Regulation 306

Shift to one-year pre-test (p. 719)

[T]he rule now requires only a one-year pre-test. This requires the insurance company to project the accumulating fund values to the following policy anniversary, using the most recent information available to the insurance company and without regard to any automatic adjustments made at the policy anniversary date to keep the policy exempt. For current policies, the rule requires that it be reasonable to conclude that the pre-test will be met at all times in the future, including post-endowment. In either case, a policy must meet the pre-test requirements at all times in the past, and once a policy is offside, it can never get back onside.

Example of additional exempt test policy where >8% annual increase in death benefit (p. 720)

Example 1

Assume that a life insurance policy is issued with $1 million of coverage. Further assume a savings element of $3,527, so that the benefit on death at the end of year 4 is $1,003,527. At that stage, year-over-year increases in the benefit on death do not breach the 8 percent threshold (because $1,003,527 is less than the original death benefit increased by 1.08). Now assume that $100,000 is deposited and a yield is earned in year 5 that increases the end-of-year death benefit to $1,114,639. Because this increase is greater than the 8 percent allowed, two ETPs will be created. One has a death benefit of $1,083,808 (108 percent of $1,003,527) and exempt-limit attributes based on the original issue age and the necessary accumulation in the fifth year of the ETP. The second ETP has a death benefit of $30,831 ($1,114,639 − $1,083,808) and exempt-limit attributes based on the attained age at the time the additional ETP was created (the original issue age plus five years in this case) and an accumulating fund of zero. To determine whether the policy will still be exempt, the aggregate savings element is determined for each of these two ETPs, and those amounts are then summed and compared with the policy's actual accumulating fund.

Application of ETP rules at coverage rather than policy level (pp. 720-721)

One significant change to the ETP rules is the application of these rules at the coverage level under the policy rather than at the policy level. This will further restrict the amount of tax-free accumulation within an exempt policy. The coverage-level requirements apply only to policies issued after 2016. This is accomplished by creating the notion of "coverage" under a policy and defining it for the purposes of the ETP rule. [F.N. 58: Regulation 310, paragraph (a) of the definition of "coverage" applies a wide definition for the purposes of the ETP rules in regulation 306, whereas for the purposes of regulations 307 and 308, the definition of "coverage" in regulation 1401(3) applies.]

The effect of applying the ETP rule at the coverage level rather than the policy level can best be illustrated by the following example.

Example 2

Assume that a policy covers the lives of two individuals, one with a death benefit of $700,000 and the other with a $300,000 death benefit Under the current rules, when the 8 percent test is applied at the policy level, the benefit on death can increase in respect of either coverage so long as the benefit on death under the policy as a whole does not increase by more than $80,000. For future policies, any increase in the benefit on death of any coverage under the policy is limited on its own by the 8 percent limit; accordingly, a coverage with an increase in the benefit on death below the 8 percent limit cannot be applied to shield an increase in excess of 8 percent on any other coverage under the policy. In the example, the benefit on death in respect of the $700,000 coverage cannot increase by more than $56,000, and the benefit in respect of the $300,000 coverage cannot increase by more than $24,000. One impact of these changes is that adding coverage to an existing policy will create no more deposit room than buying a new stand-alone policy.

Redating of exempt test policy where >250% increase in accumulating fund over 3 years (p. 721)

In addition to the so-called 8 percent test, another rule currently applies to limit the size of deposits made to the policy after the policy has been in force for 10 years or longer. This is accomplished by comparing the accumulating fund of the actual policy on the 10th and every subsequent policy anniversary with the accumulating fund of the actual policy on the 3d preceding policy anniversary. If the ratio of the accumulating fund in the current year to the accumulating fund on the 3d preceding anniversary exceeds 250 percent (the so-called 250 percent test), the ETPs of the policy are deemed to have been reissued on the later of the 3d preceding policy anniversary and the date on which the relevant ETP was issued. This "re-dating" of the ETP will reduce the amount that can be accumulated in the actual policy, because the policy will have an accumulating fund based on a policy that has been in force for only 3 years. In situations where the policy has been funded at a minimum level, this could potentially make it difficult for the policyholder to make sufficient deposits to result in the policy being "paid-up" [f.n. 61: A "paid-up" policy is one that has sufficient cash values that the premiums or cost of insurance can be funded now and in the future by the policy's internal values. In other words, the policyholder does not expect to pay any further premiums or make additional deposits to the policy to keep it in force.] at a later date. Traditionally, this re-dating of ETPs has been avoided by ensuring that the policyholder withdraws funds from the policy prior to the application of the test. [f.n. 62: The amount withdrawn would have to ensure that the policy no longer fails the 250 percent test.]