Creating An Asset Class

Published in August 2020

​Permanent life insurance can be much more than an estate tax solution for Canada’s business families. It can build business value and be a source of liquidity in all market conditions, including during a global pandemic. 
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This case study highlights a significant issue that can be faced by business families. Names have been changed for privacy reasons while the situation and key issues are based on a real story.

The Gill family of Vancouver has had a long history of business success dating back to the early 1900s. They began a sawmill operation in the core of the city and stayed small and profitable for two generations. Then, things started to evolve.
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In the 1970s, brothers Andy and Raj were the third generation running the business. Andy, the oldest, was conservative by nature – and happy with the status quo. Raj had more of an entrepreneurial mindset and was captivated by the growth in real estate as Metropolitan Vancouver expanded. Raj saw an emerging opportunity but knew his brother was more cautious.

So, Raj proposed a pilot project. The Gills would continue running their sawmill operation while developing some of the land that the family owned along the banks of the Fraser River in what was then the outskirts of the city.

The real estate development became a profitable endeavour and opened Raj’s eyes to the potential. Fortunately, the two brothers enjoyed working together on the real estate project – the planning, building, and marketing - so when they had an opportunity to sell the sawmill to a buyer from up the coast they took the plunge and deployed those proceeds into additional real estate development.

The Growth Years
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By the 1980s, Gill Developments had grown exponentially. However, their tax advisors making them aware of a new ‘silent’ partner in their endeavour – the Canada Revenue Agency (CRA). The appreciation of their real estate threatened the long term survival of their holdings as those significant increases would be taxed as a capital gain when the ownership eventually changed hands to the next generation of their respective families. Plus, they were not protected from the unexpected, either. 

Andy & Raj needed to have a plan. Their business was asset rich but cash poor so liquidity could become an issue. Without cash, some – or even all – of the assets may be forced to sell in order to meet the future tax obligations to the CRA and perhaps for other unexpected needs. They were concerned. 

As their own children approached adulthood and began working in the business, Andy & Raj grew a big desire to keep their successful enterprise family-owned through multiple generations. This meant that Gill Developments must be able to cover the capital gains tax bill when the inevitable happened in the future and for the unexpected at any point in time, for both of them. ​ ​

The brothers became highly motivated to prepare their business. 

Putting A Strategy In Place

The Gills and their advisors explored many options. Everything was on the table.

They started by looked at selling existing properties in order to start a liquidity fund. As they felt that their most attractive properties would fetch the best prices, they didn't want to do that. They also wanted to avoid having monies sitting idle for a unknown amount of time so kept looking. 

Another option was brought to their attention by their tax advisor: using the tax-advantages and leverage of life insurance. 

After reviewing the lowest cost options called term and term-to-100 life, these policies were determined to be the least expensive on the surface but neither created any cash value. The ongoing expense of the annual premium payments would constantly erode their working capital for years and decades to come. They did not like those answers. 
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Andy & Raj examined the next option – permanent life insurance. It was being expressed as a new asset class. The permanent policy’s cash value would be listed on the balance sheet as a capital asset. They also learned that the policy(s) premium deposit obligations would be met after making a defined number of payments and no future deposits would be required. The cash value of the policy would increase each year as would the final payout amount after the passing of the life(s) insured. 

Andy & Raj realized that they could create a valuable, leveraged source of funds for their capital gains tax obligation so they decided to follow this advice to use permanent insurance.

The Financial Crisis - Putting Cash Value To Use

Fast forward a couple of decades. Their business was thriving. Their permanent policies were fully paid up and continuing to rise in value. Andy & Raj were secure in the knowledge that their estates would have the liquidity needed to meet their capital gains tax exposure to the CRA such that the two brothers would create a wonderful legacy for future generations of their families.

What they didn’t know or fully appreciate at that time was just how valuable the cash value of their policies would prove to become during their lifetimes.

In 2007, Metro Vancouver was burgeoning and the Gills wanted to capitalize. Gill Developments embarked on a major expansion plan and doubled their land holdings. 

Just one year later, the 2008 financial crisis hit. Banks quickly reduced their exposure to many exposed industries – including real estate. Gill Developments was no exception. With a single phone call in September 2008, Andy and Raj’s long-term bank manager of 30 years called and wanted more equity for their outstanding loans. 

The Gills had a problem. They had already committed to their expansion plans and were highly leveraged. Fortunately, the Gills' permanent insurance policies had built significant value. So Andy and Raj posed the question. ​Could the value of their permanent life insurance policies be used to help them through this credit crunch? 

"Yes!".

Using their policies as additional collateral for their existing lines of credit, Andy & Raj were able to meet the increased equity obligations of the bank. Their loan-to-value ratios came into line with the new requirements of the stressed financial world and the brothers did not have to take further action or collapse their policies. 

The Need Strikes Again

Andy and Raj paid off their credit lines by 2010. Their land development projects had moved forward successfully and their related income grew. A strong appreciation had been gained that they had a rainy-day fund should a future need or opportunity arise again.

Eventually, it did.

When the global pandemic of 2020 hit, Andy and Raj turned to the value of their policies again. This time, they created a new line of credit in order to buy real estate at reduced prices.

Photo by Yasmin Dangor on Unsplash

A Little Foresite Brought Big Benefits

The Gills hadn’t foreseen the financial crisis of 2008 nor did they predict the global pandemic of 2020. They did understand the value of having another asset class on their balance sheet. 

While their primary focus had been to cover future tax liabilities, Andy and Raj’s gained an appreciation for having an alternative source of liquidity and equity. Their policies help to protect their hard work to the benefit of future generations to come.

Based on an article by Paul Russell, a Freelance writer based in Toronto called Building Business Capital And Access To Liquidity When You Need It Most.

Changes have been made to meet our focus as experienced insurance advisors in British Columbia.

​Don Anderson
@ Legato
Protect your wealth and your family.

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