Insurance products and pricing are affected by changes to economics, legislation, demographics, long-term interest rates and taxation. And these shifts affect clients differently. For instance, when interest rates go up, clients on fixed incomes or those who are planning to purchase annuities are happy, but those who are servicing mortgages or loans feel strain. So, make sure you’re aware of how a change would affect your recommendations.
New actuarial tables
Since people are living longer, in December 2014, the Canadian Institute of Actuaries (CIA) proposed changes to pension mortality tables that will affect calculations for pension plan members who commute benefits prior to retirement. Pensions will also have to use the new tables to calculate liabilities for wind-up valuations. The changes went into effect October 1, 2015.
In its proposal, the CIA provided examples showing commuted values that would be approximately 4% to 7% higher than they would have been under the previous tables.
For single-life annuities deferred to age 65, the annuity factors are projected to be approximately 8% higher for females from ages 20 to 65.
For males at age 20, the impact is approximately 2% and increases to over 8% at age 60. Joint-life and survivor-deferred annuities will be similarly impacted.
Also changing is the 1971 Individual Annuity Mortality Table. The Department of Finance has updated that table to the Annuity 2000 Basic Mortality Table, which comes into effect for annuities issued after 2016.
One strategy that could be affected by that change is insured annuities. In this approach, an individual or a couple purchases a prescribed annuity, which pays out for the life of the annuitants. Only the income received is taxable, and return of capital is not. (The return of capital and interest portions remain constant, as they are based on a fixed formula.) A portion of the after-tax proceeds is used to purchase a guaranteed insurance contract, either on an individual- or joint-life basis. On death, the annuity ceases and the death benefit is paid.
The strategy usually results in a higher after-tax return when compared to other fixed-income investments, such as GICs or strip bonds. But the change in the mortality table, and the subsequent change in the payout, will increase the taxable portion of the annuity payment, lowering the strategy’s rate of return. Under the current mortality table, a 65-year-old male has a life expectancy of 17.3 more years. The new table, effective for annuities after 2016, moves his life expectancy to 19.6 more years, causing the taxable portion to increase by as much as 100%.
In 2017, the planned increase in the Investment Income Tax (IIT) will likely cause insurance prices to increase. That’s because the embedded reserve for Universal Life LCOI policies will be included in determining the IIT base, increasing the IIT payable on LCOI and limited-pay UL policies. For younger clients, LCOI rates could increase by up to 9%, with the increase being lower for older clients (3% at age 60).
And, after 2017, the calculation of the net cost of pure insurance will change. The mortality rate used as a result of the new table will be lower, and the net amount of risk will be lower as well. As a result, the adjusted cost basis for insurance in earlier years will be higher. That means it will take longer for the ACB to reach zero as a result of this adjustment.
From a surrender point of view, a higher ACB will reduce the policy gain; however, from a corporate planning view, it might also reduce the amount eligible for Capital Dividend Account treatment. This might affect deductions taken through leveraged and corporate strategies.
So, review the strategies you’ve been using—you may want clients to consider implementing these insurance strategies before the end of 2016 to take advantage of the current rules.
by Daivd Wm. Brown, CFP, CLU, Ch.F.C., RHU, TEP, a member of the MDRT, and a partner at Al G. Brown and Associates in Toronto