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Shareholder/Partner Insurance in Canada: A Complete Guide

Comprehensive Guide To Shareholder/Partner Insurance In Canada
Comprehensive Guide To Shareholder/Partner Insurance In Canada

Business continuity and stability are always top priorities for companies in Canada. However, the unexpected loss of a key shareholder or partner can jeopardize those goals. Shareholder/partner insurance provides an effective solution to ensure your company can survive the death, disability or critical illness of an owner.

This comprehensive guide from LifeBuzz covers everything Canadian businesses need to know about protecting themselves with shareholder/partner insurance.

What is Shareholder/Partner Insurance?

What Is Shareholder/Partner Insurance. How Does It Work
What Is Shareholder/Partner Insurance. How Does It Work

Shareholder/partner insurance refers to policies purchased by a corporation to fund buy-sell agreements between owners in case of death, disability or critical illness. It provides liquidity to redeem shares smoothly so the business can carry on uninterrupted.

Types of shareholder/partner insurance include:

  • Key person insurance – Covers the loss of an owner vital to the company’s success.
  • Buy-sell life insurance – Funds share buybacks when an owner passes away.
  • Buy-sell disability insurance – Provides funds if an owner becomes disabled.
  • Buy-sell critical illness insurance – Pays out if an owner is diagnosed with a major illness.

This insurance is essentially corporate-owned life, disability and critical illness policies on shareholders, with the company as beneficiary.

Read more: Corporate-Owned Life Insurance in Canada

How Shareholder/Partner Insurance in Canada Works

The mechanics of shareholder/partner insurance are straightforward:

  1. Owners enter a binding buy-sell agreement outlining the terms for share transfers if an owner dies or becomes disabled or critically ill.
  2. The company purchases individual life, disability and critical illness policies on each owner sufficient to fund the buyout terms.
  3. The business pays the premiums and is named as beneficiary on all policies.
  4. If an insured owner dies, the company receives the payout from their life policy. Those funds are then used to purchase the deceased’s shares from their estate.
  5. If an owner becomes disabled or critically ill, the same process is followed using the payout from the corresponding policy to redeem their shares.
  6. The remaining owners gain full ownership and control, while the affected owner or their family receives fair compensation.

This structured approach maintains business stability when faced with losing an owner unexpectedly.

Types of Shareholder/Partner Insurance in Canada

Types of Shareholder/Partner Insurance. Benefits and Potential Drawbacks
Types of Shareholder/Partner Insurance. Benefits and Potential Drawbacks

There are several kinds of shareholder/partner insurance available to protect Canadian businesses:

Key Person Insurance

  • Insures owners whose talent, expertise, experience, leadership, and relationships are deemed critically important.
  • Pays out upon death to help the company financially recover from losing the key person’s contributions.
  • Proceeds can cover the costs of replacing the person, paying debts/expenses, stabilizing cash flow, or funding buyouts.
  • 24% of Canadian small businesses have key person insurance according to Sun Life.

Buy-Sell Life Insurance

  • When an owner passes away, provides funds for surviving owners to purchase the deceased’s shares.
  • Avoids the undesirable scenario of shares being transferred to non-business heirs.
  • 31% of SMEs use life insurance policies to fund buy-sells per RBC Insurance.
  • Typically structured as “cross-purchase” plans where owners buy policies on each other.

Buy-Sell Disability Insurance

  • Pays out if an owner becomes totally disabled and unable to work prior to a set age, often 65.
  • Gives the company funds to buyout the disabled shareholder’s interest so they can step back.
  • Necessary protection – probability of disability by age 65 is 28.6% for females and 26.7% for males.
  • Definition of disability and waiting period before benefits start are key considerations.

Buy-Sell Critical Illness Insurance

  • Provides a lump-sum payment if an owner is diagnosed with a covered critical illness.
  • Major diseases like cancer, heart attack, stroke, paralysis, loss of speech, and other conditions are included.
  • Proceeds redeem the critically ill owner’s shares so they can focus on treatment and recovery.
  • Incapacity can happen unexpectedly at any age, so this coverage offers essential protection.
  • The lifetime probability of a critical diagnosis is:
Critical IllnessMenWomen
Cancer50.8%43.2%
Heart Attack19.8%8.3%
Stroke7.6%5.7%
Source: Sun Life

Having insurance to cover critical diagnoses is prudent protection.

