for the amount of money
received, the time the funds are received, and the income tax treatment of funds received.
THREE MATURITY OPTIONS FOR AN RRSP
Withdraw All the Proceeds as a Lump-sum Payment

Sometimes referred to as cashing in the RRSP, this option is subject to withholding tax and
requires that income tax be paid on the full amount of the proceeds in the year they are
withdrawn. A withdrawal of all the proceeds might be suitable for a plan holder with immediate
cash needs or one who wishes to finance spending in the early years of retirement for an
activity such as extensive travel. It is also used during periods of financial difficulty,
such as unemployment. By and large, though, it is not advisable to do so because
of the potentially large tax bill.

Transfer RRSP Proceeds to a Registered Retirement Income Fund (RRIF)

This maturity option extends tax-deferral benefits, since tax is paid only on the withdrawals made
each year from the RRIF. The rules governing RRIFs require a minimum annual withdrawal.
As long as the withdrawal requirement is met, the RRIF holder can vary the
amount and timing of the withdrawal of funds to suit his or her individual needs.
This is currently the most recommended (and implemented) maturity option.
Use the Proceeds to Purchase an Annuity

RRSP proceeds may be used to purchase either a life annuity, a life annuity with a
guaranteed term, or a fixed-term annuity, which provides an annual income to age
90. This option permits further deferral of tax, since income tax is payable only on
amounts received each year from the annuity.
The plan holder may transfer RRSP proceeds to any number of RRIFs and/or annuities to
arrange the flow of retirement income to meet expected requirements. The term of the
RRIFs or chosen annuities may be based on the age of the spouse, if younger, to provide
continuity of benefits to that spouse in the event the annuitant dies first.
Plan holders should ensure that RRSP investments can be converted into cash
without penalties on the date an RRSP is to be matured. For example, the maturity
dates of bonds and debentures, GICs and term deposits in an RRSP should not
extend beyond the date the plan itself is to be matured.
An RRSP holder may transfer property in an unmatured RRSP to another RRSP in his
or her name or to the plan holder’s RPP (if the RPP rules permit such a transfer),
provided the transfer takes place before the end of the year the plan holder turns 71.
PARTIAL WITHDRAWAL OF FUNDS FROM AN RRSP

An RRSP plan holder may make partial withdrawals of funds at any time, subject to
the provisions of the plan. The plan holder must pay tax on the amount withdrawn,
which will be included in his or her taxable income in the year of the withdrawal.
DEREGISTRATION OF AN RRSP
At times the word “deregistration” is used as a synonym for collapsing or cashing in an RRSP.
This usage is not entirely accurate. From Canada Revenue Agency’s viewpoint, the word
“deregistration” applies to a situation in which an RRSP no longer satisfies the rules under which
it was registered. When this occurs, it is no longer considered an RRSP. In such a case, the fair
market value of the assets in the plan is included in the plan holder’s income for tax purposes in
the year the plan is deregistered. Clearly, this is not a common occurrence.
RRSPs and Inheritance
TAX IMPLICATIONS
If the plan holder dies before the RRSP matures, the plan holder’s estate is
subject to tax on the accumulated value of the RRSP in the year the plan holder
died, unless the amount passes directly to either the surviving spouse or, under
certain circumstances, a dependent child or grandchild.

The surviving spouse (or spousal trust) may transfer the proceeds of the inherited
plan into his or her own RRSP, or take all the assets from the inherited plan as a
lump sum and pay tax on the whole sum.
A dependent child or grandchild (who is a beneficiary) may take the entire proceeds into
income and pay tax on the amount of the inheritance. Alternatively, a financially dependent
child or grandchild under 18 years of age may obtain a deduction for the inherited proceeds
if used to buy an annuity. The annuity must be for a period equal to 18 minus the age of the
child at the time the annuity is acquired. If the child or grandchild, regardless of age, is
financially dependent because of physical or mental infirmity, the inherited proceeds may be
transferred to an RRSP, a RRIF, or to an issuer to purchase a certain type of annuity.
The 2009 federal budget included a provision recognizing the decrease in value of an
RRSP/ RRIF that occurs after the annuitant’s death and before funds are distributed to
beneficiaries. Any decrease in value of an RRSP/RRIF after an annuitant’s death may be
deducted against income on the deceased annuitant’s terminal return, so long as the
distribution takes place by the end of the year following the year of death.
BENEFICIARIES OF AN RRSP
Naming a direct beneficiary of an RRSP can be done in all provinces except Quebec, where a will
must be used to specify the beneficiary. If no beneficiary is named, the proceeds of a plan are
paid to the plan holder’s estate. A plan holder can change his or her beneficiary at any time.
By naming an RRSP beneficiary in a will, rather than in an RRSP directly, it is easier

(i.e., there is less paperwork involved) to change a beneficiary when a plan holder
wishes to do so. This avoids the plan holder having to notify every RRSP issuer with
the proper legal documentation each time a beneficiary is changed. For a plan holder
with several RRSPs or one who repeatedly switches RRSPs from one issuer to
another for a better return, naming beneficiaries in a will makes sense.
However, naming a direct beneficiary results in the RRSP funds bypassing the estate
and not being subject to probate fees and the delays posed by the probate process.
Spousal RRSPs
CONTRIBUTION LIMITS
An individual may contribute to an RRSP registered in the name of his or
her spouse or common-law partner and claim a tax deduction.
For example, if Rekha has a maximum RRSP contribution limit of $15,500 but only
contributes $10,000 to a plan in her name, she may contribute $5,500 to a spousal RRSP.
Her own total tax deduction would be $15,500. In addition, Rekha’s spouse could also
contribute to his own plan up to his allowable limit and claim a corresponding tax deduction.
TAX LIABILITY FOR FUNDS WITHDRAWN FROM A SPOUSAL RRSP

Funds withdrawn from a spousal RRSP are generally treated as taxable income of
the spouse, not the contributor, since the spousal RRSP belongs to the spouse in
whose name it is registered. However, a contributing spouse may be liable for tax
on withdrawn funds, under the following rule.

Any withdrawals from a spousal plan, claimed as a tax deduction by a contributing spouse, made:
• in the year funds are contributed; or

• in the two calendar years following the year of contribution;
are taxable to the contributing spouse in the year of withdrawal, rather than to
the recipient spouse, unless:
• either spouse does not reside in Canada at the time of withdrawal; or
• the contributing spouse died during the year the funds were withdrawn; or
• the taxpayer and his or her spouse were living apart as a result of the
breakdown of the marriage.
Example: In each of four consecutive years, Patrick contributes $1,000 to his wife’s spousal
RRSP and claims each contribution as a tax deduction in each of the years that contributions
were made. Then, in the fifth year, his wife Colleen decides to withdraw all funds from her plan.
Thus, for the fifth taxation year:
Patrick includes as taxable income on his tax return the sum of $2,000 (made up of the following
contributions: fifth year – the year of withdrawal – nil; fourth year – $1,000; third year – $1,000).
Colleen includes as taxable income in her tax return the sum of $2,000 (i.e., the contributions
to the plan made for her in years 1 and 2), plus all earnings accumulated on the total
contributions of $4,000 in the plan.
To lessen the impact of the three-year rule, advisors recommend that spousal contributions be
made in December rather than the following January or February.
THE INCOME-SPLITTING POTENTIAL OF SPOUSAL RRSP

The potential for income-splitting and tax savings afforded by spousal RRSPs
depends on the following factors:
• the contributing spouse’s tax rate after retirement;
• the non-contributing (recipient) spouse’s income after retirement;
• annual income created from a spousal RRSP;
• the stability of the couple’s marital situation. For example, although a spousal RRSP is the
property of the non-contributing spouse, in divorce, contributions could become part of a
divorce settlement. Tax-free transfers between RRSPs are allowed, if ordered by a court
under a matrimonial property settlement on the breakdown of a marriage.
Contributions to a spousal RRSP can even be made after a taxpayer dies. The executor
can make a contribution on behalf of the deceased to a spousal RRSP in the year of
death or within 60 days of the year-end, up to the deceased’s limit. Also, if a taxpayer is
over 71 but has earned income, he or she can make a contribution (up to his or her limit)
to a spousal RRSP until the end of the year in which the spouse reaches age 71.

Example 1: John and Lucy have been married for 20 years and contribute the maximum
amount to their RRSPs every year. John has been earning more than Lucy over the years and
has amassed a much larger RRSP. They plan to retire in 10 years and draw on their RRSPs,
along with John’s pension from work and their government pensions. Lucy does not have a
company pension plan. John will receive more money in retirement than Lucy and, therefore,
will pay much higher taxes. In order to equalize their retirement income, John should contribute
to a spousal RRSP that Lucy can draw from in retirement. By doing this, the household will pay
lower taxes at retirement than if John keeps putting money into his own RRSP.
Example 2: Martin and Denise have decided to draw $100,000 out of their combined RRSPs when they
retire in 20 years. However, Denise’s RRSP is four times the size of Martin’s, as she has always had a
much higher-paying job and a higher RRSP contribution limit. What would happen if Denise contributed
to a spousal RRSP for Martin and equalized their RRSPs at retirement?
Assume that neither of them is entitled to payments from an employer pension plan at retirement.
Consider the following 2 alternatives.
Note: The tax rates used in these calculations are approximate and are for illustrative purposes only.
Alternative 1: Take $ 80,000 out of Denise’s RRSP and the remaining $20,000 from Martin’s.
Tax implications:
Withdrawal from Denise’s RRSP $ 80,000
Less taxes owing: $ 80,000 × 45% $ 36,000
After-tax proceeds $ 44,000
Withdrawal from Martin’s RRSP $ 20,000
Less taxes owing: $20,000 × 20% $ 4,000
Total after-tax proceeds = $44,000 + $16,000 = $ 60,000
Alternative 2: Take $50,000 out of each of their RRSPs
Tax implications:
Withdrawal from one of the two RRSPs $ 50,000
Less taxes owing: $50,000 × 30% $ 15,000
Total after-tax proceeds = $35,000 × 2 withdrawals = $ 70,000
Under Alternative 2, the family has $10,000 more upon retirement after depleting the
total family RRSPs by the same $100,000.

While the allure of spousal RRSPs may be dimmed somewhat by the pension income splitting
measures introduced in the 2007 federal budget, spousal RRSPs will continue to be of benefit to
couples who plan on retiring before age 65 and relying on their RRSP holdings for income. Also,
pension income splitting allows a maximum of 50% of eligible pension income to be split with the
spouse but to go beyond 50% would require the use of a spousal RRSP.
Using RRSP Funds to Assist First-Time Canadian Home Buyers

In an effort to spur economic activity, the federal government introduced, in its 1992 budget, a
special plan to allow home buyers to withdraw funds from their RRSPs to help finance the
purchase of a home. In the 1994 budget, the Home Buyers’ Plan was continued
indefinitely, but restricted to first-time home buyers and individuals who have not owned
and lived in a home in the previous five calendar years. The five-year qualification
period is waived for a disabled person and his or her relatives who want to purchase a
home that is better suited for the disabled person who will live there.
The maximum RRSP withdrawal for a home purchase is $25,000 for each eligible person (this limit
was raised from $20,000 to $25,000 in the 2009 federal budget). Under the plan, a home buyer and his
or her spouse may each withdraw up to $25,000 from their respective RRSPs. The home must be in
Canada, it may be new or used, and the buyer(s) must occupy it as principal place of residence within
one year following its purchase. In general, the home must be purchased before October 1 of the year
following the year of the RRSP withdrawal. For example, if an individual withdraws funds from an
RRSP in March 2011, he or she must buy or build the home before October 1, 2012. If this deadline is
not met, the plan holder must make full repayment to the RRSP by the end of that year. Any shortfall
must be included in taxable income for that year.
RRSP funds withdrawn for a first-time home purchase are not taxable, but must be
repaid in equal annual instalments over 15 years, beginning in the second year following
the withdrawal or by March 1 of the third year (for example, for a withdrawal in 2011, the
first instalment is due by March 1, 2014). If more than the minimum amount is repaid in a
year, the annual amount to be repaid in subsequent years is reduced. If less than the
minimum is repaid, the shortfall must be included in taxable income in the year it occurs.
No further repayments are allowed after the year in which a plan participant reaches age 71.
Unless the amounts are completely repaid by the end of that year, the remaining scheduled
payments must be included in income in each year as they become due. Special rules apply
to participants who die or leave Canada before they have repaid these withdrawals.
In general, Home Buyers’ Plan participants may not make tax-deductible RRSP
contributions for the year in which funds are withdrawn, unless the contribution was
made 90 days or more before the withdrawal date. However, the participant’s RRSP
contribution room may be carried forward to future years.
While the plan offers interest-free borrowing of funds and an opportunity for the home
buyer(s) to save on mortgage interest payments by making a larger down payment than
otherwise possible, the funds borrowed stop growing on a tax-sheltered basis until they are
repaid, and tax-deductible RRSP contributions for participants may be postponed for nearly a
year. A decision to participate in this plan should be based on a careful cost-benefit analysis.

Lifelong Learning Plan

RRSPs can be used to help finance education for the plan holder or his or her spouse. Under
the Lifelong Learning Plan, students in full-time training or postsecondary education and their
spouses may withdraw up to $10,000 a year from their RRSP over a four-year period, as long
as the total amount does not exceed $20,000. Amounts withdrawn must be repaid to the RRSP
in equal instalments over 10 years, or they will be included in the income of the person who
made the withdrawal. The first repayment is due 60 days after the fifth year following the first
withdrawal (or earlier in certain circumstances, such as the failure to complete courses).
Plan holders can participate in the Home Buyers’ Plan, even if they have withdrawn funds from
their RRSP under the Lifelong Learning Plan and have not yet fully repaid the balance owing.
Locked-In RRSPs
Locked-in RRSPs (also known as Locked-In Retirement Accounts or LIRAs, depending
on the province) are designed to accommodate a situation in which an individual who
has vested benefits in a Registered Pension Plan leaves a job or loses his or her
membership in the plan before being eligible to receive retirement or pension income.
Under both federal and provincial pension legislation, the individual may not take pension
benefit entitlements in the form of cash. Instead, the funds must be transferred to a
locked-in RRSP, which has restrictions like those of a pension plan. The key restriction is
that the funds cannot be withdrawn from the plan, as they can from a regular RRSP.
Locked-in RRSPs may hold the same types of investments as regular RRSPs
and plans may be managed or self-directed.
At the time the plan holder is eligible to receive retirement income, the accumulated
funds may be used to purchase a life annuity or Life Income Fund (LIF).
Retiring Allowances for Employees

A retiring allowance is:
• an amount received on or after a taxpayer retires in recognition of his or her long
service in a particular position, or
• an amount received to compensate for the loss of a job, including damages
or amounts payable because of the judgment of a tribunal.
A retiring allowance includes severance pay and payment for unused sick leave credits,
but excludes superannuation, pension, employee, death or unused vacation benefits.
An employee who is nearing retirement may negotiate a retiring allowance with his
or her employer in lieu of future salary and defer his or her salary to reduce income
tax. A retiring allowance does not have to be made in a lump sum payment, or in a
limited number of payments. The employee must include the retiring allowance in
his or her income when it is received. However, the tax on the retiring allowance
may be deferred if it can be transferred to an RRSP.
A retiring allowance may be transferred to the employee’s RRSP in the year it is received or within 60
days of the end of that year. The amount transferred cannot exceed $2,000 per year of service

before 1996 with the employer, plus an additional $1,500 per year of service before 1989, if
for those years there were no employer contributions to a pension plan or DPSP vested with
the retiree. After 1995, the provision allowing transfer to an RRSP was eliminated. However,
eligible amounts for years before 1996 may still be transferred.
The benefit of transferring a retiring allowance to an RRSP is that the tax on what
would have been considered regular salary is deferred until the employee withdraws
the RRSP funds. The amount of the retiring allowance transferred to an RRSP does
not affect the regular RRSP annual contribution limit.
REGISTERED RETIREMENT INCOME FUNDS (RRIFS),

LIFE INCOME FUNDS (LIFS) AND LOCKED-IN RETIREMENT
INCOME FUNDS (LRIFS)
LEARNING OBJECTIVES
• define Life Income Fund (LIF), Registered Retirement Income Fund (RRIF),
Locked-in Retirement Income Fund (LRIF);
• explain when (at what age) plan holders must elect to annuitize a RRIF, LIF or
RRSP and the consequences of not doing so;
• explain how to set up a RRIF;
• explain the payment stream options of a RRIF;
• describe the tax consequences on the payment flow from a RRIF;
• describe what happens to the balance of a RRIF upon death;
• explain how to set up a LIF;
• explain the payment stream options of a LIF;
• describe the tax consequences on the payment flow from a LIF;
• describe what happens to the balance of a LIF upon death.
Registered Retirement Income Funds (RRIFs)
WHAT IS A RRIF?
A registered retirement income fund (RRIF) is a fund registered with the Canada Revenue
Agency and established by an individual for the purpose of receiving retirement income.
Normally, a plan holder sets up a RRIF by transferring funds from an RRSP, although a
RRIF may be purchased with funds from another RRIF, or with pension funds that are not
locked in. Although the plan holder is not permitted to invest any more money in the plan,
the funds that remain invested continue to accumulate free of tax. A RRIF, therefore,
provides a way of extending some of the tax deferral benefits of an RRSP.
An individual may set up a managed RRIF or a self-directed RRIF at a financial

institution. The investment rules that apply to RRSPs also apply to RRIFs.

ADVANTAGES OF A RRIF
The main advantage of a RRIF is that it shelters retirement income until funds are
withdrawn. Compared to an annuity, a RRIF gives the plan holder more control of
his or her capital and greater flexibility in withdrawing funds. Also, with a RRIF,
ownership of the funds remains with the plan holder and, on death, the balance in
a RRIF may be passed to the designated beneficiary or estate of the deceased.
The plan holder needs to project his or her anticipated annual income requirements
to select the most appropriate plan or combination of plans.
WITHDRAWALS FROM A RRIF

RRIFs require a minimum annual withdrawal (except in the year a RRIF is established), which
is taxable as income. There is no maximum withdrawal. Originally, RRIFs were designed to
be depleted by the time the owner reached age 90. The federal government
eliminated that requirement in 1992.
For RRIFs established before 1993 (qualifying RRIFs) whose holders are 78 or
younger, the minimum amount that must be withdrawn each year is equal to the
market value of the RRIF’s assets at the beginning of a calendar year, divided by
the number of years left until the plan holder (or spouse, if younger) reaches 90.
For example, Jan Elder, a 74-year-old RRIF holder who has $160,000 in assets from a RRIF
established in 1992, is required to withdraw a minimum of $10,000 [$160,000 ÷ (90-74)].
For RRIFs established after 1992 (non-qualifying RRIFs) or for RRIF holders over
78, the minimum amount that must be withdrawn is a fraction that increases
gradually each year, levelling off at 20% of the value of the RRIF’s assets, once the
plan holder (or spouse, if younger) reaches 94.
Table 8.4 lists the minimum amount to be withdrawn as a percentage of RRIF assets at each age:
TABLE 8.4 RRIF WITHDRAWALS
Age Qualifying RRIF % Non-Qualifying RRIF %

at January 1 (for RRIFs set up before 1993) (for RRIFs set up after 1992)
71 5.26% 7.38%
72 5.56% 7.48%
73 5.88% 7.59%
74 6.25% 7.71%
75 6.67% 7.85%
76 7.14% 7.99%
77 7.69% 8.15%
78 8.33% 8.33%
79 8.53% 8.53%
80 8.75% 8.75%

TABLE 8.4 RRIF WITHDRAWALS – Cont’d
Age Qualifying RRIF % Non-Qualifying RRIF %

at January 1 (for RRIFs set up before 1993) (for RRIFs set up after 1992)
81 8.99% 8.99%
82 9.27% 9.27%
83 9.58% 9.58%
84 9.93% 9.93%
85 10.33% 10.33%
86 10.79% 10.79%
87 11.33% 11.33%
88 11.96% 11.96%
89 12.71% 12.71%
90 13.62% 13.62%
91 14.73% 14.73%
92 16.12% 16.12%
93 17.92% 17.92%
94 or older 20.00% 20.00%
RRIF withdrawal rules are not straightforward. Web-based “Minimum RRIF withdrawal”
calculators are available to assist retirees. Financial institutions and planner/advisor
firms also have staff members who are very familiar with these rules. In the summer of
2008, the C.D. Howe Institute (a well-known nonpartisan public policy think tank)
recommended to the federal government to lower minimum withdrawal rates from RRIFs
or, better still, abolish mandated annual withdrawals altogether.
Except for prescribed minimum payments, RRIFs offer considerable flexibility. For
example, the plan holder can vary the income flow (minimum, level or an indexed
amount) and the schedule of payments (annual, semi-annual, quarterly or monthly).
Any amount above the minimum can be withdrawn. This allows for varying cash
flows, including lump-sum withdrawals for things like vacations or major purchases.
FREQUENTLY ASKED QUESTIONS ABOUT RRIF
How many RRIFs can a taxpayer purchase?

There is no limit. A taxpayer may own more than one RRIF at a time.

What happens to the RRIF if a RRIF holder dies?

Accumulated amounts in a RRIF must be included in the income of the RRIF holder
in the year of his or her death, with the following exceptions:
i) If the RRIF is transferred directly to a surviving spouse, the RRIF payments are taxable in the
spouse’s hands for the years in which they are received. Alternatively, the surviving
spouse can use the funds to buy another RRIF, certain types of annuities, or, if he or she has not
reached age 71 at the time of the RRIF holder’s death, transfer the funds to an RRSP.
ii) If the funds are inherited by a financially dependent child or grandchild, the options
are the same as explained earlier in the RRSPs and Inheritance section.
If an individual owns several RRSPs, must they all be matured and transferred to a RRIF at once?
No. RRSPs can be matured at different times (over several years, if desired,
before age 71) and transfers can be made to one or more RRIFs each time.
Can a person mature an RRSP and purchase both a RRIF and an annuity?
Yes. An advisor can suggest a suitable mix, depending on a client’s goals and
objectives, retirement lifestyle, tax situation, etc.
Life Income Funds (LIFs)

A Life Income Fund (LIF) provides an alternative to a life annuity for individuals who
have transferred pension funds to a “locked-in” RRSP. A LIF is similar to a RRIF, but
with additional limitations. LIFs are purchased with “locked-in” retirement savings,
such as another LIF, a locked-in retirement account (LIRA), locked-in pension funds
or locked-in RRSPs. A LIF may also be purchased with pension funds, if an
individual’s pension plan has been amended to permit the purchase of a LIF.
A RRIF may be purchased only with funds from an RRSP, another RRIF, or
pension funds that are not locked-in. A LIF offers the same range of investment
alternatives as a RRIF. Some provinces have a minimum age requirement, such
as 55, for establishing a LIF. With a RRIF, there is no minimum age requirement.
Like a RRIF, the LIF holder must withdraw a minimum amount each year. However, unlike
a RRIF, there is also a stipulated maximum amount that can be withdrawn each year. This
maximum is determined by a formula which applies a term-certain annuity to age 90 (in most
provinces) to the value of the fund at the beginning of each year. This limit on the maximum
withdrawal prevents the LIF holder from cashing-out the LIF, unlike a RRIF holder who may
cash out at any time. For this reason, a LIF is sometimes referred to as a locked-in RRIF.
LIF payments must be included in taxable income for the year in which they are
received. Like RRIFs, any amount withdrawn above the minimum is subject to the
withholding of income tax by the financial institution administering the plan.
In some provinces, the balance of funds remaining in a LIF must be used to
purchase a life annuity by December 31 of the year in which an individual turns 80.
This requirement was removed in the 2005 federal budget for federally regulated
LIFs. In Quebec, there has been no such requirement since 1998.

As an alternative to a life annuity, a LIF offers the plan holder the ability to
control the investment of the funds, greater flexibility in withdrawals and the
option to leave a potential estate for his or her heirs.
If the LIF owner dies, pension legislation usually requires that the funds be paid
to his or her surviving spouse by:
• transferring the assets to another LIF that names the spouse as the annuitant;
• using the funds to purchase an immediate or deferred life annuity that names
the spouse as the annuitant;
• transferring the funds to a locked-in RRSP or LIRA that names the spouse as the annuitant.
Since a LIF is treated the same way as a RRIF under the Income Tax Act, the same
rules regarding the rollover of a designated benefit to a spouse, or to financially
dependent children or grandchildren, also apply.
Locked-in Retirement Income Funds (LRIFs)

A Locked-in Retirement Income Fund (LRIF) is another variation of a registered
retirement income fund and is subject to the same rules as RRIFs under the Income Tax
Act, including the minimum withdrawal rules. An LRIF is available only to members of
pension plans in certain provinces. The money deposited in an LRIF comes from the
same sources as a LIF. Saskatchewan introduced a prescribed RIF (PRIF) in 2002,
which is very similar to an LRIF. A PRIF is also available in Manitoba.
The main difference between a LIF and an LRIF is that the LRIF, unlike a LIF, has
no requirement to annuitize the balance of funds remaining at the age of 80. Thus,
LRIFs and LIFs (depending on the plan holder’s province of residence) may be
structured to last a lifetime, just like a RRIF.
On July 27, 2007, O. Reg. 416/07 under the Pension Benefits Act was filed by
the Ontario government. The Regulation made some important changes to the
rules governing locked-in accounts.
The key changes are:
• A new Life Income Fund (the “New LIF”) is introduced effective January 1, 2008.
It will provide more flexible payments and allow owners a one-time opportunity
to withdraw up to 25% of the amount in the New LIF.
• Owners of Old LIFs are no longer required to purchase an annuity by the end of
the year in which they reach 80 years of age.
• An option to directly transfer money from a locked-in account to an unlocked
vehicle, an RRSP or a RRIF is provided in certain situations.
• The current Life Income Fund (the “Old LIF”) and the Locked-In Retirement Income
Fund (“LRIF”) will not be available for purchase after December 31, 2008.
As can be seen from the changes brought in by the Ontario government, provincial governments
alter the rules regarding LIFs, LRIFs, PRIFs, etc. from time to time. Therefore, it is important

that advisors review the latest rules and regulations in the related province regarding
these vehicles before advising their clients.
For LIFs that hold investments stemming from federally regulated registered
pension plans, the 2008 federal budget significantly enhanced the flexibility to
withdraw funds from LIFs through three provisions:
• Individuals 55 or older with small holdings of up to $22,450 will be able to wind up
their accounts with the option to convert to a tax-deferred savings vehicle. The
threshold for small holdings will increase with the average industrial wage.
• Individuals 55 or older will be entitled to a one-time conversion of up to 50 per cent of
LIF holdings into a tax-deferred savings vehicle with no maximum withdrawal limits.
• All individuals facing financial hardship (e.g. low income, high disability or
medical-related costs) will be entitled to unlock up to $22,450. This maximum
will also increase with the average industrial wage.
ANNUITIES
LEARNING OBJECTIVES
• define the term “annuity”;
• describe the difference between prescribed rate annuities and accrued rate annuities;
• differentiate between an immediate annuity and a deferred annuity;
• compare the difference between an insurance company’s deferred annuity and
a GIC issued by banks and trust companies;
• explain, using examples, withdrawal rights and the impact of market value
adjustment on withdrawals;
• describe the factors influencing annuity payments;
• explain the creditor protection available through a deferred annuity contract;
• explain the concept of a structured settlement annuity;
• differentiate between a term certain annuity and a life annuity.
An annuity is a contract between two parties, the issuer and the annuitant/
policyholder. The person whose life the annuity is based on is called the
annuitant or payee and is usually the policyholder.
The annuity issuer agrees, for a stipulated premium deposit, to make regular payments to
the annuitant. These payments may be fixed or variable and are guaranteed for a fixed
period or for life, or both. Annuities can be purchased with funds that are held in registered
plans (such as an RRSP, a RRIF, an RPP or a DPSP) or from unregistered funds, such as
personal savings that have been in guaranteed investment certificates or term deposits.

