The ins and outs of life insurance for small businesses

Insurance industry leader breaks down the benefits for continuity planning, estate equalization, and more

The ins and outs of life insurance for small businesses

While life insurance is typically considered a way to provide security for individuals and households, it’s also worth considering for business owners looking to protect their legacy and life’s work, according to one industry leader.

“Their businesses are likely their passion, and when an individual puts so much dedication and time into something, it’s important to have a robust continuity plan to ensure the owner’s intentions for the business are well documented and communicated,” says Michael Aziz, chief distribution officer at Canada Protection Plan.

There’s certainly no shortage of research on the risks surrounding small businesses. According to PwC’s 10th Family Business Survey, published 2021, two thirds of family businesses in North America lack a robust, documented, and communicated plan; while the rest do have a plan, only an estimated 9% have reviewed their plans post implementation. In Canada, almost two thirds of small businesses (63%) are family owned, which means insuring the business is the same as protecting the business owners’ families and legacies.

Life insurance: multi-pronged business protection

Adequate life insurance, Aziz says, can support the continuity of businesses in numerous ways. Some business-owned whole life insurance policies come with cash values business owners can leverage to obtain loans they might need to grow or pivot their businesses.

“With a Permanent Life Insurance policy, business owners can gain access to additional cash flow by leveraging the cash value of their policy and benefit from tax-deferred cash value growth,” he says. “The small business owner can decide to pay back the loan into the life insurance policy or have the loan amount deducted from the death benefit – this provides the small business owner with the flexibility they need.”

For businesses where critical tasks are concentrated to one or two key people, the death benefit from key person life insurance could support the company through a transition period in case the worst happens. In the case of co-owned businesses, life insurance could be used in buy-sell agreements in case one of the owners unexpectedly passes away, in which case the death benefit would go to the late owner’s beneficiaries, compensating them for their share of the company’s value, as well as protect the remaining owners.

“Life insurance can be a good backstop to protecting the value of a business,” Aziz says. “Businesses lacking a plan could face significant risks in the case of an unexpected critical illness or death of an owner or key decision-maker, including successors lacking proper knowledge or credibility to lead the business, and severed relationships between remaining owners or key decision-makers.”

Life insurance can also be used for estate equalization, particularly in cases where not all family members will take over the business. “In the event of the owner passing, the intended family owners could inherit the business, while the others would receive an insurance payout equivalent to the value of their portion of the business,” Aziz says.

Time-strapped business owners face risks

Why aren’t more business owners taking steps to protect that wealth? It’s hard to know for sure, but Aziz speculates it’s because business owners are strapped for time. “They’re likely focused on improving day-to-day efficiency and profitability, which doesn’t leave a lot of time or energy to plan out across a longer horizon,” he says.

Getting life insurance could also lead to uncomfortable conversations about life-altering disasters or, at worst, the possibility of someone’s death. In many cases, it can feel easier to put off the decision or ignore the problem – until it inevitably becomes impossible to ignore.

“Owning a small business already involves so many caveats to manage, with money being a major stressor for many,” Aziz adds. “Some may believe they don’t need additional coverage due to potentially higher premiums, especially if they already have personal life coverage on themselves, and their home and care are already insured.”

For small business owners looking to get life insurance, he says the amount and appropriate type of insurance ultimately hinges on what they want to use it for. Under that broad prescription is a dizzying array of additional considerations – the amount of time needed to replace a key person, the size and overhead costs associated with running a business, whether or not they want the option to up their coverage later on, and any debt that would need to be paid in case the worst happens, among other factors.

“There are nuances depending on the intended use that are important to consider when trying to find the right product and right coverage,” he says. “We always recommend having a thorough discussion with a licensed insurance professional and, depending on the situation, a tax advisor or lawyer.”