Disability Income Insurance Taxation

If you have a disability policy, either through work or independently you need to know a thing or two about taxation.

Canada Revenue wants its taxes one way or another, coming or going, the choice is yours. Disability benefits can either be taxed on the premium or on the benefit. Since the premium is typically many times larger than the premium the best way is usually to pay the tax on the premium dollars rather than the benefit.

If you have a disability policy through work you want your employer to deduct the premium from your paycheque. If the employer pays even 1 cent of the disability premium, the benefit becomes taxable. The general rule of thumb for most employers is that benefit costs are split 50/50 with the employee. Usually the cost of health and dental benefits is far higher than the disability premiums so the 50/50 split ensures that the disability benefit is non-taxable at time of claim. However, for some single employees and especially employee’s who waive their health and dental benefit this may cause a tax problem.

Mr. Family Man
Life Insurance	$3.00
AD&D	$0.50
Long Term Disability	$23.50
Health Care	$62.75
Dental Care	$85.16
Total	$174.91

Assuming a normal 50/50 Split
Employee’s Cost	$87.45
Employer’s Cost	$87.46

Since Mr. Family Man’s 50% share, $87.45, is larger than his Disability Premium of $23.50 he is safe.

Now let’s look at someone who waived their health and dental benefits because they have coverage through a spouses plan.

Mr. Waiver Man
Life Insurance	$3.00
AD&D	$0.50
Long Term Disability	$23.50
Health Care	$0.00
Dental Care	$0.00
Total	$27.00

Assuming a normal 50/50 Split
Employee’s Cost	$13.50
Employer’s Cost	$13.50

Mr. Waiver Man’s share is now only $13.50, which isn’t enough to cover his entire LTD premium of $23.50, his disability benefit will be taxable.

So how do we fix it? We don’t want the employee paying for more than their 50%, and we don’t want the benefit to be taxable so what do we do? We give the employee a raise.

Payroll adds $10.00 to Mr. Waiver Man’s income, and deducts a full $23.50 from his pay cheque, Mr. Waiver Man see the same net paycheque at the end of the day. The employer portion now becomes $3.50 plus the $10 raise total $13.50, their portion is also the same. Mr. Waiver Man is paying the whole LTD premium of $23.50 which makes it non-taxable.

The only think CRA really cares about is that the employee is paying income tax on $23.50 of income. It’s a little extra work on the part of Payroll and Human Resources but it provides a huge increase in benefit to the employee.

Individual Disability Policies are usually best held personally and not inside a company for the same reason. You have to pay the premium is after tax dollars but a tax free benefit is usually a far better deal.

Commission

I get paid to sell a product, insurance. Just like every other merchant or retailer I earn money for every unit of product I sell. I really don’t see it any different than a buying an apple at a grocery store, I have something you want, you have to pay me for it. You are free to shop around and find the best value on apples or insurance policies, and if I do my job right you will buy from me.

I know a lot of people out there have a beef against commissioned sales people, stereotypes abound of the greasy sleazy pushy salesman. The door to door insurance salesman is also engrained in most people’s minds. While most stereotypes are based on reality, and there are those kinds of people in my industry and others, I certainly don’t consider myself one and most insurance advisors (notice how that sounds so much better than insurance agent) really are trying to do their best for their client. While you will have to take my word for it, I have never tried to up-sell or sell an un-needed product solely to boost my bottom line. I also have no qualms with what I get paid as I have a very extensive and specialized body of knowledge and experience and the services I provide and my time are valuable. Now with the moral hazard out of the way let’s get to the good stuff.

Group Insurance

Let’s start with group insurance as that is what I spend most of my time doing, and where I earn most of my money. I also think the group insurance commission methodology is a lot better than the individual products for reasons I will cover. Group insurance pays an annual commission, each year the group spends with an insurance company I get paid. Most small groups work on what is known as the Crown Scale, or something like it. The crown scale is a decreasing scale which pays less as the group gets larger.