An annuity is insurance against the risk of living too long and outliving one’s capital. With an annuity,
future payments are guaranteed to be made in spite of changes in market and economic conditions.
This guarantee, however, is (largely) as good as the insurer making it. Although Assuris (a not-for-
profit organization that protects Canadian policyholders in the event their
life insurance company becomes insolvent) provides some level of protection against loss,
it is important for an advisor to check out the stability and financial strength of the financial
institution issuing the annuity, especially since annuity payments may have to be
made for several decades.
Straight Life Annuities

A straight life annuity pays the purchaser a guaranteed monthly or annual income until he or
she dies. The payments end when the annuitant dies, regardless of the length of time the
annuity was in place. Of all annuities, straight life annuities provide the most guaranteed
income per dollar of premium paid. This is because when the annuitant dies, the payments
stop and no residual payment is made to the annuitant’s estate or beneficiary.
Straight life annuity payments are a blend of capital and income, which establishes
a guaranteed lifetime cash flow for an annuitant. The main advantage of a straight
life annuity is the fact that an annuitant cannot outlive his or her capital.
A straight life annuity is suitable for an individual who has no dependants, wishes to receive the
highest guaranteed payout during his or her lifetime, and is not concerned with leaving an estate.
A straight life annuity is also suitable for a person with dependants who are fully provided
for by other means, such as life insurance policies. This person need only be concerned
with obtaining the highest available guaranteed income from the straight life annuity.
Only life insurance companies can issue life annuities.
Life Annuities with a Guaranteed Payout Period

Since payments from a straight life annuity cease at the death of the annuitant, an
early death could result in a significant loss of capital for the annuitant’s estate. As
an alternative, an annuitant may purchase a life annuity that provides a guaranteed
number of payments to his or her beneficiary after the annuitant’s death.
For example, if a purchaser of a life annuity with a 15-year guaranteed term dies after seven years,
his or her beneficiary would continue receiving the same payments for another eight years. If the
annuitant outlives the guarantee period, payments continue until death, but there are no
payments after the annuitant’s death. For example, if the same annuitant dies after
17 years, his or her beneficiary would get nothing.
Factors Affecting a Life Annuity’s Payout

As well as the type of life annuity selected and the annuitant’s state of health, the
following factors must be taken into consideration when determining the amount of
income guaranteed by the annuity issuer:
• The funds available to buy the annuity.

• The age of the annuitant. The younger the annuitant, the longer he or she is expected to
live, so payments will be lower. For example, a healthy 50-year-old who invests $100,000
will get lower payments than a healthy 70-year-old investing the same amount.
• The table of mortality used by the issuer.

• The interest rate used to calculate the annuity. Rates in force when the annuity is purchased
stay in force for the duration of the annuity. This is one of the most important factors in
determining how much income will flow from an annuity. In the 1980s, when interest rates were
very high, annuities were offering high guaranteed payments. The popularity of annuities waned
once interest rates fell, along with the amounts guaranteed to be paid.
• The cost of the guarantee(s), which involves a mortality or life expectancy factor.
• The frequency of the annuity payments. The more often payments are made,
the lower the payments will be.
• The sex of the annuitant. Females are expected to outlive males. Therefore, annuity
payments are lower for a female annuitant than a male of the same age for an
otherwise identical annuity (that is, the same guarantees, interest rates and so forth).
Fixed-term (or Term-certain) Annuities

A fixed-term or term-certain annuity provides the annuitant with a specified guaranteed annual
income for a specified number of years, with payment going to a designated beneficiary if the
annuitant dies. The most common term is to age 90. If the annuitant dies before the term ends,
the annuitant’s estate or beneficiary receives the unpaid balance of the annuity, either as a
lump sum or as installment payments that continue for the duration of the term.
The size of the annuity payments is based on interest rates and the term of the
annuity. The longer the term, the lower each annuity payment will be. Age, sex
and mortality tables are not used to determine the size of the payments, since the
income is not related to the expected life span of the annuitant.
Term-certain annuities can be issued by various financial institutions, not just
life insurance companies.
Deferred Annuities
Immediate annuities begin payments immediately after the date of purchase. Deferred
annuities permit the deferral of payments for several years – but no later than the end
of the year the annuitant turns 71, for annuities purchased with registered funds.
A deferred annuity can be for life or for a fixed term with payments on a fixed or variable
basis. The annuity issuer guarantees exactly how much monthly income will be paid out
later based on the premiums paid over the life of the deferred annuity.
The size of the premium paid for a deferred annuity depends on factors such as how
soon the annuitant wishes to receive income payments and how much income is
needed. The issuer of a deferred annuity may allow the holder to pay different
amounts each year, if this is preferable. During the deferral period, a competitive rate
of interest is credited; an appropriate guaranteed period or provision can be included.

Contributions to an unregistered deferred annuity are not tax-deductible.

In recent years, the opportunity to defer the tax payable on investment income
from deferred annuities has been reduced.
• For annuities acquired or materially altered after 1989, accrued investment

income must be included in taxable income annually.
• For annuities in effect before 1990, accrued investment income must be
included in taxable income at least every three years.
Deferred annuities are available through life insurance companies, some trust companies
and other financial institutions licensed to carry on annuity business in Canada.
A deferred annuity can be surrendered at any time, and income tax is payable
only on accumulated interest that has not been included in income.
A deferred annuity contract contains a written set of annuity rates for future use.
If, at the time an annuity option is selected, the annuity issuer is using a higher
set of payout rates, the annuitant normally receives the higher rate.
Money invested in a deferred annuity is invested with the expectation that it will
grow. The annuitant is given several different investment choices with the
insurance company. At the end of the deferral period, the contract must either be
cashed in or be converted into an immediate annuity.
Deferred annuities are similar to guaranteed investment certificates in several ways. To begin with, the
money that is invested is expected to earn a return (interest). The interest in both products
is eventually returned to the investor. The returns on a deferred annuity are often
comparable to the returns on a GIC in that they depend on the term of the contract
and the competition in the market place.
There are also important differences. An investment in a GIC is owned directly by an
investor. With a deferred annuity, the investor (annuitant) purchases an annuity contract
and the money is invested on behalf of the annuitant. Also, a beneficiary can be named
in an annuity, unlike a non-registered GIC. By naming a beneficiary, proceeds can be
passed on outside a will, avoiding the expense and time-consuming process of probate.
By naming a beneficiary in a deferred annuity, the contract can also be protected from
creditors, unlike a non-registered GIC. Individuals who invest in a deferred annuity may
have their investments reinvested at a guaranteed rate set out in the annuity contract,
unlike a GIC, which will be reinvested at prevailing market rates when it matures.
Other Types of Annuities

There are many possible variations on the way annuities are structured.
• An instalment refund annuity guarantees that if the annuitant dies before
having received as much money as was deposited, income payments will
continue to the beneficiary until the refund is complete.
• A life annuity, cash refund, is the same as an instalment refund annuity,
except that if the annuitant dies, the beneficiary receives a lump-sum cash
refund, representing the unpaid balance of the original purchase price.

• In a life annuity, increasing income, annuity payments increase annually (for example,
by 4% a year) and an appropriate guaranteed payout period may be included.
• A joint-and-last-survivor annuity pays a specified income regularly, as long as either

person is living. On the death of the first person, payments continue to the survivor for
the remainder of his or her life. Payments may remain at the same level, or the survivor
may get a lower payment. If the survivor is to receive lower payments, the original
payments will be higher than if income stays at the same level after the first death.
In a joint-and-last-survivor annuity (fixed payments), payments are made during the life
of the annuitant and continue during the life of the survivor after the annuitant’s death.
In a joint-and-last-survivor annuity (reduced payments), one level of monthly payments

applies during the life of the annuitant, and the survivor receives reduced monthly payments
for life, equal to about one-half or one-third of the original annuitant’s monthly payments.
• An impaired life annuity is for individuals who have health problems that reduce
their life expectancy relative to a person of the same age in normal health. Medical
evidence of the impairment (such as a physician’s report) must be provided. The
annuity payments are higher than those from other types of life annuities, and are
equivalent to those made to an older individual in better health.
• With reference to non-registered funds, a prescribed annuity differs from a straight annuity
in that straight annuity income is heavily taxed in the early years, because the payment
is made up of interest. In later years the tax liability decreases as the capital is
used up. A prescribed annuity overcomes this uneven taxation and provides a
level after-tax income by spreading the tax load over the life of the annuity.
When an annuitant receives payments from prescribed annuities (those purchased with
money on which tax has been paid), he or she pays tax only on the interest generated
by the capital; the capital portion is tax-free. This is different from annuities bought with
matured RRSP proceeds, where the full annuity payment is taxable in the hands of the
annuitant because the principal cost of the RRSP annuity was tax-deductible and the
income accumulated in the RRSP on a tax-free basis.
Also, with prescribed annuities, the interest included in the annuitant’s income
stays at the same level throughout the annuity’s term. In the early years, the
taxable amount is lower (than with a non-prescribed annuity); this provision
permits some deferral of taxes. To be considered a prescribed annuity, certain
conditions stipulated in the Income Tax Act must be met.
• A participating annuity provides for increased payments to the annuitant if the
investment yields are higher than expected or expenses are lower than
expected. It consists of a guaranteed portion and a dividend portion.
• In an indexed annuity, payments increase each year in line with a formula usually related
to increases in the cost of living. By comparison, in most other types of annuities, income
payments made in each period remain the same. Payments in the early years may be
much less than in later years, especially in annuities that have a long duration.

• Under a variable annuity, the amount of monthly payment to the annuitant

varies according to the value of the investments in a segregated fund into which
premiums are placed. Many variable contracts provide a “floor” below which
benefits may not fall. The floor for benefits is usually equal to 75% of premiums
paid, regardless of what happens to the value of the variable annuity fund.
• Integrated annuities are offered to early retirees to bridge the income gap until they
receive benefits from Old Age Security (OAS) and Canada Pension Plan or Quebec
Pension Plan. When early retirees reach age 65, their annuity payments decrease by
the amount defined by government benefits, applicable at the time of purchase.
There is a broad range of annuity types and features and significant differences in
prices among various issuers. Purchasers should seek expert advice on the most
appropriate type of annuity and the issuer.
A Split Annuity Program

It is possible to design a split annuity program to meet the needs of a person who wants the
guaranteed income of an immediate annuity, but who is reluctant to deplete capital immediately.
Under a split annuity program, the funds available for annuity purchase are split
between an immediate term-certain annuity and a single-premium deferred annuity. The
term-certain annuity provides a guaranteed income over a pre-determined period.
When the income from the term-certain annuity ceases, the full amount originally
invested is available as a lump sum from the single-premium deferred annuity.
Withdrawal Rights and Market Value Adjustments

An annuity issuer can impose a penalty for early withdrawal of invested funds. The
withdrawal charge will be stated in the annuity contract.
Deferred annuities generally allow for full or partial withdrawals, although a
withdrawal charge may be imposed. A tax penalty may also be imposed.
The withdrawal charges are to cover the issuer’s administrative, sales and
marketing costs. Like the back-end charges imposed when an investor redeems
money from a mutual fund company, withdrawal charges on an annuity are intended
to discourage the policyholder from withdrawing the money.
For example, Carlos has an annuity worth $50,000 and wants to redeem all of the money three
years before maturity. The insurance company has a policy of charging 2% of the amount of
the withdrawal if made with three years left to maturity. In this case, Carlos would receive only
$49,000 [$50,000 – (2% × $50,000)]. If Carlos redeems the policy with four years left on the
contract, the withdrawal charge might have been 3% of the amount withdrawn.
Immediate annuities may be commutable or non-commutable. A commutable

contract can be cancelled any time; any unpaid payments are paid out in a lump
sum to the policyholder. A present value calculation is done to determine the value
of the future payments paid out in one lump sum. A non-commutable contract does
not allow future payments to be paid as one lump sum.

Market value adjustments are often made in addition to withdrawal charges. The
amount of money that is returned to the investor is adjusted to reflect any changes in
interest rates from the time of the original investment. This can be done in two ways.
• If, for example, a three-year term deposit is redeemed after one year, the interest paid will
be based on the one-year interest rate at the time of issue, instead of the three-year rate.
• Alternatively, if interest rates have gone up since issue, the insurance company will
have to pay another annuity purchaser a higher rate of interest for the same size of
investment. The annuity issuer will charge a penalty for early withdrawal to adjust
for the interest rates now available in the market. This is similar to interest penalties
charged for paying off a mortgage before the maturity date. (Financial institutions
usually charge the higher of either the loss of interest based on the actual mortgage
rate and prevailing interest rates or three months’ interest charges.)
Structured Settlement Annuities

A structured settlement is the payment of money for a personal injury claim, in which all or part
of the settlement calls for future periodic payments. These periodic payments can be funded
through an annuity purchased from a life insurance company. Payments for the settlement of a
personal injury or death claim are made tax-free to an individual or his or her beneficiaries.
A structured settlement combines an immediate lump-sum payment and a series of

future periodic payments, specifically designated to meet the needs of an individual
claimant. This arrangement recognizes that an injured person not only has
immediate cash needs, but also needs future cash flow.
Instead of making a lump-sum cash settlement with a claimant, a casualty insurance company
will often pay the insurance proceeds directly to the issuer of an annuity, which will then be
responsible for administration and for making annuity payments to the claimant.
As legal awards continue to escalate, structured settlements based on annuity programs are
financially attractive for resolving expensive claims and provide benefits to all parties involved: the
corporate defendant/casualty insurer, the claimant/recipient and the annuity issuer.
The advantages to the claimant include:
• lifelong financial security through guaranteed periodic payments to provide for

the future needs of the claimant or the claimant’s family;
• upfront cash for immediate needs;
• substantial tax savings, since annuity payments from a personal injury
settlement are tax-free;
• relief from the burden of investing and managing large sums of money;
• protection from creditors and other parties, because the annuity cannot be
commuted, pledged, assigned, encumbered or transferred to other parties.

ADVANTAGES OF INCOME-SPLITTING BETWEEN SPOUSES
LEARNING OBJECTIVES
• explain how income splitting between spouses can help to reduce taxes for
both pre- and post-retirement.
Income splitting is used to minimize current taxes and to transfer assets to one’s spouse or
children. Income is diverted from a person in a high tax bracket to a member of one’s family
in a lower tax bracket. Income splitting can help reduce a family’s overall tax burden.
The Canadian tax system uses progressive tax rates, whereby the marginal tax rate
(tax on each additional dollar of income) increases as taxable income increases.
Therefore, the tax on two $50,000 incomes is less than the tax on one $100,000
income. The following is a list of some of the legitimate ways a family can split income.
Paying Salary (or Profits) to Family Members

A taxpayer who is a sole proprietor of a business or a partner in a partnership can pay a salary to
his or her spouse for working in the business or partnership and have this salary treated as a
deductible business expense. The salary is included in the income of the spouse. The salary must
be reasonable for the services provided, or the deduction will be disallowed. The spouse is
allowed to contribute to the Canada Pension Plan/Quebec Pension Plan (CPP/QPP) and to tax
deferral plans, such as an RRSP, and to claim deductions for such contributions.
Similarly, an individual can arrange a business partnership with his or her spouse.
Profits allocated to the spouse are taxable in the spouse’s hands, provided the
payments are commensurate with the effort or capital contributed by the spouse.
Splitting Investment Income among Family Members

It is advantageous to split investment income between high- and low-tax-bracket
spouses and children for favourable tax treatment.
Each family member claimed as a dependant by a high-tax-bracket taxpayer can
receive a certain amount of interest and/or grossed-up taxable dividends from
taxable Canadian companies tax-free without seriously affecting the high-tax-
bracket taxpayer’s ability to claim certain credits for them.
Splitting Retirement Income

A spousal RRSP is a useful tool for splitting retirement income. (RRSPs,
including spousal RRSPs, have been covered in detail earlier in this chapter.)
Also, a measure introduced in the 2007 federal budget assists considerably in splitting retirement
income — Canadians receiving “qualifying pension income” are entitled to allocate (or split) up to 50%
to their spouse. For Canadians age 65 and over, the major types of qualifying pension

income are: RPP payments, RRIF payments and RRSP annuity payments. For
Canadians under age 65, qualifying pension income primarily includes RPP payments.
Withdrawals from RRSPs, and OAS, GIS and CPP/QPP payments do not qualify.
For income tax purposes, the amount allocated is deducted in determining the income of the person
who actually received the pension income and included in computing the income of the person to
whom the pension income is allocated. Since it, in many cases, increases the transferee’s tax payable,
both persons must agree to the allocation in their tax returns for the year in question. The pension
income that is allocated retains its character and is treated as income of the lower-income spouse for
all purposes under federal income tax rules. This means that some couples may now receive a second
pension income tax credit where previously only one was available. In addition, splitting pension
income could mean higher OAS entitlements for some couples.
CPP Income Sharing/Assignment between Spouses

As explained earlier in this chapter, spouses in an ongoing relationship are permitted to
share their CPP retirement pensions. If both spouses agree, the CPP retirement pension
received can be shared in a ratio that reflects the time that the couple was living together
relative to the period of time during which contributions were made, to a maximum of 50% of
each spouse’s benefit. If both spouses are eligible for a CPP pension, both pensions must be
shared. The attribution rules do not apply. The QPP also provides for this sharing.
Payment of Expenses by the Higher-Income Spouse

It is tax-effective for the higher-income spouse to pay all the family’s expenses, while the lower-
income spouse invests as much of his or her income as practical. The investment income earned will
be taxed at a lower rate than if it were earned by the higher-income spouse. The expenses paid by
the higher-income spouse may include the lower-income spouse’s taxes (other than those withheld
from his or her salary) and the lower-income spouse’s personal debt, such as credit
card balances, if the amounts were not incurred to earn income. This arrangement
will allow the lower-income spouse to generate investment income that otherwise
would have been used to pay off personal debt.
RETIREMENT INCOME NEEDS ANALYSIS: AN EXAMPLE
LEARNING OBJECTIVES
• develop a plan for an individual who has decided to retire.
Retirement Budgeting
To determine a client’s retirement income needs, advisors should prepare a realistic retirement
budget. This involves calculating the cash inflows and outflows for the client and projecting
estimated needs for a significant period of time into the future. The client and advisor must make
assumptions about the probable state of family or individual finances and lifestyle at retirement.

A starting point for making these projections is the existing situation. A current budget can
serve as a basis for discussing retirement needs. A projected retirement budget would then
be prepared using two steps to adjust for changes in income and expenditures:
i) estimate expected retirement income, and

ii) estimate expected retirement expenses.
Projected retirement expenses are, as a rule, about 70 percent of pre-retirement expenses. Income to
meet these expenses normally comes from three sources: employer and private pension plans (such
as RPPs or RRSPs), government programs (OAS, CPP/QPP) and accumulated savings.
Expenditures usually change at retirement. It is helpful to divide expenditures into fixed (non-
discretionary) and flexible (discretionary) components. Based upon lifestyle choices, the client
can then, with the assistance of the advisor, determine which can be reduced on retirement.
Estimating Income and Expenses

Consider the case of Seema Shetty, aged 50, a university professor, who expects to
retire at 65 with a pension from the university of $54,000 (Seema does not want to
include government pensions in this calculation). She wants to keep both her house and
cottage, and continue to travel. She has a $50,000 non-registered investment portfolio.
An analysis of her expenditures results in estimated total expenses of $66,780.

This leaves her with a shortfall of $12,780.
Retirement Budget Estimate

Income
Total Income – university pension $ 54,000
Expenditures
Housing: property taxes, utilities, maintenance, improvements $ 17,200
Clothing $ 1,000
Food $ 6,000
Car repair and maintenance, instalment payments, gas, commuting costs, etc. $ 6,000
Charitable contributions $ 1,500
Insurance: auto, property, liability $ 2,500
Medical and dental care $ 1,000
Entertainment: vacations, movies, plays, concerts, sports events, entertaining $ 11,000
Taxes: federal and provincial $ 20,580
Total expenditure $ 66,780
Surplus(+) / Deficit(–) $ 12,780

Meeting the Shortfall

Professor Shetty, therefore, has to develop a plan to meet this shortfall of $12,780. The amount
required to meet this shortfall can be determined by calculating the amount of additional savings
required, given expected retirement age of 65 and life expectancy of 85. The following takes a
conservative approach by using a real after-tax rate of return estimated at 3%.
Determining Savings Required For Retirement

PV Present Value
PMT Payment
FV Future Value
N Number of compounding periods
Inter est Ra te
Using a financial calculator, the following numbers can be determined:
Annual income needed from investments $ 12,780.00
(1)
Savings required by retirement date, in current dollars $ 190,134.00
PMT = 12,780, I = 3, N = 20, FV = 0, PV = ?
Value of personal savings at retirement (2)

$ 77,898.00
PV = 50,000, I = 3, N = 15, PMT = 0, FV = ?
Amount of savings required to cover the deficit $ 112,236.00
($190,134 - $77,898)
Savings required each year $ 6,034.54

FV = 112,236, I = 3, N = 15, PV = 0, PMT = ?
(1)
PV of annuity required to pay out $12,780 over 20 years of retirement.
(2)
FV of current portfolio of $50,000 at retirement.

Assessment and Required Action

There are two ways to assess Seema’s situation: one based on assets and
the other based on income. Both lead to the same conclusion.
For the asset approach, an analysis of her situation reveals that she will need savings of
$190,134 at retirement. However, her projected accumulated savings at retirement, based on
present savings, is only expected to be worth $77,898. Therefore, she must begin saving an
extra $6,034 per year, starting now, to ensure that she has the required $190,134 at retirement.
Required savings $ 190,134

Projected savings $ 77,898
Shortfall – $ 112,236
or: $6,034 in additional savings required per year, from now to retirement.
Another way of saying the same thing, but instead based on income, is that, between her
expected annual retirement income of $54,000 and annual retirement expenditures of
$66,780, she will have an annual shortfall of $12,780. She can withdraw from her
savings, expected to be worth $77,898 at retirement, $5,236 a year for 20 years
(assuming the remaining savings grow at a 3% real after-tax return), after which she will
be fully depleted. This $5,236 (PV = $77,898, FV = 0, N = 20, I = 3%, PMT = ?) will make
up some of the $12,780 shortfall, but there will still be a deficit of $7,544 per year.
Annual shortfall $ 12,780
Saving depletion $ 5,236
Deficit $ 7,544
$112,236 ($190,134 - $77,898) will generate the $7,544 (PV = $112,236, FV =

0, I = 3%, N = 20, PMT = ?). So, the savings of $6,034.54 each year for the next
15 years will fund the deficit of $7,544 for 20 years.
Whether the income or the asset approach is used, it is clear that further action is
necessary. This action may involve any or all of the following options:
Option 1: Seema can retire on time, if she manages to save an additional $6,034 per year and
make it grow at a 3% after-tax real rate of return.
Option 2: Even if Seema cannot save additional funds, she still can, conceivably, meet her
retirement goal, if she succeeds in having her savings grow faster than the
estimated 3% after-tax real rate.
Option 3: Seema can lower her retirement income goal.
Option 4: Seema can extend her planned retirement age beyond age 65.
Canadians are beginning to realize that government and employer pension plans
may not fully meet their retirement needs. And many working Canadians do not
have pension plans at their place of employment!

A potential shortfall in the retirement budget requires the development of specific strategies to
solve the problem. These strategies can be conveniently divided into the following categories.
• Tax-advantaged investment planning. This strategy requires that the client

consider the possibility of making the maximum contribution to registered
plans, if that is not currently being done. Clients should also look into and take
advantage of the new Tax-Free Savings Account (TFSA).
• Savings planning. Increasing the amount of annual savings may entail a
thorough examination, and eventual reduction, of current monthly expenses. A
more austere budget may force the client to choose between non-essential
current expenditures and a better standard of living at retirement.
• Asset allocation planning. A review of the existing investments may induce the client
to shift the current portfolio into more aggressive investments, if there are strong
feelings about the desired level of retirement income. Of course, if these planning
strategies do not produce the desired results, the client would be forced to lower the
desired retirement income or advance the retirement age, neither of which might be an
attractive alternative. When securities markets are highly volatile (for example, in the
summer and fall of 2008), caution should be exercised in moving towards more
aggressive investments, especially in the case of investors close to retirement.

Chapter 9
Needs Analysis/
Risk Management

9
Needs Analysis/
Risk Management
CHAPTER OUTLINE
Introduction
Life Insurance Needs
• Last Expenses
• Mortgage, Education and Emergency Fund
• Income for Survivors
Life Insurance Needs Analysis
• Case Study - Tom and Debbie Duncan
Needs Analysis and Fact Finding
• Principles, Concepts, and Techniques
Matching Insurance Products with Client Needs
Risk
• Definitions
• Kinds of Personal Risk
• Risk Management
• Options for Managing Risk
• Impact of Changes in Mortality Rates
• Impact of Changes in Morbidity Rates

Completing an Application for Insurance
• Age
• Premium
Steps in Researching Product Availability and Pricing
Reports for Insurance Applications
The Role Of Insurance in Risk Management
• Insurance Providers
• Insurance and Financial Planning
Developing a Personal Financial Plan
• Interview the Client
• Gather Client Data and Determine Goals, Objectives and Expectations
• Analyze the Data and Develop Strategies
• Create and Document a Plan
• Implement the Plan
• Monitor the Effectiveness of the Plan and Modify the Strategy as Necessary
Financial Needs Analysis

• Life Insurance Needs Analysis
• Retirement Income Needs Analysis
• Analyzing the Numbers
Client Service Strategy
• The Report Presentation
• Long-term Goals
• Needs
• Current and Future Risks
• The Plan for Achieving the Goals
• Ongoing Needs

INTRODUCTION
Needs analysis refers to the process of gathering information from a client that is pertinent to
his/her insurance needs, including information about the client’s objectives and financial
circumstances. Risk management is a process by which we protect the people and things that
are important to us and minimize the financial impact of loss, damage, or injury to them.
This chapter covers both of these key areas of the insurance industry, going through the
various techniques of gathering information and the risk management process that includes
both risk assessment and risk control.
LIFE INSURANCE NEEDS
Insurance is a tool that can be used to manage the financial risk associated with uncontrollable events.
Conceptually, insurance is simply a way of sharing the losses of a few people among many.
Historians believe that the first form of insurance may have existed in China as early as 5000
BC. There, boat operators found it advantageous to redistribute their cargoes to several boats
as they approached treacherous rapids on their rivers. If one boat was lost, all the boat
owners shared the loss and no single owner was forced to face financial ruin.
While the loss of precious cargo or other valuable assets can have severe financial impact,
there is another asset possessed by every individual that has considerably more value. An
individual’s ability to earn an income is their most valuable asset next to life itself. Indeed,
the ability to achieve financial goals and attain financial independence is predicated on
one’s ability to earn an income.
The two uncontrollable events that can completely derail financial success for an individual
and their family are death and disability. Death and disability result in the wage earner’s
income stream coming to an abrupt end.
The chart below clearly illustrates the huge earning potential that each of us have. The only
obstacle to an individual and their family not realizing these huge income streams is death
or disability. Fortunately, insurance can play an effective role in replacing the income
stream when death or disability strikes.

