This article appears in the February 2020 issue of Advisor’s Edge magazine. Subscribe to the print edition or read the articles online.
If your client is terminally ill and struggling financially, their permanent life insurance policy might provide relief by paying the death benefit early, by way of a loan against the benefit. Such payments typically require a life expectancy of no more than a year, but that’s starting to change.
Last year, BMO Insurance introduced a program that provides an advance death benefit payment for clients experiencing financial hardship whose life expectancy is less than five years. The program will provide as much as 50% of the benefit, up to a maximum of $250,000, payable in annual instalments over the course of five years. The idea is to provide an option for policyholders facing unexpected medical expenses.
Steven Cooney, senior vice-president and head of individual life and annuities at BMO Insurance, says he’s unaware of other programs with a five-year duration that are similar to BMO’s program.
“We’re taking a bolder stance,” he says. “We think it’s the right thing to do.”
The five-year duration aligns with recommendations made by the Conference for Advanced Life Underwriting (CALU).
“With medical advancements, it’s hard to get a doctor to say, ‘Yes, this person has a life expectancy of less than a year’ or less than two years,” says Kevin Wark, tax advisor for CALU. “By expanding this to five years, we thought that would open the door to more people being able to qualify.”
Guy Legault, CALU’s president and CEO, says he hopes other insurers follow suit with the five-year duration. “In the new year, we’ll be talking to the other companies,” he says.
CALU will also continue to highlight long-term care needs. Legault says not enough is being done as Canada faces a “tsunami” of care costs with an aging population. While programs like BMO’s aren’t a panacea, they help, he says.
Advising clients on the new program
Cooney says it will be up to advisors to examine clients’ circumstances and determine whether or not BMO’s program is a fit.
Clients must be educated about the program’s terms so they understand what amounts they’ll receive over what time period, the costs (including interest) and what will remain for beneficiaries. Clients must provide written proof of financial hardship, including expenses that exceed after-tax income and a net worth of $250,000 or less. Policy costs are withheld from each of the five annual advances to the client.
An advisor can consider whether there are other ways to accomplish the client’s goal besides taking out the loan against the death benefit, Wark says, and can help manage the loan if that’s what the client chooses. As such, relative to the client selling their policy (for which there are considerable constraints — see “Advisors cautioned about life settlements,” below), with a program like BMO’s “there is an advice component,” which means clients can make qualified decisions, he says.
Other potential options, Wark says, include accessing the policy’s cash value, borrowing from a family member (repayable from the insurance on death) or borrowing against another asset such as a home. The advisor could also “confirm if there are any ancillary benefits under the policy such as disability waiver of premium or a critical illness benefit that could provide funds to maintain the policy in force and help cover living expenses,” he says.
With BMO’s program, clients should also be aware that, once they’re in the program, the policy can’t be surrendered. “There wouldn’t be any changes of ownership or beneficiaries,” Cooney says.
Advance payments in context
In most of Canada, clients don’t have the option of selling their insurance policies on a secondary market.
CALU highlighted issues with the secondary market by explaining the evolution of viatical and life settlements in a practice note published last year that was based on a 2015 research report.
A viatical settlement — when an insurance company or third party purchases a life insurance policy from a terminally ill policyholder — became popular in the U.S. in the 1980s during the AIDS epidemic, typically for policyholders with a life expectancy of less than two years, the note said. (In Canada during the AIDS epidemic, insurance companies offered collateral loans or advance death benefits, it said.)
As AIDS treatments improved and became less costly, demand for viatical settlements waned. As a result, companies offering the settlements expanded the profile of policies being acquired to include those of seniors with decreased life expectancies, the CALU note said. This practice grew into the life settlements market.
Eventually, investor demand for life settlements exceeded supply, and stranger-oriented life insurance (STOLI) arose in the U.S., which was sometimes abused through misrepresentation. Segments of the life settlement industry would actively solicit people who were older and uninsured to apply for policies that would be transferred to investors within a short time period.
Growth of the STOLI market was curtailed in the face of lawsuits brought by insurance companies, investors and others, the note said, and most states now have some form of legislation governing viatical and life settlements.
Canada’s life settlement market is relatively small because most provinces have anti-trafficking provisions that prohibit creating a marketplace for selling insurance policies (except back to the originating insurance company).
Advance access to death benefits was first made available to terminally ill Canadian policyholders in 1988, says commentary from the Canadian Life and Health Insurance Association. “Canadian insurers are international leaders in this area as this initiative has been copied widely around the world,” it said.
Still, while viatical settlements and STOLI have been more common in the U.S., Cooney says there were some in Canada.
About five years ago, Wark says CALU observed growth in Quebec’s life settlements market, which is among the handful of provinces without anti-trafficking provisions for life insurance. “Investor groups were actively soliciting policies,” he says. “CALU’s members and their clients were being approached to provide life insurance policies to investor groups.”
That’s when CALU decided to research the life settlements market in Canada and the U.S. In addition to summarizing the research, the practice note explains insurance trafficking rules and how advisors can be at risk if they go offside of those rules.
While Canada overall has seen little development in the life settlements market, the evolution of advance death benefits is a welcome option for clients in need, where suitable.
Advisors cautioned about life settlements
The provinces without life insurance anti-trafficking rules are Quebec, New Brunswick, Nova Scotia and Saskatchewan (though the latter is in the process of amending its insurance act). Life settlement companies can purchase insurance policies from policyholders in these four provinces.
However, if an advisor facilitates an insurance transfer from a client in Ontario, for example, to an investor group in Quebec, Ontario’s anti-trafficking provisions would apply, says Kevin Wark, tax advisor for the Conference for Advanced Life Underwriting (CALU). In provinces where an advisor breaches the anti-trafficking provisions, the insurance acts allow for various penalties, potentially including fines and loss of licence.
Also, contractually, advisors can’t facilitate the purchase or sale of policies without risking loss of their contracts with most insurance companies. That’s because “Canadian life insurers are opposed to life settlements generally and to [stranger-targeted life insurance] in particular,” a CALU practice note said. The note lists several concerns, including anti-trafficking provisions, the potential for fraud and compensation conflicts.
At the same time, most insurers acknowledge that the type of activity that would cause an advisor to fall within the trafficking prohibition is somewhat subjective, requiring discussions with the advisor before deciding to terminate their contract.
For example, facilitating a private sale (i.e., to a third party not in the business of purchasing policies) without payment of a finder fee to the advisor might not be treated as trafficking by the insurers, the note said.
Still, CALU suggests advisors “exercise extreme care” when a client asks for support to sell their policy, even where the client lives in a province that permits life settlements.
“Where it is unclear whether your participation might be considered ‘trafficking,’ having a discussion with the insurance company that issued that policy is recommended,” it said.
CALU also suggested advisors review their errors and omissions insurance to see if they have coverage for claims arising from life settlement activity, from either policyholders or investors.
When a client seeks your advice on selling their life insurance policy as part of a life settlement, consider the following:
- Why is the client considering this sale? What has changed in their situation?
- What other options, such as an advance death benefit or collateral loan, are available that would allow the policyholder to retain part or all of the policy and related death benefit?
- Does the activity fall within provincial legislation that prohibits trafficking in life insurance?
- Is the life settlement company reputable and will it keep its promises?
- Are all fees and costs being properly disclosed to the policyholder?
- How will proceeds from a policy sale be treated for tax purposes?
- Will the activity cause the life insurer to cancel the advisor’s contract?
- What liability could arise from the activity, and would it be covered by errors and omissions insurance?