Business Insurance Applications Flashcards

What is the primary purpose of key person life insurance?

Answer: To indemnify the business for financial losses resulting from the death or disability of a critical employee or owner

Key person insurance protects a business from the economic impact of losing a critical individual — such as a top salesperson, a founder, or a specialist — whose absence would cause measurable financial harm. The business is the owner, premium payer, and beneficiary. The proceeds help the company recruit a replacement, cover lost revenue, or repay debts.

In a buy-sell agreement funded by life insurance, what event typically triggers the buyout?

Answer: The death or total disability of a business partner

A buy-sell agreement is a legally binding contract that governs what happens to a business owner's interest upon certain trigger events — most commonly death or total disability. Life insurance funds the buyout, allowing the surviving partner to purchase the deceased's share from their estate at a pre-agreed price without needing external financing.

In a cross-purchase buy-sell agreement between two equal business partners, who owns and pays for the life insurance policies?

Answer: Each partner personally owns a policy on the other partner's life and pays the premiums

In a cross-purchase arrangement, each partner personally owns a policy on the other's life. If Partner A dies, Partner B receives the proceeds and uses them to buy A's ownership interest from A's estate. This structure is simpler with two partners but becomes complicated with more, since each additional partner requires more policies.

What is a Business Overhead Expense (BOE) disability policy designed to cover?

Answer: Reimbursement of fixed business operating costs — rent, utilities, staff salaries — while the owner is disabled

A BOE policy pays the ongoing fixed operating expenses of a business when the owner-operator is disabled and cannot generate revenue. It is distinct from personal disability insurance: BOE benefits reimburse business expenses (not personal income) and are taxable to the business while premiums are deductible. It keeps the business running during a short-to-medium term disability.

A corporation is the owner and beneficiary of a life insurance policy on a key shareholder. Upon the shareholder's death, proceeds are received by the corporation. What is the tax advantage available under the Income Tax Act?

Answer: The proceeds may be credited to the Capital Dividend Account (CDA), allowing tax-free distribution to surviving shareholders

When a private corporation receives a life insurance death benefit, the amount exceeding the policy's adjusted cost basis (ACB) is credited to the Capital Dividend Account (CDA). The CDA allows the corporation to pay capital dividends to shareholders tax-free, making corporate-owned life insurance a highly tax-efficient way to transfer wealth to surviving shareholders.

Which factor most distinguishes key person insurance from a personal life insurance policy taken out by an employee?

Answer: The business, not the insured individual, is the owner, premium payer, and beneficiary of key person insurance

The defining characteristic of key person insurance is the insurable interest and ownership structure: the business owns the policy, pays the premiums, and collects the death benefit. The insured is the key employee or owner. Premiums are generally not tax-deductible to the corporation (since the corporation is the beneficiary), but the death benefit is received tax-free (subject to CDA rules).