NINE • NEEDS ANALYSIS / RISK MANAGEMENT 9• 5
WITH 5% ANNUAL INCREASES
Current earnings
Age $ 24,000 $ 72,000 $ 120,000
30 2,167,687 6,503,062 10,838,437
40 1,145,450 3,436,351 5,727,252
50 517,886 1,553,657 2,589,424
Source: Unum/Provident
The values in the chart are staggering. Does this mean that individuals should insure
themselves for these amounts? This question has been the topic of interesting debate. To put
it in perspective, if your home was valued at $500,000, what amount of insurance coverage
would you purchase to protect it? If your new car was worth $25,000, how much would you
expect your automobile insurance company to pay if the car was written off in an accident on
the way home from the dealership?
The argument could be made that the examples of insuring a home or car are very different
than insuring one’s ability to earn an income. However, there is merit to the idea of closely
examining the amount of insurance that would be appropriate for individuals to carry in the
event of their premature death.
In addition to the emotional anguish that accompanies the death of a family member, there is
also an immediate need for cash to pay the bills associated with death. Life insurance is a tool
that can create a readily available pool of cash when it is needed most.
In determining the amount of life insurance required, reasonable estimates of a family’s
immediate and long-term needs must be made. Advisors generally focus on the following
cash and income needs:
• last expenses
• mortgage, education and emergency fund
• income for survivors
Last Expenses
Upon death, an income earner’s last expenses become the surviving family’s first expenses.
These usually include:
• final medical bills (not covered by provincial health insurance or other medical insurance)
• funeral and burial/cremation costs
• current bills for household and personal expenses
• outstanding loans, including credit card balances
• unpaid property taxes

• probate costs, legal and executor fees

• unpaid income tax, including capital gains taxes generated by deemed dispositions
Mortgage, Education and Emergency Fund

A key component in any life insurance plan is to provide surviving family members with a
permanent mortgage-free residence. A mortgage fund cancels a mortgage balance, and with
it, all future interest payments.
As the economy continues to shift in favour of knowledge workers, a good education is
becoming increasingly important. At the same time, tuition fees are rising as governments
face funding restraints. Consequently, it is more important than ever for income earners with
dependant children to plan for their education.
Life insurance can prevent an education plan from falling off track.
Adequate funding is also needed to provide dependant survivors with something to draw on
in case of emergency, serious illness, or accidents. Typically, three to six months’ total
family income should be available in case of emergency.
Income for Survivors

Finally, adequate funds are necessary to provide surviving dependants with an income. This
may include funding until children are able to pay their own way. This dependency period
usually ends when the youngest child reaches age 18. For children that are university bound,
this period extends until they graduate. In addition, the surviving spouse may also require
income. Life insurance can provide monthly income to the surviving spouse or, if both
parents have died, income for the guardian to use in raising the children.
LIFE INSURANCE NEEDS ANALYSIS
LEARNING OBJECTIVES
• Given client-specific information, recommend the amount of life insurance
required to provide for the financial needs of an individual and their family.
Financial planning is a continuous process requiring periodic review and plan updates.
The insurance plan is no exception. Having the proper amount of life insurance coverage
is a very important consideration.
Determining the appropriate amount of life insurance one should have is a two step process. First, an
asset inventory is prepared detailing the value of assets that would form the individual’s estate at
death. Second, estate obligations at death are determined based on immediate cash needs at death and
ongoing income needs for one’s survivors. The estate capital required to fund the latter need can be
significant, particularly if the insured wants to guarantee the ongoing income for the survivor’s
lifetime and also protect that income against inflation. A Capital Needs

Analysis schedule is provided below to facilitate the determination of an individual’s life

insurance requirements. There is a further financial needs analysis for Arthur and Gloria
Repaldo near the end of this chapter.
TABLE 9.2 CAPITAL NEEDS ANALYSIS
If you die Assets Available If your spouse dies

$ Cash $
$ Personal life insurance $
$ Group life insurance $
$ CPP/QPP death benefit ($2,500) $
$ RPP death benefit $
$ RRSP assets to liquidate $
$ Investment portfolio to liquidate $
$ Other assets to be sold $
$ Total Cash Available [A] $
Estate Obligations at Death

$ Last expenses $
$ Mortgage cancellation $
$ Credit card balances $
$ Education and emergency fund $
$ Car loan $
$ Total Cash Needed [B] $
Income Needs of Survivor

Required gross monthly income
$ (generally 70% to 80% of current income) $
Less CPP survivor benefit

$ (maximum $529.09 if under 65 in 2011) $
Less CPP children’s benefit

$ (max. $218.50 per child under 18 in 2011) $
$ Net monthly income required [C] $
Total capital needed to produce income [D]

$ (C x 12) / .05 discount rate $
$ Total Additional Capital Needed [B+D-A] $

Case Study - Tom and Debbie Duncan

The following case study may better illustrate how a capital needs analysis would help a
family determine the most appropriate amount of insurance for their personal situation.
Tom and Debbie Duncan are in their early 30s and have two young children. They each earn
$45,000. They also have a $15,000 car loan and a $100,000 mortgage. Tom and Debbie
want to accumulate funds for retirement. They also place a high value on assisting their
children with the cost of post-secondary education and want to leave them $25,000 each.
They have $2,000 in the bank and RRSPs of $15,000 each. They do not want to liquidate
their RRSPs if one of them dies. Tom and Debbie have $200,000 and $250,000 of group life
insurance respectively, through their employers. They also each have a $200,000 term life
insurance policy. They have estimated last expenses at $15,000 and feel that 3 months of
their combined salary should be adequate for emergencies.
They want to provide for each other and their children in the event of their premature death,
but they are not sure they have enough insurance to accomplish this goal. They feel that any
capital left on their death would earn 5% (discount rate). Prepare a capital needs analysis to
determine what amount of life insurance is appropriate for both Tom and Debbie. Make any
reasonable assumptions that may be required to complete the analysis.
If Tom dies Assets Available If Debbie dies

$ 2,000 Cash $ 2,000
$ 200,000 Personal life insurance $ 200,000
$ 200,000 Group life insurance $ 250,000

$ 2,500 CPP/QPP death benefit $ 2,500
$ 0 RPP death benefit $ 0
$ 0 RRSP assets to liquidate $ 0
$ 0 Investment portfolio to liquidate $ 0

$ 0 Other assets to be sold $ 0
$ 404,500 Total Cash Available [A] $ 454,500

$ 15,000 Last expenses $ 15,000
$ 100,000 Mortgage cancellation $ 100,000

$ 0 Credit card balances $ 0
$ 72,500 Education and emergency fund $ 72,500

$ 15,000 Car loan $ 15,000
$ 202,500 Total Cash Needed [B] $ 202,500

TABLE 9.3 CAPITAL NEEDS ANALYSIS – Cont’d
If Tom dies Assets Available If Debbie dies

$ 2,813 (at 75% of current income) $ 2,813

$ - 529 (maximum $529.09 if under 65 in 2011) $ - 529

$ - 437 (max. $218.50 per child under 18 in 2011) $ - 437
$ 1,847 Net monthly income required [C] $ 1,847
Total capital needed to produce income [D]

$ 443,280 (C x 12) / .05 discount rate* $ 443,280
$ 241,280 Total Additional Capital Needed [B+D-A] $ 191,280
* At an assumed long-term rate of return of 5%, $443,280 would be required to meet income needs of
$22,164 a year (or $1,847 a month).
As the suggested solution indicates, to meet their goal of providing for each other financially
in the event of one of their premature deaths, Tom and Debbie would need additional life
insurance of approximately $241,000 and $191,000 respectively.
The capital needs analysis is a powerful tool that can calculate the appropriate amount of life
insurance needed in any individual situation. It is a tailored approach that considers each
person’s values and goals.
NEEDS ANALYSIS AND FACT FINDING
LEARNING OBJECTIVES
• describe the principles, concepts, and techniques involved in needs analysis and fact-finding.
Principles, Concepts, and Techniques

One theory that attempts to explain why people choose to purchase from one advisor rather
than another is that potential clients purchase goods and services, not because they necessarily
understand those goods or services, but because they feel that the advisor understands their
situation and has made an appropriate recommendation for that situation.
If you accept this theory, the question for an insurance advisor becomes, “How do I get enough
information about a potential client, without annoying the client?” Consider the last time you
purchased a product and needed help in deciding which product was best for your situation.

Probably the successful salesperson asked some basic questions about your use of the
product. Did your confidence in the salesperson’s recommendation increase as the
salesperson became more aware of how you intended to use your purchase?
Similarly, think of your experiences with professionals such as doctors or lawyers. In your
initial meeting, the professional probably pulled out a pad of paper, asked questions, and
recorded the answers before proceeding with any recommendations. Insurance advisors
should adopt the same approach.
Most advisors recognize the need to gather pertinent information about their clients. The
question is not, “Should I get information about my client’s situation?” The real
question is, “How will I use that information to best serve my client’s needs and build a
solid, long-term relationship with that person?”
Two types of questions are involved in a thorough fact-finding interview. The first are the so-
called “census” or data questions, e.g., name, date of birth, income, etc. The second are the
“feeling” or open-ended questions. These latter questions usually begin with, “How did
you...?” or “Why did you...?” or “Tell me more about...” These questions require more than a
“yes” or “no” response and more than a simple piece of information.
In order to conduct an effective interview, the advisor must develop good questioning
and listening skills, perhaps by taking a course in “Effective Listening.”
Insurance regulators have made it clear that an insurance advisor should:
“Make a diligent and business-like effort to learn the information about a client
that is pertinent to his/her insurance needs, including information about the
client’s objectives and financial circumstances.”
An advisor, especially in today’s litigious climate, must ensure that he or she can justify
any recommendations made or products sold. It is not enough to say “I knew from years
in the business that the client needed …” Regulators have prescribed a “Know Your
Client” rule that advisors must comply with. An advisor must know his or her client’s
situation, needs, risk tolerance, and ability to afford the proposed solution.
A serious attempt to gather the “facts” and record them is practical, not only at the time of
the initial meeting, but also as part of a long-term relationship with the client.
An advisor will usually ask a client or prospective client a series of fact-finding questions to
analyze the client’s situation and come up with an appropriate solution. A sample fact-finding
questionnaire (unfilled and filled out) is in Appendix 9A at the end of this chapter.

NINE • NEEDS ANALYSIS / RISK MANAGEMENT 9•11
MATCHING INSURANCE PRODUCTS WITH CLIENT NEEDS
LEARNING OBJECTIVES
• select the most appropriate insurance products and benefits (life, health, disability) to
match a particular client’s situation and needs, given specific client information.
Once you have recorded specific facts about your client’s situation, you can analyze them and
come up with suitable recommendations. Without information that is unique to your client’s
situation, you will simply be selling a product instead of providing a solution to a problem.
Going through a “fact-finding” questionnaire is an efficient way of gathering and retaining
information about your clients. The following sample cases look at specific scenarios and
how the advisor can best serve his or her client’s needs after gathering useful information.
Example 1: Shirley Morton is a 33-year-old single woman who works as a secretary in the small
office of a manufacturing company. She earns $35,000 a year and is a non-smoker. The
company does not have a group benefit plan. She has a universal life policy for $50,000 that
she bought to take care of final expenses and as a bequest for her favourite charity. She chose
universal life in order to increase her retirement income over and above her RRSPs. Lately,
Shirley has been concerned about the effects of a prolonged disability on her financial situation.
After discussing the situation with Peter, her advisor, Shirley feels that her savings would
allow her to meet her financial commitments for three months if she were unable to work.
She is, therefore, comfortable with a 90-day waiting period before receiving any proceeds
from a disability insurance plan.
Peter, using the software provided by one of the disability insurance providers through whom he places
business, determines Shirley’s occupational class. Based on her income, the benefit would be a
maximum of $1,900 a month until age 65, with a 90-day waiting period. Since Shirley is covered by
Employment Insurance, there will be a step-benefit. The coverage after 90 days will be $900 a month,
increasing to $1,900 after 120 days. The premium, subject to satisfactory underwriting evidence, is
$86.15 a month.
Shirley likes the proposal, but does not feel comfortable with the premium and thinks that
something in the order of $50.00 a month would be more in keeping with her budget. Peter
comes up with two alternative proposals.
The first is to extend the waiting period to 180 days, but even then the premium is too high.
Furthermore, Shirley says that she could not afford six months without much income. Peter
then shows Shirley the premium for $1,100 of monthly benefit with a 120-day waiting period
and including a Future Insurability Option (FIO). The FIO would allow her to buy additional
coverage of up to $500 per month at standard rates without having to provide evidence of
insurability. The premium for this policy would be $51.96 per month.
The second proposal is to maintain the step-benefit but to change it to $900 with a 90-day
waiting period, increasing to $1,100 after 120 days. In this case, too, FIO would be included
for $500. The premium for this option would be $54.23.

Which of the above is the one most suitable for Shirley? That is her decision. The advisor must explain the
pros and cons of each approach so that Shirley can decide which she is most comfortable with (or which
one she is least uncomfortable with). An advisor should come up with alternative solutions for a client, but
the final decision is always the client’s. However, advisors should always document their
recommendations, so that a client cannot later say that he or she was not offered a choice of options.
Example 2: Jose and Maria are 33 and 31, respectively, and both are non-smokers. They
have two children: Miguel aged 6 and Rosa aged 3. Recently, Maria and Jose have been
concerned about what would happen if one of them died prematurely. They discuss their
situation with their advisor, Roberto.
Maria earns $36,000 a year and Jose earns $58,000. The couple feels that the loss of either income
would be catastrophic. After discussing their situation with Roberto, they have determined that, ideally,
they would like to have $70,000 of total yearly income if one of them died before Rosa, their youngest
child, reached age 25. After Rosa turns 25 in 22 years (by which time Maria would be
53 years old), Maria would need total income of $45,000 (including her own salary) for 12 years
to her age 65.
Calculations:
Insurance on Jose $70,000 - $36,000 = $34,000/year 22 years
$45,000 - $36,000 = $9,000/year 12 years
Insurance on Maria $70,000 - $58,000 = $12,000/year 22 years
After some additional discussion, Roberto decides to use a net rate of return of 2%, (assuming a
return of 4.5%, taxed at 24% to provide 3.42% after tax and deducting modest infl ation of 1.42%).
Roberto then calculates the lump sum required (see Future and Present Value Tables in Appendix 9B).
Jose 34,000 × 17.658(1) = $ 600,372

9,000 × 10.5753(2) × 0.6468(3) = $ 61,561
Total $ 661,933
Maria 12,000 × 17.658(4) = $ 211,896
1
Use the Present Value of Annuity Factors table at 2% for 22 years
2
Use the Present Value of Annuity Factors table at 2% for 12 years (65 – 22 – 31)
3
Since the fund is not required for 22 years, use the Present Value Factors table at 2% for 22 years in the future
4
Use the Present Value of Annuity Factors table at 2% for 22 years
Roberto determines that, subject to satisfactory underwriting evidence, Ten-Year Renewable

and Convertible Term insurance for $665,000 on Jose without any supplemental benefits would
be $39.94 a month for the first ten years. A similar policy on Maria for $250,000 (the minimum
amount for this particular “preferred rate” policy) would be $14.40 a month. This approach will
keep premiums down, give the clients the required coverage, and allow them to convert to
whole life insurance in the future as their cash flow improves.
Jose and Maria ask to see how much the premiums for Universal Life would be for each of them.

Roberto’s software shows that the company could offer $665,000 of Universal Life insurance on
Jose, after satisfactory underwriting, for a minimum premium of $206.99 a month. Maria’s policy
would have a minimum premium of $62.86 a month for $215,000 of Universal Life insurance.
Jose and Maria say that the total premium of almost $270.00 per month is a “little less” than they
had thought it would be. After inquiring further about this response, Roberto determines that they
would consider paying up to $350.00 monthly. Roberto runs several alternative illustrations based
upon paying more than the minimum premium. He also shows the clients two other alternatives that
incorporate RRSPs. The first would apply the difference between the term policies (about $55.00
a month) and $350.00 to the couple’s RRSPs. The second would apply the difference
between the minimum UL premiums (about $270.00) and $350.00 to their RRSPs.
Roberto provides relevant information to Jose and Maria, who make the final decision. The key
factor in this case, before making a final recommendation, is finding out what the clients’ goals
and means are and how they would like their family provided for in case of death.
Example 3: Freddie and Linda are both age 42 and both are corporate lawyers, earning $200,000
each. They have no children, but they both have elderly mothers (ages 78 and 81) who rely on
Freddie and Linda to give them each $1,000 a month to supplement their retirement pensions.
Freddie and Linda’s advisor, Munira, suggests setting up an annuity for their mothers to ensure they will
continue to be looked after if both Freddie and Linda die before they do. After discussing the relative merits
of different annuities, Freddie and Linda decide on life annuities with no guaranteed period. These annuities
will cost $126,600 and $133,982, respectively, at today’s rates. The different premiums are attributed to
Freddie’s and Linda’s mothers being of different ages. To fund this amount, they dec ide to purchase a Joint
Life Renewable Term-20 policy, payable on the second death, for $260,000. As both mothers are elderly,
the need is for around 20 years, hence the Term-20 policy. They choose a joint last-to-die policy because
Freddie and Linda’s individual salary is more than adequate to meet the $2,000 per month obligation for
both mothers, upon the first death. Although annuity rates in
the future are not guaranteed, Munira advises that, as time passes, any increase in annuity rates
may be offset by the lower individual rates payable as their mothers get older. Both Freddie and
Linda feel comfortable knowing that their mothers would have the funds available to purchase an
annuity and maintain their standard of living. The cost for the insurance policy is $81.44 a month.
RISK
LEARNING OBJECTIVES
• define the risk of death and explain how it can be managed;
• explain how risk management applies to the risk of death;
• describe the impact of changes in mortality rates in Canada;
• define the risk of disability and explain how it can be managed;
• explain how risk management applies to the risk of disability;
• describe the impact of changes in morbidity rates in Canada.

Definitions
• Risk: A hazard; the possibility of suffering harm or loss; exposure to mischance; the
act of taking a chance.
• Chance: Casual or fortuitous circumstances; an accident; the probability of an
event occurring; the absence of design.
• Probability: The likelihood of an event occurring, measured by the percentage of the actual
occurrences observed in a population, divided by the whole number of possible occurrences.
• Probable: That which may be expected to happen.
Kinds of Personal Risk

• The risk of death is known as mortality and is commonly expressed as deaths per
thousand people per year for a specified age group.
• The risk of disability is known as morbidity and is commonly expressed as the
incidence of disability per thousand people per year for a specified age group.
Virtually every action involves some risk. For example, while crossing the street, one
might be hit by a car or while cooking dinner, one might get burned. Most risks do not
cause us much concern or are manageable with normal precautions.
There are some risks that individuals cannot afford to take on themselves, such as the risk of
destroying a car, the loss of one’s home by fire, or premature death. In some cases, people
are required by law (e.g., automobile insurance) or encouraged by financial institutions (e.g.,
creditor life insurance) to insure these risks.
Some people are not aware of potential risks. This is where a qualified advisor enters the
picture. It is the advisor’s job to assess the potential needs of a client, evaluate any risks,
and make recommendations to cover the risk. The client can then decide whether or not to
act on the recommendation.
If the client chooses not to take action, the advisor should put all the essential details of the
risk, his or her recommended solutions, and the client’s decision not to proceed into a
registered letter and send it to the client. The advisor should also keep a copy on file to
document the situation and forestall any claim under Professional Liability Coverage.
RISK OF DEATH
The chance of an individual dying is 100%. In other words, everyone alive right now will
eventually die. The manageable part of the risk is that an insurance company, after factoring
out those who are most at risk of dying soon (the ill and the very elderly), can reasonably
quantify the number of people who will survive a given year.
Let’s look at a Life Insurance Mortality Table in Appendix 9C. For non-smoking men
aged 35, we see that there are 9,797,694 survivors from the original 10,000,000 who were
born 35 years ago. In the following year, 11,659 of those men are expected to die. To pay the
claims of those expected to die would require $1.190 in premium for each $1,000 of coverage
[(11,659 $1,000) 9,797,694 = 1.189974]. Actuaries can also determine the required premiums
for men aged 36, 37, 38, and 39 to determine the premium for a 5-year renewable

term policy issued to an individual aged 35. The premiums must be discounted to the year in
which the policy is issued in order to calculate a present value for the premium amount. Of
course, other factors must be considered, such as premium tax, expenses, commissions and
profit, before arriving at a final premium.
RISK OF DISABILITY
The risk of disability, i.e., the chance of an individual becoming disabled, is not 100%. Some
fortunate people will never experience a serious disability. At the same time, a person may
experience disability more than once in a lifetime. The manageable part of the risk is that an
insurance company, after factoring out those who are most at risk of becoming disabled (the ill,
those in hazardous occupations, and those who participate in dangerous activities), can reasonably
quantify the number of people who will become disabled over a given period and how long their
disabilities will last. The table below provides some statistics. Clearly, as one gets
older, the chance of becoming disabled decreases as there are fewer years left in which to
become disabled. However, disabilities that occur when one is older tend to last longer,
because the body takes longer to recuperate.
TABLE 9.4 MORBIDITY RATES
Age % Disabled at least once Duration of disability

25 20.3 2.4 years
30 19.6 2.9 years
35 18.9 3.4 years
40 18.1 3.9 years
45 17.0 4.2 years
50 15.3 4.5 years
55 12.5 4.6 years
60 7.8 ?
Risk Management
Risk management is a process by which we protect the people and things that are important
to us and minimize the financial impact of loss, damage, or injury to them. People in the risk
management field need to address such questions as how to prevent employee injuries in the
workplace or how to cover the cost of repairing a damaged piece of machinery. Similar
questions arise on a purely personal level: What can be done to protect family members
from death, injury or illness? What insurance would be needed to pay for vehicle damages
that would otherwise impose a hardship on the household budget?
Risks include legal, criminal, financial, professional, and health risks, as well as risks
arising from numerous forms of property ownership, like houses and automobiles,
cottages and boats, computers and sound systems.

Most of us have an instinctive sense of risk. We are aware of the potential dangers that
surround even routine daily activities, from getting injured when crossing the street to having
a heart attack because our cholesterol level is too high. Although we try not to become
obsessed about the many hazards that confront us, these risks shape our behaviour.
Risk management involves the following processes:
• Risk Assessment (figuring out what the risks are and what to focus on)
1. List the potential risks that can harm an individual’s personal and financial well
being. (What can go wrong?)
2. Assess the probability of these risks occurring. (How likely are these things
to go wrong?)
3. Estimate the financial impact and other consequences of something going
wrong. (What happens after they go wrong and what will it cost to make things
right, or at least better?)
4. Rank the risks (What’s the worst thing that could happen in terms of potential losses?
The second worst thing? And so on.). Are there other risks that should be considered?
• Risk Control (doing something to protect oneself from potential losses)

1. Formulate strategies to lessen the highest-ranked risks. For example, introduce health
and safety measures in the workplace to reduce accident rates and/or buy insurance.
2. Implement the strategies.

3. Monitor the effectiveness of the strategies and the changing levels of risk. For
example, conduct annual reviews to see if the controls are still adequate, if they are
still required, or whether there is a better alternative available.
The goal should be to manage the risks we are exposed to, so that no matter what happens,
we will never face large, permanent financial losses. For example, a financial planning
practitioner needs to carry professional liability insurance to cover the risk of being sued
by a dissatisfied client or, even worse, a dissatisfied group of clients.
Options for Managing Risk
AVOID THE RISK

The most common form of managing risk is to avoid the risk. Persons who are terrified of
airplane crashes can avoid all flying and thereby drastically reduce the possibility of dying or
being injured in a plane crash. However, the possibility of injury or death still remains in a
minuscule way, because it is still possible that a plane could crash into one’s house or car.
There is always the possibility of dying or being injured, no matter how hard one tries to
avoid a “risky” venture.

ACCEPT THE RISK

Acceptance of a risk means accepting the consequences of a “loss.” For example, an
individual may choose to forgo the “extended warranty insurance” available on a big screen
TV and be prepared to pay for the repair or replacement of the item if it malfunctions (self-
insuring the risk). Alternatively, someone might feel they live a life with very little risk and
don’t worry about becoming disabled, so they don’t purchase disability insurance.
REDUCE THE RISK OR ITS CONSEQUENCES

Certain risks can be reduced and any losses incurred may be lessened. For example, a casino may
institute a non-smoking policy within its premises (in jurisdictions where the law does not yet
mandate non-smoking). This type of ban could lessen the possibility of a fire occurring. In
addition, the casino may have to install smoke detectors, an alarm system, and a fire-sprinkler
system. By doing this, the casino lessens the damage (loss) that might occur in the event of a fire.
TRANSFER THE RISK

The most common method of transferring the risk is by purchasing insurance. Insurance is
appropriate when the consequences of loss could be great but the probability of loss is small.
Life insurance, disability insurance, long-term care insurance, critical illness insurance, and
accident and sickness insurance products meet these criteria, as the likelihood of an insured
event occurring within the covered period is small.
Insurance companies achieve a degree of risk sharing even when they insure a particular risk
by including provisions such as deductibles (so that the insured pays the first $100 or $500 of
a loss), co-insurance factors (in which the insured pays a percentage of the costs incurred),
exclusion clauses (in the case of a person who, for instance, engages in high-risk activities
such as skydiving), and/or by charging extra premiums for substandard risks (for example, a
heavy smoker with high blood pressure would pay substantially higher premiums for the same
face amount of life insurance than a non-smoker of the same age in good health would).
STEPS IN MANAGING THE RISK

There are five acknowledged steps in managing all risks. They are:
1. Identify the risk. What are you trying to protect? For example, loss of income.
2. Determine the objective. What is the probability of the risk occurring and what are
the potential consequences?
3. Consider the viability of various options for dealing with that risk (avoid, accept,
reduce, and/or transfer).
4. Implement the most suitable option.
5. Monitor the situation to ensure that the option implemented remains the preferred option.
Impact of Changes in Mortality Rates

Consider the life insurance mortality tables in Appendix 9C. By looking across the columns for
age 35, we see that 11,659 male non-smokers and 18,043 male smokers out of the original
10,000,000 people born 35 years ago, are likely to die within one year of turning 35. These
numbers change to 101,234 and 224,279 respectively at age 65. In other words, the probability

or risk of dying is substantially greater at age 65 than at age 35. Therefore, the premium to
insure a 65-year-old will be significantly higher than that for a 35-year-old.
In recent years, however, life expectancy has been increasing. Fewer people have been dying
at all ages, and this has reduced the cost factor of insurance related to mortality.
Impact of Changes in Morbidity Rates

Take another look at Table 9.4. For people aged 35, the likelihood is that 18.9 percent will
become disabled at least once and the disability is likely to last slightly more than 40
months. As the probability of becoming disabled increases, or the severity of the disability
worsens (so that individuals are disabled for longer periods), insurance premiums increase.
While mortality rates have gone down in recent years (i.e., life expectancy has increased for both
males and females), the incidence of disability has jumped significantly and so have claims for
disability benefits. That’s one reason why premiums for disability insurance have shot up. Also,
while people are living longer, they may be disabled for longer periods of time than in the past.
Consider, for example, an individual with serious kidney disease who 25 years ago would have
likely died much sooner than a person today (who is likely to survive because of advanced
dialysis treatments and kidney transplants); however, such a person today may face long-term
disability (and be unable to work) for more than ten or twenty years.
COMPLETING AN APPLICATION FOR INSURANCE
LEARNING OBJECTIVES
• demonstrate proficiency in performing mathematical calculations for a life
insurance application.
A sample generic life insurance application is included in Appendix 9D.
Several calculations must be performed as part of the application process. Although advisors
use software to perform the calculations, they need to know how these calculations work in
order to answer inquiries from prospective clients. The most common calculations an advisor
should be familiar with are those that involve the age of the client and those used to
determine the premium to charge for a particular policy.
Age
Advisors must determine the client’s age in order to quote a premium for an insurance policy.
This appears to be a straightforward matter; however, some insurance companies quote premiums
based on the actual age of the client and others do so based on the client’s nearest birthday.

