21 June 2007 Roundtable, 2007-0229771C6 - Conversion rights and paragraph 148(10)(d)

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether the conversion of a life insurance policy into another life insurance policy issued by the same insurer pursuant to the terms of the policy would result in a disposition of the policy.

Position: Determination can only be made on a case by case basis.

Reasons: It is necessary to determine whether the changes that are made to the terms of the policy are so fundamental as to go to the root of the policy.

CLHIA ROUNDTABLE - MAY 2007

Question 4

Conversion rights where amount of insurance varies

At the 2005 CLHIA meeting, the CRA's reply to question 9 (subsequently published as technical interpretation 2005-0164711C6) stated that where all other terms of the original conversion rights of a term life insurance policy were respected then, in circumstances described, exercising the conversion right would not constitute a disposition of the policy and would not result in any change in the issue date and/or last acquired date of the policy.

The preamble to question 9 included the following:

"Provincial insurance laws recognize that changing consumer needs and circumstances may necessitate or permit a change in insurance coverage. Where an insurance policy's terms permit such a change, these laws facilitate the conversion of one life insurance policy into another issued by the same company, without new underwriting by the insurer. Under the resultant policy, the insurer is generally prohibited from (a) restricting benefits payable due to suicide and (b) contesting evidence supplied by the applicant and measuring life under the original policy, rights that an insurer normally has with a new policy.

Paragraph 148(10)(d) provides that "a policyholder shall be deemed not to have disposed of or acquired an interest in a life insurance policy (other than an annuity contract) as a result only of the exercise of any provision (other than a conversion into an annuity contract) of the policy".

Based on this provision, it has long been understood by the industry that, subject to the exclusion with respect to annuity contracts, the conversion of a policy into another life insurance policy issued by the same insurer in accordance with the terms of a policy does not result in a disposition of the policy or a change in either the policy's issue date or last acquired date.

As a result, the "new" policy is treated as a continuation of the "original" policy in respect of both the determination of the adjusted cost basis under section 148 and exempt room under section 12.2."

Given the reply that the CRA gave at the 2005 meeting and in the subsequent technical interpretation, it appears that the CRA agrees with the industry's understanding regarding conversions outlined above.

Scenario

Suppose that Company A issues a term policy providing the right to convert it to any permanent policy that Company A is issuing at the time that the policyholder chooses to exercise the conversion right. Assume the term life insurance policy has a level death benefit of $250,000.

Question:

Will the CRA confirm that in each of the following situations, where all other terms of the contractually provided conversion rights are respected, the conversion will not constitute a disposition of the policy and will result in the new policy having the same issue date and last acquired date as the original term policy?

1. The entire $250,000 is converted to a permanent policy. Would the Agency also confirm that the adjusted cost basis (ACB) of the resultant policy immediately after the conversion is the same as the ACB of the term policy immediately prior to the conversion?

2. $100,000 of the term policy is converted to a separate permanent policy and the term policy continues with the remaining $150,000 death benefit. The continuing term policy retains its original issue date and date last acquired. Will the Agency confirm that the ACB of the permanent policy would be a pro-rata portion of the adjusted cost basis (100,000 / 250,000) of the term policy and that the remainder of the pre-conversion policy's ACB would remain with the residual term policy? If not, how would the ACBs of the permanent and term policies be determined?

3. The entire $250,000 is converted to a permanent policy and an additional $75,000 of death benefit is issued as part of that permanent policy as of the date of conversion based upon new underwriting information (including medical information as required by the insurance company's normal underwriting standards) provided for the additional death benefit only. Only the $75,000 is subject to any limitations on coverage, such as suicide restrictions and contestability of evidence supplied to obtain that coverage, that are normally applicable to newly issued coverage.

Agency's Response

To clarify, our reply to question 9 at the 2005 CLHIA meeting pertained to a situation where Company A had issued a term policy convertible to whole life. Company A was then acquired by or combined with Company B, in whole or in part. When the policyholder exercised the conversion right contained in the term policy, the result was a whole life policy issued by Company B. We were not asked to nor did we provide any comment on whether a disposition results on the conversion of a policy into another life insurance policy issued by the same insurer in accordance with the terms of the policy. In that particular situation, if the exercise of the conversion right would not, by virtue of paragraph 148(10)(d), result in a disposition of the term policy if the whole life policy had been issued by Company A, it would not result in a disposition where Company B issues the whole life policy.

Paragraph 148(10)(d) provides that a policyholder will not be deemed to have disposed of or acquired an interest in a life insurance policy (other than an annuity contract) as a result only of the exercise of any provision (other than a conversion into an annuity contract) of the policy. In order to give meaning to the word "only", it is our view that it is necessary to determine whether the changes that are made to the terms of the policy, including but not limited to the premium structure, are so fundamental as to go to the root of the policy. If this were the result, there would be a disposition of the policy and the acquisition of a new policy. Such a determination can only be made on a case by case basis. Accordingly, in the situations described above, we would need to consider the changes to the terms of the policy before expressing an opinion on the application of paragraph 148(10)(d) to that particular policy.

We can confirm that there is nothing in the Act that provides for an allocation of the adjusted cost basis of a life insurance policy where the policy is "split" into two separate policies. As noted above, it is a question of fact whether in such circumstances a disposition would result on the conversion. In our view, the fact that the legislation does not contemplate this type of situation suggests that paragraph 148(10)(d) was never intended to provide for a non-disposition of the policy in such circumstances.