Life Insurance 101 and Then Some

Let’s face it, life insurance, the various types, terms, products and durations available to the Canadian consumer is downright confusing and overwhelming.  I’ve struggled to figure this stuff out and I write about personal finance, saving, debt and investing every week.  So, for today’s post thanks to some help from my friends at LSM Insurance I thought I’d post a life insurance primer, and then some.  The guidelines below are just that, there is no one-size-fits-all when it comes to risk.  That’s what insurance means to me anyhow, transferring risk.

Life insurance is generally grouped into two (2) major buckets:

  1. Temporary
  2. Permanent

Let’s take a look at each.

  1. Temporary Insurance (Term Insurance)
  • Insured for short-term; coverage ends with term.
  • Terms can be 5, 10, 20, or even 30 years.
  • In terms of premiums paid, usually provides the largest “bang for your buck”.
  • No cash value.

Why Term?

Term insurance is popular and rightly so, for people with mortgages, small business owners with debts or entrepreneurs experiencing major start-up costs.  If these costs (or risks) will not last forever, term is usually a good choice.

  1. Permanent Insurance
  • Insured until the policy matures – refer to sub-categories below.
  • Policy guaranteed not to change although some products are adjustable – refer to sub-categories below.
  • In terms of premiums paid, premiums can be higher than term insurance (when you’re younger) and can be lower than tern insurance (when you’re older).  As such, if you’re going to renew term insurance a few over during your lifetime then obtaining permanent insurance is generally a better way to go.
  • There is a cash value, see below folks.

Some permanent insurance plans allow you to pay for a limited number of years, then never again.

There are three (3) major types of permanent insurance, let’s take a quick tour…

2a. Whole Life

This is lifetime coverage for most plans, as long as you pay the premiums!   Premiums for some plans “level out” over time, premiums tend to be front-loaded early-on (you pay more when younger) but you under-pay for your coverage over time (you pay less as you get older).  For other plans, you have a guaranteed payment-period and once your premiums are paid, that’s it, you’re done and you can keep the coverage.

  • Policies are structured to last your entire life.  Policies remain in force regardless of your age or health status.
  • All whole life plans build up a cash value over time.
  • Some whole life policies pay a dividend (participating life insurance).  Policyholders are usually encouraged to reinvest the dividends paid into the cash value (CV) of the policy, and use the dollars to purchase additional, paid-up insurance.
  • Once whole life coverage has been issued, it cannot be revoked or reduced or cancelled unless there is a non-payment of fraud involved.
  • If you cancel your whole life policy – you’ll likely get what is called the cash surrender value (CSV) – which is really a refund in premium overpayments.

Why Whole Life?

Whole Life Plans are popular for some Canadians because of the certainty they provide and the CSV available to policyholders.  These plans provide more guarantees but this certainty sometimes comes at a cost (more than term insurance).

2b. Universal Life

  • This combines two quality elements of financial planning:  insurance protection and investment options.
  • You can choose a guaranteed death benefit amount, pay premiums into a “policy fund” and any money over and above what is required for your death benefit can be placed into an investment account to grow a) tax-deferred or b) used to increase the value of your death benefit.  So, you have lifelong coverage with flexible premiums and adjustable benefits.

Why Universal Life?

Universal life can be good for businesses, a tax-efficient way to provide coverage to yourself as an owner or your employees and it can be good for investors.  Individual investor who have maxed out their Registered Retirement Savings Plans (RRSPs) and want to maximize their estate, for one example, can choose to own universal life.

2c. Limited-Pay

  • The insured pays a premium over a period of time that is shorter than the duration of the coverage.  For example, the insured is covered for life but the policy premiums only last 20 years.
  • Limited-pay policies are fully guaranteed – the payment period will not vary.  The payment window can be anywhere from 10 to 20 years or more depending upon policy terms and conditions.
  • Limited-pay policies can be participating or non-participating. (You already know from above participating policies pay a dividend; the dividend can be used to increase the death benefit of the policy).

Why Limited-Pay?

Limited-Pay policies can be an effective way to hedge any inflation or underlying investment risk.  For example, a universal life policy with an underlying equity investment might project a payment period of 15 years, but if the markets tank, the insured may have to pay up for more years than that.

This post didn’t even tackle the balancing act of using life insurance, disability insurance and critical illness insurance to protect you and your family, so I’ll leave those details for another day.

In the end, just reminder from me about two key things:  life insurance is about transferring risk away from you to someone else and it’s designed to protect the financial security of those you love should a catastrophic event unfortunately occur.

Thanks to the team at LSM Insurance (affiliate) for sharing some finer details about life insurance, and then some.

My name is Mark Seed and I'm the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, we're inching closer to our ultimate goal - owning a 7-figure investment portfolio for semi-retirement. We're almost there! Subscribe and join the journey. Learn how I'm getting there and how you can get there too!