EXAMPLE
An application is being completed on February 3, 2008. The client was born on May 4, 1972. If
the age is based on current age attained, then the client would be considered 35 years old.
Year of last birthday 2007

Year of birth 1972
Age last birthday 35
Based upon the same scenario as above, if the age is calculated as of the nearest birthday,
the client is closer to age 36 than age 35, being 35 years, 8 months, and 30 days old.
Date of application Feb 3, 2008

Date of birth May 4, 1972
Age: 35 years, 8 months, 30 days
Premium
A male, non-smoker, age 35 is applying for a Whole Life plan with the waiver of premium
benefit. He has 3 children aged 7 years, 4 years, and 2 months and wishes to include a
children’s term rider (CTR) of $12,500.
• The annual Whole Life premium is $25.17 per $1,000 of face amount.
• The Waiver of Premium (WP) is $0.66 per $1,000 of face amount.
• The CTR premium is $6.00 per $1,000 of face amount.
• The administrative cost (policy factor) is $75.00 a year or $7.50 a month.
Calculate the annual and monthly premium for a policy with a $100,000 face value (to
convert to a monthly premium, multiply the annual premium by 0.09 - the conversion factor).
Paying on a monthly basis will add 8.3% to the cost of insurance for this client ($2,733.00
annual premium versus total monthly premiums of $2,960.64).
Annual Premium
Basic $ 25.17 × 100 = $ 2,517.00
WP $ 0.66 × 100 = $ 66.00
CTR $ 6.00 × 12.5 = $ 75.00
Policy Factor = $ 75.00
Total Annual Premium $ 2,733.00

Monthly (Pre-Authorized Cheque) Premium

Basic $ 25.17 100 $ 2,517.00
WP $ 0.66 100 $ 66.00
CTR $ 6.00 12.5 $ 75.00
$ 2,658.00
Conversion to PAC ($2,658.00 × 0.09) $ 239.22
Policy Factor $ 7.50
Total Monthly Premium $ 246.72
STEPS IN RESEARCHING PRODUCT AVAILABILITY

AND
LEARNING OBJECTIVES
• explain the steps in researching product availability and pricing.
There are hundreds of different insurance products, and thousands of product variations, available
in the marketplace to cover practically any risk imaginable. Suppose your analysis of a client’s
situation reveals an obvious need for securing protection through the purchase of life insurance
and your client agrees that the risk can only be properly addressed by a customized policy. At that
point, numerous factors must be considered before deciding what type of life insurance, policy
benefits, and riders would be ideal for the client. Here are just a few:
• Is the need for life insurance of a permanent nature or is the need for a set period?
• Does the client prefer to “rent” or “own” such insurance?
• What premium commitment is the client prepared to make?
• What other financial obligations does the client have?
• What is the client’s age?
• Does the client smoke? Is the client in good health and insurable?
• Is the client single or married? Does the client have any children? How old are the children?
Assume that the client leans towards term insurance mainly because of the cost factor.
Then, a new set of considerations has to be examined, such as:
• Will it be level term, increasing term or decreasing term?
• Will it be renewable and convertible term, just renewable, or non-renewable term?

• Will it be yearly renewable term (YRT), 5-year term (T-5), 10-year (T-10), or 20-year
term (T-20)?
• Is Term-to-100 a viable alternative?
As you can see, an advisor has to carefully analyze and evaluate the situation to determine what the
best option(s) would be for a particular client at a particular point in time and continually monitor
the plan to ensure it meets the client’s needs as the client’s situation changes.
A 5-year renewable and convertible term policy may be available from over fifty insurance
companies. Clearly the advisor cannot do a detailed analysis of each provider’s product package
(although nowadays vast quantities of data can be put at an advisor’s finger tips through software
and the Internet). Usually, an advisor’s research involves the products of several companies
and the pros and cons of their policy wordings, e.g., definition of disability and exclusions. A
new advisor will generally offer the product line of only one or two companies that he/she is
familiar with until more experience is accumulated. To reduce the time required to obtain this
knowledge, a new advisor may wish to partner with a more experienced advisor. Sales managers,
MGAs (Managing General Agents), and/or product consultants with various companies may also
provide assistance in researching and obtaining appropriate product information.
A crucial consideration in deciding which insurer’s product to recommend is the financial
stability and solvency of the insurer issuing the policy. As many insurance products are of a long-
term nature – in some cases, spanning fifty years or more – it’s quite important that the insurance
company (an advisor recommends) has a distinguished record of client satisfaction and service
along with consistently excellent financial ratings from independent agencies such as A.M. Best.
Clients should also be reassured that in addition to the guarantees provided by insurance
companies to back their own products, the industry as a whole has set up a compensation fund
(called Assuris) that guarantees death benefits, monthly incomes, health expenses and cash
values up to specified levels in case of insurer insolvency. Assuris thus serves as an added
layer of protection for buyers of life insurance and related products.
Differences in premium costs for practically identical policies issued by different insurers can be
huge. That’s because each insurer has its own set of underwriting standards, risk profiles, target
markets, profit expectations, overhead costs, etc. While Sterling Life may be able to offer a 5-
year renewable term policy to a 30-year-old non-smoking female client for an annual premium of
$300, Gold Life may offer a similar policy for an annual premium of $390. On the surface,
the choice is a no-brainer, i.e., the policy should be placed with Sterling. But there are some
important factors to keep in mind. For instance, what happens at the end of the first 5-year
period? Sterling might offer a renewal premium at age 35 of $600 while Gold may bind itself to
renew at $500. Sterling’s policy may include certain restrictions upon renewal that are absent
from Gold’s policy. Also, Sterling may have been in business for only three years while
Gold may have been around for 55 years.
Product proliferation is so widespread in the insurance industry that apples-to-apples
comparison between policies is difficult, and in some cases such as universal life, practically
impossible. That’s why clients rely on advisors to inform them, educate them, guide them,
and make recommendations that are in keeping with the client’s objectives, expectations,
preferences, and financial and personal circumstances. At all times, the client’s best interests
must prevail when researching product availability and pricing.

REPORTS FOR INSURANCE APPLICATIONS
LEARNING OBJECTIVES
• demonstrate proficiency in using typical insurance mathematical formulas and
concepts to prepare reports for insurance applications.
An advisor often uses a policy illustration as a sales tool. A policy illustration helps the
client understand the features and benefits of a particular product; it shows how a policy will
work and what the potential outcome could be if certain assumptions hold true. A policy
illustration does not provide any guarantee of actual future performance or results.
It’s important for the advisor to understand the rationale behind the assumptions used in the
policy illustration and communicate that understanding to the client. The Canadian Life and
Health Insurance Association (CLHIA) has put together guidelines that must be followed
when preparing policy illustrations. Although policy illustrations are nowadays prepared
using customized software and follow an approved format, the advisor should be able to
calculate the numbers on his or her own. By being able to do so, the advisor will be better
able to explain the illustration to the client. Knowing the details and mechanics of policy
illustrations can help an advisor compete for new business and enhance existing business.
Each insurer’s formatting of a policy illustration is somewhat unique although all must
cover specified data in a specified manner under insurance regulation. The following is a
detailed description of what an advisor can expect to see on a typical policy illustration for
Participating Whole Life with the dividend option of Paid-up-Additions. What follows is
an outline of the policy illustration in Appendix 9E.
• Page 1:
Shows who the illustration was prepared for, by whom, the plan of insurance, and the
date prepared.
• Page 2:
Contains a basic summary of the coverage and premium. It also shows, at the bottom of
the page, the page number and the total number of pages that make up the illustration. It
also indicates that the illustration is not valid if all pages are not included.
• Page 3:
Indicates the purpose of the illustration and the basis for the three scenarios presented;
the insurer’s current dividend scale, the current dividend scale reduced by 1%, and the
current dividend scale reduced by 2%.

• Pages 4-6:
The guaranteed amounts for policy years 1-64
– Column 1 The policy year
– Column 2 The annual premium required
– Column 3 The guaranteed cash value
– Column 4 The guaranteed death benefit
The non-guaranteed amounts
– Column 5 The total cash value. This is the sum of the guaranteed cash value
plus the cash value of the dividends based on the current dividend
scenario in policy year 1 (in this case, the cash value of the
dividends is $596 – 300 = $296).
– Column 6 The total death benefit. This is the sum of the $100,000 face amount
plus the paid-up additions. In year 1, the total is $101,672 which
means that the $296 calculated for column 5 bought $1,672 of
additional insurance ($101,672 - $100,000 = $1,672).
– Columns 7-10 These columns repeat columns 5 & 6 using the two alternative
scenarios.
N.B. Even though future dividends are not guaranteed, a dividend once earned (paid) is vested and
cannot be reduced or reclaimed.
• Pages 7-9:
The guaranteed amounts
– Column 1 The policy year
– Column 2 The annual premium required
– Column 3 The guaranteed cash value
The non-guaranteed amounts
– Column 4 The net cost of pure insurance (NCPI) for the policy
– Column 5 The adjusted cost basis (the sum of the annual premium paid from
column 2 less the NCPI from column 4)
– Column 6 The total cash value (from column 5 pages 4–6)
– Column 7 The taxable gain on surrender: cash value in column 6 less the sum of
the yearly adjusted cost basis in column 5 (negative amounts = 0)
– Columns 8-11 These columns repeat columns 4–7 based on Alternative Scenario 1.
N.B. For Policy Year 11, the Total Cash Value is $28, 228.70 and the Adjusted Net Cost is
$27,130.02. The actual difference is $1,098.68. The difference of $.01 is due to rounding.

• Pages 10-12:
– Columns 1-7 These repeat the same columns on pages 7-9
– Columns 8-11 These columns repeat columns 4–7 but they are based on Alternative
Scenario 2.
• Page 13:
This Company requires that the proposed owner sign a receipt for the illustration
and acknowledgement of its contents.
Although it is not necessary to go through every line of an illustration with a client or prospect,
the advisor must provide full, true and plain disclosure of all salient facts and features using
simple terminology the client will comprehend. It is also necessary for the advisor to answer all
client questions and address all client concerns in a way the client will understand and appreciate.
An advisor who is not prepared or is hesitant in answering questions will have a difficult time
closing the deal or receiving referrals to other prospects. Professional credibility relies on the
advisor’s level of confidence and ability to communicate clearly in a compelling manner.
THE ROLE OF INSURANCE IN RISK MANAGEMENT
LEARNING OBJECTIVES
• explain the role of insurance in managing risk as a part of financial planning;
• define and explain financial planning in the context of selling insurance.
The purpose of insurance is to share a risk among the members of a group, so that no
one member suffers a catastrophic loss. Insurance replaces the possibility of a large
loss by the certainty of a small loss (the premium).
In order for an insurer to undertake a risk:
1. the level of risk must be similar among the group members;
2. there must be a large number of group members so that the risk can be predicted with
some degree of accuracy;
3. any potential loss must be quantifiable;
4. the losses must be outside of the control of the insured;
5. the losses must not be caused by a general catastrophe such as a war, which would
affect all the members at once.

Insurance Providers
There are basically two main providers of insurance: the private sector and the public sector.
1. Private-sector insurers consist of:
• mutual insurance companies which are owned by their policyholders and
may distribute surplus capital or earnings among the policyholders;
• stock insurance companies which are owned by the company’s stockholders, pay
dividends to participating policyholders, and may distribute surplus capital or
earnings among the stockholders as dividends;
• co-operative insurance companies and fraternal benefit societies (including
trade unions, alumni groups, and medical groups).
2. Public-sector insurers include both the federal and provincial governments. The insurance is
either compulsory, provided to all and paid by all, or non-compulsory, which can be
purchased and paid for by only those who wish to participate to minimize potential losses.
Compulsory programs include:
• CPP and QPP, which provide death, survivor, disability and retirement benefits;
• Employment Insurance;
• Workers’ compensation.
Non-compulsory plans include:
• crop insurance;
• flood insurance;
• Canada Mortgage and Housing Corporation (CMHC) mortgage insurance
Government-backed insurance programs are not considered to include public

assistance initiatives such as:
• Health care;
• old age pensions;
• social assistance (welfare).
Insurance and Financial Planning

Varying types of insurance are vital to the financial well-being of families. While the loss of
a tangible asset, such as a house or car, may harm a family financially, the most valuable
asset most people have is the ability to earn an income. People also need financial resources
to achieve certain goals. Insurance protects people from the financial uncertainties
associated with death, disability, or a critical illness. Having an insurance program in place
can help mitigate the financial effects that these events would have on a family. People who
do not have appropriate insurance in place are financially vulnerable. They may have to use
their own funds to pay for the consequences of unforeseen events. Their funds may be
limited, but even sizable financial resources can be depleted quickly in the event of a death,
disability, critical illness or need for long-term care.
The following types of insurance available from private-sector insurance companies can be
used to manage risk as a part of financial planning.

1. Life insurance can be used, in the event of death:

• to replace income;
• to pay funeral and burial/cremation costs;
• to pay off mortgages;
• to eliminate outstanding debt/loans;
• to pay any unpaid taxes;
• to pay probate and legal costs and executor fees;
• to pay any capital gains taxes due upon death;
• to facilitate estate desires (inheritance or charitable gifting);
• to help keep a business viable when an owner or key employee dies;
• to facilitate the transfer of ownership of a business owner’s interest upon death.
2. Disability insurance – after allowing for government plans – can be used:
• to replace income when the income earner is ill or injured thereby helping
maintain a reasonable quality of life and desired lifestyle;
• to help keep a business viable when an owner or key employee becomes ill or injured.
3. Critical illness insurance can be used:

• to pay medical bills;
• to seek alternative forms of treatment or treatment in another country;
• to help renovate a house for an individual with special health needs;
• to make major lifestyle changes (and improve quality of balance of life);
• for any other need or desire the insured may have.
4. Long-term care insurance can be used, in coordination with provincial and group
health plans:
• to pay for institutional health care and/or personal care;
• to maintain and enhance dignity and independence;
• to pay for other services such as in-home private nursing or nursing home care;
• to protect retirement savings from depletion.
5. Extended health insurance can be used:
• to supplement provincial health insurance plans that usually cover basic hospital
and medical services;
• to cover prescription drugs, dental care, vision care, private duty nursing, private or
semi-private hospital accommodation, and the services of paramedical practitioners
(such as massage therapists, chiropractors, or physiotherapists).
6. Automobile insurance can be used to pay for:
• third-party liability costs;
• accident benefits;
• damage to a vehicle.

7. Homeowners’ insurance, including tenant packages, can be used:

• to protect property;
• to provide liability coverage for owners in the case of an accident on private property;
• to protect the contents of a house or apartment.
8. Commercial property insurance can be used:
• to compensate a business for losses due to fire or theft.
9. Liability insurance can be used:
• to provide errors and omissions coverage;
• to protect an advisor from financial losses if he or she is sued.
DEVELOPING A PERSONAL FINANCIAL PLAN
LEARNING OBJECTIVES
• explain the procedure for developing a personal financial plan for a client.
Not all insurance advisors are financial planners, but many financial planners are licensed to
sell insurance. Although you might not be required to prepare a complete financial plan for
your clients, you still need to understand your client’s present situation and identify instances
in which insurance would provide an appropriate solution to potential risks.
There are six steps in preparing an effective financial plan. They are:
1. Interview the client through a discovery process that fulfills the requirements and
spirit of the Know-Your-Client (KYC) rule.
2. Gather client data (financial and personal) to determine and document the client’s
goals, objectives and expectations.
3. Analyze the data and develop strategies to achieve the client’s goals and objectives.
4. Create and document a plan that incorporates optional strategies from which the client
can select.
5. Implement the plan.
6. Monitor the effectiveness of the plan and modify the strategies as necessary.
Interview the Client

The interview and client discovery process provides an opportunity to determine what issues
(immediate and long-term needs or desires) the client has identified and whether a financial plan
can address them. This is also a good time to determine if the advisor and the client will be
comfortable in a long-term relationship. The advisor should make it very clear to the client that

choices and decisions must be made about alternative strategies for dealing with planning
issues. Insurance might be a solution to some of their concerns, but that can be determined
only once all the facts are known. The advisor must also make it very clear that the client
might need to consult a lawyer, accountant or other specialist to deal with issues related to
an area in which the advisor is not licensed or does not have the necessary expertise.
Often, a letter of engagement or a formal contract is used to establish the relationship between
the client and the advisor. The letter or contract outlines the advisor’s services, the client’s
role and accountabilities, and describes the information that the advisor will need from the
client in order to provide those services.
Gather Client Data and Determine Goals, Objectives and

Expectations
Use the Client/Family Personal and Financial Review form in Appendix 9A (or a similar form) to
record the data obtained from the client. The information-gathering process is an important part of
relationship-building and the development of trust and understanding. Remember that people tend
to buy goods or services, not because they necessarily understand them, but because they feel that
the advisor understands them and can apply them to address particular issues.
During the information-gathering process, the advisor must help the client develop realistic
and specific goals. Many clients may have goals that are unrealistic, such as to retire at the
age of 45, even though they do not have any savings or financial plan. Some clients’ goals
are non-specific, such as “to have sufficient retirement income.” These clients may not
know exactly how much income they need or how to accumulate it.
Objectives might be broken down into three distinct phases:
• Short-term: these goals should be accomplished within 5 years. They may include
such things as paying off a car loan, or taking an extended vacation.
• Medium-term: these goals should be accomplished within 20 years. They may include
accumulating post-secondary education funds for children or paying off a 25-year
mortgage in 15 years.
• Long-term: these goals will take more than 20 years to accomplish. They may include
saving for children’s weddings, maximizing retirement income, or providing an
inheritance for future grandchildren.
The advisor should document and prioritize the client’s objectives clearly and succinctly and
ensure that the client agrees that these are, indeed, his or her objectives and that the timelines
are appropriate. The advisor must also develop a complete understanding of the client’s current
financial, personal, family and business position. The advisor may have to go back to the client to
re-examine any objectives that seem unreasonable and work with the client to modify them.
Analyze the Data and Develop Strategies

Once the data is collected and goals and expectations have been determined, the advisor has
to analyze the data and come up with strategies and alternatives to achieve them in the most
efficient and integrated manner possible. This is likely going to take quite a bit of time and effort
to do properly. Client situations are getting more complex and demanding; for instance, advisors

may have to deal with clients in second or even third marriages with step-children, half-children,
biological children from different partners, not to mention ex-spouses. The advisor needs to take
a holistic approach to the client’s situation so that factors like tax planning, risk management,
retirement planning, investment planning and estate planning are taken into consideration. If a
client is a business owner, it brings an added layer of complexity to the situation and may require
the advisor to consult a specialist in business continuation and succession planning.
Create and Document a Plan

The strategies, options, and plan for achieving the client’s goals and objectives must be
carefully and thoroughly documented in a polished presentation package. Documenting the
plan demonstrates the professionalism, competence and care of the advisor and enhances
the client’s opinion of the advisor and their relationship.
Thorough documentation of the discovery process, data analysis and recommendations
provide a reliable record of any advice given in case something untoward happens that
causes the client to take legal action. The advisor must be able to demonstrate that any
options presented or advice given was appropriate to the client’s situation.
The plan document should include:
• the client’s personal and financial data;
• the client’s prioritized goals, objectives, desires and expectations;
• the assumptions made for any recommendations, advice or illustrations;
• the recommended options, strategies and integrated plan to address immediate and
future needs or desires;
• identification and explanation of any services that may be required from other
professionals for successful implementation of the plan.
In addition, the advisor should record in the client file the decisions made by the client (or
the client’s failure to make a decision) and how these decisions were implemented.
Implement the Plan

This is where “the rubber meets the road.” If the client develops “cold feet” or procrastinates
after having agreed with the plan, the plan is a useless piece of paper, like an unsigned
will. It is important that the client realize that it is in his or her interest to implement the
recommendations. If the client needs insurance, the advisor must put the insurance in place.
Many clients feel that their situation is just fine as it is and they have no financial concerns.
It is the advisor’s job to uncover issues and circumstances for which insurance would be an
effective solution.
Monitor the Effectiveness of the Plan and Modify the Strategy

as Necessary
A financial plan, like a will, is not a static document, carved in stone. Things change! The plan must
be reviewed periodically, or when significant changes occur, to ensure that the plan remains practical
and effective. Generally, an annual meeting with a client is sufficient; however, if a major

financial or personal change occurs, such as divorce, unemployment or the birth of a child,
the plan should be reviewed at that time.
FINANCIAL NEEDS ANALYSIS
LEARNING OBJECTIVES
• design and develop a financial needs analysis for a client to reduce the probability
and/or severity of risk related to retirement planning, investment planning, tax planning
and estate planning;
• develop a strategy to address a client’s ongoing financial needs using an effective
financial planning process.
The following information contains the results of a fact-finding interview with Arthur and Gloria
Repaldo (see Appendix 9A). The advisor has scheduled another appointment for the same time in
two weeks to review the data gathered, identify the shortfalls in the Repaldos’ current plan (the
risks), present a plan for dealing with the shortfalls, and suggest alternative strategies.
Practically all agents, advisors and planners have access to sophisticated planning software.
Some companies use highly customized and proprietary programs while others may favour
the style and formatting of one commercial software package over another.
When using such software, it is vitally important to understand and be able to explain the
process, mechanics and basic mathematics that drive the analyses and resulting projections.
For the Repaldo case study, we will rely on a standard financial calculator to exhibit the
insurance and retirement needs analyses process and basic math for a fairly typical couple.
Insurance and financial planning software generally rely on spreadsheets to generate analyses and
projections. Most of the mathematics involved is based on time value of money factors. While
going through the analysis for the Repaldos, it is important that you follow and understand
the process involved rather than concentrate on specific numbers and calculations.
Also, keep in mind that clients can and will make requests that may seem atypical to you, but
make a lot of sense from their perspective; for example, a client may ask that you do not
include certain assets or sources of income in your projections and calculations. In most
cases, it would be prudent to abide by such requests.

