The Better a Leveraged Insurance Strategy Performs, the Shorter Its Shelf Life
In 2024, Manulife stopped selling a premium-financed life insurance product to wealthy clients in Hong Kong after the territory's insurance regulator started asking hard questions about it. The product was legal. Clients wanted it. Advisors could show the math. It came off the shelf anyway, because it had grown popular enough, with enough borrowed money behind it, that the people responsible for the whole system decided it needed to slow down.
That story happened on the other side of the world, but the pattern applies to anyone in Prince Edward Island holding, or thinking about, a policy financed with a bank loan. Every one of these arrangements has two parts: a tax principle that tends to last for decades, and a lending arrangement that can change in a single renewal cycle. If your corporate balance sheet, your retirement income or your plan for handing the business to the next generation depends on that loan behaving the same way for twenty years, you are carrying a risk that rarely shows up in the illustration.
A sensible plan built on an ordinary year
Here is a typical version of how these plans come together. This is an illustration, not a real client.
A Charlottetown family business has been profitable for a long time. The owner is in his fifties, the kids are working in the company, and the accountant keeps pointing out that retained earnings are piling up inside the corporation. Some of that money is now earning passive income, and once passive income passes $50,000 a year, the corporation starts losing access to the small business deduction. The owner also wants a tax-free pool of money at death to equalize the estate between the children who run the business and the ones who don't.
So the corporation buys a permanent whole life policy with a $100,000 annual premium. Each year, a bank lends against the policy's growing cash surrender value, so the money paid in as premium comes back out as a loan and goes into the business. When the owner dies, the death benefit is paid to the corporation, the loan is repaid, and the remainder, less the policy's adjusted cost basis, can flow to the family tax-free through the capital dividend account. Interest on the loan may be deductible if the borrowed money is used to earn business or investment income.
Every piece of that is reasonable. Premiums at that level are about where lenders start finding these arrangements worth their time. Insurance lenders in Canada commonly advance 90% to 100% of the cash surrender value. The owner keeps his working capital, protects the estate, and slows the passive income problem. Nobody did anything reckless.
Popularity is what draws a regulator's attention
Regulators tend not to go looking for products that hurt a handful of people. They react when a large number of people are relying on the same structure at once, because that is when one problem turns into many. The Hong Kong product drew scrutiny once premium financing had become a big business and the regulator worried about clients who might not fully understand what happens when the borrowing goes wrong.
Canada has its own record of this. Through the 2000s, the "10-8" arrangement paired an insurance policy with a loan secured against it, and the gap between the rate the policy earned and the rate the loan charged produced very attractive deductions. It worked so well that it spread. The 2013 federal budget eliminated the tax benefits, and the change reached arrangements already in place, not only new ones. People who had set them up years earlier, entirely within the rules of the time, were given a short window to unwind or lose the advantages.
Insurance regulators in Canada have also spent the past several years stressing fair treatment of customers. Their focus includes complex products where a large commission could tempt an advisor to recommend more borrowing than a client's situation can support. Here on the Island, the Superintendent of Insurance oversees the industry under the provincial Insurance Act, and suitability matters more as the amount of debt grows.
A practical warning sign: there is usually a lag of a few years between a strong new product reaching the market and regulators catching up with it. If an arrangement looks dramatically better than anything else available in Atlantic Canada, you may be buying it during that window.
The lender can change the deal without any new law
Back to the Charlottetown owner. Nine or ten years into the plan, he hasn't been thinking about tax legislation. He's been running his business. The thing he never modelled was the loan renewal.
Banks decide how much to lend against a policy based partly on the capital they are required to hold, under rules set by the Office of the Superintendent of Financial Institutions, and partly on their own appetite for this kind of collateral. Either can change. A bank that cuts back on insurance lending doesn't need a budget announcement to do it. It sends new terms at renewal.