For comprehensive protection, a combination of the above policies is recommended.

Benefits of Shareholder/Partner Insurance in Canada

There are many compelling reasons for Canadian corporations to secure shareholder/partner insurance:

Maintains Control

  • The remaining owners keep majority ownership and preserve their vision for the company.

Provides Immediate Liquidity

  • Avoids the need to use operating funds or arrange financing to buy shares.

Sets Share Value

  • Price is established objectively in advance according to a set formula.

Avoids Lengthy Disputes

  • Strict buy-sell terms prevent messy conflicts over share value and transfers.

Speeds Transition of Ownership

  • Shares can transfer seamlessly within a matter of days or weeks.

Tax Advantages

  • Proceeds received tax-free by the company. Share redemptions with retained earnings taxed heavily.

Prevents Unwanted Share Transfers

  • Stops shares from being inherited by the deceased owner’s heirs or transferred outside the business.

Enables Business Continuity

  • Lets the company quickly regain stability and continue operations through a major change.

Protects Against Competitors

  • Competitors can’t gain influence by purchasing shares of a deceased or disabled owner.

Given the broad benefits, shareholder/partner insurance should be strongly considered by all Canadian corporations to support continuity and succession planning.

Determining Appropriate Coverage

Choosing adequate coverage is among the most critical aspects of implementing effective shareholder/partner insurance. Several important factors must be considered:

Value Per Ownership Percentage

This is the baseline for coverage amounts. Common valuation methods include:

  • Book value – Net equity per recent financial statements.
  • Appraisal value – Professionally assessed fair market value.
  • Earnings-based – Formula based on revenues or profitability.
  • Agreed value – Set price per share agreed to by owners.

Adjustments

Additional considerations include:

  • Goodwill and intangibles – Brand equity, trademarks, patents, client relationships, and other intellectual property.
  • Shareholder loans – Any outstanding debts the owner owes the company.
  • Growth projections – Leave room for higher future valuation. Review regularly.

Individual Shareholder Needs

While formulas help guide overall coverage, the needs of each owner can vary. Factors like age, health, majority status, and existing personal net worth may require special consideration when determining policy amounts for each individual.

Ideally, consult a professional advisor to ensure you procure sufficient coverage. Failing to secure adequate insurance could leave the company underinsured. Regular reviews of policies are also prudent as the business evolves.

Potential Drawbacks and Limitations of Shareholder/Partner Insurance

While highly beneficial, shareholder/partner insurance does have some drawbacks that business leaders should be aware of:

Expensive Premiums

  • Costs rise significantly with the insured’s age and declining health. Large policies can be prohibitively expensive.

Administrative Burden

  • Maintaining records, paying premiums, updating policies and beneficiaries takes time.

Strict Policy Limits

  • Insurers enforce caps on maximum coverage amounts that may prove inadequate. Retaining excess liquidity could be required.

Difficulty Accurately Valuing Shares

  • Hard-to-value intangibles like goodwill and intellectual property complicate arriving at a fair overall value.

Interest Misalignment

  • If ownership is contentious, conflicts can arise on whether redemptions are truly in the company’s best interests.

Cross-Purpose Tax Issues

  • Complexities balancing corporate and personal tax optimization. Careful structuring is required.

Does Not Cover Other Events

  • Buy-sells triggered by disagreement, merger or acquisition, or retirement are not covered by these policies.

While limitations do exist, shareholder/partner insurance still provides robust protection if implemented thoughtfully by a skilled advisor.

Tips for Purchasing Shareholder/Partner Insurance Policies

Tips for Purchasing Shareholder/Partner Insurance Policies
Tips for Purchasing Shareholder/Partner Insurance Policies

Here are some best practices I recommend when arranging shareholder/partner insurance for Canadian businesses:

  • Consult legal and tax experts to ensure policies are structured optimally.
  • Choose an experienced broker to access the broadest range of insurers and products.
  • For life insurance, explore cross-purchase agreement to spread premium costs.
  • Communicate details to owners so they understand how it works.
  • Review policies at least biannually as the business situation evolves.
  • Phase in policies gradually if the budget is tight. Some protection is better than none.
  • If possible, stagger policy terms to smooth future renewal mismatches.
  • Formally document the business purpose to defend against CRA shareholder benefit audits.