34 Responses to "Life Insurance 101 and Then Some"

  1. Wow, bloggers seems to get into a groove sometimes and post about similar topics. I think I read 2 other articles today that were either directly about insurance or loosely related to insurance. This is definitely the most comprehensive one though that gives a fantastic overview of all the options out there.

    My father purchased a small 20 pay permanent policy on me when I was young and it was a good thing he did because I ended up getting Type 1 Diabetes. Forget about getting life insurance with that disease, it would be too expensive to make sense!

    However, the policy he bought allowed me to purchase $100,000 of extra insurance at 3 points in my life when I turned 24, 27, and 30 years of age. I took advantage of all 3 and purchased 20 year term at 27 and 30 years of age. I converted the policy I bought at 24 to whole life permanent. I plan to keep that one my entire life as a guaranteed tax free inheritance for my kids so if I decide I want to spend the rest, at least they will have something!

    Reply
    1. Thanks Stephen! This article took some time to write 🙂

      Having some form of whole life insurance is a great thing I think and great for estate planning purposes, good on your kids to have a financially savvy father.

      Reply
      1. Well don’t leave us hanging Glenn! Do you mean the “only buy term and invest the difference” people? Never buy whole life? What is it? 🙂

        I’m no insurance expert so I’m sure I made some less-than-optimal decisions. However, I think what I have is better than nothing especially considering I’m Type 1 Diabetic.

        Reply
        1. Consumer advocates – I bet including this blogger – will tell you a) don’t buy whole life and b) don’t put insurance on children. Anyone want to disagree with that?

          Your parents however, put a quick pay whole life on their children. Did they need that coverage? Did it make financial sense? Again, I think you’ll find consumer advocates would say no. Lots of articles around about how you shouldn’t put insurance on their kids.

          Your justification is proof by lottery. It’s the same as justifying buying scratch and win because you won $100. The $100 winners are big proponents of playing, but that doesn’t make scratch and wins good financial sense.

          Here’s the flip side however. Brokers see this stuff everyday. You sell someone’s kid a policy, they get diabetes. AND you upsold on future insurability. Now the kid has a policy, and you’re a hero. What do you do with your next clients? You probably try and sell them a quick pay whole life. Not because you’re screwing people, but because you have a heightened awareness of the risk vs. benefits. That makes them wrong most of the time, but right once in a while (and it makes the ‘don’t put insurance on your kids’ crowd’ right mostly, but wrong once in a while).

          That’s why I’m careful to educate. Insurance on your kids? You’re not buying insurance on your kids – you’re paying for future insurability. That’s what your dad did – he paid to make sure you could buy insurance later.

          That’s the correct measure IMO. Are you willing to pay premiums on children just to guarantee their future insurability? See the link that Mark posted in his comment – personal finance bloggers don’t do this.

          Given that you have had diabetes, would you put insurance on your kids? Probably. I have a boatload of life insurance on my kids. But almost all of my clients, it’s the last thing they have.

          I guess my point is, be careful with emotional pitches on life insurance. Your case is good in that it serves to show people it CAN happen. Whether it’s still a good financial decision to do what your father did is more of a ‘it depends on your risk tolerance’.

          And yes, you did just about perfect, retrospectively :). Quick pay whole life with PUA’s or GIO on kids make for some excellent justifications :).

          Reply
      2. Not to generalize Glenn, but I would suspect most 30- and 40-somethings raising a young family should likely have enough life insurance to cover their liabilities + a few years of lost income + a bit more as a buffer in the event of a family death. That’s at least $500,000 per adult for life insurance. That’s just me though.

        Thoughts? Chantal?

        I recall this article on your site Glenn:
        https://www.lifeinsurancecanada.com/the-life-insurance-lifestyles-of-canadian-financial-bloggers-part-ii-of-iv/

        Reply
  2. The article should have stopped after temporary insurance for the big majority of people, in my opinion.

    People should invest by themselves in RRSP-TFSA-RESP, not give their money to insurance companies. It’s not like they need more 🙂

    Life insurance is an important topic, one mus assess their needs related to mortgage/kids/tax/etc….

    Reply
    1. I think life insurance has it’s place, same with disability insurance, but I would agree folks should also be focusing on saving for themselves and for their kids’ future where they can, I like your order although I have a bias to the TFSA first over RRSP. Thanks for your comment!

      Reply
      1. I was not consciously making an order. 🙂

        I prefer TFSA for the vast majority of people too if they have the discipline to stay invested (withdrawals are so easy!). When maximum is reached, RRSP can be great if you are in a high tax rate.

        I use a mix of TFSA and RRSP, since I am unsure of my future tax rate Vs current tax rate (might be higher, might be lower).

        I have disability insurance (at work + my own) and life insurance (at work + my own), but I don’t pay extra for them to make “investments”… I pay them to insure the risk.

        Reply
        1. Ha, good to know.

          Yes, the TFSA lacks some incentives for tapping into that account, but then again, all investing requires some discipline. I use both for the same reasons, who knows what the future holds?