Annual Premium	Commission
$0 - $10,000	10%
$10,000 - $25,000	7.5%
$25,000 - $50,000	5.0%
$50,000 - $100,000	3.0%
$100,000 - Thereafter	2.0%

The scales vary slightly but are all about the same. Some companies also pay a higher first year commission, typically 15% on the first $10,000 and the rest of the scale is the same.

Now on a group with say 3 employees, with an annual premium of $10,000 my compensation is $1,000 per year. It might take me three months, half a dozen meetings, a dozen quotes, and a hundred emails to prospect, quote, and sell a group. There is a lot of work that goes into setting up a group and I only get paid a measly grand. Of that I have to split it with the house so I walk away with $500. But I get it every year I keep the group. The small group market is tough, there is almost as much work to be done with a 3 life group as with a 30 life group. There are a lot more 3 life groups though so it becomes a numbers game.

Next let’s look at a bigger group, 120 members, $350,000 in annual premium.

Annual Premium	Commission %	Commission $
$0 - $10,000	10.0%	$1,000
$10,000 - $25,000	7.5%	$1,125
$25,000 - $50,000	5.0%	$1,250
$50,000 - $100,000	3.0%	$1,500
$100,000 - Thereafter	2.0%	$5,000
	Avg. 2.82%	Total $9,875

I make a respectable 10 grand, and from the clients perspective they are getting a good value as my fee is less than 3%.

Depending on how much business I have with any one insurance company I can also receive a “Building Bonus”. I have almost no bonus with some companies and I have a really good bonus with others. My top group bonus is 40%, so on the large group I would get an extra $3,950 bringing my total compensation up to about $14,000. I don’t think much about the bonus, it is just something that happens over time, as you add new groups or you build up an asset base your bonus level grows. I haven’t actually looked at which companies pay a higher bonus or whose might be easier to achieve. I always place the group with the company that is the best fit for them; I try not to think about the commissions until after the cheque arrives.

In the large group market, there we can also work on a fee for service basis, we currently charge 4%. We offer fee for service but don’t use it much since we then have to add GST/PST/HST which we don’t have to charge if we receive a commission.

Individual Insurance

Individual insurance is a whole different ballgame. Payday comes only when you make a sale, and some sales make for big paydays. After a sale you receive a small trailer usually 1-3% which is supposed to keep you interested enough to provide service for the client after the sale. Because individual insurance provides a big commission and only minimal follow up pay less scrupulous agents will push for a large volume of sales. This is where insurance agents can get a bad reputation. If all the agent is concerned with is their paycheque, they will try and force you to buy a policy that you maybe don’t need or don’t understand. Once you buy you never hear from them again because your usefulness to them is done and they would rather not have to go on service calls that don’t pay anything.

The amount of commission we are paid depends on the type of policy we sell. The one constant is that the amount of commission is always based on the first year’s premium. Most if not all of your first years premium goes to the advisor.

Term 10 typically pays 40% of first year premium.

Term 20 typically pays 50-60% of first year premium. Since premiums and commission scale are higher there is a lot more money to be made selling Term 20 over Term 10. I almost always sell Term 10.

Universal Life, the big commission Kahuna. Universal Life is incredibly profitable for insurance companies so they pay a big commission for the agents to sell it. Universal life commissions are usually 70% of the first years commission, plus 3% of any deposits. The premiums are also a lot higher than term insurance so 70% of a lot of premium is a heck of a lot of commission.

Example: Male Age 40, Non-Smoker. $1,000,000 face amount

	Commission Scale	First Years Premium	Compensation
Term 10	40%	$740.00	$296.00
Term 20	60%	$1350.00	$810.00
Universal Life	70%	$5435.16	$3804.61

Pretty big difference eh? It is easy to see how an agent can be swayed to pressure someone into buying a Term 20 over a Term 10, and selling that big UL is every agents dream. Now obviously someone looking for a cheap mortgage insurance policy isn’t going to buy a million of Universal Life, but it is pretty easy to see how they could be talked into a 20 year term. Same length as your mortgage, who knows what rates will be in 10 years, what if your health changes, think of the added security yadda yadda...