Life Insurance Needs Analysis

An insurance needs analysis begins by filling out the Capital Needs Analysis schedule
presented and explained in an earlier section of this chapter. Below is the completed Capital
Needs Analysis for the Repaldos.
If Client Dies If Spouse Dies

(Arthur) (Gloria)
Assets Available
$ 20,000 Cash $ 20,000
$ 500,000 Personal life insurance $ N/A
$ 60,000 Group life insurance $ 129,600
$ 2,500 CPP death benefit $ 2,500
$ N/A RPP death benefit $ N/A
$ N/A RRSP assets to liquidate $ N/A
$ 25,000 Investment portfolio to liquidate $ N/A
$ N/A Other assets to be sold $ N/A
$ 607,500 Total Cash Available [A] $ 152,100

$ 27,500 Last expenses $ 29,000
$ 36,800 Estate Taxes & Probate Fees $ 6,600
$ 85,000 Mortgage Elimination $ 85,000
$ 3,000 Revolving Debt $ 3,000
$ 25,000 Emergency fund $ 25,000
$ 15,000 Car loan $ 15,000
$ N/A Other Obligations to be met $ NA
$ 192,300 Cash Needed at Death [B] $ 163,600

$ 3,710 (85% of current household income) $ 2,310
$ − 493 (maximum $493.28 if under 65 in 2008) $ − 493
$ N/A (max. $208.77 per child under 18 in 2008) $ N/A
$ 3,217 Net monthly income required [C] $ 1,817
$ 772,080 Total capital needed to produce income [D] $ 436,080
(C x 12) / .05 discount rate
$ 356,880 Total Additional Capital Needed [B+D-A] $ 447,580

ASSETS AVAILABLE IF ARTHUR DIES
Cash:
Joint Chequing Account $ 8,500
Savings Accounts $2,500 + $4,000 $ 6,500

CSBs $ 5,000
$ 20,000
Personal Life Insurance:

T-10 Policy # 11223344 $ 250,000
T-10 Policy # 99887766 $ 250,000

$ 500,000
Group Life Insurance:
YRT Plan: # Not Known 1 x salary $ 60,000
CPP Death Benefit: Arthur has been making maximum contributions to CPP
and therefore qualifies for the full death benefit which is received tax free
$ 2,500
RPP Death Benefit: Some RPPs provide a lump sum at death in conjunction with the ability to roll over the
vested plan interest to a locked-in spousal plan. The death benefit is usually modest. It can be a set sum in
the $10,000 to $50,000 range or a percentage of vested plan interest such as 10%. RPP death benefits are
received tax-free by the beneficiary. In this case, Arthur does not have an RPP.
RRSP Assets to Liquidate: RRSP/RPP assets should rarely, if ever, be liquidated to provide funds or
income in the event of death prior to retirement. Using registered assets planned to support a carefully
calculated retirement lifestyle in place of appropriate insurance or non-registered savings simply replaces
one problem (death) with another (insufficient retirement assets). Liquidating registered assets also ‘burns -
up’ valuable contribution room and forgoes the potential of many years of tax deferred compounding; a very
poor scenario of risk management, retirement planning, and income tax planning.
Investment Portfolio to Liquidate:

GICs (most GICs can be cashed in the event of death) $ 10,000
Balanced Mutual Fund $ 15,000
$ 25,000
($3,000 capital gain on balanced mutual fund x 50% inclusion rate, so taxable gain = $1,500)
Other Assets to be Sold: None
Total Cash Available if Arthur Dies: $ 607,500

ASSETS AVAILABLE IF GLORIA DIES
Cash: The same cash total is available $ 20,000

should either Gloria or Arthur die.
Personal Life Insurance: None

Group Life Insurance:
YRT Plan: # Not Known 3 x salary $ 129,600
CPP Death Benefit: The plan first determines the amount of the retirement pension, or what it
would have been at age 65 when death occurred. The death benefit is equal to six months of this
retirement pension, up to a maximum of $2,500 [($884.58 maximum benefit x 90% entitlement) x 6
months of benefits]. Gloria would qualify for the full CPP death benefit.
$ 2,500
RPP Death Benefit: Gloria’s RPP does not offer a death benefit.
RRSP Assets to Liquidate: None
Investment Portfolio to Liquidate: None
Other Assets to be Sold: None
Total Cash Available if Gloria Dies: $ 152,100
ESTATE OBLIGATIONS AT ARTHUR’S DEATH
Last Expenses:
Funeral and Burial $ 17,500

Legal Fees $ 7,500
Administration Expenses $ 2,500
$ 27,500

ESTATE OBLIGATIONS AT ARTHUR’S DEATH – Cont’d
Estate Taxes and Probate Fees:

Arthur’s Regular Income Taxes for the Year $ 12,075
Capital Gains Tax on the Balanced Mutual Fund $ 467 $ 1,500 Taxable Gain @ 31.15%
Capital Gains Tax on the Cottage $ 21,805 $ 165,000 FMV - $25,000 ACB
Arthur Wishes to ‘Trigger’ the Gain on his Death = $ 140,000 Gain x 50% inclusion
= $ 70,000 Taxable Capital Gain
$ 70,000 @ 31.15% = $21,805

Probate Fees $ 2,463 $ 2,500 Savings Account
$ 5,000 CSBs
$ 10,000 GIC
$ 15,000 Mutual Fund
$ 165,000 Cottage
$ 197,500
( $ 50,000)Base for $250 Fee
$ 147,500 @ $15 per $1,000
= $ 2,213 Fee
+ $ 250 Base Fee
$ 2,463
$ 36,810
Mortgage Elimination: Eliminating all debt upon the first death of a couple significantly reduces
the overall amount of insurance required. It is much more efficient to retire the lump sum debts
than to annuitize the ongoing debt servicing costs. Eliminating debt provides substantial peace
of mind for the survivor and the family, eases current and future demand on cash flow, and
provides greater financial flexibility for achieving other goals and objectives.
$ 85,000
Revolving Debt:
Credit Cards $500 + $1,750 $ 2,250
Retail Card $ 500

Gas Card $ 250
$ 3,000

ESTATE OBLIGATIONS AT ARTHUR’S DEATH – Cont’d
Emergency Fund: The Repaldos do not currently have an identified emergency fund or line of
credit. Based on household income of $103,200 per year, they should create a minimum of 3
months’ reserve upon either Arthur’s or Gloria’s death [($103,200 / 12) x 3 = $25,800].
$ 25,000
Car Loan: $ 15,000
Total Cash Needed if Arthur Dies: $192,310
ESTATE OBLIGATIONS AT GLORIA’S DEATH
Last Expenses:
Funeral and Burial $ 25,000
Legal Fees $ 2,750
Administration Expenses $ 1,250
$ 29,000
Estate Taxes and Probate Fees:
Gloria’s Regular Income Taxes for the Year $ 6,336
Probate Fees $ 250 $ 4,000 Savings Account

$ 15,000 Jewelry
$ 5,000 Collectibles
$ 24,000
( $ 50,000) Base for $250
$ 250
$ 6,586
Mortgage Elimination: $ 85,000
Revolving Debt: $ 3,000

Emergency Fund: $ 25,000
Car Loan: $ 15,000
Total Cash Needed if Gloria Dies: $163,586

GLORIA’S INCOME AND INSURANCE NEED IF ARTHUR DIES
Required Gross Monthly Income: Gloria and Arthur wish to maintain 85% of gross household income if
either of them were to die prior to retirement. Monthly gross household income is currently $8,600
($5,000 + $3,600).
$8,600 @ 85% $ 7,310
($ 3,600) Gloria’s Continuing Income

($ 493) CPP Survivor’s Benefit
$ 3,217 Income Shortfall
Capital Needed to Annuitize Income Shortfall: $ 3,217 x 12 Months for Annual Sum
= $ 38,604 ÷ 0.05 Annuity/Discount Factor

= $ 772,080 Capital to Support Income
Total Capital Needed at Arthur’s Death: $ 772,080 Capital to Support Income

+ $ 192,300 Cash Needed at Death
$ 964,380 Total Capital Required
Shortfall of Available Capital (Insurance Need): $ 964,380 Total Capital Required
( $ 607,500) Capital Available at Death

$ 356,880 Insurance Need
ARTHUR’S INCOME AND INSURANCE NEED IF GLORIA DIES
Required Gross Monthly Income: Gloria and Arthur wish to maintain 85% of gross household income if
either of them were to die prior to retirement. Monthly gross household income is currently $8,600
($5,000 + $3,600).
$8,600 @ 85% $ 7,310

($ 5,000) Arthur’s Continuing Income
($ 493) CPP Survivor’s Benefit

$ 1,817 Income Shortfall
Capital Needed to Annuitize Income Shortfall: $ 1,817 x 12 Months for Annual Sum
= $ 21,804 ÷ 0.05 Annuity/Discount Factor
= $ 436,080 Capital to Support Income
Total Capital Needed at Arthur’s Death: $ 436,080 Capital to Support Income

+ $ 163,600 Cash Needed at Death
$ 599,680 Total Capital Required

Shortfall of Available Capital (Insurance Need): $ 599,680 Total Capital Required
( $ 152,100) Capital Available at Death

$ 447,580 Insurance Need
Retirement Income Needs Analysis

After considerable discussion regarding their desired retirement lifestyle, the Repaldos feel that
70% of current income would be required to live the life they envision and hope for. The
couple’s current combined income is $103,200 before tax and approximately $84,800 after tax.
[($5,000 income x 12 months) + ($3,600 income x 12 months)] – [($1,006 tax x 12 months)
+ ($528 tax x 12 months)]
= [($60,000) + ($43,200)] - [($12,072) + ($6,336)]
= $ 103,200 - $18,408
$ 84,792
The Repaldos would need approximately $60,000 of after-tax income to support their desired
retirement lifestyle. For tax purposes, it would be advantageous to equally split their retirement
income so both can benefit from the lowest possible tax rates. This would indicate that Arthur
and Gloria should each receive about $30,000 per year of after-tax retirement income:
$84,800 x 70% $59,360 of after tax income ÷ 2 $29,680
Using financial planning software, tax software, or through trial and error, it can be determined
that Gloria and Arthur would each require about $36,750 of pre-tax income indexed
to 2.5% inflation to provide $60,000 total of after-tax income for their retirement years.
A $36,750 income for individuals over the age of 65 who qualify for all age and pension tax
credits results in a marginal tax rate of 24.15% and an average tax rate of approximately 18%.
$36,750 gross income – 18% average tax = $30,135 after tax
In 11 years, $36,750 of current annual pre-tax income would equate to 48,219 of future
annual pre-tax income, indexed for inflation at 2.5% (N = 11 years, I = 2.5% inflation, PV
= $36,750, PMT = 0, Solve for FV)
DETERMINE INCOME RESOURCES AVAILABLE AT RETIREMENT

The Repaldos wish to retire in 11 years when Arthur is age 65 and Gloria is age 63. Both will
apply for CPP at that time. Arthur will have OAS income available to him at retirement, but
Gloria will have to wait 2 years until age 65 for OAS. Gloria will delay receiving her company
pension until age 65 to receive full benefits and full indexing under the plan. For simplicity,
calculations will include all of Gloria’s and Arthur’s retirement incomes. They may have to
supplement their retirement income for 2 years from Arthur’s non-registered assets.

Client’s (Arthur’s) Retirement Resources in 2019

Arthur’s CPP: Arthur qualifies for full CPP benefits of $884.58 per month or $10,615 per
year in current dollars (2008). As he will not be taking CPP early or late, there will be no
reduction or increase to the pension amount other than for inflation. Adjusted for 2.5%
inflation, CPP will provide about $1,160.65 per month (N = 11 years, I = 2.5% inflation, PV
= $884.58, PMT = 0, Solve for FV) or $13,928 per year in 2019.
Arthur’s OAS: Arthur qualifies for full OAS benefits. The OAS claw back mechanism begins
when retirement income exceeds $64,718 in 2008 and is an indexed amount. As Arthur will
only require about $36,750 of retirement income in today’s dollars (also indexed), his OAS will
not be affected by the claw back provisions. An OAS benefit for 2008 of $502.31 per month or
$6,028 per year will equate to $659.07 per month in 2019 dollars (N = 11 years,
I = 2.5% inflation, PV = $502.31, PMT = 0, Solve for FV) or around $7,910 per year.
Arthur’s Registered Savings:
• Arthur has no RPP through work.
• Arthur currently has $60,000 in his RRSP averaging an 8% return to which he contributes
$200 per month. If contributions and performance are maintained, the RRSP will be worth
approximately $179,848 in 11 years (N = 11 years, I = 8%, PV = $60,000,
PMT = $2,400, Solve for FV).
Arthur’s Non-Registered Savings:
Arthur has indicated that his non-registered savings are not earmarked for retirement; he
considers them more of a “fun fund” that they could draw on, if and when they wish,
without guilt or difficulty.
Arthur’s Pre-Tax Capital Need for Retirement Starting in 2019:
Indexed Income Need of $4,018.25/Month $48,219/Yr

Minus Arthur’s CPP Income $1,160.65/Month $13,928/Yr
Minus Arthur’s OAS Income $659.07/Month $7,910/Yr
Minus Arthur’s RPP Income N/A N/A
Minus Arthur’s Non-Registered Investment Income N/A N/A
Income Shortfall /Surplus $2,198.53/Month $26,381/Yr
Spouse’s (Gloria’s) Retirement Resources in 2019

Gloria’s CPP: Gloria’s historical and projected CPP contributions indicate she will qualify for
90% of plan benefits. At 2008 levels she would be entitled to $796.12 per month ($884.58
maximum benefit x 90% entitlement) or $9,554 per year. Gloria will be electing to take CPP 2
years ‘early’. The reduction in CPP benefits is 0.5% per month for each month taken prior to
age 65. Gloria will have her CPP reduced by 12% (0.5% per month x 24 months) leaving her
with a 2008 CPP entitlement of $700.59 per month ($796.12 – 12%) or $8,407 per year.
Adjusted for 2.5% inflation, CPP will provide about $919.24 per month (N = 11 years,

I = 2.5% inflation, PV = $700.59, PMT = 0, Solve for FV) or $11,031 per year at
Gloria’s retirement in 2019.
Gloria’s OAS: Gloria qualifies for full OAS, but cannot begin receiving it until 2 years after
retirement when she turns age 65. As Gloria will only require about $36,750 of retirement
income in today’s dollars, her OAS should not be affected by the claw back provisions. The
OAS claw back begins at $64,718 for 2008. In 2021, the claw back threshold will be $89,215
(N = 13 years, I = 2.5% inflation, PV = $64,718, PMT = 0, Solve for FV). An OAS benefit for
2008 of $502.31 per month or $6,028 per year will equate to $692.44 per month
in 2021 dollars (N = 13 years, I = 2.5% inflation, PV = $502.31, PMT = 0, Solve for FV)
or around $8,310 per year.
Gloria’s Registered Savings:
• Gloria’s Defined Benefit Pension Plan (DBPP) will provide retirement income
based on 2% per year of service times her career average salary. Gloria reports
seeing a document showing her projected pension benefit at $35,200 per year.
• Gloria currently has $46,000 in her conservative fund-of-funds portfolio RRSP
averaging a 6% return to which she contributes $50 per month. If contributions and
performance are maintained, the RRSP will be worth approximately $96,305 in 11
years (N = 11 years, I = 6%, PV = $46,000, PMT = $600, Solve for FV).
Gloria’s Non-Registered Savings:
Gloria has no significant non-registered savings.
Gloria’s Pre Tax Capital Need for Retirement Starting in 2019:
Indexed Income Need of $4,018.25/Month $48,219/Yr

Minus Gloria’s CPP Income $919.24/Month $11,031/Yr
Minus Gloria’s OAS Income $692.44/Month $ 8,310/Yr
Minus Gloria’s RPP Income $2,933.33/Month $35,200/Yr
Minus Gloria’s Non-Registered Investment Income N/A N/A
Income Shortfall/ Surplus $526.76/Month $6,322/Yr

Household Retirement Income Needs/Resources in 2019
TABLE 9.6 THE REPALDOS’ RETIREMENT NEEDS ANALYSIS SUMMARY
Client (Arthur) Spouse (Gloria) Household

Retirement Income Need Starting 2019 $48,219 Indexed $48,219 Indexed $96,438 Indexed
Available Retirement Income $21,838 Indexed $54,541 Indexed $76,379 Indexed
(Shortfall) / Surplus ($26,381) $6,322 ($20,059)
Arthur’s retirement income will need to last until Gloria’s expected death at age 90, or for a
period of 27 years (age 90 – age 63 at retirement). Gloria’s retirement income will need to
last until her expected death at age 90, or for a period of 27 years (age 90 – age 63 at
retirement). If Arthur survives Gloria, he would still have his CPP, the CPP Survivor’s
Benefit, his OAS, and 60% of Gloria’s company pension to support his advanced retirement
years. If Gloria exceeds her life expectancy, she will be able to rely on her CPP, CPP
Survivor’s Benefit, OAS, and company pension to support her advanced years.
To equalize income during retirement, Gloria could share some of her pension income with
Arthur or she could begin making contributions to a spousal RRSP for Arthur. Arthur needs
to build sufficient RRSP assets to generate the shortfall of indexed retirement income of
$20,059. A 2.5% inflation rate applied to the balanced mutual fund return of 8% results in an
inflation adjusted return of approximately 5.5%. As all numbers are in pre-tax dollars and
Arthur’s average tax rate of 18% applies to overall retirement income, no other adjustment is
needed for the interest component of the time value of money calculation. Therefore, Arthur
will require a lump sum of $278,782 in his RRSP at age 65 to support $20,059 of annual
indexed income for 27 years [N = 27 years, I = 5.5, PMT = $20,059, FV = 0, Solve for PV].
At the end of the 27 years, the RRSP would be depleted.
Arthur currently has $60,000 in his RRSP that will be worth approximately $179,848 in 11
years with continued annual contributions of $2,400. Gloria currently has $46,000 in her
RRSP that will be worth approximately $96,305 in 11 years with continued annual
contributions of $600. If Gloria ceased contributing to her RRSP, it would be worth
approximately $87,321 in 11 years [N = 11 years, I = 6% return, PV = $46,000, PMT = 0,
Solve for FV]. Therefore, Arthur and Gloria will have $267,169 ($179,848 + $87,321) of the
required $278,782 RRSP assets to address the retirement income shortfall of $20,059.
Arthur has no PA, allowing him annual RRSP contributions of $10,800 and he is only making
contributions of $2,400 per year at present. Because Arthur is paying more in tax than Gloria, the
couple should ‘shift’ Gloria’s $50 per month RRSP contribution so that they are made by Arthur
to his own plan to reduce overall tax liability. The $50 per month of contributions would leave
a modest shortfall of about $1,626 in their retirement ‘nest egg’ [N = 11 years, I = 8%
return, PV = $ 0, PMT = 600, Solve for FV; ($267,169 + $9,987) - $278,782]. Arthur could
contribute an additional $8,400 to his personal RRSP if cash flow allowed.
Gloria’s Pension Adjustment (PA) is $7,176. Gloria’s annual RRSP contribution room is
$7,776 ($43,200 x 18%). She therefore has $600 of contribution room for a spousal RRSP.

Arthur’s Non-Registered Investments

Arthur has a $10,000 GIC earning 4% interest that is fully taxable. He also has unused RRSP
contribution room of $110,000. If Arthur invested the GIC proceeds in his balanced mutual fund
RRSP and added the resulting tax refund of $2,576, it would provide an additional $29,323 of
retirement capital by 2019 [N = 11 years, I = 8% return, PV = $ 12,576, PMT = 0, Solve
for FV].
Retirement Needs Analysis Summary for the Repaldos

If Arthur and Gloria implement the preceding adjustments to their savings, they should be
fairly confident of having the capital and income sources necessary to support their desired
retirement standard of living. See Table 9.7 below:
TABLE 9.7 THE REPALDOS’ RETIREMENT NEEDS ANALYSIS SUMMARY
Client (Arthur) Spouse (Gloria) Household

Retirement Income Need
Starting 2019 $48,219 Indexed $48,219 Indexed $96,438 Indexed
Less:
CPP $13,928 Indexed $11,031 Indexed $24,959 Indexed
OAS $7,910 Indexed $8,310 Indexed $16,220 Indexed
RPP N/A $35,200 Indexed $35,200 Indexed

Shortfall to be Funded ($26,381) $6,322 ($20,059)
Funding Method
RRSP Contributions $3,000 Annually nil $3,000 Annually
Continued RPP Contributions N/A $2,160 Annually $2,160 Annually
RRSP Catch-Up Contribution $12,576 One Time $12,576 One Time
Additional RRSP Contributions $7,800 Potential nil $7,800 Potential

Spousal RRSP Contributions N/A N/A nil
Current Net Cash Flow ($4,800) $16,488 $11,688

RRSP Contributions ($600) $600 Shift to Arthur
Spousal RRSPs Not Required Not Required Not Required

Adjusted Net Cash Flow ($5,400) $17,088 $11,688

Analyzing the Numbers
LIFE INSURANCE
• Arthur: If Arthur were to die now, Gloria would experience a deficit of $356,880 in
the funds available to her. If Arthur is not prepared to accept this deficit, then he will
have to acquire an additional $355,000 to $360,000 of life insurance.1
• Gloria: If Gloria were to die now, Arthur would experience a deficit of $447,580 in
the funds available to him. Gloria, therefore, needs an additional $445,000 to $450,000
of life insurance. The advisor should confirm if the insurance company would offer
$500,000 of death benefit for a lesser or similar premium as there are often price
breaks for policies of $500,000 or more.
RETIREMENT
• The couple: The Repaldos’ current situation will result in their accumulating just enough in
RRSP assets to supplement their government and employer ‘pension’ incomes by $20,059
per year for 27 years to Gloria’s age 90 indexed at 2.5% for inflation. When either Gloria
or Arthur dies, there will be substantial ongoing income based on their own resources
along with CPP Survivor Benefits and the required 60% of pension income to a
surviving spouse for Arthur should Gloria predecease him.
• Arthur: Arthur has a number of opportunities to reduce the amount of tax he is currently
paying and what he will have to pay during retirement. Arthur is paying almost twice
the amount of tax Gloria is ($12,072 per year versus $6,336 per year). All future RRSP
contributions should be made by Arthur to his own plan. Shifting Gloria’s $600 RRSP
contributions to Arthur would reduce his tax by about $155 ($600 x 25.76% ATR). This
would also help split income during retirement so Arthur and Gloria pay as little tax as
possible. Arthur also has non-registered assets that are earning fully taxed interest income
that he has not earmarked for any particular purpose. Using the GIC as an RRSP catch-up
contribution would save approximately $3,240 of tax now ($12,576 x 25.76% ATR), and
allow tax deferred compounding for many more years within the RRSP and, later, the RRIF.
• Gloria: Gloria’s indexed pension of $35,200 per year is a major factor in their ability to
achieve their retirement goals without having to increase RRSP contributions and adjust
their current style of living. This provides the couple an opportunity to augment
retirement savings as cash flow allows - saving tax now and providing a cushion for
their retirement years. With no demand for additional retirement savings, the Repaldos
can fully address their life insurance needs without having to modify their current
lifestyle as they have a little over $11,000 of adjusted net cash flow.
1
This is a rounded figure. The insurance advisor should always get the client’s understanding and approval to round
up or down. Some clients object to insurance advisors who round up numbers. In any case, it is not that significant
whether Arthur buys $350,000, $355,000, or $360,000 of life insurance, there are many assumptions that must be
realized for the numbers to be 100% accurate. Moreover, as time passes, the income required for Gloria may be
greater or lower, due to inflation or lifestyle changes although the period required will be shorter.

CLIENT SERVICE STRATEGY
Since we are dealing with a couple and examining their needs in the event of a premature
death and for their retirement years, the report should be broken down into insurance and
retirement needs. It is important to note that the couple approached the
agent/advisor/planner wishing to have these immediate needs addressed. Had the approach
been for “financial planning”, a more holistic and integrated analysis would have been
required encompassing comprehensive long-term planning and presentation of a formal
plan to the couple. This should still be done in the near future.
The Report Presentation

The advisor’s presentation should follow a logical order that builds understanding of the
current situation and appreciation for the actions needed to achieve the clients’ stated goals
and objectives:
• Review and confirm the clients’ goals and objectives.
• Review and confirm the clients’ current assets.
• Review and confirm any other potential assets available.
• Review and confirm all assumptions used for the analyses and projections.
• Explain the shortfall between what the clients need and desire and what they can
accomplish given their current cash flow and net worth.
• Achieve mutual understanding of the issue or opportunity and agreement that
action is required.
• Demonstrate how financial planning and appropriate solutions/products can address
the issue or opportunity.
• Explain how the solutions, products and plan can efficiently and effectively be put into
place in a short period of time.
• Implement the plan in a timely manner and follow up to ensure continued alignment
with the clients’ goals and objectives.
Advisors should always remember that a client’s problems existed before the client met
them. The client might simply have been unaware that one or more problems existed. After
working to uncover issues, the advisor should put forward appropriate solutions and
implement those solutions. If clients don’t implement the recommendations, the advisor
must document the fact that they were given optional solutions to their problems and they
chose not to do anything about them. By doing this, a client or, even worse, the spouse of a
deceased client cannot come back to the advisor and say, “Why didn’t you tell me I could
have done something about that?” The advisor is not only protecting himself or herself
from being sued, but creating another opportunity to provide and implement a solution.

Long-term Goals
INSURANCE
The Repaldos want to ensure that should either of them die prematurely, their current and future
standard of living will not be seriously impacted and that their plans for retirement will be
fulfilled. They feel they will need to maintain 85% of household income if either of them were to
die prior to retirement. This will require $3,710 of monthly replacement income to Gloria’s age
63 should Arthur die in addition to a lump sum of $192,300 to address final expenses and retire
all debt. If Gloria were to die, Arthur would require $2,310 of monthly replacement income to
age 65 in addition to a lump sum of $163,600 to address final expenses and retire all debt.
RETIREMENT
Both Arthur and Gloria wish to retire when Arthur reaches age 65 in 11 years with an income
need projected to be $96,438 per year or $8,037 per month based on 70% of current household
income indexed at 2.5%. They assume they will maintain their current investment style and
investment choices with continued returns of 4% on medium-term fixed income vehicles, 6% on
a conservative fund-of-funds portfolio, 8% on a balanced mutual fund, and a rate of inflation
of 2.5%.
Needs
INSURANCE
If Arthur dies prematurely, there would be a shortfall of $356,880. If Gloria dies prematurely,
there would be a shortfall of $447,580. These needs are temporary, based on current amounts that
may require indexing to ensure they remain sufficient, from now until the Repaldos’ planned
retirement in 11 years at which time they feel they will have accumulated sufficient assets and
entitlements to maintain their retirement standard of living should either of them die.
RETIREMENT
Based on their current plans, Gloria and Arthur will accumulate just enough in their RRSPs to
augment their indexed ‘pension’ incomes by the required $20,059 per year. The Repaldos can
reduce current and future tax liability by having Arthur make larger RRSP contributions now for
their tax deductibility and to equally split income during retirement. In effect, it would make
sense if Arthur’s RRSP/RRIF could be considered the equivalent of Gloria’s defined benefit
pension plan. Although tax rules would allow Gloria to shift a sufficient portion of her pension
income to Arthur for equalization, it would still be advisable to take reasonable measures now to
accomplish this; tax rules can change and there are current tax advantages.
Current and Future Risks

What major risks do the Repaldos face?
• One, or both, of them may die prematurely.
• One, or both, of them may become disabled without adequate insurance and/or
experience significant costs for treatment and lifestyle adjustment.
• Their marriage may fail.

• One, or both, of them may become unemployed for a prolonged period.

• Inflation may run at a higher rate than expected or may be unusually high at
an inopportune time.
• The return on their investments may be less than forecast. Consider the dramatic
declines in North American stock markets in September/October of 2008!
• One, or both, may lower their tolerance for investment risk and thereby reduce
rates of return.
• One, or both, may live longer than expected depleting their registered and non-
registered capital.
The Plan for Achieving the Goals
INSURANCE
The Repaldos’ need for additional insurance is temporary (to Arthur’s age 65) and therefore
should be addressed by term insurance. The options available that keep costs low are Yearly
Renewable Term (YRT), 5 Year Term (T-5), and 10 Year Term (T-10). T-10 tends to be the
“cheapest” if renewed once for less than 5 years compared to the total premiums that would be
required by renewing the other options as necessary. The policies should be Guaranteed
Renewable to ensure they will remain in force until no longer needed. The policies may also be
Guaranteed Convertible if the Repaldos felt they may want to leave significant estate
capital for family or charitable gifting. A 2.5% indexed death benefit of $350,000 on
Arthur’s life would cost approximately $125 per month. A 2.5% indexed death benefit of
$450,000 on Gloria’s life would cost approximately $75 per month.
Alternative
The Repaldos may also consider a Joint-First-to-Die Term 10 policy to keep premiums as
low as possible; there would be no financial need after the first death as all debt would be
retired and future income needs secured. A 2.5% indexed Joint-First-to-Die policy of
$450,000 would cost approximately $180 per month.
Placing the policy(ies) would require the Repaldos to adjust their current discretionary
expenses or modestly alter their retirement plan to afford the annual premiums of
approximately $2,160 to $2,400.
It would not make sense for either Arthur or Gloria (or jointly) to purchase participating
whole life or universal life insurance due to their ages and temporary need. There would
not be sufficient time between now and retirement to build meaningful cash surrender
values to augment retirement income.
RETIREMENT
Based on their current plans, Arthur should increase his annual RRSP contributions by $600
while Gloria ceases making contributions to her RRSP. Once the $2,400 required for insurance
protection has been factored into their cash flow, the Repaldos would still have about $9,288 of
annual net discretionary income that could be directed to RRSP contributions for Arthur. This
would save tax now, build a retirement asset safety margin, and help split income during

retirement. Implementing these few simple steps will efficiently provide the capital
needed by 2019 to support their desired retirement lifestyle to Gloria’s life expectancy.
Alternative
The Repaldos may consider using the equity in their home at retirement to supplement any
income or capital needs at that time. Monetizing the equity in their home by taking advantage of
a program such as CHIP (Canadian Home Income Plan) could provide an additional $188,000 of
capital. Their home will be debt free at retirement and worth approximately $470,000 of which
they could access 40% (N = 11 years, I = 3% growth rate, PV = $340,000, PMT = 0, Solve for
FV, multiply by 0.40). A program such as CHIP can provide regular income, periodic lump
sums, or the entire amount at one time to be used as best felt or needed.
Ongoing Needs
As mentioned, the Repaldos have only dealt with their immediate needs regarding life
insurance and saving for retirement at this point. The agent/advisor/planner should position
the need for total needs planning in the most compelling manner possible. It would be
optimal to use the implementation of the above recommendations as the starting point of a
comprehensive financial plan that would be developed within a month or so.
Client-centred advisors who strive for superior service quality use appropriate contact
management software to systematically follow up with clients and periodically update plans,
projections and needs. A yearly review would probably be sufficient; however, the advisor
should be prepared to discuss concerns raised by the client if they arise before a scheduled
review. In fact, it is incumbent upon the advisor to stay abreast of any developments in his
or her clients’ lives that may affect the plans in place. This is accomplished through
systematic “care calls” or by ensuring clients are aware of the importance of keeping the
advisor up-to-date regarding any changes and commit to doing so.

