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FMV of Life Insurance

BCH Actuarial Services Inc. can provide its clients with actuarial valuations of life insurance policies.  For details on our fees and the process to request a valuation, click here.

In the case of marriage breakdown, the CSV (Cash Surrender Value) of a life insurance policy is typically used as the value of the policy for the purpose of property equalization.  However, there are many cases when the CSV significantly understates the fair value of the life insurance policy and it would be appropriate to have policy valued by an actuary to ensure a fair divsion of assets between spouses.

There are various reasons why the Fair Market Value (FMV) of a life insurance policy can exceed the CSV.  One reason is because the life insurance policy was designed with no CSV (i.e. some Term to 100 policies).  Another common reason is because the health of the insured has declined since the policy has been issued; as a person’s health declines, the FMV of the policy will increase and approach the face value of the life insurance policy.  For example, if a person who is terminally ill and is certain to die in the few days has a $100,000 life insurance policy in force, the FMV of the life insurance policy is $100,000 even thought the CSV will be substantially less or even $0.

As the result of taxation rules in Canada, the transfer of a life insurance policy from an individual shareholder to a non-arm’s length corporation (i.e. a company controlled by the individual) may provide the individual shareholder with the ability to withdrawal retained earnings on a tax-free basis.   When a non-arm’s length shareholder transfers a personally owned life insurance policy to their corporation, there are two consequences from a tax perspective: the deemed disposition of the policy by the shareholder and the transfer of the policy from the shareholder to the corporation. 

The first consequence, the deemed disposition, will result in the shareholder being deemed to have received taxable income equal to the CSV of the life insurance policy less the Adjusted Cost Basis (ACB) of the insurance policy.  In the situation where the policy has no cash surrender value, the disposition does not result in any taxable income for the shareholder. 

The second consequence, the transfer of the policy, allows the shareholder can receive a payment from the corporation equal to the FMV of the life insurance policy in exchange for the transfer.    This amount can be paid from the corporation to the individual shareholder tax free. 

For example, assume an individual shareholder has an old Term to 100 life insurance policy with no CSV.  In addition, assume the FMV of the insurance policy was determined by an independent actuary to be $150,000.  If this shareholder transferred this policy to their company, this would not result in any taxable income for the shareholder since the CSV is zero and they would receive $150,000 from the corporation (i.e. retained earnings) tax-free.

Any life insurance policy can be transferred from a shareholder to a corporation.  The policies which are most likely to have a higher FMV than CSV are permanent insurance policies (or term policies with the option to convert to permanent) and policies with very low CSVs.

There are several risks to a transfer of the life insurance policy.  First, the transfer of the life insurance policy to the corporation increases the exposure of this asset to creditors.  In addition, if the life insurance policy needs to be transferred out of the corporation in the future, the transaction will occur in reverse and if the FMV of the policy has increased further, there will be a significant tax liability for the shareholder. 

The information above is general information and is not comprehensive.  The advice of a tax advisor should be sought in order to fully understand all consequences of a potential transfer.