Ownership and Beneficiary Considerations

How shareholder/partner insurance policies are structured is critically important to avoid potential legal and tax issues down the road:

Corporate Ownership

  • The company should own the policies, pay all premiums, and handle administration.
  • Avoid individual shareholders owning policies on each other’s lives.

Company as Beneficiary

  • List the corporation as the sole beneficiary on all policies.
  • Never name individual shareholders as beneficiaries.

Tax Implications

  • Improper structuring can trigger shareholder benefit tax consequences.
  • Consult a lawyer and accountant to ensure policies are arranged tax-efficiently.

While concepts like corporate-owned and cross-purchase agreements can seem complex, a skilled advisor will ensure you implement the optimal structure.

Premiums and Cost Considerations of Shareholder/Partner Insurance

As with all insurance, premiums are driven primarily by the insured’s risk profile:

Age

  • Costs rise exponentially as owners age. Policies should be secured when shareholders are young and healthy.

Health

  • Individuals with pre-existing medical conditions or who use nicotine pay significantly higher premiums.

Gender

  • Rates are lower for women than men of the same age and health status.

Policy Term

  • Longer terms cost more in total premiums but have lower annual costs. Shorter terms are more expensive annually.

Coverage Amount

  • Premiums increase with higher death benefits, monthly payouts, or lump-sum coverage.

Insurability

  • Different insurers have varying comfort levels with risk, so costs can diverge notably.

For budget-conscious companies, term life insurance often offers the most affordable premiums while still providing substantial coverage.

Why Shareholder/Partner Insurance in Canada is Essential

Given the risks all businesses face, having appropriate shareholder/partner insurance should be considered mandatory governance. The unexpected loss of a founder, CEO, or other senior leader can be catastrophic without proper coverage.

These policies provide both a financial and operational safety net at a very reasonable cost relative to the protection obtained. They provide business leaders the reassurance that their company’s future will be secured even in difficult circumstances.

Conclusion

Losing a key partner without proper shareholder/partner insurance can lead to loss of control, business disruption, and financial instability.
By implementing the appropriate policies and structures, Canadian companies can protect against the unexpected loss of an owner.
Work with qualified legal, tax and insurance advisors to craft and execute a comprehensive shareholder/partner insurance strategy tailored to your specific situation.

Protect Your Business Now

At LifeBuzz, we have the expertise required to ensure you safeguard your company with customized and affordable shareholder/partner insurance.

Get a Free Quote to protect your business’s future.

Frequently Asked Questions (FAQs)

Can shareholders get life insurance on each other without the company's involvement?

Yes, shareholders can privately take out policies on each other's lives. But corporate owned insurance is often preferable for administrative ease and tax reasons.

Is the death benefit from shareholder insurance considered a dividend?

No, shareholder life insurance proceeds are received tax-free by the company and do not constitute a dividend.

What approvals are required for shareholder insurance?

Shareholder insurance should be approved by the board of directors and laid out in the shareholders' agreement. Shareholders should also approve policies on their lives.

Can premiums be split between the company and shareholders?

Yes, the premiums can be structured in various ways - paid fully by the company, fully by shareholders, or divided between the two.

Do life insurance proceeds count toward capital gains exemption limits?

No. Shareholder life insurance proceeds increase the capital dividend account, not the capital gains. So they do not affect the lifetime capital gains exemption.

What happens if shareholder insurance lapses due to nonpayment?

The policy would terminate. Any coverage issues due to lapse should be addressed in the buy-sell agreement to avoid disputes.

Can shareholders borrow against the cash value of permanent shareholder policies?

Yes, permanent shareholder insurance like whole life insurance builds cash value that can be borrowed against by the policy owner, which is typically the company.

Does the share price have to match the shareholder policy amount?