Chapter 10
Common and
Contract Law Statutes
© CSI GLOBAL EDUCATION INC. (2011) 10• 1

10
Common and
Contract Law Statutes
CHAPTER OUTLINE
Introduction
Common Law and Tort Law
• Common Law
• Tort Law
Contract Law
• Prerequisites for a Legal Contract
• Relevant Parties to an Insurance Policy
Remedies for Insurance Contract Disputes
• Legal Remedies (Damages)
• Equitable Remedies
• Rescission of Contract
• Payment of Insurance Money into Court
• Rectifi cation
• Declaratory Judgment
• Institutional Remedies
The Criminal Code and the Distribution of Insurance Products
• Theft
• Misrepresentation
• Fraud
• Forgery
• Proceeds of Crime (Money Laundering) and Terrorist Financing Act

TEN • COMMON AND CONTRACT LAW STATUTES 10•3
INTRODUCTION
Insurance law is based on the law of contract and the law of tort, both of which are common
law concepts. In this chapter, we will examine the prerequisites for a legal contract, focusing
on insurance contracts in particular. We will also explain the legal remedies available for
disputes over a life insurance contract and the implications of the regulations governing the
distribution of insurance products as they relate to the Criminal Code of Canada. Finally, we
will briefly discuss money laundering and anti-terrorism legislation, and how these laws may
affect the responsibilities of those involved in financial transactions.
COMMON LAW AND TORT LAW
LEARNING OBJECTIVES
• define and explain the terms — common law and law of tort.
Common Law
Canadian law is part of the common law tradition, which originated in England. The term “common
law” refers to the body of judicial decisions that has developed over time. Judges decide each dispute
they hear by referring to past decisions, while at the same time establishing rules
for future controversies.1 Furthermore, the reasons given by the judges for their
decisions are considered to be the law.
Because decisions are not written down in one authoritative code, such as the civil code that is
used in jurisdictions like Quebec, common law is often thought of as unwritten law. Common
law is also distinguished from legislation, which is an enactment by Parliament, a provincial
legislature, or a city council that states certain rules and principles that must be interpreted and
followed by the courts,2 although common law provides the foundation for the creation and
interpretation of legislation. The doctrine of legislative supremacy dictates, however, that a rule
found in common law may be modified, abolished, or overridden by legislation.
The doctrine of stare decisis (“to stand by that which is decided”) dictates that common law is
developed by judges, who consider the principles of law that have been applied to similar
situations in the past. Those principles are considered to be binding on all future decisions on
situations in which the facts are substantially the same. Once a judge has read and considered
the principles and reasons of the many earlier written judgments on similar situations, his or
her task is to contribute ideas that lead to the further evolution of the common law.
The concept of precedent developed from the system of accurately reporting court decisions. A
precedent is a court decision or adjudicated case that is considered an authority for a later
1
Hutchinson, Allan and Pam Marshall, The Law School Book: Succeeding at Law School, p. 37.
2
Ibid.

identical or similar case. Judges are required to follow the principle that “like cases are to be
treated alike,” so their written reasons for their decisions are binding on lower courts in
deciding later cases that involve similar facts and situations.3
Tort Law
Canadian tort law is primarily judge-made law. The term “tort” is difficult to define. It comes
from the Latin word tortus, which means crooked, and the French word tort, which means
wrong.4 The classic textbook definition states that a “tort” is a legal construct and is not to be
confused with a “wrong” in the general sense. It exists only where the law says it exists, and
where the law provides a remedy.5 A tort has also been defined as a type of civil injury or
wrong that leads to civil proceedings in which the plaintiff claims the enforcement of some
right. Examination of the context in which tort operates sheds more light on this fuzzy concept.
Interaction between individuals inevitably produces conflict. The expectations of an individual or
group may not be met, the status quo may be altered to the disadvantage of one of the parties, or
one party may sustain a loss or injury. An injury may be a personal injury, or it may involve
damage to proprietary interests, to someone’s dignity, to business interests, to the environment, to
one’s reputation, or one’s privacy. Whatever the type of injury, there is a victim and an
identifiable person who is responsible for the harm done. The conduct that produced the loss or
injury may have been deliberate, or the result of carelessness, or the outcome of an accident.
Should the
legal system respond? Is the victim entitled to compensation, and if so, how much? Who should
provide it? Should the person who caused the injury be accountable for it? These are the essential
questions of the law of torts. The law of torts determines which losses or injuries suffered by
which individuals will be remedied, how, and to what extent.6
The purpose of the law of torts is to grant compensation for injuries sustained by one person as
the result of the conduct of another. 7 The distinction between tort and contract is that in tort
law, the actions of each party (the things they must do or refrain from doing) are determined by
the law, while in contract law, the actions are decided upon by the parties themselves. Also, in
tort law, the legal obligation to do something or refrain from doing something is towards
persons generally, whereas in contract law it is towards a specific person or group of persons. 8
Defamation, nuisance and negligence are examples of torts.
3
Hutchinson, Allan and Pam Marshall, The Law School Book: Succeeding at Law School, p. 38.
4
Klar, Lewis N., Tort Law, Thomson Canada Ltd.: Toronto, 1996.
5
(1988), 52 D.L.R. (4th) 193 at 1999 (S.C.C.)
6
Klar, ibid., p. 2
7
Linden, Allen, and Lewis Klar, Canadian Tort Law: Cases, Notes and Materials, 11th Edition,
Butterworths: Toronto, Vancouver, 1999, p. 1.
8
Ibid., p. 2

CONTRACT LAW
LEARNING OBJECTIVES
• define the term “law of contract”;
• list and explain the fundamental prerequisites for a legal contract, focusing on insurance.
An insurance policy is a special kind of agreement called a contract. A contract is a legally
enforceable agreement between two or more parties, under which the parties accept certain
obligations.9 The law of contract deals with the circumstances in which agreements are
considered legally binding or enforceable.
Contractual obligations are distinct from other legal obligations, because they are based on
the agreement of the contracting parties. Generally speaking, the two parties to an
individual life or health insurance contract are the insurance company that issues the policy
(the insurer) and the individual who purchases the policy (the insured or policyholder).
The principles of contract law determine the legal status of a contract: whether the contract
can be legally enforced and who has the right to enforce a contract.
• A valid contract is one that is legally enforceable.
• A void contract is one that was never legally enforceable.
• A voidable contract is one in which a party has the legal right to avoid his or
her obligations under the contract without incurring legal liability.10
Prerequisites for a Legal Contract

A valid contract, in the form of a life or health insurance policy, has five general requirements. 11
VALID OFFER AND ACCEPTANCE

The parties to the contract must show that they agree to and accept the terms of the contract.
For life and health insurance policies, like other contracts, the parties reach a “meeting of the
minds” or mutual assent on the terms of their agreement through a process of offer and
acceptance, in which one party makes an offer and the other party accepts that offer. Mutual
agreement and acceptance of the contract occurs when all parties clearly and outwardly
express that they intend to be bound by the terms of the contract.
9
Treitel, Sir Guenter, 10th ed. The Law of Contract, Sweet and Maxwell: London, 1999, p. 6
10
Ibid.
11
In theory, life and health insurance contracts are said to be informal contracts, because they can be made in
either written or oral form. In Canada, however, provincial laws require insurance contracts to be in writing.

GENUINE INTENTION TO CREATE LEGAL RELATIONS

A valid contract is created when there is a “meeting of the minds” of the parties. If one party
misunderstands the terms of the contract, in some circumstances there will be no mutual assent.
Also, if a party’s consent to a contract is not voluntarily given, he or she does not really intend
to create a legally enforceable contract. For example, if a ruthless son forces his aged and feeble
mother to sign over ownership of the family home to him, that contract would not hold up in a
court of law because consent was not voluntarily given or properly obtained.
CAPACITY TO CONTRACT
The parties to the contract must be legally capable of entering into a contract. The
insurance company must have the legal capacity to issue the policy and the applicant must
have the legal capacity to buy that policy.
An insurer acquires legal capacity to enter into an insurance contract by being licensed to do
business by a provincial regulatory authority. Individuals, in order to enter into a contract,
must usually be adults (over the legal age of majority in the jurisdiction where the contract is
formed) and must have the necessary mental capacity to understand the terms of the contract.
Minors, the mentally disabled, and those who suffer from some illness, disability or condition
that impairs their judgment (e.g., alcohol or drug abuse) may not have the legal capacity to
enter into a contract.
A minor who has attained the age of 16 years has the capacity of a person of the age of 18 or 19
(depending on the province’s age of majority) to apply for life insurance on his own life or on the life
of someone else. However, a minor cannot receive insurance money and give a valid discharge as a
beneficiary until reaching the age of majority. A minor can sue to have a policy declared void, in
which case the insurer would have to refund the premiums the minor paid on that policy.
A contract entered into by a person declared insane or incompetent is usually void.
Contracts entered into by someone whose mental competence is impaired are generally
voidable by the mentally impaired person.12
CONSIDERATION
The parties to the contract must exchange legally adequate consideration. Each party must give
or promise something that is of value to the other party. The prospective policyowner fills out an
application form and pays the first premium (called an initial premium) as consideration for a
life or health insurance contract. In return, the insurer promises to pay the benefit if the
conditions stated in the policy occur. If the prospective policyowner does not pay the initial
premium, then no contract has been formed, because the applicant has not provided the
required consideration. Renewal premiums, which are premiums payable after the initial
premium, are a condition of continuing the policy, but are not consideration for the policy. 13
LAWFUL OBJECT OF THE CONTRACT

The contract must be for a lawful purpose.14 A contract cannot be made for a purpose that
is illegal or against the public interest. An agreement in which one person promises to
perform an illegal act is unenforceable and, therefore, void.
12
p.75-76 Chapter 5: The Insurance Policy
13
Ibid., p. 77
14
p.74 Chapter 5: The Insurance Policy

TEN • COMMON AND CONTRACT LAW STATUTES 10• 7
“A life or health insurance contract is said to have a lawful purpose when it has an
insurable interest. That is to say, its purpose is to protect against financial loss, not to
provide a means of possible financial gain, such as is the case of speculating on a life or
profiting from ill health.”15 The absence of a lawful purpose and corresponding insurable
interest would cause a contract to be void. Nevertheless, once a valid contract is formed, a
continuing insurable interest is not required for the contract to remain valid.
UTMOST GOOD FAITH

In addition, insurance contracts are also considered to be contracts of “uberrimae fidei” (i.e.,
utmost good faith). The applicant for life insurance is expected to disclose any information
material to the application, whether or not requested by the insurer. If a fact is likely to affect
the insurer’s decision in terms of accepting the risk, issuing the policy, charging a specified
premium, etc., then that fact must be disclosed by the prospective insured to the insurer. So, for
example, if an applicant suffers from Huntington’s Disease (a neurological disorder that causes
uncontrolled body movements and loss of intellectual faculties) but no question on the life
insurance application covers this type of disorder, then the applicant is obliged, by the doctrine
of utmost good faith, to reveal to the insurer’s agent that he or she suffers from it. However, if
the same applicant had a particularly bad case of heartburn three weeks before the application
was completed and otherwise has no known digestive problems, then this incident of heartburn
would not be considered material to the risk and need not be disclosed. The insurer, likewise, is
obliged to reveal all pertinent information to the insured that would be considered material to
the contract of insurance.
Relevant Parties to an Insurance Policy

An insurance policy is intangible personal property, representing a bundle of legal rights that
have value and that are legally enforceable. The owner of an insurance policy, also known as the
policyholder, has ownership rights in an insurance policy. For example, the owner of an
insurance policy has the right to name a beneficiary under the policy or change the beneficiary at
any time while the policy is in force. The owner of an insurance policy can also dispose of the
policy. The owner may also transfer ownership of the policy by assigning it to someone else.
The insured is generally also the person whose life is insured under the policy. The insured,
however, may insure the life of another person. The life insured is the person whose life is
insured and whose death would result in insurance proceeds being payable to a beneficiary.
The life insured may be a spouse, child, or other relation to the policyholder, or someone in a
business relationship with the policyholder, such as a key employee or a partner.
The beneficiary under an insurance policy is the person entitled to receive proceeds on the
death of the life insured.
An insurer is the party which assumes the risk, i.e., the insurance company or underwriting
organization with whom a contract of insurance is made. It is also said to be the party that
sells insurance.
15
p.77 Chapter 5: The Insurance Policy

REMEDIES FOR INSURANCE CONTRACT DISPUTES
LEARNING OBJECTIVES
• explain remedies available for disputes over life insurance contracts.
A plaintiff files a civil action to seek a remedy for the wrong he or she has suffered as a result
of the conduct of the defendant. In common law jurisdictions, remedies usually fall into two
categories: legal or equitable remedies. Legal remedies are primarily the payment of monetary
damages to an injured party. Equitable remedies are requirements placed on a defendant at the
discretion of the court that complement or substitute for a legal remedy, if a legal remedy is
inadequate to compensate for the wrong that was done. Since the merger of the courts of law
with the courts of equity in the late 19th century, plaintiffs in the common law jurisdictions in
Canada have had the right to seek both legal and equitable relief in the same court.
The laws of Quebec governing remedies for civil wrongs are codified: statutes define the
remedies available for each type of civil wrong and there is no distinction between legal
remedies and equitable remedies. Nevertheless, the remedies available in Quebec parallel
those available in the common law jurisdictions.
Legal Remedies (Damages)

The basic remedy for common law and civil law jurisdictions is damages, i.e., monetary
compensation for the losses a plaintiff suffered as a result of the defendant’s wrongful
conduct. The judge will award the plaintiff compensatory, punitive, or nominal damages,
depending on the nature of the defendant’s wrongful conduct and the type of loss suffered.
• Compensatory damages are awarded in breach of contract and tort cases. In contract cases,
they are intended to allow the plaintiff to achieve the same financial position that he or she
would have achieved if the contract had been performed. In tort cases, the compensatory
damage is intended to restore the plaintiff to the financial position he or she was in before
the tort occurred and to compensate the plaintiff for pain or suffering caused by the tort. The
judge will assess the facts to determine the amount of compensation to be awarded.
• Special compensatory damages are awarded in tort cases in which the plaintiff’s
losses are readily quantifiable; for example, if there are medical invoices related to the
injury sustained by a plaintiff.
• General compensatory damages are awarded when the plaintiff’s losses are not
easily determined, as in cases of pain and suffering.
• Punitive damages are awarded to punish the defendant and deter others from similar
wrongful behaviour. They are not awarded if the defendant has already been punished
under the Criminal Code for the behaviour on which the civil liability is based and are
generally not awarded for breach of contract cases.

• Nominal damages are awarded in cases in which it is proven that a plaintiff has
suffered a wrong, but has suffered little or no loss as a result of the wrong or cannot
prove the amount or extent of the loss.
In Quebec, damages are awarded for a defendant’s failure to fulfil contractual obligations known
as inexecution of obligation. The amount of damages is calculated as the amount the plaintiff
lost, plus the profits the plaintiff would have earned if the defendant had not broken the contract.
Quebec makes no distinction between general and special compensatory damages, and
rarely awards punitive damages.
Equitable Remedies
Equitable remedies are said to be discretionary because, in each case, the court uses its
own judgment and conscience to decide what is fair and equitable rather than being
bound by the rules of law. A plaintiff will be granted equitable relief when:
1. There is no adequate legal remedy. Monetary damages or other legal remedies will
not adequately compensate the plaintiff for injuries suffered from the defendant’s
wrongful conduct.
2. He or she is not guilty of unfair or unethical conduct.
3. The plaintiff makes his or her claim without undue delay. A plaintiff’s unreasonable
delay (in bringing a claim) that causes harm to the defendant will lead to the denial of
equitable relief. A plaintiff must, therefore, take action within a reasonable time after a
cause of action arises in order to be awarded equitable relief.
Examples of equitable remedies that may be awarded when there is no adequate remedy at
law include mandatory or prohibitory injunctions and specific performance.
• An injunction is a court order that requires a party to do or refrain from doing a certain
act (e.g., from breaching a contract).
• A mandatory injunction orders a party to do something.
• A prohibitory injunction orders a party not to do something.
• Specific performance is a remedy that requires the defendant to perform what he or she
has promised to perform, according to the terms agreed on when the parties entered into
the contract.
Like the common law courts, the civil law courts in Quebec typically award these remedies
when monetary damages will not adequately compensate the plaintiff for his or her injury or
loss. An injunction is granted only if irreparable injury or waste would result without the
injunction. Specific performance is an exception to the general rule that the defendant’s
failure to perform certain obligations must be remedied by damages.

Rescission of Contract
Rescission of a contract means the cancellation of the contract. In common law
jurisdictions, it is an equitable remedy generally available to a plaintiff where:
• there is no adequate legal remedy; and
• material misrepresentation, fraud, or mistakes are proven to have occurred.
The contract is declared void and the parties return to the positions they were in before entering
into the contract. For a life insurance contract, this may involve refunding any premiums paid.
Keep in mind the 10-day right of rescission provision, designed to protect purchasers, that is a
standard policy provision in life insurance contracts (covered earlier in Chapter 2). A contract
may be cancelled by the agreement of all parties to the contract, or by one party exercising its
right to void a voidable contract, or by court order. Court order is an equitable remedy and
is thus only available when there is no adequate remedy at law. In Quebec, a contract
can be cancelled by court order.
Payment of Insurance Money into Court

An insurer who is obligated to pay insurance proceeds may pay the funds into court and
obtain a valid discharge, i.e., a document indicating that its obligation has been legally
fulfilled. This situation would occur, for example, if a life insured dies and the insurer is
uncertain who the money should be paid to because of adverse claims (from potential
beneficiaries). An insurer obligated to pay insurance proceeds to a minor (as beneficiary of
a life insurance contract) is required to pay the money into court to the credit of the minor.
Rectification
Rectification is an equitable remedy whereby a written contract is redrafted to express the
true intentions of the parties at the time they entered into the contract. The remedy is
available when an agreement was made and written, but the written document does not
accurately reflect the intentions and agreement of the parties. For example, typographical
errors on an insurance policy may change the meaning or scope of the policy. If the parties
cannot mutually agree to correct such a mistake, one party may seek a court order to “rectify”
or correct the mistake in the written contract.
Declaratory Judgment
A declaratory judgment is a judicial statement of parties’ legal rights or lack of rights, but
it does not include specific relief or any means of enforcing those rights. This remedy is
discretionary and is usually not granted if other, more suitable, remedies are available.

Institutional Remedies
The following is a list of some of the institutional remedies available for insurance
contract disputes.
1. An informal resolution process – for instance, the Financial Services Commission of

Ontario’s Office of the Insurance Ombudsman. The Insurance Ombudsman offers
consumers an informal forum for resolving complaints about the business practices of
insurance companies in Ontario. Specifically, the office helps consumers if they have
already tried and failed to resolve disputes directly with the insurer. The Insurance
Ombudsman also makes recommendations to the Superintendent of Financial Services
to investigate consumers’ complaints relating to unlawful business practices.
2. The creation of the Financial Consumer Agency of Canada and the Service
OmbudCentre to ensure that all federally regulated financial institutions comply with
consumer protection laws and regulations and offer financial consumers a seamless,
central contact point to independent and impartial ombud services.
3. The Canadian Life and Health Insurance Association (CLHIA) also provides help through
its Consumer Assistance Centre. A consumer may raise a concern about some aspect of a
relationship with a life or health insurance company, including contractual disputes with the
insurance company. If the problem cannot be resolved by the Consumer Assistance Centre,
consumers may pursue the matter through the CLHIA Ombusdservice.
4. For problems with group insurance, CLHIA offers group arbitration guidelines. These are
used in situations involving a change in group life carrier. For example, a claim may arise
regarding payment of a death benefit, a commitment regarding waiver of premium due to
disability, or payment of disability installments. If the former and current insurers cannot
agree on their respective liabilities, CLHIA may help resolve the matter.
THE CRIMINAL CODE AND THE DISTRIBUTION OF

INSURANCE PRODUCTS
LEARNING OBJECTIVES
• describe the implications of the regulations governing the distribution of insurance
products as they relate to the Canadian Criminal Code regarding misrepresentation,
theft, forgery, and fraud.
Life insurance agents may be held criminally responsible for violations of the Criminal
Code16 in their capacity as distributors of insurance products. The main offences relate to
theft, misrepresentation, fraud and forgery.
16
R.S. 1985, c. C-46

Theft
A person commits theft if, among other things, he or she receives money, a valuable security, or
a power of attorney to buy or sell property that is supposed to be used for a certain purpose and
is instead used for another purpose, or if the money due to one person is paid to another. For
example, if a purchaser of life insurance gives money to an agent for the policy premium and
the agent gives the money to his or her spouse instead of to the insurance company, theft has
occurred. Depending on the severity of the offence (whether it is deemed to be an indictable
offence or summary conviction offence), a person found guilty of an indictable offence may be
imprisoned for a maximum of 10 years where the value of what is stolen exceeds $5,000 or for a
maximum of 2 years where the value of what is stolen does not exceed $5,000 OR be
imprisoned for 6 months and/or be fined a maximum of $2,000 for a summary conviction
offence. (An indictable offence is more serious than a summary conviction offence.)
Misrepresentation
In the case of insurance, a person commits fraudulent misrepresentation or acts under false
pretences when he or she knowingly makes a false statement of fact with a fraudulent intent
to induce an insurer to, for instance, issue a policy it would not otherwise have issued. Either
the agent or the insured can commit such misrepresentation. The agent might misrepresent
himself or herself or the insurance company he or she is representing to get a sale and the
insured might misrepresent himself or herself to get a policy issued.
The criminal offence lies in using false information to accomplish what would otherwise
constitute theft or knowingly making a false statement, in writing or otherwise, that will be
relied upon by the other party. An insurer might be guilty of misrepresentation if one of its
documents contains false information on its financial condition or its ability to pay a claim.
An individual might provide false information to obtain personal property, a loan, payment of
money, extension of credit, cheques, drafts or promissory notes.
If a life insured dies and it is found out that the policy was issued under false pretences, the claim
for the policy proceeds could be denied, and only the policy premiums that have been paid would
be refunded to the beneficiary. A person found guilty of misrepresentation is liable for a term of
imprisonment not exceeding 10 years where the value of what is obtained exceeds $5,000 and not
exceeding 2 years where the value of what is obtained does not exceed $5,000.
Fraud
Anyone who uses deceit, falsehood or other fraudulent means to obtain property, money,
valuable securities, or any service from another person or group is guilty of fraud. A person
found guilty of an indictable offence may be imprisoned for a maximum of 14 years where
the value of the subject matter exceeds $5,000 or for a maximum of 2 years where the value
of the subject matter does not exceed $5,000.