Bonuses also exist in the Individual market, I will only touch on them briefly as they vary so much from company to MGA to brokerage. The bonus is designed to be paid to the agency that employs the advisor. However, a lot of agents are independent or self employed, in which case they can keep the bonus. The bonus is dependent on how much business an agent writes with a company or MGA. The more business, the bigger the bonus. A bonus is based on the First Year Commission (FYC) rather than the premium. Bonuses range from zero to as high as 250% of FYC though the MGA usually takes about half of this amount. Most of my bonuses range between 100-160% of FYC. Essentially I get paid double if not closer to two and a half times base commission for certain policies. If I sold that UL policy above with a company that pays me a good bonus of 160% I would bank almost $10,000. While not common I know agents that have sold a Universal Life policy with a $50,000 per year premium and made their income from the year on the one policy.

A lot of you are probably thinking, that we get paid too much, and sometimes that is true, but all too often we don’t get paid enough. If I charged an hourly rate for the work I do for clients who never buy a policy I would probably be better off. I have done huge, ridiculous, tedious work for countless clients without ever seeing a dime.

As I started off saying, I like the group insurance commission method a lot more than the individual. There is too much pressure on a person to sell individual policies to get a paycheque. With the group market you don’t get paid as much but you get paid every year you keep the client, and to keep the client you have to communicate with them, solve their problems, go through the renewal process and actively be involved with the client. With a 20 year term policy you sell it once and then see you again in two decades, if the agent is even still in the business (there is a prolific dropout rate of new advisors). Another thing I like about the group market is that since I get paid every year from an existing group of clients I have a steady cash flow; I don’t have to be living paycheque to paycheque or policy to policy. Having a base of income is a huge benefit as it allows me to focus on the needs of my clients rather than my empty wallet. While I am still motivated to sell new policies it removes a level of desperation that can come at the end of a slow month with few sales.

There has been a small movement for the last 10 years or so to change how commissions are paid in the individual market. The push has been to implement a flat commission scale similar to the group market. If you sell a term 10 policy, you get 10% of your commission each year for 10 years. Each year you would need to sit down with the client and get them to sign off before you get paid. This would keep an advisor in constant communication with their clients, would weed out the agents just looking for a quick payday and would greatly improve the minimum level of service we provide. Sadly, there has been a lot more opposition to this movement than support. I think the day that regulations require us to show in big bold face type on the front of the policy what we get paid in dollars and cents the switch will happen. Until then don’t be afraid to ask what your advisor is getting paid. Their services may feel free since you never write them a cheque directly but you are indeed paying them out of your own pocket. Make sure you are getting what you paid for.

The lone pollster wants to hear about Segregated Funds

What’s a Segregated Fund? Seg funds as I will occasionally refer to them, are investments sold by insurance companies. They get the name Segregated because the assets and investments are held separated or segregated from the other assets of the insurance company. The reason for this is that the insurance company can go bust and your investments will still be there.

Segregated Funds are most easily compared to a Mutual Fund, they are typically a fund or basket of stocks, bonds and securities wrapped up in a package. Segregated Funds versions of popular Mutual funds are often provided by the insurance arm of the investment firm. Third party funds are also available based on popular Mutual Funds from dealers like Fidelity, AIM Trimark, Dynamic and others. Segregated funds can be used in RRSP, RESP, TFSA and non-registered accounts. They don’t tend to have the breadth of choice available in the Mutual Fund or Electronically Traded Funds (ETF) markets but they have an excellent selection of asset classes covered. They also don’t sport as many tax options such as corporate class mutual funds.

