Life Insurance for a Business Bank Loan

We cover this specific case variously throughout this guide but it's common enough and straightforward enough to cover it in a distinct article.

Why Lenders Require Business Bank Loan Insurance on Key Employees

It's for exactly the reason we talked about in the first paragraphs of this guide. The lenders are at risk of not being repaid the loan, or having difficulty getting repaid, if a key person dies or becomes disabled during the term of the loan. Again, with high probability it will be fine, but with low probability the results are catastrophic – six or seven figures lost. Requiring life and/or disability removes that financial risk – the results of loan payment are now guaranteed.

What Do They Typically Ask For?

Again, this is straightforward. The requirements for key person life insurance are just for the amount of the outstanding loan, in force for the term of the loan.

For disability, the requirements are more based on the available coverage options – in this case Business Loan Protector which will provide loan payments starting after 60 days, for 2 years. At that point the expectation is that the key person has been replaced and is up to speed, and the corporation is once again able to start repaying the loan without insurance.

There's clearly a dichotomy here that in the event of death they want the loan fully repaid and in the event of disability they only want payments covered for two years, but that's mostly driven by the available disability policies that are available.

Collateral Assignment

The lender wants the loan fully covered with a life insurance policy. But the policy has level coverage while the outstanding loan balance is generally decreasing. If the key person passes, does the lender just make a nice profit?

Turns out, no. Instead, we do what's called a collateral assignment form. It's just a simple form that states that the lender is to be paid the death benefit up to the amount of the outstanding loan at that time, and that any remaining death benefit proceeds are paid to the corporation. So if there's any money left over, it's for the corporation.

In practice, with this form in place, the insurance company at time of claim requests the amount of the outstanding loan and then cuts a cheque to the lender and a cheque to the corporation for any remaining proceeds. So yes, it works as you'd expect, and it's a smooth process.

Taxation on Business Loan Insurance in Canada

In general, life insurance premiums are not tax deductible by the corporation. Also in general, any death benefits paid are not taxable – a $1MM death benefit is a full $1MM, no deductions, no taxes owing.

There's one exception from this rule of thumb though. The CRA has a list of four or five specific criteria that if met, allows you to tax deduct your life insurance premiums. See your accountant for the full list of requirements, but in practice they boil down to two requirements:

• The lender is a recognized Canadian financial institution i.e. a bank or credit union (private lenders won't qualify)
• The lender has required that life insurance be in place to cover the loan. So, get a letter from them stating this.

See also: How Quickly Can We Get This Set Up?