Fraud includes:
• The falsification of books or documents. This includes destroying, mutilating, altering,
falsifying, or making false entries in books or documents, 17 or omitting or altering a material
fact on a written document, with intent to defraud. Anyone convicted of any of these acts is
guilty of an indictable offence punishable by imprisonment for a maximum of five years. A
life insurance agent would be considered guilty if, for example, he or she, knowing that
a potential client is likely to be denied coverage because of a serious medical condition,
altered medical evidence or omitted it from the policy application in order to secure a
policy contract.
• Using falsified documents. A person who, intending to deceive someone else, uses a
document, in which the other person has an interest, that contains any false or erroneous
statement or is defective in any material way and that is intended to mislead the other
person, is committing fraud. An agent who does such an act, with intent to deceive a
client, employer or other person, is also guilty of fraud.
• Secret commissions. An individual who gives or offers an agent or insurance company
employee some undisclosed reward, advantage or benefit in exchange for doing or not
doing something or for showing or not showing favour or disfavour to any person in
relation to an insurance transaction is committing fraud. An agent who demands,
accepts, or offers or agrees to accept such an undisclosed reward, advantage or benefit
from any person is also guilty of fraud. This type of fraud is punishable by
imprisonment for a maximum of five years.
A violation of the provision against secret commissions would be said to occur if an
agent, unbeknownst to his or her employer, accepts money from an applicant for
insurance as payment for altering medical evidence in order to fraudulently secure life
insurance coverage on the applicant’s life.
Forgery
A person commits forgery if he or she knowingly makes a false document intending that anyone
who uses it and believes it to be genuine will be influenced by it in some way or induced to do or
refrain from doing something. It is also a criminal offence to use, deal with, or act upon a forged
document or induce or attempt to induce another person to do so. Every one who commits
forgery (a) is guilty of an indictable offence and liable to imprisonment for a term not exceeding
ten years; or (b) is guilty of an offence punishable on summary conviction.
Furthermore, anyone who demands or obtains anything using a forged document or uses a
forged document to have goods or money delivered or paid to any person is guilty of an
indictable offence punishable by imprisonment for a maximum of 14 years.
If a life insurance agent forges the signature of a potential insured on a cheque, which gives
a false impression of the account holder’s intent to direct the payment of funds, that agent is
committing forgery. The agent would be violating section 368 of the Criminal Code, uttering a
forged document, by presenting this cheque (as if it were genuine) as consideration for a policy.
If the agent obtained a blank cheque from a client, made it payable to himself or herself, forged
17
Defined as a receipt, account, or other writing.

the client’s signature, and presented it to a financial institution for payment, that agent would
be committing forgery.
Here are two cases of theft, fraud and forgery, provided for illustrative purposes.
1. On May 2, 1991, the chairman of the board of a corporation that marketed, sold, and
administered life, health, and accident insurance policies to purchasers of automobiles
was charged with six counts of fraud and three counts of theft. On April 15, 1993, after
some plea bargaining, he pled guilty to two counts of fraud. One of them alleged that he,
“by deceit, falsehood or other fraudulent means, defrauded Transamerica Occidental Life
Insurance Company of money, property or valuable security of a value exceeding $1,000 by
receiving premium money as an agent for Transamerica Occidental Life Insurance Company
and failing to remit that premium money and using that money for his own purposes.” 18
2. In R. v. Millward,19 Robert Charles Millward entered a guilty plea to defrauding Colonia

Life Insurance Company of money in an amount exceeding $5,000 between July 1, 1986,
and March 31, 1988. Colonia was a life insurance underwriter. Millward operated an
independent insurance brokerage through his own company. Colonia appointed Millward as
its agent. Colonia received an application for a life insurance policy from Rocky Mountain
Drilling, a company owned by the life insured, Mr. Zutz. The policy named Rocky Mountain
as the owner, Mr. Zutz as the life insured, and Mrs. Zutz as the beneficiary. Millward was
the agent who sold the policy. Mr. Zutz cancelled the policy a year later. Shortly thereafter,
Millward stated to Colonia, falsely as it turned out, that he had received a request from Mr.
Zutz to reinstate the policy. He provided Colonia with a void cheque and a request for
automatic premium withdrawals from an account held by a numbered company. Millward
controlled this company; he had not disclosed this fact to Colonia. Colonia shortly thereafter
received an application, supposedly completed by Mr. Zutz, to transfer ownership of the
reinstated policy to the numbered company and to change the beneficiary to the numbered
company. Mr. Zutz died a year later and Colonia received, through solicitors for the
numbered company, a claim on the policy. Colonia paid $350,000 to the numbered company,
which amount was diverted to Millward for his own use. It was determined, during the court
proceedings, that the signatures of Mr. Zutz, on the application to transfer ownership of the
reinstated policy to the numbered company, were forged.
Proceeds of Crime (Money Laundering) and Terrorist Financing Act

The United Nations defines money laundering as “any act or attempted act to disguise the
source of money or assets derived from criminal activity.” Essentially, money laundering is
the process whereby the proceeds of crime are transformed into perceived “clean money”
that can circulate freely in the legitimate financial system, by making its criminal origins
difficult to trace. The money laundering process is continuous, with the proceeds of crime
constantly being introduced into the financial system.20
18
Transamerica Occidental Life Insurance Company v. Toronto-Dominion Bank (April 9, 1999), (1999-04-
09) ONCA C29582 – Source: http://www.canlii.org/on/cas/onca/1999/1999onca239.html
19
[2000] A.J. No. 387
20
FINTRAC website: http://www.fintrac-canafe.gc.ca/intro-eng.asp

Under Canadian law, a money laundering offence occurs when a person conceals or
converts property or the proceeds of property (money), knowing or believing that the
property or the money was derived from the commission of a criminal offence.
The Proceeds of Crime (Money Laundering) and Terrorist Financing Act creates a framework
for the mandatory reporting of suspicious transactions and the cross-border movements of large
amounts of currency and monetary instruments. The Act also established an independent anti-
money laundering agency, the Financial Transactions and Reports Analysis Centre of Canada
(FINTRAC) that collects and analyzes information intended to help law enforcement officials
investigate and prosecute money laundering offences. Financial institutions are required to
report such transactions to FINTRAC who in turn is permitted to disclose this information to
law enforcement agencies when there are grounds to suspect that it would be helpful in a money
laundering or terrorist financing investigation.
Under the Act, suspicious transactions must be reported and these obligations are extended to
non-bank financial institutions and certain other businesses or individuals that may be deemed
vulnerable to money laundering activities, such as lawyers and accountants. The regulations
also expanded reporting entities to include life insurance companies, agents, and brokers. The
regulations define life insurance broker or agent as “an individual who is registered or licensed
under provincial legislation to carry on the business of arranging contracts of life insurance.”
For purposes of the Act, suspicious is defined as “if reasonable grounds exist to suspect a
money laundering offence” and “reasonable grounds to suspect” is determined by what is
reasonable in the circumstances, such as normal business practices.
In addition, financial institutions are required to check a list supplied by the Canadian
government (and posted on the website of the Office of the Superintendent of Financial
Institutions [OSFI]) of terrorist groups and persons suspected of being involved in terrorist
activities. If an account is identified as belonging to a name on the list, the institution is
required to immediately freeze the assets in the account and report it to FINTRAC, the
RCMP and Canadian Security Intelligence Service (CSIS).
TYPES OF OFFENCES RELATED TO MONEY LAUNDERING
General Offences
If a person or entity fails to keep and retain records that relate to financial activities in accordance
with the regulations, that person or entity is guilty of an offence. Conviction on this offence may
lead to a maximum fine of $500,000 or to imprisonment for up to five years, or both.
Reporting Offences
If a person or entity fails to report transactions in the manner and form set by regulations and
there are reasonable grounds to suspect the transactions are related to a money laundering
offence, the person or entity can face a maximum fine of $2 million or imprisonment for a
maximum of five years, or both. An employee will not be convicted for failing to report a
transaction, if the transaction was reported to his or her immediate superior.
Disclosure Offences
Financial institutions and their employees must not disclose the fact that a suspicious transaction
has been reported, nor disclose the contents of such a report, with the intent to influence a
criminal investigation, whether or not a criminal investigation has begun. It is an offence under

the Criminal Code to “tip” a client that a suspicious transaction has been, or is going to
be, reported and such offence is punishable by imprisonment and/or fine.
Depending on the way in which information was disclosed, a person could be liable to criminal
prosecution for various offences, including counseling an offence, accessory after the fact, breach of
trust by a public officer, obstructing a peace officer, obstructing justice, and public mischief.
Identifying Suspicious Transactions

What types of activities or events may indicate potential wrongdoing and raise suspicions?
Aside from some blatantly obvious things, such as a client admitting or bragging about having
ties to organized crime or attempting to use aliases and several similar but different addresses,
there are some common indicators, or red flags, that should reasonably raise suspicion. If you
provide life insurance as your main occupation or as one of the many services you offer, you
should look out for some of the following indicators that money laundering is occurring.
• The client wants to purchase a life insurance policy using a cheque drawn on an
account that is not his or her own.
• The client wants to purchase a life insurance policy, the purchase has no apparent
purpose, and the client refuses to divulge the reason for the purchase.
• The client conducts a transaction that results in a marked increase in
investment contributions.
• The client who has only small policies or transactions based on a regular payment structure
makes a sudden request to purchase a substantial policy with a lump sum payment.
• The duration of the life insurance policy is less than three years.
• The client is more interested in the consequences of canceling or surrendering a policy
than in the policy benefits and/or the long-term return on investments.

Chapter 11
Professional Standards

11
Professional Standards
CHAPTER OUTLINE
Introduction
The Agent’s Responsibilities and Duties
• Duties to the Insurance Company
• Acting for the Insurance Company vs. Acting for the Client
• Duties to the Client
• Duties to the Regulator
• Know Your Client
• Case Studies of the Duties and Responsibilities of an Agent
Provincial Regulations
• Distribution of Insurance
• Role of Regulators with Agents
• Replacing a Life Insurance Policy and Completing the Basic Disclosure Statement
Errors and Omissions Insurance
• The Purpose of Errors and Omissions Insurance
• Coverage
• Fraud Coverage
• Benefits of Errors and Omissions Insurance
• Case Studies of Errors and Omissions Insurance

Assuris
• Members
• Products Covered
• Failure of a Member
• Coverage
An Effective Client Monitoring System
• Why Have A Client Monitoring System?
• The Five Main Components of a Client Monitoring System

INTRODUCTION
The agent has a responsibility to both the client and the insurance company. The agent
must exercise “utmost good faith” in all dealings. The agent must know the extent of his
or her authority and not exceed that authority, and elicit all information required by an
insurance carrier to determine whether or not to issue a policy.
In this chapter, you will learn about the professional standards that agents are expected to
uphold with respect to their dealings with clients and insurance companies.
THE AGENT’S RESPONSIBILITIES AND DUTIES
LEARNING OBJECTIVES
• explain the responsibilities and obligations of the agent in an agent-client
relationship, including agency law;
• using specific examples, explain the agent’s duties towards the client, including
ensuring full disclosure, putting the client’s interests first, refraining from coercion, not
exerting undue influence, and conducting due diligence;
• explain the agent’s responsibility with respect to the “Know Your Client” rule and
ensuring the suitability of products for the client.
Duties to the Insurance Company

The agent is responsible to the insurance company to know the extent of his or her authority and
not to exceed that authority. The agent also has the duty to elicit all the information required
by an insurance carrier to determine whether or not to issue a policy. Omitting certain
pieces of information is just as wrong as submitting information that is known to be false.
The extent of the agent’s authority can be actual or apparent.
Actual authority can be expressed (written or oral instructions) or implied. The written or oral
instructions express specifically what the agent is authorized to do. Implied authority is what
the agent needs to perform the functions of his position. In other words, implied authority
extends to how agents carry out their authorized tasks.
For example, an agent may have implied authority to choose how to deliver an insurance
policy to a policyowner. Unless the insurer explicitly instructs an agent to personally deliver
the policy to the policyowner, it may be left to the agent to decide whether to deliver a
policy in person, by courier, mail or some other means.
An insurance company generally attempts to limit express authority of its agents by setting
specific limitations in the “agent’s” contract. For example, the agent may not be authorized to
collect any premiums after the initial premium paid with the application or paid upon delivery

ELEVEN • PROFESSIONAL STANDARDS 11•5
of the policy. However, if the agent does collect subsequent premiums, the company
would be prevented from denying the agent’s authority to do so, because a regular client
would not be expected to know that the agent was exceeding his or her express authority.
In other words, the agent would have apparent authority to collect such premiums.
Apparent authority is the authority that a client would reasonably assume an agent to have
because of the agent’s duties. For example, the agent is often asked to interpret the questions
on a life insurance application. An agent might interpret the medical question that asks,
“Have you ever had, or received treatment or advice for any nose, throat, lung, or any other
respiratory disorder?” as excluding the ’flu or the common cold. A client who relies on this
interpretation in good faith is relying on the agent’s apparent authority.
If, however, the client is in doubt about the agent’s interpretation, he or she should ask the
company to provide proof that the interpretation is correct, or, failing that, he or she could
prepare a “memorandum of understanding” outlining the interpretation and sending a copy to
both the agent and the company. Canadian courts have decided, in some situations, that the
insurance company is considered to know information that was given to the agent (i.e., the
agent’s knowledge is imputed to the insurer), while in other situations, they have decided that
it was the insured’s responsibility to review the answers and make any corrections before
signing the application.
If an agent does not have actual or apparent authority, the insurance company can ratify
(i.e., confirm or approve) the actions of the agent if all of the following occur:
• the agent conveyed the impression that he or she was acting for the company;
• the agent indicated that he or she was acting for the company;
• the client believed that the agent had the authority;
• only the company can ratify the transaction;
• the company ratifies the entire transaction.
Acting for the Insurance Company vs. Acting for the Client
Agency Law. Usually an agent is considered, under the law, to be acting for the insurer when
performing the normal duties of selling, servicing, or monitoring policies. These duties include:
• prospecting for clients and soliciting new business;
• completing applications for certain classes of insurance;
• completing insurance company forms
• delivering policies;
• collecting the initial premium;
• servicing current clients.
On the other hand, when the agent is giving advice, or performing specific duties that the
client has requested, the agent is generally considered to be acting on the client’s behalf.
Advice giving includes financial or estate planning advice that is not necessarily related to a
particular insurance product.

Duties to the Client

The agent must exercise “utmost good faith” in all dealings with any client or potential
client. The agent’s particular duties are:
1. Providing and collecting accurate information. The agent must collect sufficient
information to ensure that any recommendation he or she makes is suitable and
appropriate to meet the client’s needs and resources. (See the section on “Know Your
Client” later in this chapter.) The client must have been given sufficient information to
make an informed purchasing decision.
2. Putting the client’s interests first. The agent must place the client’s interests before
his or her own. Any sale or direction given to the client should be based upon the
client’s needs, desires, and financial ability to pay and not upon the agent’s desire for
commission, recognition, or sales achievements.
3. Avoiding misrepresentation and ensuring full disclosure. Since trust is of
paramount importance in the agent’s dealings with clients, the agent must avoid all
false or misleading statements. There must be full and complete disclosure. It is the
agent’s duty to avoid giving information that would lead the client to draw an
erroneous conclusion. Potential clients are entitled to all information required to
determine their best course of action. Misrepresentation can occur, not only by giving
false information that would mislead, but also by omitting information that would
correct a mistaken impression. For example, the agent might emphasize the build-up
of cash value within a policy, without explaining that the build-up is subject to a
decreasing surrender charge over the first 10 years. If the agent fails to correct the
client’s mistaken impression, then he or she is misrepresenting the situation.
4. Not exerting undue influence. Individuals in certain positions could use their position to
coerce someone into buying an insurance policy from themselves or from A rather than
from B, while the person so approached may prefer not to buy an insurance policy at all.
Coercion does not have to take place overtly, but as long as the client is placed in a
position where he or she might feel a sense of coercion, it may be construed as coercion.
For example, suppose a business owner is a client of an agent and the agent asks the
business owner to “influence” an employee to grant the agent a selling interview. The
employee may feel pressured to grant the interview because the request came from his or
her boss, even though the employee already has sufficient insurance. Financial
institutions and their agents/ employees have to ensure that they do not engage in
coercive tied selling where, for example, a client seeking life insurance is offered a
lower premium only if a large savings deposit is made.
5. Avoiding conflict of interest. Because the agent enjoys a position of trust and respect,
he or she may be called upon to act in a capacity other than as an agent. A position of
this nature has a potential for conflict of interest. For example, acting as an executor,
trustee, company director, or guardian may lead to a conflict of interest if the position
involves buying insurance and the agent is required to make the purchase. It is wise,
therefore, for the agent to refrain from participating in any decision to purchase
insurance. In the case of a will or guardianship, the document could authorize any
purchase deemed necessary and the agent would be entitled to compensation for the
product sale, over and above normal executor or guardianship fees.

6. Conducting due diligence. The agent is a professional and his or her manner and
thoroughness in all client dealings should reflect professionalism. When giving advice
or a recommendation, the agent must ensure that it is well thought out. All advice
should be in writing and the agent must keep copies.
Agents must not give advice if they are not qualified to do so. If the situation is complex
and the agent is inexperienced, the agent should get written permission from the client to
discuss the situation with an expert and to share any compensation with the expert,
according to proper procedure. If an experienced agent who has specialized in one or two
specific areas, such as disability insurance, group insurance, or retirement planning, is not
comfortable selling a different kind of insurance, such as business insurance, the agent
should call in a business insurance specialist. Agents must be aware of what they don’t
know and not attempt to bluff their way through situations in which they have little
knowledge or experience.
Due diligence also means that if an agent has doubts about the accuracy of any answers
from a client who is applying for insurance, he or she must ensure that the applicant is
aware of the consequences of any incorrect answers, e.g., the policy proceeds may not
be paid out at death to the beneficiary.
7. Maintaining confidentiality. The agent will, in the normal course of gathering
information, acquire business or personal details about a client or potential client. The
agent must keep this information confidential. It is wise not to divulge any information
acquired from a client, even if it is not confidential, because discussing such information
with others can affect the relationship with the client. If it becomes necessary to discuss
any private matters with a third party, the agent must first obtain written permission
from the client or prospect to do so.
8. Demonstrating and maintaining competence. Each year, the agent should complete
several hours of continuing professional education of a type recommended and/or
approved by the insurer, member association(s) or regulators. In most jurisdictions,
continuing education is required by regulation.
Duties to the Regulator

The agent has the following duties towards the regulator:
1. Licensing. The agent must meet the minimum educational requirements and successfully
complete an examination (and course of study, where required) that has been approved by
the regulators. The agent must also meet regulatory requirements regarding character and
financial stability. Once the agent acquires a license, he or she must maintain it by:
• paying the appropriate annual or bi-annual fee;

• meeting continuing education requirements;
• maintaining professional liability insurance (E&O).

2. Payment of premiums. The agent must not directly or indirectly pay any premium on
behalf of the insured. If an agent is asked to advance funds to a client to pay a premium,
the agent must get a signed debt instrument (IOU). Failure to do so could leave the
agent open to a charge that could jeopardize his or her license.
3. Rebates. The agent must not rebate any premium. A rebate is either refunding a portion of
the first premium on an insurance policy or paying the entire amount on behalf of a client.
4. Inducements. The agent must not offer an inducement to purchase insurance. An

inducement is the offer of something of value to induce a prospective client or client to
purchase insurance. Inducement could be an expensive gift or a job offer to a spouse or
child of the insured.
5. Fronting. The agent must not “front” for another licensed person, i.e., he or she must
not submit an application for insurance to an insurer if another agent or an unlicensed
person has actually completed the application but has not signed it. Not only is fronting
improper, but if something goes wrong, it is the agent who signed and submitted the
application who will be held accountable. Agents who have participated in similar
arrangements in the past have not only lost their licenses, but have frequently been left
with a substantial debt as a result of chargebacks (returning commissions that were
paid unlawfully). Regulators take fronting very seriously.
6. Commissions. The agent must not share commissions, as a part of any agreement, whether
overtly or secretly, with anyone who is not entitled to receive commissions. It is, however,
normal practice to give a gift of a nominal value (some regulators have indicated $50.00
or less) to people who have provided assistance in helping an agent secure new
business. There are three conditions that must be met to avoid a charge of paying a
commission to an unlicensed person:
• it must be a nominal amount;
• it must not depend on whether a sale is made;
• it cannot vary with the amount of commission earned.
7. Errors and omissions insurance. The agent must maintain professional liability coverage
(E&O) that meets the minimum requirements of the regulator. Some jurisdictions require
at least $1 million of coverage to cover a single occurrence, $2 million in the aggregate, a
deductible of $1,000 or less, and extended coverage for loss resulting from fraudulent acts.
(See the section on E&O insurance later in this chapter.)
8. Continuing education. The agent must meet mandated continuing education (CE)
requirements. For example, the Insurance Council of Manitoba requires licensed life
insurance agents to accumulate 30 continuing education credit hours in a year. In
Saskatchewan, licensees are required to accumulate a total of 30 continuing education
hours every two years.
9. Observance of laws. The agent must obey all laws governing distribution.

ELEVEN • PROFESSIONAL STANDARDS 11• 9
Know Your Client

To best serve a client’s needs, the agent should follow a six-step planning process.
GATHER THE FACTS

The agent should collect data such as:
• current assets: cash, RRSP, pension plan(s), investment portfolio, any other fixed assets
that might be liquidated;
• potential assets: personal life insurance, group life insurance, CPP death benefits,
CPP survivor benefits;
• current liabilities: mortgage, bank, credit card or other loans (including any on life
insurance policies);
• potential liabilities: final expenses, educational fund for children, probate fees, legal
fees and executor fees;
• the date of any will and the date of any revisions.
It is imperative that the agent get a “snapshot” of the client’s current situation. Often, it is
not as the client may wish or hope that it is.
IDENTIFY GOALS AND OBJECTIVES

The client’s goals might be:
• reducing or eliminating debt;
• providing for children’s education;
• building a fund to allow the client to open his or her own business;
• providing for early retirement;
• leaving an estate.
Information of this nature is important in working with the client to determine the best
strategy to be used to enable the client to reach his or her goals.
IDENTIFY PROBLEMS, ANALYZE THE DATA AND OBJECTIVES, AND DEVELOP STRATEGIES TO
ACHIEVE THE DESIRED RESULTS
Barriers to those goals might include:
• insufficient life, critical illness, long-term care, or disability income insurance in
place to meet the client’s goals and objectives;
• debt load that leaves little room for any solutions;
• an ineffective strategy.
PROVIDE ALTERNATIVE SOLUTIONS & DOCUMENT THE PLAN AND STRATEGY

• allows the client to make an informed decision
• shows professionalism

PUT THE PLAN INTO ACTION

• once client makes a decision, implement the plan.
• make sure the reasons for implementing or not implementing the plan are documented
and well understood.
PERFORM PERIODIC REVIEWS AND UPDATES

• things change and needs change
• ensures plan remains practical and effective
Case Studies of the Duties and Responsibilities of an Agent
EXAMPLE 1 AGENT ENGAGES IN REBATING AND IGNORES KYC RULE
Sally is a single mother with two young children. She is an insurance agent on contract with
a small company. Lately, sales have been slow and her manager hasn’t been happy. She
knows that unless she produces some sales results in the next two weeks her contract will
be cancelled. She has an appointment that night.
Sally has never met her prospects, John and Diane Patterson, before. The appointment was
made as a result of a direct mail campaign and the couple had expressed interest in term
insurance. What follows is part of Sally’s interview with John and Diane.
Sally: On your reply card you expressed interest in purchasing term insurance. Is that right?
John: Yes. Diane and I have no insurance at all, not even at work, since we work for small
companies. We are starting a family soon and we felt that I should have some insurance.
Maybe Diane should too. Right, Diane?
Diane: Well, I’m not sure about me.
Sally: Diane, don’t you think that John would have a diffi cult time if something happened to you
after the baby is born?
Diane: I guess so, but what’s going to happen to me? I’m young.
John: Maybe we’ll look at something smaller for Diane. My earnings are higher than hers right
now.
Sally: Well, I think I have enough information now. (She pulls out two application forms and
starts writing.) Is that “Patterson” with one or two t’s?
Diane: Is that an application?
Sally: Yes.
Diane: We aren’t ready to do anything right now. We just wanted to get some information. I’m
not due for six months.
Sally: Our company is having a special for young couples and my manager has authorized me
to pay the fi rst monthly premium for one young couple so you don’t even have to put up
anything at this point. Your address is…?

Has Sally met her responsibilities?

No. Sally has violated her duties to the regulator by offering to pay the first premium due
under the policy. She has also violated her duty to the client by not collecting sufficient
information in keeping with the “Know Your Client” rule and by not placing the clients’
interests before her own.
EXAMPLE 2 AGENT ENGAGES IN “FRONTING” AND SECRETLY SHARING COMMISSIONS
Masood has been a relatively successful agent for a number of years and is well known by
many other agents. One day, he bumps into Jim, a long-time acquaintance and another agent:
Jim: Hi, Masood. I haven’t seen you in a long time. How have you been?
Masood: I’m well and business is pretty good, although it could always be better. How about you?
Jim: Business is pretty good. I don’t know if you heard, but I don’t put business through XYZ
Insurance any more. I’ve had all kinds of problems with their manager. He delays my
commission cheques for weeks on end, so I just stopped putting business through them. I
still like some of their products, though. You still have a contract with them, don’t you?
Masood: Yeah. I still do. I don’t think that I’ll qualify for their convention this year, but it should be
close.
Jim: How close? Their qualifying period is almost over.
Masood: Just a couple of thousand dollars worth of premium.
Jim: Maybe I can help.
Masood: How?
Jim: Well, like I said, I still like some of their products and have been putting my applications
through another person I know. He gets the bonuses and all the other incentive stuff and
pays me 50% of the commission, so he’s not out-of- pocket on the taxes. That’s fair, isn’t it?
Masood: It seems reasonable.
Jim: It just so happens that I’ve got an application here in my briefcase. I could put it through
you. All you have to do is sign it and submit it. It’s enough for you to qualify for the
convention. What do you think?
Masood: Why not? Everyone wins.
Has Masood met his responsibilities?

No. He has violated his duties to the regulator by fronting for Jim and secretly sharing
commissions. Masood has also violated his responsibilities to XYZ Insurance by
submitting an application that he has not completed, for an applicant who he has not met.

EXAMPLE 3 AGENT VIOLATES DUE DILIGENCE REQUIREMENT
Yuri has an appointment with a small business owner and has completed a thorough fact-
fi nding interview based on a questionnaire that he had received from Ivan, one of the
other agents in his offi ce.
The business owner asks Yuri if the buy-sell insurance that is being proposed will be tax-
deductible if the corporation owns it. Yuri isn’t sure, but is convinced that if the premiums are
tax-deductible, then his chances for a sale are greatly increased. He answers, “Yes, of course.
It is a business expense. All business expenses are tax-deductible.”
When Yuri returns to the offi ce, he talks to Ivan and shows him the information that he
collected during the interview. Ivan suggests that the amount of insurance is insuffi cient for
the client’s needs and should be increased by $250,000.
Yuri is so excited about the sale, he forgets to ask Ivan about the tax-deductibility of the premiums.
When the application is submitted, Yuri asks the company to issue an alternate policy which he
will try to place upon delivery.
Has Yuri met his responsibilities?

No. Yuri has violated his duty to the client by giving tax-related advice that he is not equipped to
give. The client also has not approved an application for a greater amount of insurance.
PROVINCIAL REGULATIONS
LEARNING OBJECTIVES
• state and define the provincial regulations that govern the distribution of
insurance products;
• explain the mandate and role of the regulatory bodies in relation to life insurance agents;
• identify the agent’s responsibility in determining the requirements for replacing one
life insurance contract with another.
Distribution of Insurance
The provincial Insurance Acts, which are periodically updated, regulate the distribution of
life insurance in each province and territory. The acts specify what must be included in an
insurance policy and what constitutes the “policy,” such as the application, the policy
contract, any document attached to the policy when issued (for example, medical evidence, or
questionnaires relating to activities such as scuba diving or flying), and any amendment to
the contract agreed to in writing after the policy is issued.

ELEVEN • PROFESSIONAL STANDARDS 11• 13
The acts also dictate that the policy must contain:

1. the name or a complete description (company name or number) of the policyowner and
of the person whose life is insured (if they are not the same person);
2. the amount, or the method of determining the amount, of the insurance money
payable, and the conditions under which it is payable;
3. the amount, or the method of determining the amount, of the premium, and the
grace period, if any, within which it may be paid;
4. whether the contract provides for participation in a distribution of surplus or
profits declared by the insurer;
5. the conditions upon which the contract may be reinstated if it lapses;
6. the options, if any, of surrendering the contract for cash, obtaining a loan or an
advance, or obtaining paid-up or extended insurance.
Unfair and deceptive acts and practices in the business of insurance are not defined, but
regulators “may examine and investigate the affairs of every person engaged in the
business of insurance in order to determine whether such person has been, or is, engaged
in any unfair or deceptive act or practice.” (A “person” may be an individual or a
corporation). Regulators may give notice in writing to the person:
1. to cease or refrain from doing any act or pursuing any course of conduct identified by
the regulator;
2. not to engage in the business of insurance or any aspect of the business of
insurance specified by the regulator.
3. to perform acts that, in the opinion of the regulator, are necessary to remedy a situation.
Role of Regulators with Agents

Regulators have the following authority over agents:
LICENSING
Provincial and territorial regulators:
• prescribe the requirements, qualifications, and terms and conditions for granting
or renewing licences;
• hold examinations and set standards for those examinations;
• classify applicants and restrict or prohibit the licensing of certain classes of applicant;
• require that insurers report unsuitable agents to the regulators;
• require that insurers establish and maintain a screening system for contracted agents.
STANDARDS AND PROCEDURES

Provincial and territorial regulators:
• prescribe standards of practice for agents;
• set procedures governing the disciplining of agents;
• regulate accounts and records to be maintained when agents collect premiums personally;

• set the minimum standards for Professional Liability Coverage (E&O), if required by
the province or territory;
• set a minimum standard for Continuing Education (CE);
• stipulate the duties of the agent when an existing life insurance policy is replaced by another.
Replacing a Life Insurance Policy and Completing the Basic

Disclosure Statement
Agents must know and understand the replacement regulations in their home province or
territory and all provinces and territories where they are licensed. This means understanding
what constitutes a replacement and when a Basic Disclosure Statement (BDS) is required.
A replacement occurs when an existing personal life insurance policy may be cancelled and
an application is taken for a new individual policy. The agent must complete a BDS before
taking the new application, review it with the client, and leave a copy with the client. Both
the original and the new policy must be individual insurance, not group insurance.
If a replacement is needed because of a change in the policyowner’s circumstances, and a
change to the original policy is not possible or advisable, the agent should complete and
review with the policyowner an analysis of the policyowner’s insurance needs. This analysis
should be performed in all situations, regardless of whether a replacement may be needed.
A replacement occurs when a contract of life insurance is purchased whereby:
• the original policy is rescinded, surrendered or lapses;
• the original policy is changed to paid-up life insurance or continued under an automatic
premium loan or extended term insurance (in these situations, the owner ceases to pay
premiums but the policy remains in force under an automatic non-forfeiture option);
• the original policy is changed so that 50% or more of the cash value is released;
• the original policy is subjected to a single loan or a series of loans over time
amounting to 50% or more of the policy’s cash value.
Replacement rules generally apply even if the contract being replaced is one issued
by the insurer doing the replacing.
Replacement does not include a transaction where:
• a new contract of life insurance is made with an insurer with whom the person has
an existing contract of life insurance in furtherance of a contractual conversion
privilege exercised by the person,
• a contract is replaced by an annuity, or
• a contract is replaced by group insurance.
Many insurers have procedures in place for changing over from one insurance policy to
another. Agents should acquaint themselves with the terms and conditions of these
procedures and fully inform their clients. If a client wishes to proceed with a replacement,
the agent must proceed in accordance with the replacement regulations.
What follows is the regulation in Ontario regarding duties of an agent with respect to
replacement of life insurance contracts but other provinces have similar rules.

