The ability to convert a term insurance policy automatically to some type of permanent policy is becoming more difficult — and potentially costlier. This means clients may have to explore their long-term policy options earlier than they had anticipated.

The average amount of a death benefit has increased. Due to industry convergence, advisors should be aware that the acquiring insurer may not interpret the conversion provision as liberally as the company that originally provided the client’s policy.

For example, a client who may have once been able to convert a term policy to any of the permanent policy products offered by an insurer would now face more restricted choices. And these choices may be even more restricted in the future, say insurance advisors.

As a result, advisors are strongly advised to read closely the wording of the term insurance contracts they are selling to make sure their clients are getting the best conversion options. But considering the potential difficulty that clients may face when it comes time to convert, it may be advisable for them to buy as much permanent insurance as they can afford or, alternatively, an equally expensive long-term policy.

Previously, says Jim Bullock, registrar of the Peel Institute of Applied Finance in Toronto, a client could convert to the same policy as someone who had bought a new policy and had to pass a medical: “But that may not be in the best interest of the company any more.”

If a client had a heart attack during his 10-year term policy — the most common term policy sold in Canada — converting to permanent insurance without having to undergo a medical provides the client with “a valuable option,” says Bullock. But this also increases the risk the insurer takes on. As a result, most companies have developed a special class of permanent products that are “eligible” for conversion — as set out in new term policies — but require much higher premiums, insurance advisors say.

In essence, a penalty has been built into conversion, says Bullock: “It takes the edge off the benefit of getting permanent insurance.” The rationale is simple, he adds, “Usually it’s unhealthy people that look to convert. Healthy people would shop around for the best price on a new term policy.”

Moreover, conversion may be particularly difficult if a client wants to convert to a policy that has “increasing death benefits,” says Ashley Crozier, president of Crozier Financial Group in Toronto. That includes universal life policies, which have “fund plus” options — the death benefit plus the value of the investment fund. It also includes whole life policies in which dividends may be used to increase the death benefit, adds Crozier.

Not well understood

This shift in insurer approach to conversion has been around for about five years, but it is not well understood, says Tim Fitzpatrick, president of CoVirt Inc. , a Toronto-based company that provides Web-based insurance administrative services.

Conversion used to involve the same premium price as the premium on renewal, says Fitzpatrick. As a result, the ability to convert looked good to clients. And advisors who have been in the business for a while might still assume conversion is a good thing, he suggests. But the insurance landscape has changed dramatically.

Conversion was a less risky prospect for insurers when older advisors were all captive agents, death benefits were low and the in-house products they sold didn’t involve the complications of increasing death benefits. But with the increase in the average size of the death benefit, insurance company actuaries have been forced to take a second look at the size of their reserves.

Fitzpatrick says the average policy was worth $25,000 in 1975; now, it’s more like
$250,000. “It’s expensive for insurers to offer the same prices as if they are offering them to a new [healthy client],” he adds. Therefore, advisors should pay close attention to the restrictions attached to conversion “eligibility” in the policies they sell.

The conversion clause in new policies may also prohibit conversion to policies with increasing death benefits, notes Crozier. The alternative may be a very long-term policy such as a T-100. On the upside, he says, a T-100 may be about the same price as a universal life or whole life policy, but it won’t have the same investment flexibility attached.

@page_break@A liability issue

However, conversion may become a liability issue if a client learns a policy with better conversion options was available at a better price, says Bullock. The same would hold true for clients looking for a new term policy. A new policy may have cheaper premiums, for example, but the conversion provision in the client’s policy from his initial company may be better. Therefore, it may be better to renew with the original insurer.

Advisors should be clear and point out this type of risk to clients, says Bullock. They should also document it by sending clients a letter, so clients won’t have any basis for liability lawsuits against their advisors down the road.

One of the problems advisors face in successfully advising clients, says Fitzpatrick, is that term policies with good conversion options are more expensive than other policies, so they don’t usually pop up on “best quote” surveys. It may be helpful for both advisors and their clients if policies with good conversion options were separated from other policies in those surveys, he says.

Nonetheless, Crozier suggests that even with term policies, clients need to keep in mind they are likely to face a significant premium increase when they renew. For example, a $1-million policy could see its premium jump from $1,500 to $8,000 per year. “The client is in for sticker shock,” he says.

Crozier also suggests it’s important for advisors to be aware of the renewal practices of the companies they are dealing with and consider the implications for their clients. “If there’s a chance that the client will want permanent insurance eventually, why not start them off with it?” he says. IE