          Smart call on the insurance, you seem to be in a good place to manage the risk(s) cashinstinct.

          Reply
    1. Is it really that important to get the “exact right number” as long as you are in the right ballpark. People always seem to say you need to really crunch the numbers and know exactly what you need the insurance for. Sure, that’s smart … but really I look at it as having something that will help in the transition of an unexpected death until everyone can adjust and get back on their feet.

      In a single income family situation, I think it would probably be of increasing importance to know exactly how much you need.

      Reply
      1. Like Chantal wrote, exact numbers are not crucial but you need to be in the ballpark. Where you are unsure, this is where I think a financial professional delivers value. I would suspect most 30- and 40-somethings raising a young family should likely have enough life insurance to cover their liabilities + a few years of lost income + a bit more as a buffer in the event of a family death. That would be a minimum I think. That’s just me.

        Reply
  3. Agreed exact numbers are not crucial. But to just go to an RBC or BMO website (just picking them as examples) and take out $250,000Term 20 when you need a lot more does not make sense. There has has to be a formula / methodology used to determine the need

    Reply
  4. We have and have had none, with the exception of whatever work provided… Now that all is said and done and I am in my 40’s with a zero debt, own 2 homes and a few investment accounts that are enough to allow me not to have to work, I can say it worked for us. Assess YOUR needs is the must tagline for insurance. If I or my wife were to suddenly pass tomorrow, the remaining family would do just fine and have extra ta-boot. Should we have had insurance, probably, but we invested it instead, and “against all odds” as people in the insurance industry who continually tell me when they via for me as a client, it worked out for us… so far as I am reminded… One day maybe I will eat my words, but for my family it has worked out in our favour having only basic stuff provided by our employers. – cheers.

    Reply
    1. I think if you have coverage via your employer, ample coverage to cover liabilities and then lost income for a few years and such Phil, then you’re one of the lucky ones.

      I know in my case, should something happen to my wife or myself, work coverage is insufficient. This is why we need(ed) additional insurance. Going-forward though, my hope is we can self-insure but we’d need to be a very good financial position (ahem, like you 🙂 to do that. For now, some life insurance and disability insurance is there to transfer risk away from us.

      Thanks for your detailed comment. BTW, you should write a post on my site sometime – how you can managed to become debt-free, in 40s, own 2 homes and “a few investment accounts”.

      Reply
      1. I’d be happy to… You have my e-mail. Since I’ve never written anything other than to answer questions on blogs, I might need a basic template or something, maybe Q’s from you and I can answer based on how life has worked for us. Cheers and thanks for making me blush while I grin from ear-to-ear. The secret is really simple… Learn to be a DIYer and live on less than you have coming in while investing the rest.

        Reply
  5. I need a bit of clarification. I was shopping for a fixed term life policy – for 30 years.
    We mentioned the possibility of purchasing a home in the future. I was offered a – Mortgage credit insurance policy. I was told this is the same thing…only under a different name. Is this correct? whether this is true or not.. What exactly is the difference if any, between the two?
    Thank you

    Reply
  6. Thanks for your input Mark.
    To be more specific; this was offered by my insurance company.
    We have our car and rental insurance with them. (Quebec, Canada- insurance company). This was what we were told we needed when we asked for a term life policy of 300,000 They sent an agent to our home. We have not applied for a mortgage, nor do we own a home at present.
    When we questioned him, this was his response:

    To answer your question, the life insurance that you have applied for is a term life insurance. In comparaison with the mortgage credit insurance both are term life insurance. They are the same product the only difference is the title.

    I know that your main goal is to protect your family which means that in your actual situation your family will be protected. On the other hand, if you purchase a home in the next 3 years, your insurability will be guaranteed. Fortunatly, you won’t have to add the mortgage insurance that the bank will offer you.

    Most of the time, the loan insurance is included in your mortgage payment. Although, your mortgage will not be cleared as fast as you want. Some financial institution will give you the opportunity to pay that on a monthly bases, but like I said, all the institutions are different.

    Let me show you an example of a situation that can happen to you with a mortgage and without one under this policy:

    If your mortgage is worth 300 000$ and your life insurance worth 500 000$, you will have the opportunity to put 300 000$ on the house and the other 200 000$ Can be managed by you the way you want.

    Right now, you have no mortgage so your 500 000$ Would be managed the way you want; and you will be protected for the next 30 years. That amount will replace your husbands salary. To make sure that you will keep the same lifestyle that you have.

    Usually, the title of a mortgage credit insurance is for people that already have an insurance on their mortgage trough the bank. So they are replacing by this product to clear the mortgage faster.

    Reply
  7. [PDF]K050 Mortgage Credit Insurance, table – La Capitale
    https://www.lacapitale.com/…/lacapitale/…/K050_Table_MortgageCreditIns…
    Presented to: Prepared by: Date: Mortgage Credit Insurance. For peace of mind, cover your credit and hold on to what you’ve earned.

    Reply

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