“Where replacement of a contract of life insurance is intended, the agent shall:

a) prior to accepting an application for a contract of insurance,
i) obtain from the applicant a list of all life insurance contracts intended to be replaced,
ii) complete, sign, review with the applicant and leave with the applicant a disclosure
statement respecting each contract of life insurance intended to be replaced, and
iii) obtain on each completed disclosure statement referred to in (ii), the signature of
the applicant and the signature of the life insured, if other than the applicant,
attesting to the receipt of the completed disclosure statement;
b) within three working days from the date of receiving the application for the contract of
insurance, forward to every insurer whose contract is intended to be replaced, a copy of
the completed disclosure statement as presented to and signed by the applicant without
the information recorded under the column entitled “Proposed Replacement Policy”;
c) where there is borrowing on an existing contract of insurance involved in the
transaction, caution the applicant that it is not usually advisable to borrow against
policy loan values beyond the expected ability or intention of the applicant to repay;
d) forward to each insurer requested to issue a new life insurance contract,
i) an application for a contract of insurance,
ii) a copy of the completed disclosure statement as presented to and signed by
the applicant,
iii) a copy of all written proposals presented to the applicant by the agent during
the solicitation of the application for a contract of insurance,
iv) all written directions received from the applicant; and
e) deliver each new contract of life insurance to the applicant as soon as is practical in the
circumstances after receiving it from the insurer, unless contrary written directions have been
received from the applicant.” [R.R.O. 1990, Reg. 674, s. 2 (2); O. Reg. 761/94, s. 1.]
The agent must complete the BDS fully before taking the application, in order for the client
to make an informed decision. The complete copy of the BDS, signed by both the
policyowner and the agent, must be reviewed and left with the client. The applicant must
also sign a statement stating whether he or she intends to obtain a replacement policy. The
application form includes a question about the applicant’s intention to obtain a replacement.
The agent is personally responsible for forwarding the BDS to the Canadian head office of the
original carrier within three working days. (If the agent employs an assistant and requests that the
assistant forward the form, the agent is held responsible if the form doesn’t arrive or arrives late.)
The agent is also responsible for forwarding the appropriate copy of the BDS to the new carrier.
If, when the replacement policy is issued, the terms are different from those that the client
applied for, and the client still wants to proceed with the replacement, the agent must
complete a new BDS at that time and distribute the copies to the same parties.
Since there are several Basic Disclosure Forms in use across the country, the jurisdiction
where the application is signed will determine which form is applicable.

ERRORS AND OMISSIONS INSURANCE
LEARNING OBJECTIVES
• describe the benefits of errors and omissions (E&O) insurance for the consumer, the
agent, and the insurance company;
• using a specific example, explain how errors and omissions insurance responds
to a consumer loss.
In the past, insurance agents were hired by one company and sold that company’s products
almost exclusively. If an agent wanted to sell another company’s product, the agent had to
request permission from his or her own company. If permission was granted, then a one-time-
only agreement would be completed with the other company for that particular piece of business.
This system gave the “sponsoring” insurance company more control over the activities of
its agents and, therefore, more responsibility. It made agents employees of the insurance
companies and made it possible for them to be bonded. Bonding protected the public
against any wrongdoing on the part of an agent employee.
Many agents wanted their own liability coverage in case they were personally sued, and
inquired through their professional associations about the feasibility of obtaining appropriate
coverage for themselves.
In the early 1990s, federally chartered life insurance companies were given the right to acquire
subsidiaries. The companies began to explore different ways to distribute their products, but they
were hampered by the requirement that agents have life insurance sales as their sole occupation.
Starting in 1995, when sponsorship was being phased out or eliminated by most jurisdictions,
and the relationship between agents and companies was undergoing profound changes, it
became impossible to continue bonding agents. Regulators began to make professional
liability coverage (errors and omissions insurance) mandatory. Some jurisdictions also
began to make fraud coverage mandatory as well.
The Purpose of Errors and Omissions Insurance

The purpose of errors and omissions insurance is to ensure that consumers do not suffer a
financial loss from misleading or dishonest sales practices and that consumers:
• have sufficient information to make informed buying decisions;

• understand what they have purchased;
• know which company is underwriting their risk;
• know who is accountable for the agent’s actions;
• know how to seek and get remedy from sales misconduct quickly and inexpensively.
Errors and omissions insurance covers an insurance agent for unintentional (or perceived)
errors that cause a client to suffer a loss.

Coverage
Insurance regulators in most provinces have made errors and omissions (E&O)
insurance mandatory.
Mandatory coverage includes a minimum level of insurance per occurrence and a minimum
amount of aggregate coverage. This means that the insured (i.e., the agent) would be covered
for, say, $1 million maximum for any one individual claim and for at least $2 million total
for all claims.
The E&O policy covers the activities of an agent pertaining to any product or service offered
by a life insurance company up to the policy maximum. Some common clauses are:
1. Limit of liability: this would include an annual limit per insured and an aggregate for
all claims.
2. Deductible: this clause specifies the amount of the deductible and what it applies
to. Deductibles may be limited, by regulation, to a maximum of $1,000.
3. Insured: staff of the agent may also be covered for certain actions.
4. Insured services: the services that are specifically covered may include:
• products sold by life insurance companies, such as life insurance, annuities,
variable products, and group plans;
• planning services provided by the insured, such as personal financial planning, estate
planning, retirement planning, and analysis of financial plans and recommendations;
• labour-sponsored plans;
• tax advice and preparation;
• educational plans;
• other services outside the life insurance product line (these may be included
with or without additional premium depending upon the carrier).
5. Prior acts: there may be a time restriction on the coverage, and an additional premium
may be required to extend that term.
6. Extension of claim reporting: explains how future claims are accommodated
after retirement or leaving the business.
7. Defence costs: these may be covered over and above individual loss limits, up to
the maximums stated.
8. Territory: this specifies where the coverage applies.
9. Exclusions: Certain acts are excluded from coverage, for example:
• fraudulent or criminal acts (although there may be an endorsement to cover these
acts in certain provinces);
• services not stated in the policy;
• warranties or guarantees of future performance.

Fraud Coverage
Some regulators (Newfoundland, Ontario, and Saskatchewan for example) require fraud
coverage in addition to E&O insurance. Fraud coverage is not something that would
normally be purchased by an agent, as it provides insurance for dishonest acts. Agents with
integrity would argue that they are honest and, therefore, don’t need or want the coverage.
Agents with a dishonest streak would not purchase the product, as buying it would be a red
flag to regulators to investigate their actions. Therefore, unless it is made mandatory, no
one would buy fraud coverage.
Fraud coverage usually applies only to life insurance and accident and sickness
insurance products.
Benefits of Errors and Omissions Insurance

Benefits of E&O for the consumer:
• in most cases there will be sufficient funds to satisfy a judgment;
• there is recourse, beyond the agent and the insurer, in case of agent error or incompetence;
• redress for losses should be quicker and less expensive.
Benefits of E&O for the agent:
• after a relatively small deductible, the agent is fully covered in most cases;
• premiums are relatively low;
• defence costs are included;
• time spent in defence proceedings is reduced and, therefore, more time is
available for productive activities;
• claims made in situations in which the agent is perceived to have erred but where his or
her actions are in conformity with “due care” do not have the same effect in time,
money, and effort as would be expended where there is no coverage.
Benefits of E&O for the life insurance company:
• if the life insurance company has sponsored the plan and arranged for the coverage of its
agents, then the life insurance company will probably be a co-insured under the policy,
giving it standing to file a claim if the agent refuses to do so after having been advised
by the client;
• a good producer’s ability to generate sales may not be lost to the life insurance company
in terms of the time, effort, and money that otherwise may need to be spent on defence.

Case Studies of Errors and Omissions Insurance

Since the insured under the E&O policy is the agent, generally, the E&O insurance carrier
will deal only with the agent.
Example 1: In August, an agent, Janice O’Brien, meets with her client, Harold Yee. Mr. Yee,
who retired earlier in the year, and his wife are going on an extended trip and will be returning in
early April of the following year. Mr. Yee gives a cheque post-dated to February to Ms. O’Brien,
and she accepts it for Mr. Yee’s RRSP. In March, she realizes that the cheque was never
forwarded and deposited to the RRSP.
Mr. Yee has a basis for bringing suit against Janice O’Brien. She should immediately inform
her E&O carrier of a possible claim.
The E&O carrier may have to “make the client whole.” In other words, pay for the client’s
financial losses, i.e., the loss of the tax refund and any consequential losses such as the
lesser amount that would be available for Mr. Yee’s retirement.
Example 2: An agent, Brian Short, meets with a client, Elena Ivanovich, and after a fact-fi nding interview,
Ms. Ivanovich applies for life insurance. A few months after the policy is issued, Ms. Ivanovich suddenly
learns that she has a serious illness that had not previously been diagnosed. The prognosis is not good -
she is expected to survive for several years, although in a totally disabled state.
Ms. Ivanovich claims that Mr. Short did not offer her the option of including the Waiver of
Premium for Disability Benefit in the policy. Mr. Short agrees that he did not offer the benefit, as
it is not a benefit that he personally favours. Ms. Ivanovich now claims that she would have
included it in her policy if she had been given the option.
Ms. Ivanovich has a basis for bringing suit against Brian Short. He should immediately inform
his E&O carrier of a possible claim.
Again, the E&O carrier may have to “make the client whole.” In other words, it would pay for Ms.
Ivanovich’s financial losses, i.e., make the premium payments that might have been waived if
the Waiver of Premium for Disability Benefit had been included.
Example 3: In a fact-fi nding interview, an agent, Maria Ciavarro, learns that a prospective
client, Ilsa Bjorn, has a previously diagnosed serious illness. Ms. Ciavarro advises Ms. Bjorn
that life insurance will not be issued in her situation. Ms. Bjorn, therefore, does not complete
the application. Ms. Bjorn’s health deteriorates over time. She later learns that some insurance
companies would have underwritten the original risk, but that now they no longer would do so.
Ms. Bjorn has a basis for bringing suit against Maria Ciavarro, because Ms. Ciavarro overstepped her
expertise and authority. It was up to the underwriting department at her company to decide whether to
accept the risk or not. Ms. Ciavarro should immediately inform her E&O carrier of a possible claim.
To “make the client whole,” the E&O carrier may have to pay the face amount of the
insurance that Ms. Bjorn wanted to purchase (and was advised she could not purchase).

Example: Akiko Fujiki hires Anita to work in her offi ce for the summer. One day, a client, Gunter
Amrhein, requests that Ms. Fujiki forward him a copy of a benefi ciary change form that he earlier
completed and submitted, changing the benefi ciary from his wife to another woman. Ms. Fujiki
gives Anita the form attached to the fi le and tells her to forward it. Unfortunately, Anita sends it to
Mr. Amrhein’s wife, and it causes grief to Mr. Amrhein, who demands compensation for the error.
Ms. Fujiki should immediately inform the E&O carrier of a verbal demand for compensation
for an error caused by her employee, Anita.
Resolving this case will depend on whether the damage can be quantified, i.e., the financial
repercussions caused by Mrs. Amrhein finding out that she is no longer named as
beneficiary under her husband’s policy.
ASSURIS
LEARNING OBJECTIVES
• explain how Assuris (previously CompCorp) would respond to the insolvency
of an insurance company and the limits that would apply.
Assuris (covered earlier in Chapter 5B) protects Canadian life insurance policyholders
against loss of benefits caused by the financial failure of a member company.
Members
Life insurance companies licensed to write life insurance in Canada are required to be
members of Assuris.
Products Covered
Eligible under Assuris coverage is life insurance, health insurance, critical illness insurance,
long-term care insurance, segregated funds, annuity income, disability income as well as
TFSAs, RRSPs and RRIFs.
Failure of a Member
In the event that a life insurance company is declared insolvent, a liquidator is appointed to
manage the insolvency. Assuris and the liquidator work together to protect policyholders’
interests. Rather than cancelling the policy and paying cash compensation, Assuris protects
policyholders by facilitating the transfer of policies to a solvent company and ensuring the
continuity of covered benefits under the original terms of the policy.

Coverage
The following benefits are fully covered by Assuris up to:
Monthly Income
[individual disability income insurance, individual payout annuity] $ 2,000 per month
Individual Health Expenses Insurance

[travel insurance, supplementary medical expense insurance,
critical illness insurance] $ 60,000
Individual Life Insurance Death Benefit $ 200,000
Individual Life Insurance Cash Value $ 60,000
If a policyholder’s total benefits exceed these amounts, Assuris will cover 85% of the
promised benefits, but not less than these amounts.
For example, assume that an insurance company becomes insolvent and a liquidator
arranges to pay 75% of its claims. If a claim was for $100,000 cash value and the liquidator
pays $75,000, Assuris would pay $10,000, since Assuris covers 85% of the promised
benefits, i.e., $85,000 in total. If a cash value claim was for $60,000 and the liquidator pays
$45,000, Assuris would pay the balance of $15,000 since the coverage limit is $60,000 and
the claim falls within that limit - the policyholder would receive the full $60,000.
If, for instance, a policyholder has a $500,000 death benefit, payment of 85% of the
promised death benefit, i.e., $425,000, will be made.
Accumulated Value benefits (such as accumulation annuities and RRIFs) are fully covered
by Assuris up to $100,000. If accumulated value benefits are over $100,000, Assuris will
ensure that the policyholder receives at least $100,000.
Assuris provides separate protection for individual, group, registered and non-registered
benefits, individual TFSAs and group TFSAs.
For the latest information on covered benefits and additional details, refer to the Assuris
website at http://www.assuris.ca

AN EFFECTIVE CLIENT MONITORING SYSTEM
LEARNING OBJECTIVES
• list and define five components of an effective client monitoring system.
A client monitoring system is a system that profiles a client and maintains a paper or
electronic record of all business dealings between the agent and the client. The information
collected is confidential and should not be divulged or shared with any other individual or
entity without the client’s permission (preferably written permission).
Once data has been collected, it must be reviewed and updated. The client’s goals may
change, which affects the validity of the recommendations made by the agent. After all,
who would have confidence in a medical practitioner who never asked questions to update
patients’ medical profiles, and made diagnoses and health recommendations based on
information collected years earlier?
Also, a client may not wish to share all personal information with the agent at the first
meeting or even at the first few meetings. The client may share it gradually over time as
his or her trust and confidence in the agent’s ability increase. The monitoring system will
ensure that new information is captured and reflected in the plan prepared for the client.
An effective system requires work. However, the professional rewards will be well
worth the effort.
Why Have A Client Monitoring System?

Regulators, the courts, clients, and their lawyers often question whether an agent has
collected sufficient pertinent information on a client’s needs, objectives, and financial
circumstances to justify recommendations made when selling an insurance policy. They may
ask whether the sale was appropriate for the client, or if the solution proposed by the agent
was reasonable under the circumstances. In several recent cases, the courts have decided that
the agent had not provided an adequate level of service after the sale of the policy.
Consider the following cases.
1. An agent had a client who moved and changed jobs. After some time, the policy lapsed
and the agent received a notice from the insurance company that mail sent to the client
has been returned by the post office. The insurance company requested assistance in
locating the client. The agent called directory assistance but failed to locate the client.
In this case, the court held that the agent should have used the same effort to find the
client as he had expended in trying to obtain the client in the first place. The agent was
found to be at fault. With an up-to-date client monitoring system, the agent would have
likely known the whereabouts of his or her client and done something to locate the
client before the policy lapsed.

2. An agent sold $100,000 of permanent life insurance to a client when there was a clear
indication that $500,000 of term insurance would have been more appropriate. The insurance
policy had to be replaced. With an up-to-date client monitoring system, there would be
evidence that sufficient pertinent information on the client’s needs was assessed and there
was a legitimate reason for selling $100,000 worth of permanent coverage. The agent should
have had this crucial backup information in writing or in electronic form.
Business relationships today tend to be long-term partnerships rather than purely

transactional in nature. Without accurate current data and appropriate use of that data, an
agent will not be able to properly manage client relations.
An effective client monitoring system will also allow the agent to offer the client
other appropriate products and services when they become necessary.
The Five Main Components of a Client Monitoring System
SUMMARY OF CONVERSATIONS AND MEETINGS

On the front, inside cover of each client file, or in a separate area of the electronic client file,
the agent should record a synopsis of each and every business contact with the client. The
information kept should be as complete as possible. An example of a paper record follows:
CLIENT JOAN SMITH
Date Summary of Contacts Follow-up

31 OCT Spoke to Joan. Wants to contribute to RRSP early December CALL
due to temporary market downturn. 19 NOV
At the top of each page, there should be some identifier, so that the information will be
complete even if the summary is separated from the rest of the file.
When arranging a meeting with a client, the agent should prepare an agenda for the meeting,
and add to it during the meeting, if necessary. During the meeting, the agent can check off
those items that have been dealt with, note how they were dealt with, and make a note of
those that require further action and the delivery date.
PERSONAL DATA
Personal data should be collected so that the agent has a better understanding of the
client’s situation and can provide appropriate advice. The basic information that should
be collected includes:
• Name: Enter the full name of the individual as it appears on official documents.
Any shortened name or nickname should follow.
• Smoking status: Is the person a smoker or non-smoker?
• Residence address: Enter the full residence address including postal code.

• Date and place of birth: Include city and the province, if Canadian, or country, if
outside Canada.
• Telephone numbers: Enter all phone numbers such as residence, cell, fax, and
business telephone number, including extension.
• E-mail address: Include both business and personal e-mail addresses.
• Business information: Include company name, address, job title, name of
administrative assistant, date started.
• Spouse: The same information should be collected for the client’s spouse.
• Children: For each of the client’s children, the agent should record the name, sex,
date of birth, and place of birth.
• Dependants: Partial or potential dependants should also be listed. The client may
share responsibility for nursing care expenses for an elderly parent or relative. There
may also be payments related to a previous marriage that affect the client’s ability to
pay for a certain kind of policy.
• Recreational activities: If the client takes part in risky activities such as hang gliding
or car racing, some companies may charge an extra insurance premium or deal with
such activities through an exclusion.
• Will: Basic information should be collected for both spouses, such as the existence of a
will, the date it was prepared, the date it was last reviewed, and where it is kept. (It is not
often advisable to keep the will in a safety deposit box as, under normal circumstances, it
will be more difficult to access the box after the institution is aware of the death. Many
times, the legal advisor will have the signed copy, which is a reason for knowing the name
and location of the lawyer.) This information should be collected so that the client(s) can be
advised to contact their legal advisor if there is no will or if it has been more than three to
five years since it was reviewed. The agent should not give legal advice.
• Professional advisors: It may be useful to have the names, addresses, and telephone
numbers of the client’s doctor, lawyer, accountant, and other advisors. This information is
not collected to enable the agent to discuss the client’s affairs without permission.
• Income: Record amounts and source, including salary, investment income, bonuses,
rental income, alimony, pension and any other regular stream of income.
• Assets: Record the amounts and details of all assets, keeping in mind that some assets
may not be available in all circumstances. For example, the family home is an asset, but
it should not be used in any calculations done in the event of death, unless the home is to
be sold. If the home is sold, then alternative accommodations must be obtained and this
cost should be taken into account under expenses (rent) or as a reduced asset, if a
smaller, lower-cost home or condominium is purchased.
• Liabilities: Record amounts and type, including mortgage, credit cards, student loans,
car loans, lines of credit and personal loans.

PRODUCTS OWNED & REASON PURCHASED

• Personal life insurance: List the insurance company, the amount of insurance, the type,
the premium, the beneficiary, and the owner for each policy.
• Group life and health benefits: List the amount of insurance, the premium, the carrier,
and the benefits provided, such as extended health, dental, or flexible benefit options.
• Individual disability insurance: List the premium amount, the amount of coverage,
the carrier, and other benefits provided, such as a cost of living rider, a partial
disability benefit, or survivorship benefits.
• Critical illness: List the diseases covered, the benefit amount, and the premium amount.
• Long-term care: List the premium, the benefit amount, the elimination period, and
any other benefits or riders.
• RRSPs and other investments: List the amounts held, the company they are held with,
the products that they are comprised of, and any restrictions on the money, such as a
locked-in RRSP, or investments earmarked for an emergency or for a specific purchase
such as a house or car.
GOALS
What are the client’s dreams and ambitions? What are his or her financial objectives to
realize those dreams?
• Short-range goals: Short-range goals may be expected to start or conclude within the
next two to five years. Short-range goals might include taking a new job or moving to
a better position within the same company, starting a family, purchasing a home,
redecorating or remodeling a home, setting up an investment portfolio, or travel.
• Medium-range goals: These are goals 5-20 years into the future. They might
include funding children’s education or starting/purchasing a business.
• Long-range goals: These are goals 20 years or more into the future, such as retirement.
• Other eventualities: It is important to ask the client about what the client would want
to happen after his or her death, in the event of his or her disability, in the event of a
spouse’s death, or after retirement.
FOLLOW-UP SYSTEM
Relationships with clients are similar to relationships with friends. Close friendly relationships are
built upon regular contact. Absence does not usually make the heart grow fonder. Absence permits
someone else to step into the opening. It takes a lot of effort to locate, develop, and keep clients.
Although some relationships will deteriorate over time for a number of reasons (the client may
move away or become uninsurable, or the agent may decide to work with a
different market), no one should lose a client because of failing to contact them when
required or requested.

A follow-up system should include the following elements:

• Personal follow-up: The agent should consider contacting clients, prospects, and their family
members on birthdays, anniversaries, and other significant dates by telephoning, or sending a
card or e-mail message. This means ensuring sufficient lead-time to allow for mailing or for
times when the agent is away on business. Be aware that not all clients will
appreciate this kind of attention and might find it a personal invasion. Make sure you
don’t only contact clients on special dates as a phone call on another day for no other
reason than to make sure things are okay is often more memorable to a client.
• Policy follow-up: Certain events require contact, such as policy anniversaries, renewal dates
for term policies, or option dates for guaranteed insurability or future purchase options.
• Other follow-up dates: Agents should respond to requests from the client such as: “Call
me in the beginning of April. We get our bonus in March and I’d like to convert my term
policy to a universal life policy.” “My daughter is getting married in August and I want
to get a policy loan in July.” Although an agent could tell the client to call when ready,
it’s more impressive if the agent notes down the date and calls the client.
The agent needs a simple, easy-to-use follow-up system that will allow him or her to maintain
a professional focus and concentrate on other aspects of the business. Some companies offer
follow-up systems for a monthly fee. Computer-based reminder systems are also widely available.

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Chapter 1

© CSI GLOBAL EDUCATION INC. (2011) 1•1

1•2 © CSI GLOBAL EDUCATION INC. (2011)

ROLE IN THE ECONOMY

© CSI GLOBAL EDUCATION INC. (2011)

RISKS THAT PEOPLE FACE

© CSI GLOBAL EDUCATION INC. (2011)

© CSI GLOBAL EDUCATION INC. (2011)

THE INSURANCE AGENT’S ROLE

© CSI GLOBAL EDUCATION INC. (2011)

TYPES OF INSURANCE POLICIES

© CSI GLOBAL EDUCATION INC. (2011)

Accident and Sickness

© CSI GLOBAL EDUCATION INC. (2011)

THE UNDERWRITING PROCESS

© CSI GLOBAL EDUCATION INC. (2011)

EVOLUTION OF THE INDUSTRY

© CSI GLOBAL EDUCATION INC. (2011)

Year Total Life Insurance (Millions)

© CSI GLOBAL EDUCATION INC. (2011)

In 2009, Canadians purchased $311.6 billion of life insurance: $205.7 billion in

© CSI GLOBAL EDUCATION INC. (2011)

© CSI GLOBAL EDUCATION INC. (2011) 2•1

2•2 © CSI GLOBAL EDUCATION INC. (2011)

© CSI GLOBAL EDUCATION INC. (2011) 2•3

© CSI GLOBAL EDUCATION INC. (2011)

NEEDS MET BY LIFE INSURANCE PRODUCTS

DYING TOO SOON

© CSI GLOBAL EDUCATION INC. (2011)

• an emergency fund for survivors after the death of an income earner;

LIVING TOO LONG

© CSI GLOBAL EDUCATION INC. (2011)

Personal Life Insurance and Taxation

TAX-FAVOURED TREATMENT OF LIFE INSURANCE PROCEEDS

USING LIFE INSURANCE PROCEEDS TO DEFRAY CAPITAL GAINS TAXES

© CSI GLOBAL EDUCATION INC. (2011)

Business Needs Met by Life Insurance Products

THREE FORMS OF BUSINESSES

WHY BUSINESSES PURCHASE LIFE INSURANCE

© CSI GLOBAL EDUCATION INC. (2011)

BUSINESS CONTINUATION INSURANCE

ESTABLISHING A BUSINESS LIFE INSURANCE PLAN

© CSI GLOBAL EDUCATION INC. (2011)

© CSI GLOBAL EDUCATION INC. (2011)

KEY PERSON LIFE INSURANCE

© CSI GLOBAL EDUCATION INC. (2011)

Business Life Insurance and Taxation

TAX-FAVOURED TREATMENT OF LIFE INSURANCE PROCEEDS

USING LIFE INSURANCE PROCEEDS TO DEFRAY CAPITAL GAINS TAXES

© CSI GLOBAL EDUCATION INC. (2011)

Choosing a Life Insurance Policy to Suit Specific Needs

Example 1: Young Parent Dying Suddenly with a Lot of Debt

Was this an appropriate solution?

© CSI GLOBAL EDUCATION INC. (2011)

What other options were available to Waldo and Martha?

Example 3: An Individual Who Suffers a Disability with Hope for Recovery

Was this policy appropriate for Ingrid’s situation?

Example 4: A Business Owner Who Is Injured

© CSI GLOBAL EDUCATION INC. (2011)

Example 5: An Older Individual Who Develops a Debilitating Illness

Example 6: An Older Individual Dies, Leaving a Large Estate

© CSI GLOBAL EDUCATION INC. (2011)

The properties will be transferred to her surviving children.

What problems might arise from Roger and Susan’s plan?