LLQP Life Insurance Product Types 2 — Questions and Answers

Question 1: What is the key feature that distinguishes universal life insurance from traditional whole life insurance?

Universal life has a death benefit while whole life does not
Universal life offers flexible premiums and an adjustable death benefit (Correct answer)
Whole life is always more expensive than universal life
Universal life does not accumulate cash value

Correct answer: Universal life offers flexible premiums and an adjustable death benefit

Universal life insurance is distinguished by its flexibility, allowing policyholders to adjust both premium payments and death benefit amounts within certain limits.

Universal life (UL) insurance was designed to provide greater flexibility than traditional whole life. Key flexible features include: adjustable premium payments (within minimum and maximum limits); adjustable death benefit (subject to evidence of insurability for increases); transparent cost structure showing the cost of insurance, administrative fees, and investment returns separately; choice of investment options for the cash value component; and the ability to overfund the policy to accelerate cash value growth (within tax-exempt limits). Traditional whole life has fixed premiums, fixed death benefits, and the insurer manages all investments. UL appeals to policyholders who want permanent coverage with the ability to adjust their policy as their financial situation changes. However, UL requires more active management and carries investment risk that whole life does not.

Question 2: What does the 'convertibility' feature in a term life insurance policy allow?

Converting the death benefit into a lump sum payment while alive
Converting the term policy to a permanent policy without providing medical evidence (Correct answer)
Converting the policy from one insurer to another
Converting the beneficiary designation from irrevocable to revocable

Correct answer: Converting the term policy to a permanent policy without providing medical evidence

Convertibility allows term life policyholders to convert their policy to a permanent life insurance product without providing evidence of insurability.

The convertibility feature is one of the most valuable options in a term life insurance policy. It allows the policyholder to convert their term coverage to a permanent life insurance policy (typically whole life or universal life) without undergoing new medical underwriting. This is particularly valuable because: the policyholder's health may have deteriorated since the original policy was issued; the conversion locks in insurability at the health status reflected in the original policy; it allows a staged approach to life insurance planning (starting with affordable term and converting to permanent when budget allows). Conversion is typically available up to a specified age (commonly 65 or 70) or until a certain number of years before the term period ends. The permanent policy premium will be based on the policyholder's attained age at conversion, which will be higher than if they had purchased permanent insurance originally, but the key advantage is guaranteed insurability.

Question 3: What is a 'participating' whole life insurance policy?

A policy where the policyholder participates in choosing investments
A policy that pays dividends to policyholders based on the insurer's financial performance (Correct answer)
A policy where multiple people share the same coverage
A policy that requires participation in a wellness program

Correct answer: A policy that pays dividends to policyholders based on the insurer's financial performance

A participating whole life policy pays dividends to policyholders based on the insurance company's investment returns, mortality experience, and expense management.

Participating (par) whole life insurance policies allow policyholders to share in the insurance company's favourable financial results through dividends. Dividends are determined annually by the insurer's board of directors based on three factors: investment returns exceeding assumptions; mortality experience better than expected; and operating expenses lower than projected. While dividends are not guaranteed, many major Canadian insurers have a long history of paying them consistently. Policyholders can use dividends in several ways: receive cash; reduce premiums; purchase paid-up additional insurance; accumulate at interest within the policy; or repay policy loans. Participating policies typically have higher initial premiums than non-participating policies, but the dividend history can make them more cost-effective over the long term. The dividend scale is reviewed annually and can be adjusted up or down.

Question 4: What is 'decreasing term' life insurance and when is it most commonly used?

A term policy with decreasing premiums over time
A term policy where the death benefit decreases over the term period, often used for mortgage protection (Correct answer)
A term policy that decreases in duration each renewal period
A term policy sold at a discount to groups

Correct answer: A term policy where the death benefit decreases over the term period, often used for mortgage protection

Decreasing term life insurance has a death benefit that decreases over the term period, commonly used to cover a declining obligation like a mortgage.

Decreasing term life insurance features a death benefit that reduces over the policy term while premiums remain level. This product is designed to match declining financial obligations, most commonly: mortgage balances that decrease with each payment; business loans being amortized; income replacement needs that decrease as children grow older and become independent; and other debts being paid down over time. Mortgage life insurance offered by banks is typically a form of decreasing term insurance. The key advantage is that premiums are lower than level term insurance because the insurer's risk decreases each year. However, individual decreasing term policies from life insurance companies offer advantages over bank mortgage insurance, including: the policyholder owns the policy and chooses the beneficiary; coverage is portable if the mortgage is transferred; and the beneficiary receives cash rather than having the mortgage paid directly to the lender.

Question 5: What is the 'exempt test' under the Income Tax Act as it applies to life insurance policies in Canada?

A test to determine if insurance premiums are tax-deductible
A test to determine if a life insurance policy qualifies for tax-exempt accumulation of investment income (Correct answer)
A test to determine if the policyholder is exempt from medical underwriting
A test to determine if the death benefit is exempt from estate taxes

Correct answer: A test to determine if a life insurance policy qualifies for tax-exempt accumulation of investment income

The exempt test under the Income Tax Act determines whether a life insurance policy's investment component qualifies for tax-exempt growth of accumulated income.

The exempt test, defined in Regulation 306 of the Income Tax Act, determines whether a life insurance policy qualifies as an 'exempt policy' for tax purposes. An exempt policy allows investment income to accumulate within the policy on a tax-deferred basis, and the full death benefit (including accumulated investment income) is paid tax-free to the beneficiary. The test compares the policy's accumulating fund to the accumulating fund of a benchmark policy (an endowment at age 90, or 100 for newer policies). If the policy's accumulating fund does not exceed the benchmark, the policy is exempt. If it exceeds the benchmark, the excess is taxable as investment income. This test is particularly relevant for universal life and whole life policies where the cash value component can grow significantly. The exempt test limits the amount of tax-sheltered savings that can be held within an insurance policy, preventing policies from being used primarily as tax shelters.

Question 6: What is 'term to 100' life insurance and how does it differ from traditional whole life?

It is identical to whole life insurance
It provides coverage to age 100 with level premiums but typically has no cash value or dividends (Correct answer)
It is a term policy that renews every 100 months
It is a policy that costs $100 per month regardless of coverage amount

Correct answer: It provides coverage to age 100 with level premiums but typically has no cash value or dividends

Term to 100 (T100) provides permanent-like coverage to age 100 with level premiums but typically does not accumulate cash value or pay dividends, making it less expensive than whole life.

Term to 100 (T100) is a Canadian insurance product that fills the gap between temporary term insurance and full permanent whole life insurance. It provides level premiums guaranteed to age 100 (effectively permanent coverage) but without the cash value accumulation, dividends, or policy loan features of whole life. Because the insurer does not need to fund a cash value or dividend account, T100 premiums are significantly lower than whole life premiums for the same death benefit. T100 is ideal for clients who need permanent coverage (estate planning, final expenses, business succession) but do not need the savings component of whole life. Some T100 policies do develop a modest cash surrender value in later years. If the insured survives to age 100, the policy is typically considered paid up, and the death benefit remains in force. T100 has been a popular product in Canada for cost-effective permanent protection.

LLQP Life Insurance Product Types 2

What is the key feature that distinguishes universal life insurance from traditional whole life insurance?