FORUM MAGAZINE
CORPORATE INSURANCE
By Kevin Wark and Glenn Stephens
Budget Proposals
Changes of interest to financial advisors
The March 29, 2012, federal budget contained a number of proposals of specific interest to financial advisors. Let’s look at three of those proposals in detail.
Exempt Test
The current tax rules governing life insurance policies have been in force for 30 years. Considering that these provisions were enacted when universal life policies were just being introduced in the Canadian market, there is an obvious need for reform.
An important first step in the reform process is the enactment of new exempt test provisions. These rules define an “exempt test policy,” which establishes limits within which an insurance policy’s cash values can grow on a tax-deferred basis. The current rules do not properly reflect the sophistication of current product designs. They are also subject to different interpretations, which have resulted in significant disparities in the understanding and application of the exempt test rules by different insurance companies.
In 1998, the insurance industry — represented by the Canadian Life and Health Insurance Association (CLHIA) and the Conference for Advanced Life Underwriting (CALU) — made a submission to the Department of Finance (Finance) on the reform of the exempt test rules. Fourteen years later, Finance is finally ready to act, and the proposals seem to follow industry expectations.
The new rules would, among other things, use more up-to-date mortality and interest rate assumptions. The rules regarding the measurement of an exempt policy’s savings element would also be tightened to leave less room for interpretation. This would include a requirement that savings be measured without consideration for surrender charges.
A detailed discussion of the proposals is beyond the scope of this article and better explained by an actuary. However, some conclusions can be made about the likely impact of these changes: life insurance policies will continue to be eligible for long term, tax-sheltered savings; there will be some reduction in longer-term, tax-exempt savings room and in the amount of permitted deposits; and policies with extremely short “quick pay” periods will no longer be exempt.
Finance announced the proposed changes would apply to policies issued after 2013. Consultations between the insurance industry and Finance will be necessary in order to finalize all the details. It remains to be seen whether the 2014 implementation date is overly optimistic, given the significant amount of work that is required, including a major overhaul of insurance companies’ products and taxation systems.
RCAs
The legislative intent behind the introduction of retirement compensation arrangements (RCAs) in the 1980s was to create a new tax regime for certain funded non-registered pension plans. Over the years, a number of creative strategies have been introduced that, in the CRA’s opinion, have created advantages not intended by the legislation. In particular, there has been concern over strategies that provide the employer with a deduction for RCA contributions and which allow such contributions to be indirectly returned to the employer or a related party, often through “loan back” arrangements. The CRA has also identified cases where the ownership of a life insurance policy is shared by an RCA and another party (such as a shareholder, employee or employer), and where an advantage arises from the RCA, in effect subsidizing the other party’s insurance costs.
The proposals introduced in the 2012 budget would suggest that Finance agrees with CRA’s concerns. Proposed changes include: restrictions on eligible investments for RCAs by treating them as “prohibited” investments (e.g., these rules would penalize an RCA from investing in the shares or debt of an employer in which the RCA beneficiary had a significant interest — an interest of 10 per cent or more — by imposing a 50 per cent tax on such investment); a 100 per cent penalty tax on the fair market value of certain advantages (This would presumably include advantages realized under the shared ownership life insurance arrangement mentioned above); and restrictions on the refund of the RCA tax in circumstances where RCA property has lost its value.
Group Sickness and Accident Plans
There is currently no taxable benefit where an employer makes a contribution to a group plan in respect of certain lump sum benefits that an employee might receive. This would include accidental death and dismemberment policies and critical illness policies that were part of the employer’s group benefits package.