Insurance Audit for the Business Owner
Many business owners understand the important role that life insurance plays in effective corporate planning. Whether it is the funding of a shareholders’ agreement, life insuring corporate debt, or protecting against loss from the death of a key employee, life insurance is of great value in underpinning the financial success of a corporation.
Just as life insurance needs for families change over time the same is also true for requirements of a business. If it has been some time since you last reviewed your corporate needs then it is probably time for a corporate insurance audit. This is especially true if the company has grown in value since the time the insurance was first implemented. The scope of the audit and the insurance related issues include the following:
Current corporately owned life insurance
Have the factors which affect pricing changed?
- If you were previously a smoker, do you now qualify as a non-smoker?
- If your policy was issued with a higher premium due to adverse health or other additional risk factors (such as participation in hazardous activities) would you now qualify for reduction?
If the current coverage is renewable term insurance should the policy be re-written now before it renews at a substantial increase?
Term Life Insurance policies usually have a conversion period until age 70 or 75 allowing the policy to be converted to a permanent policy without medical evidence. If the policy is nearing the end of the conversion period your options should definitely be explored, especially if you would no longer qualify for new life insurance.
Are the beneficiary and ownership designations still compliant with current income tax regulations and Canada Revenue Agency policy? For example, if your corporately owned policy has a beneficiary designated other than the corporate owner, you may wish to review that arrangement to confirm that you are not attracting any shareholder benefit or other undue re-assessment risk. Also confirm that that the beneficiary designation is consistent with Capital Dividend Account planning.
Life insurance funding of the Shareholders Agreement
Has the share value of the company increased? If it has, then the amount of life insurance that the company owns to fund the shareholders’ agreement should be increased.
If new shareholders have been added to the agreement, then those new shareholders should be insured in similar fashion to the others.
If the company continues to grow and thrive, it may be appropriate to change the type of life insurance held to something longer term or more permanent. For example, perhaps 20 year renewable term would be preferable to 10 year term or coverage to age 100 would be more appropriate than coverage which would expire. Insurability can be lost at any time and the longer the term of the policy the longer the current premium will continue.
Insuring the human life value
Key person life insurance is often used to reimburse a company for loss in the event of the death of an employee which would severely affect profitability or share value of the corporation. Periodically the company should review the policies it maintains for this purpose to ensure that the proper amount of coverage is in place. Identify key employees whose loss would adversely affect the bottom line of the corporation and insure them.
Life insuring corporate debt
Corporations commonly make use of lending facilities in operating or growing the business. Often the bank will require that corporate debt be life insured to repay the loan in the event of the death of a shareholder or key employee. Should this be the case, a portion of the insurance premiums paid for this purpose may be tax deductible. The amount of the deduction (the collateral insurance deduction) is equal to the Net Cost of Pure Insurance (NCPI) as outlined in the Income Tax Act.
Companies should routinely review their collateral insurance arrangements to confirm that the amounts are sufficient. Also, policies issued after December 31, 2016 may have a higher NCPI if the insured is charged a higher premium due to medical or other underwriting conditions. For this reason, if there is existing collateral term insurance issued prior to this date with a rating for health or other factors it may be beneficial to re-write the policy. The result could be either a lower premium due to improved health of the insured or a higher collateral insurance tax deduction due to the increased NCPI.
Capital Dividend Account planning
The advantages of the Capital Dividend Account underscore the benefit of insuring corporate debt. If a shareholder whose life is insured for this purpose dies and the insurance proceeds retire the outstanding bank debt, even though there may not be any residual proceeds remaining, a Capital Dividend Account is created that is up to 100% of the death benefit. Capital dividends can be distributed to the surviving shareholders free of income tax.
Be careful to protect Generation 2 policies
The provisions of the Income Tax Act dealing with the taxation of life insurance policy were changed effective January 1, 2017. These changes modified certain factors that ultimately result in the amount of death benefit that can be credited to the Capital Dividend Account. Policies issued between December 1, 1982 and December 31, 2016 are referred to as Generation 2 policies and those contracts generally provide a larger CDA contribution than do Generation 3 policies issued in 2017 and later. As a result, unless there are extremely extenuating circumstances, permanent or cash value Generation 2 life policies should be maintained in their current form.
Given the demands of running a business, it’s easy to put off what may seem to be a low priority item on your to-do-list. Life is unpredictable so it is advisable to always be prepared for events that are out of your control. Reviewing corporate insurance coverage periodically will help to ensure that the right amount and the proper plan is in place. If you think now is the right time, give me a call and I’ll be happy to assist. As always, please feel free to share this information with anyone that may find it of interest.