Here is how that plays out, using illustrative numbers. Say the loan balance has reached $1,000,000 and the policy's cash surrender value is $1,100,000. At a 100% advance rate, the bank is willing to lend up to $1,100,000, so the owner is comfortable. Now the bank lowers its advance rate to 75%. The most it will lend is $825,000 (75% of $1,100,000). The owner has to come up with $175,000 ($1,000,000 minus $825,000) or pledge other collateral. He also stops receiving the new annual advances that were supposed to cover future premiums.
If this happens in a strong year, it's a nuisance. If it happens when sales are down and the operating line is already stretched, the corporation is paying down debt with money the business needs to keep running. The policy is still in force. The tax rules haven't changed. Grandfathering protects nothing here, because nothing was taken away by legislation. The only change was the bank's lending policy.
Products are temporary; principles last longer
The Manulife product, the 10-8 structure and any particular bank's lending program are all products. They belong to a company or exist under a specific set of rules, and they can be withdrawn. The principles underneath them have lasted much longer. Interest on money borrowed to earn income has been deductible under the Income Tax Act for a long time. The capital dividend account is a long-standing feature of private corporations. The same principle of turning non-deductible borrowing into deductible borrowing is what makes the Smith Manoeuvre™ work on a home mortgage.
The plans that hold up best on the Island tend to use the loan to keep cash inside a business rather than to profit from the gap between the loan rate and policy dividends. The owner treats the policy like a long-term bond with a tax-free payout at death, and he can afford to pay the premium without the loan if he has to. When the spread is the whole point of the strategy, any change in rates or lending terms threatens the entire thing. When liquidity is the point, a lender pulling back is painful, but the plan survives.
Before you sign, or at your next review, ask the person who designed the plan to show you the year where the bank cuts its advance rate by a quarter, interest costs run two points higher than projected, and the business is having a soft year, all together. Then ask where the cash comes from in that year. If the answer is a specific account, a credit facility already in place, or premiums the corporation can carry on its own, you have a plan that can absorb the next change in rules. If the answer is that it's never happened before, that answer depends on the plan staying unpopular.
In 2024, Manulife stopped selling a premium-financed life insurance product to wealthy clients in Hong Kong after the territory's insurance regulator started asking hard questions about it. The product was legal. Clients wanted it. Advisors could show the math. It came off the shelf anyway, because it had grown popular enough, with enough borrowed money behind it, that the people responsible for the whole system decided it needed to slow down.
That story happened on the other side of the world, but the pattern applies to anyone in Prince Edward Island holding, or thinking about, a policy financed with a bank loan. Every one of these arrangements has two parts: a tax principle that tends to last for decades, and a lending arrangement that can change in a single renewal cycle. If your corporate balance sheet, your retirement income or your plan for handing the business to the next generation depends on that loan behaving the same way for twenty years, you are carrying a risk that rarely shows up in the illustration.
A sensible plan built on an ordinary year
Here is a typical version of how these plans come together. This is an illustration, not a real client.
A Charlottetown family business has been profitable for a long time. The owner is in his fifties, the kids are working in the company, and the accountant keeps pointing out that retained earnings are piling up inside the corporation. Some of that money is now earning passive income, and once passive income passes $50,000 a year, the corporation starts losing access to the small business deduction. The owner also wants a tax-free pool of money at death to equalize the estate between the children who run the business and the ones who don't.
So the corporation buys a permanent whole life policy with a $100,000 annual premium. Each year, a bank lends against the policy's growing cash surrender value, so the money paid in as premium comes back out as a loan and goes into the business. When the owner dies, the death benefit is paid to the corporation, the loan is repaid, and the remainder, less the policy's adjusted cost basis, can flow to the family tax-free through the capital dividend account. Interest on the loan may be deductible if the borrowed money is used to earn business or investment income.
Every piece of that is reasonable. Premiums at that level are about where lenders start finding these arrangements worth their time. Insurance lenders in Canada commonly advance 90% to 100% of the cash surrender value. The owner keeps his working capital, protects the estate, and slows the passive income problem. Nobody did anything reckless.
