Insurance Audit for the Business Owner
Many business owners know the important role that life insurance plays in effective corporate planning. Whether it be the funding of a shareholder’s 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 the business. If it has been some time since you have reviewed your corporate insurance needs then it is probably time for a corporate insurance audit. This is especially true if the company has enjoyed consistent or significant growth 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 reviewed and 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, if it is obvious that ten-year renewable term insurance does not provide a long enough term, then the coverage should be changed to 20 year term or longer, or perhaps term to 100 or permanent coverage. 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 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. If there is no key person insurance determine whether there should be by identifying those employees whose death would adversely affect the bottom line of the corporation.
Life insurance collateral deduction
When considering the advantages of the Capital Dividend Account it is recommended that corporate debt be life insured. 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 tax free to the surviving shareholders making insuring corporate debt very advantageous. In addition, the corporation can deduct from income the net cost of pure insurance of the insurance policy.
If the corporation owns life insurance on a shareholder or key employee for this purpose check to make sure that the right amount of coverage is in place. If not, there should be an additional policy purchased or perhaps a re-write of existing coverage that results in the appropriate amount. If there is current collateral term insurance in place that has been issued with a rating due to less than ideal health or other factors it is recommended that an attempt be made to re-write that coverage. It is possible that the insured can now qualify for lower standard rates of insurance resulting in a lower premium.
If the current insurance was issued with an additional risk premium due to health or other issues this would be another reason to re-write the coverage. This is because substandard policies (those with a rating) issued after December 31, 2016 now have a higher net cost of pure insurance and therefore a higher collateral insurance deduction than those issued before this date.
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, that Generation 3 policies issued in 2017 and later. As a result, unless there are extremely extenuating circumstances, those 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. With the help of an experienced advisor, an insurance audit can be very advantageous and have a positive effect on both the bottom line and the balance sheet of the corporation. 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.