If they are so similar why not just buy a Mutual Fund? While there are lots of similarities there are also a lot of differences, most of these have to do with guarantees. Remember Seg Funds are sold by life insurance companies; they are essentially a life insurance contract. Because of this they inherit several benefits of life insurance, namely they can have a beneficiary, and they bypass probate fees. Segregated Funds also have guarantees which no Mutual Fund has. The two main guarantees are the Death Benefit Guarantee and the Maturity Guarantee.

Death Benefit Guarantee, because they are life insurance seg funds have a beneficiary, they also have a death benefit which is paid to this beneficiary at the time of the owners death. The catch is that unlike a traditional life insurance policy with a flat face amount the face amount of the seg fund varies with the performance of the investment. However, to be called a seg fund all policies must provide a minimum 75% guarantee. This is to say that if you invest $100 in a seg fund, the market tanks and the investments are only worth $50 at the time of your death, the insurance company will pay your beneficiary the guaranteed amount of $75. Most insurance companies also offer funds with a 100% guarantee; every dollar you pay into a fund is guaranteed to be paid back to your beneficiary at the time of your death, regardless of the current market value.

Maturity Guarantee, seg funds also have a maturity date, the maturity date is usually 10 or 15 years after the first date of purchase. The maturity date operates similar to the death benefit guarantee except you don’t have to die, good thing that. Again 75% is the minimum guarantee, if an investor purchases $100 of Seg Funds today and had a 75% guarantee, they are guaranteed to be paid back the higher of the current market value or 75% of their original investment. 100% guarantees are also available but usually carry a 15 year maturity date. Insurance companies can afford to do this because there are very few occasions in history where 10 year returns have been negative. The exception to the rule is right now, some investments, specifically those in the NASDAQ index, are indeed negative over 10 years. There are several insurance companies, most notable Transamerica which are currently paying out large sums of money to Seg Fund holders due to their maturity date guarantees.

Resets are another special feature of Segregated Funds. While options vary, policies are available with guarantee reset options. Resets allow you to lock in the current market value of your investment as the new guarantee. For example if you originally invested $100 in a 75% guaranteed seg fund and it had grown in value over 4 years to $150 you could use a reset which would now increase your guaranteed amount from $75 to $112.50. Should the market take a turn for the worse and your investment drop in value to $80 you would receive an extra $32.50 thanks to your guarantee. One important thing to note is that using a reset will also extend the maturity date. In the above scenario where the reset is used in year 4 the maturity date would be pushed out another 10 years from that point. So the owner would not be able to collect on the guarantee until 14 years into the contract.


Creditor protection is another benefit of segregated funds, especially for business owners. If for whatever reason you were sued for a million dollars, lost and were unable to pay the fine; your creditors can come after your other assets, your home, your cars, your savings and your RRSP’s. One thing they are not allowed to come after is your life insurance, specifically a life insurance policy with an irrevocable beneficiary. Now remember segregated funds are a form of variable life insurance, and you can designate an irrevocable beneficiary.
Assume a business owner is married, but his wife doesn’t own any shares in the company. The company has a segregated fund policy which is used as key person insurance on the business owner, a legitimate use. The company is sued for a million dollars, which it cannot repay. The creditors can then turn to the shareholders for further reimbursement. Mr. Business Owner could potentially lose his company, his home and his life savings due to the lawsuit. However, he was smart and appointed his wife as an irrevocable beneficiary to the segregated fund policy. He has effectively relinquished control of the policy to his wife, she has to sign in order to make any changes to the policy, she will not sign the policy over to the creditors, and since she doesn’t own any shares is not a party to the lawsuit. The money is safe.
Now there have been court cases over this where the business owner knows fair well that he is going to be sued and lose. Liquidating all of one’s assets and dumping them into a segregated fund policy is not going to stop a judge from turning over the policy to a creditor in a fraudulent case like this. However, there is a good history of this method working for regular deposits and amounts which cannot be attributed to directly and intentionally hiding money from a pending lawsuit.