Popularity is what draws a regulator's attention
Regulators tend not to go looking for products that hurt a handful of people. They react when a large number of people are relying on the same structure at once, because that is when one problem turns into many. The Hong Kong product drew scrutiny once premium financing had become a big business and the regulator worried about clients who might not fully understand what happens when the borrowing goes wrong.
Canada has its own record of this. Through the 2000s, the "10-8" arrangement paired an insurance policy with a loan secured against it, and the gap between the rate the policy earned and the rate the loan charged produced very attractive deductions. It worked so well that it spread. The 2013 federal budget eliminated the tax benefits, and the change reached arrangements already in place, not only new ones. People who had set them up years earlier, entirely within the rules of the time, were given a short window to unwind or lose the advantages.
Insurance regulators in Canada have also spent the past several years stressing fair treatment of customers. Their focus includes complex products where a large commission could tempt an advisor to recommend more borrowing than a client's situation can support. Here on the Island, the Superintendent of Insurance oversees the industry under the provincial Insurance Act, and suitability matters more as the amount of debt grows.
A practical warning sign: there is usually a lag of a few years between a strong new product reaching the market and regulators catching up with it. If an arrangement looks dramatically better than anything else available in Atlantic Canada, you may be buying it during that window.
The lender can change the deal without any new law
Back to the Charlottetown owner. Nine or ten years into the plan, he hasn't been thinking about tax legislation. He's been running his business. The thing he never modelled was the loan renewal.
Banks decide how much to lend against a policy based partly on the capital they are required to hold, under rules set by the Office of the Superintendent of Financial Institutions, and partly on their own appetite for this kind of collateral. Either can change. A bank that cuts back on insurance lending doesn't need a budget announcement to do it. It sends new terms at renewal.
Here is how that plays out, using illustrative numbers. Say the loan balance has reached $1,000,000 and the policy's cash surrender value is $1,100,000. At a 100% advance rate, the bank is willing to lend up to $1,100,000, so the owner is comfortable. Now the bank lowers its advance rate to 75%. The most it will lend is $825,000 (75% of $1,100,000). The owner has to come up with $175,000 ($1,000,000 minus $825,000) or pledge other collateral. He also stops receiving the new annual advances that were supposed to cover future premiums.
If this happens in a strong year, it's a nuisance. If it happens when sales are down and the operating line is already stretched, the corporation is paying down debt with money the business needs to keep running. The policy is still in force. The tax rules haven't changed. Grandfathering protects nothing here, because nothing was taken away by legislation. The only change was the bank's lending policy.
Products are temporary; principles last longer
The Manulife product, the 10-8 structure and any particular bank's lending program are all products. They belong to a company or exist under a specific set of rules, and they can be withdrawn. The principles underneath them have lasted much longer. Interest on money borrowed to earn income has been deductible under the Income Tax Act for a long time. The capital dividend account is a long-standing feature of private corporations. The same principle of turning non-deductible borrowing into deductible borrowing is what makes the Smith Manoeuvre™ work on a home mortgage.
The plans that hold up best on the Island tend to use the loan to keep cash inside a business rather than to profit from the gap between the loan rate and policy dividends. The owner treats the policy like a long-term bond with a tax-free payout at death, and he can afford to pay the premium without the loan if he has to. When the spread is the whole point of the strategy, any change in rates or lending terms threatens the entire thing. When liquidity is the point, a lender pulling back is painful, but the plan survives.
Before you sign, or at your next review, ask the person who designed the plan to show you the year where the bank cuts its advance rate by a quarter, interest costs run two points higher than projected, and the business is having a soft year, all together. Then ask where the cash comes from in that year. If the answer is a specific account, a credit facility already in place, or premiums the corporation can carry on its own, you have a plan that can absorb the next change in rules. If the answer is that it's never happened before, that answer depends on the plan staying unpopular.
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