New tax rules will lead to higher universal life pricingBy Alain Thériault | March 31 2016 07:00AM
New taxation rules for life insurance policies will result in price increases for level cost universal life insurance. The reason: insurers’ investment income tax.
The investment income tax (IIT) insurers must pay will rise in 2017. Generally, insurers absorb this tax and include it in the product price paid by the client. Until now, the IIT applied only to the net cash value of an individual life insurance policy.
In a letter to financial advisors, Sun Life explained that the IIT rate is 15% of net investment income, and that it is not a tax directly payable by the policyholder. “But, IIT effectively reduces the rate of internal growth in the policy and requires an appropriate premium adjustment to fixed premium, fixed value policies. It is usually reflected in the administrative costs with a universal life policy or is included in the premium amount for a fixed premium policy,” said the letter.
Starting January 1, 2017, the tax will apply to the entire accumulation fund of the individual life insurance policy. “The price of level cost UL insurance will rise due to the extended application of the tax on insurers’ investment income,” financial planner Gilles Chevalier, president of Engel – Chevalier, Protection du patrimoine, explains.
Saundra Edwards, assistant VP, Business Development & Solutions, Canada-Life, Great-West and London Life, projects an increase of between 5% and 10%. “There will be an impact on level cost UL because the investment income tax on the product’s reserves will now be in the same range as for par whole life products…The largest increases will be for level COI and limited pay COI as well. It will vary by age and by products,” she says.
PPI’s executive vice-president and actuary, John McKay, also thinks that insurers will want to pass along their investment tax expense to policyholders, particularly for level cost universal life. “In addition, given the very low level of market interest rates, insurers may choose to use this repricing opportunity as a chance to raise level COI rates a little further to offset the impact of these low interest rates. The IIT by itself would likely require level COI rates to increase by about 3% - 10%, with larger increases required at the younger issue ages,” he says.
He adds that level COI universal life will be the product category most impacted by the new tax regime. The impact will be much less pronounced for high cash value products, such as par and YRT UL and negligible for term products.
Beyond the IIT impact, McKay says he doubts that the new rules will have much, if any, impact on product pricing.
Saundra Edwards projects that persistent downward trends in long-term interest rates may affect prices. “Low interest rates put pressure on insurance rates and any further pricing will have to reflect that situation,” she says.
Back in 1982, new tax rules resulted in the development of universal life insurance. In 2017, major rule changes will transform existing products, Chevalier says. “To benefit from the same possibilities in their capital dividend account after 2016, people will have to buy more insurance. We will probably be seeing automatic supplemental insurance purchase clauses to create more room for capitalization within policies,” he adds.
Leverage strategies will consequently become less appealing because the accumulation potential in policies used as guarantees will be lower, Chevalier continues. However, clients who pay excess premiums and who use a policy to guarantee a loan in 2017 may deduct the excess portion from the normal premium.
John McKay foresees changes to many features, including the level of maximum premiums and guaranteed cash value, along with the rates used to buy paid-up insurance in participating policies. “Given the restrictions that the new rules impose on fund value accumulations within level COI UL policies, it is likely that insurers will develop new coverage options to include in such products in order to allow clients to achieve larger accumulations over time. Par products already include a mechanism to do this,” he points out.
Rapidly changing situation
The situation is changing rapidly and products must now be reworked. “Products need to be changed. Launched in May 2014, Manulife’s UL product already requires minor adjustments, to ease compliance with the new rules,” says Manulife assistant vice-president, Actuarial Consulting, Pierre-Olivier Sarolea.
Some changes to products are still in the works, including the illustration software for universal life. “We currently consider the redemption fees to calculate the maximum deposit. We won’t be able to do that as of 2017,” says Diane Hamel, assistant vice president, Regional Tax, Retirement and Estate Planning for Québec, at Manulife. “We think our illustration software will be ready before January 1, 2017,” she continues.
A notable advantage resulting from the new rules concerns the 250% test. “The 250% test will be more permissive,” Sarolea points out. “You would have to fail an additional test before failing the 250%. There will be some differences in the application of the 250% test depending on whether the policy is pre- or post-2017, but the changes to this test will be beneficial for old and new policies alike.”
This test is done starting from the 10th anniversary of a universal life policy, Sarolea says. It aims to ensure that the accumulation fund is not 250% larger than it was three years earlier.
However, the maximum premium payable in the first year will be less generous, he continues. The maximum deposit is set according to the policy type exempted, which will change on January 1, 2017, Sarolea explains. The current standard, called a mixed policy, is an allowance payable for 20 years, which expires at age 85. The future mixed policy will be payable instead for eight years and will expire at age 80, Sarolea says.
“On top of that, because we can no longer factor in redemption fees when calculating the maximum deposit, the deposit may be reduced for some products. For example, products with high redemption fees in the first few years will be at a disadvantage. With the changes of 2017, the products that can be paid out in one year will be gone from the market,” Sarolea says.
Diane Hamel thinks that multi-life policies will probably vanish; sales are already sluggish. Under these policies, a client can obtain insurance of $5 million and ensure his father for $100,000, for example. The total value of the accounts is payable at each death. If the father dies first, the benefit will be $500,000 due to the son’s high coverage. It will be paid with a death benefit of $100,000 for the father, which adds up to $600,000 tax-free.
“As of 2017, the amounts that clients can withdraw tax-free will be limited based on the maximum amount that could have been deposited in the policy, under the insurance coverage of the first insured to die. In the example above, it comes to $100,000, not $5 million,” Hamel explains “The excess $500,000 will therefore become taxable. We certainly do not want to create this type of situation in future products.”