If you’re getting a mortgage for the first time or refinancing an existing mortgage at a different institution, chances are the person across the desk is going to try to peddle mortgage life insurance. Data show that about 60 per cent of Canadians with a mortgage written by a bank also have mortgage life. It’s a check mark on the mortgage application, but it’s costly, often a bad deal when sold by a lender and deeply troublesome if the borrower dies before the mortgage is paid off.
Banks love to sell mortgage life insurance. Statistics from the National Association of Insurance Commissioners, an organization of U.S. insurance regulators, shows that mortgage life insurance lenders pay claims amounting to 40 cents for every dollar they collect in premiums. Regular life insurance policies pay 90 cents of premium dollars in claims.
The concept behind mortgage life is not troublesome. The lender wants to be sure it is paid; life insurance is just a way of covering the risk of the borrower’s death before the last dollar is paid on the debt. The bank fills out a form, gets a signature, and adds the life insurance cost to the monthly mortgage payment.
The devil is in the details, goes the saying, and that is where mortgage life gets to be problematic. Mortgage life has one beneficiary, the lender, and, though the amount of the risk declines as the mortgage debt is paid down, the premium remains the same. Although the bank’s risk is decreasing, there is no transfer or spillover of benefit for anybody else — for example, the borrower’s heirs.
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Mortgage life can be risky
Not only does mortgage life not provide benefits to anyone but the lender, it also tends to be evaluated or underwritten after a claim is made. That gives the insurer the opportunity to deny the claim, often on the basis that material facts were not disclosed. Critics of the underwrite-after-claim process say that questionnaires asking about pre-existing conditions are complex and confusing. Some questionnaires ask, “Do you have a condition which would affect your health but about which you have not seen a licensed medical practitioner?” Or the ultimate basket case question: “Is there any condition that you have not disclosed which, if disclosed, would affect your insurability?” Do you recall a throb near your liver last year? Maybe you should have had imaging studies. In after-the-fact underwriting, you ignore even faint hints of illness at your financial peril.
Have you ever smoked? If you did take a puff 20 years ago but did not become a committed smoker, you can explain that and probably get a non-smoker discount on a conventional term policy. Mortgage lenders tend not to give non-smoker discounts and are keen to deny coverage if they think they have been deceived.
This is not just theoretical. Here is a case reported by the Toronto Star in 2009: In 1979 a couple took out a mortgage. In 1999, they refinanced and added more debt. They disclosed on their application form that the husband had a history of diabetes, open heart surgery and back surgery. He could not get critical illness insurance, the bank’s mortgage officer told them, but he could get mortgage life. They took the mortgage life, refinanced again in 2002, filled out the forms, and advised the bank that nothing had changed. Then came a diagnosis for stomach cancer. The bank’s policy had a provision allowing a claim if a life-threatening illness is diagnosed. The bank denied the claim, saying coverage should not have been issued. When the case hit the press, the bank decided that on compassionate grounds and, perhaps to save face, they would pay the claim.
The moral of the story is to be very careful to report every illness when seeking life insurance, report anything that could be related to questions asked, and remember that lenders do their underwriting when you have a claim. That is a terrible time to find out that you should have shopped the policy and gotten coverage from a conventional insurance company that checked you out when you bought the policy. With conventional term coverage, the insurer has two years to decline coverage for any reason. After that, you are covered even if you fudged a question.
With conventional term coverage, you can make the lender the beneficiary, provide evidence of that to the lender, and, if you change lenders, change the beneficiary. You will need the approval of the insurance company, but it is routine and usually given. As the loan value declines, you can beef up what other potential heirs get.
The price of mortgage life
Mortgage life is expensive. For example, a 38-year old man and a 37-year old female can pay $140 per month for $500,000 of term coverage with a 20-year level premium from a major bank for its mortgage life insurance. The same couple could get 10-year term renewable and convertible coverage from a major life insurer through an independent agent for $41.54 per month. $500,000 of coverage for the same couple with 20-year level term would be $66.75. Details change from one quote to another, but the size of the gap indicates the advantage of shopping. Over 10 years, in the first case, the savings would be $11,815. In the second case, which matches the 20-year term of the lender’s insurance, the savings would be $17,580.
There is also a cost strategy you can use with conventional term coverage. When young, say in your 30s, you can get 10-year level term coverage for very little. The rate rises for the next 10 years and then higher for the next. But family income is likely to rise and — this is the critical point — as mortgages are paid down, your need for coverage also declines. This is insurance cost management. Add guaranteed renewability to the 10-year term policy and you have a low-cost, intelligent method of premium management, a base insurance plan for your family or farm, portability and control.
There are other advantages to having your own term insurance to cover mortgage debt. If you change lenders, you take your coverage with you and — this is vital — there will be no gap in coverage. There are sad cases in which a mortgage borrower dies before coverage is in place in a mortgage transfer. That can’t happen if you have your own policy. Properly drafted, the policy and benefits provisions of your own policy would cover debt transfer in process.
Finally, and this is no small advantage, when you choose your own term policy, you can shop by price and have the policy tailored to your needs. Guaranteed renewability, guaranteed convertibility to whole ordinary life, various discounts for not smoking, good health, sometimes memberships in professional societies that get good insurance deals for members — all can help set the price of insurance and the bells and whistles on the policy. That is not possible with the one-size-fits-all life policies mortgage lenders offer. As well, with your own policy, you can extend coverage for other debts, even for a family loan. One policy can then cover your house, maybe some equipment purchased with loan and other obligations. That flexibility is valuable and, if you do it right, you can get more insurance, more appropriate coverage, and pay less.