The share price and policy amount can diverge, but it's optimal to have the policy benefit mirror the share value set out in the buy-sell agreement.

Written consent from shareholders is not legally required but is considered best practice when purchasing shareholder insurance.

Can deferred compensation plans replace shareholder insurance?

No, deferred compensation arrangements take time to pay out so they do not provide the immediate liquidity that shareholder insurance does upon an owner's death or illness.

What is the advantage of cross-purchase shareholder arrangements?

The main advantage is spreading the premium cost amongst the owners instead of the company bearing the full cost of all policies.

How does shareholder insurance protect minority shareholders?

It sets an objective share price upfront and provides liquidity to buy out a minority shareholder if they die or become critically ill.

Is a medical exam required for large shareholder insurance policies?

Insurers will likely require a medical exam and possibly other records like blood work for permanent policies or term policies with high death benefits.

What is involuntary loss of license insurance for shareholders?

It pays out if a shareholder who relies on a professional license, like a doctor, lawyer or pilot, has their license revoked, rendering them unable to work.

Are share redemptions with shareholder insurance proceeds eligible for the capital gains exemption?

No, the capital gains exemption does not apply since the shares are being sold to the company, not an arm's length third party.

How often should shareholder insurance be reviewed?

Shareholder insurance should be reviewed at least every 2 years as corporate valuations change. It can be adjusted to ensure adequate coverage is maintained.

Can shareholders personally own policies on each other?

Yes, this is known as a cross-purchase arrangement. But corporate ownership often provides better tax treatment.

Does shareholder insurance cover disability?

Yes, buy-sell disability insurance can be purchased to cover share redemptions if an owner becomes disabled.

What does a buy-sell agreement detail regarding shareholder insurance?

It sets out the terms for transferring shares when an owner dies, becomes disabled, or critically ill, which the insurance funds.

How long does it take for shareholder insurance payouts?

Payouts are generally made within a few weeks of submitting the death certificate or proof of illness/disability.

Is using retained earnings better than shareholder insurance?

Insurance provides a much larger, lump-sum payout immediately. Drawing down retained earnings can take many years.

Can shareholder insurance require a medical exam?

Yes, a medical exam, fluid samples, and doctor's records may be required, especially for permanent or large policies.

Are premiums level or increasing for shareholder insurance?

Term policy premiums are level. Permanent policy premiums increase annually as owners age.

Does shareholder insurance protect against creditors?

Yes, corporate owned policies are generally protected from any claims by owners' personal creditors.

Article Sources:

Delve into the principles that guide our dedication to truthfulness, clarity, and editorial autonomy by exploring the Lifebuzz.ca Editorial Policy. This is the cornerstone of our esteemed status as the premier trusted source for life insurance information in Canada.

  1. Shareholder/Partnership Agreement Planning – http://www1.manulife.com/
  2. Shareholder protection insurance – https://swoopfunding.com/
  3. Incorporating Life Insurance into Shareholder Agreements – https://www.cmbinsurance.ca/
  4. Life Insurance and shareholder benefits – https://suncentral.sunlife.ca/
5/5 - (1 vote)

Written by Ben Nguyen

Ben Nguyen is an award-winning insurance expert and industry veteran with over 20 years of experience. He is the chairman and director of IDC Insurance Direct Canada Inc., one of Canada's leading online insurance brokerages.

Ben is renowned for his extensive knowledge of life, health, disability, and travel insurance products. He is the prolific author of over 1,000 educational articles published on LifeBuzz, BestInsuranceOnline, and InsuranceDirectCanada. His articles provide Canadians with advice on making smart insurance decisions.

With a Bachelor's degree in Actuarial Science and a Fellow of the Canadian Institute of Actuaries (FCIA) designation, Ben is frequently interviewed by media as an insurance industry spokesperson.

He has received numerous honors including the Insurance Council of Canada’s Pivotal Leadership Award, the Canadian Insurance Hall of Fame induction, and the President’s Medal from the Canadian Institute of Actuaries.

Ben continues to shape the vision and strategy of IDC Insurance Direct as chairman. He is dedicated to advancing the insurance industry through his insightful leadership.

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