The fees charged for segregated funds are higher than Mutual Funds because there has to be a way to provide for all of the guarantees. A Mutual Fund might have a fee of 1.65% where an identical Segregated Fund might charge 2.45%, furthermore increasing the death benefit guarantee from 75% to 100% will typically add another 15 base points, while increasing the maturity date guarantee will add a further 20 base points. Typical Management Expense Ratios (MER’s) for seg funds run from about 2.1-3.1% depending on the asset class and fund manager.

Segregated Funds are an excellent choice of investment for business owners and more conservative investors. The maturity and death benefit guarantees are very popular, especially in today’s current economic turmoil. The fees charged are higher than those of ETF’s or Mutual Funds but they provide a valuable service in the form of guarantees and security. Segregated Funds are an excellent choice for a novice investor as well as for the average person who simply wants a secure base on which to build their savings.

E.O.&E.

My opinion: The Chamber of Commerce Group Insurance Plan

The largest group insurance plan of its kind in Canada, the chamber of commerce has a huge number of member groups. While the plan has been very successful it has some serious drawbacks.

The chamber plan is a fully pooled plan, this means that all groups pay premium into one big pool. All claims are paid out of the same pool. Claims experience is not tracked on a per group basis. If the level of the pool drops due to high claims, everyone get the same rate increase regardless of their own claims.

Because of this pooling groups with low claims are paying the same rates as groups with high claims. The low claiming groups are in fact subsidizing the claims of the unhealthy groups. This is common knowledge in the benefits world but rarely known by the average person. I have in the past made a recommendation for a group with abnormally high claims to consider the switch to the Chamber plan as their premiums would be lower thanks to being subsidized by the group. For this reason the chamber plan has become a dumping ground for groups with bad claims experience.

Groups with low claims and good experience never know they are paying too much because they receive no record of their claims and they have no way of knowing which end of the stick they are getting.

Another major drawback of the chamber plan is the prescription drug plan. The chamber uses what is known as the NAT formulary. A formulary is a list of drugs that are or are not covered under the plan. In the case of the NAT formulary, almost nothing is covered. In fact the NAT formulary is one of, if not the most restrictive formularies around. Under the NAT formulary most medical conditions only have one eligible drug. Most plans provide a wide array of medications for each specific medical condition, this allows the patient and their physician choice in selecting the medication that is best. Some drugs are more expensive than others, but they typically have benefits the cheaper drug does not possess. Under the NAT formulary only the cheapest drugs are covered, even if they have dramatic side effects. If your doctor prescribes a certain medication not covered by the NAT formulary the pharmacist can either offer to replace it with the covered drug or you only receive reimbursement for the amount of the cheaper drug. Sometimes this can cost the patient considerable amounts of money to purchase the drug their doctor recommends as well as considerable mental anguish by placing the patient in a position where they must choose between their wallet and their health.

Flexibility is another area the chamber plan lacks. Multiple plan designs are available for each benefit, but if your needs are not reflected in the existing plans you are out of luck. The chamber cannot accommodate small or specific plan design changes; they can only paint in broad strokes.

The chamber isn’t all bad mind you, their premiums tend to be pretty stable due to the large size of the pool, even with the dumping ground effect. Their price is also pretty low due to the severe limits imposed by plan designs such as the NAT formulary. The chamber group insurance plan also will provide benefits for a single person, where most other insurance companies require at least three people. The chamber plan is a good place for small new businesses to get their feet wet in the employee benefits plan world, however, once a group has a few years under their belt, or grows to more than a handful of employee’s there is a far bigger far better and brighter world of benefits out there beyond the chamber plan.

Commission

I have been asked how I get paid, the answer is the company whose product I sell pays me a commission.

I have never once been asked how much I get paid.

Due to regulations if asked we have to disclose our compensation but I have never been asked. I would like to write a post on compensation, but it is a sensitive subject and I don't know how much some people in my industry would like it. Not that I expect anyone reads the blog, with its whole 16 unique visitors ever...

So do something new, ask me how much I get paid.

What term is the right term?

