Key person insurance

How BC law treats it

Key person insurance is a contract of insurance governed by BC's Insurance Act. The company applies for, owns and pays for the policy on the life or health of the key person, who must consent. The company has an insurable interest in a director, officer or employee whose loss would cause it financial harm. The proceeds are paid to the company, not to the individual's family, unless the policy or agreement says otherwise. Companies use the proceeds in two main ways. First, to cover lost revenue, recruiting costs or loan repayments after a key person dies or is disabled; lenders sometimes require the policy and an assignment of it as security. Second, to fund a buyout under a shareholders agreement, so the surviving shareholders or the company can buy the deceased shareholder's shares from the estate at a price set by the agreement. Tax treatment is significant and requires advice. Life insurance proceeds received by a private corporation, less the policy's adjusted cost basis, are added to its capital dividend account (Income Tax Act s. 89(1)), allowing tax-free capital dividends to shareholders. Premiums on a policy the company owns for its own benefit are generally not deductible, with limited exceptions such as a policy assigned as collateral for a loan from a financial institution (Income Tax Act s. 20(1)(e.2)). The shareholders agreement, the policy ownership and the beneficiary designation should all line up with the intended buyout structure.

What it means for your business

For a closely held BC company, the death or disability of a founder can stall the business and trigger a dispute with the founder's estate. Insurance-funded buyout provisions give the estate cash and the surviving owners control. Lenders and investors may require coverage as a condition of financing. Without coordination between the policy and the shareholders agreement, the money may go to the wrong party or be insufficient to complete the buyout. Example: Three shareholders of a Vancouver engineering firm have their company buy life insurance on each of them. When one dies, the company uses the proceeds to redeem the deceased's shares from the estate at the price set in the shareholders agreement.

Risks and common mistakes

Buying a policy without matching the buyout terms of the shareholders agreement. Naming the wrong owner or beneficiary, so proceeds bypass the company or the buyout structure. Failing to update coverage as the company's value grows. Assuming premiums are deductible business expenses. Insuring only death and ignoring long-term disability of a key owner.