A solution to the 10/8 problem?

Ultimately, clients who currently have 10/8s in place have until the end of the year to unwind the arrangements. After that point, the tax benefits associated with the arrangements will be denied, making the structures punitive for policyholders.

PPI says that after having reviewed the draft legislation, it has developed an alternative offering to comply with the proposed rules, in collaboration with Quebec City-based Industrial Alliance Insurance and Financial Services Inc.

“I was encouraged by the draft legislation, because it gave clarity, and better guidance for us in designing products, and for advisors and their clients, in clearly understanding what a compliant versus a non-compliant policy will look like,” says James Burton, chairman and CEO of PPI.

When asked whether PPI has consulted the Department of Finance on the new offering, Burton says the firm has been actively involved in discussions with Finance on the topic of 10/8s through industry groups such as the Conference for Advanced Life Underwriting (CALU).

“We are very confident, based on the rigour of our process in the last many months, that we have respectfully created a compliant alternative,” he says.

Given the steps the government has taken to shut down 10/8s, however, some industry players are skeptical as to whether Finance will allow the use of alternative strategies such as this one. Asher Tward, vice president of estate planning with TriDelta Financial Partners Inc. in Toronto, says that although he’s not familiar with the details of PPI’s new offering, he doubts the Department of Finance will be comfortable with any tax planning strategy that has features similar to a 10/8.

“At the end of the day, if the tax hit to the government is fundamentally the same, they’re going to shut that down, too,” he says.

A typical 10/8 strategy involves a client purchasing a permanent life insurance policy with an investment component, and borrowing against that investment for the purpose of creating an annual interest-expense tax deduction.

Typically, the investment portion of the insurance policy in a 10/8 structure earns an annual interest rate of 8% and the interest rate on the loan is set at 10%. The 8% interest earned by the policyholder is tax-exempt as part of the investment portion of the policy, and the 10% interest payable on the loan is tax-deductible if the funds are used to invest in an eligible business investment under the federal Income Tax Act (ITA).

The government is challenging the strategy on the basis that it creates “unintended tax benefits.” Specifically, Ottawa has proposed to, after 2013, eliminate the deductibility of interest paid as part of 10/8 arrangements, eliminate the deductibility of premiums paid for policies assigned in support of such arrangements, and restrict the credit to a corporation’s capital dividend account by the amount of the death benefit that becomes payable under the policy for corporate-owned policies, which will ultimately force shareholders to pay tax when withdrawing the death benefit from the company.

The alternative strategy being introduced by PPI features a new managed investment account option within a universal life policy. The account aims to provide superior long-term returns, while reducing the amount of yield volatility experienced by policyholders, as compared to traditional investment options available within universal life policies. The investment philosophy and yield smoothing process will be similar to those used with participating whole life funds managed by life insurers, PPI says.

Clients can choose to take out a loan based on the security of the policy, with the loan rate based on the return of the managed account, plus a spread. However, the new managed accounts will be available to all policyholders of these policies, whether or not a loan is ever taken.

These are key aspects of PPI’s new offering, as they ensure it meets the criteria for a compliant policy under the draft legislation, the company says.

In the government’s draft legislation, it suggests that a compliant policy (that is, not a 10/8 policy) must meet the following conditions:

• The interest rate credited annually to a new policy investment account will not be determined by reference to the interest rate charged on a loan; and,
• Policyholders will be permitted to invest in all policy investment accounts without being required to borrow.

“We are creating a compliant account that is available to everyone, and not just those who take loans,” says Burton. “Although you can borrow, you borrow on a basis that is the credited rate in the managed account, plus a spread. Both of those key points are the ones that demonstrate that the insurance company is complying with the legislation as proposed.”

Both the rate of interest on the loan and the rate of return on the managed account will be lower than the 10% and 8%, respectively, which were commonly associated with 10/8s. Nonetheless, Burton says the rates will be appealing to policyholders.

“It’s very attractive whether or not they take the loan,” Burton says.

The new offering will be available to new clients, as well as those who currently have 10/8 arrangements in place. Those with 10/8s will be able to convert them to the new compliant structure without having to cancel their insurance policy or repay their loan, Burton says.

“We’ve created the ability that they can sign amendments that will amend their policy to become a compliant policy, and will transfer their loan to being a compliant loan,” he says.