The vast majority of life insurance sold in Canada is Term Insurance. Term Insurance provides a low cost of insurance allowing for large benefit amounts. Term Insurance typically comes in two “flavours” 10-Year Term and 20 Year Term. Which is right for you?

The length of your term starts with the need for insurance. A common use of term insurance is to pay off a mortgage or debt upon a death. Most traditional mortgages are 20 years long, with newer extended amortization mortgages at 35 and 40 years becoming more and more popular. For this example lets use a 20 year mortgage for $300,000 as our starting point. There are several way we can insure that mortgage, 2 ten year terms, or one 20 year terms.

Male age 35, Non-Smoker, regular health
Term 10: $235/year
Term 20: $359/year

On the surface a 10 year term looks cheaper than a 20 year term. However, in 10 years the first term will expire and need to be renewed. The person’s age would now be 45 and the guaranteed renewal 10 year term would cost $1,162/year

Total Cost over 20 years
Term 10 = (235x10) + (1162x10) = $13,970
Term 20 = 359x20 = $7,180

Term 20 wins hands down. HOWEVER, taking the guaranteed renewal is only one option; you can also REPLACE the policy with a new one, if you are healthy. The insurance company guarantees that once you are insured you are always insurable as long as you pay your premiums. At the end of the 10 years, even if you are terminally ill you can keep your policy, you just have to pay for it. The insurance company knows that if you are terminally ill you will pay just about anything to keep the policy so they can charge whatever they want. The other situation that crops up is that people are lazy, and they hate insurance companies, so when their term runs out, it will automatically renew, but at a higher premium. People will simply pay this higher premium without checking to see if there are better options available on the market. The price goes way up, and the apathetic pay it without question.

So your 10 year term is up, you are in good health and paying over a thousand bucks a year doesn’t really float your boat. You want to know if there is a better rate out there, so you call me, or your version of me. I check the market and see what kind of rate I can get you at your now age 45, low and behold I can get you another 10 year term policy for $404/year, almost 2/3rds cheaper than your renewal. You have to go through another medical and do the paperwork but most would agree it’s worth it. As it now turns out your two 10 year term policies cost $6390, a full $790 less than the single 20 year term.

Things to consider:

• Cashflow, do you want to pay more now and less later with a T20 or less now and more later with two T10’s
• with a T10 if you become uninsurable after 10 years, you are guaranteed to be stuck with high premiums the rest of your life.
• There is no guarantee what rates will be in 10 years, they may be far higher than today.
• 10 years is a long time, 20 even longer. A lot can happen, marriage, kids, divorce. Most people won’t review their insurance until it renews, reviewing after 10 years is far better than every 20 years.
• More conservative people tend to gravitate towards 20 year term as they prefer the long term security it offers, they are also often worried about their future health and their ability to qualify for new insurance in 10 years. More cost sensitive people tend to prefer the lower cost of entry of 10 year term, they tend to be in better health and not as worried about the future insurance market or their ability to qualify for more insurance later.

I personally prefer 10 year term in most cases. It currently has more price competition, and therefore lower premiums, it also lets me review with my clients more often as they have to see me at least once a decade, even though I prefer far more frequent visits. In 20 years you could go from being single to having grandkids, it’s just too much time. I also like 10 year term especially for credit insurance, as you pay down your debts your need for insurance decreases, after 10 years you can drop your insurance to match your debt load and reduce your premium. Its true you can reduce your insurance at any time, but again most people don’t.

So if you are healthy and think you will stay healthy 10 Year Term is probably for you, if you are worried about your health changing or want the long term stability then consider 20 year term.

An FYI, term 10 pays a lower commission to the agent than 20 year term. A good way to tell if your agent is just sales motivated is to see if they are pushing 20 year term without a good reason. Most good agents would rather sell a 10 year term, take the lower commission, and then be able to sell another 10 year term when that one ends. It indicates a long term relationship is the agents goal rather than a quick buck.