5.1 Why a Business Buys Life Insurance: Cross-Purchase vs Share Redemption Funding
Key Takeaways
- A buy-sell agreement is the continuation plan: it names the buyer, the price or formula, and the death trigger so shares or partnership units do not pass to uninvolved heirs or a third-party bidder.
- In a cross-purchase, the surviving owner is the buyer, so that person (not the corporation) should own and be beneficiary of the policy on the other owner’s life.
- In a share (unit) redemption, the corporation or partnership is the buyer and needs dedicated cash to pay the estate without draining working capital; it should own the policy and be beneficiary.
- Size each life’s buy-sell face amount to the agreed fair market value of that owner’s block; a two-shareholder $2,400,000 company with equal holdings needs $1,200,000 on each life for that slice of the need.
- Capital dividend account and split-dollar mechanics belong with business life insurance products; this section is the funding need — who must write the cheque, and where the dollars come from.
Why a Canadian business buys life insurance
The Life Licence Qualification Program (LLQP) Life Insurance module treats business life insurance needs as part of competency 1.3: you must articulate the need before you analyse contracts. Official related contents include why a business might buy life insurance, funding a buy-sell cross-purchase agreement, funding a share (unit) redemption plan, and why a buy-sell agreement is an important part of a business continuation plan.
This independent OpenExamPrep chapter helps learners study those CISRO Life Insurance module topics. It is not legal, tax, or insurance advice, and it does not claim official approval by CISRO, a provincial regulator, or a course provider.
Product mechanics such as the capital dividend account (CDA) and split-dollar or shared ownership are taught with business life insurance contracts. Stay on the funding question here: who must write a cheque the morning after a shareholder or partner dies, and where those dollars come from.
When an owner-manager dies, three problems arrive together. The estate holds an illiquid interest in a private firm. The surviving owners need control so they can meet payroll and keep customers. Banks, employees, and suppliers want proof the firm will still exist on Monday. A written buy-sell agreement names the buyer, the price (or the formula), and the trigger — death is the Life-module focus. Life insurance is what turns that paper promise into cash.
Without funded insurance, the survivor’s choices are ugly: raid personal savings, borrow, offer the estate an instalment note it may refuse, or watch the deceased’s shares pass under the will to a spouse or children who never wanted to run a machine shop. A competitor can offer the estate a quick cheque. That is a continuation failure, not a “wrong rider.”
Two-shareholder Canadian corporation: the numbers
Use a dollar trail on the exam. Labels without amounts are how candidates miss owner-and-beneficiary questions.
Northline Precision Ltd. is a Canadian-controlled private corporation. Amira Patel and Benoit Tremblay are unrelated, each own 50% of the common shares, and both work in the business. A recent independent valuation puts the fair market value (FMV) of the company at $2,400,000. Each 50% block is therefore worth $1,200,000. Their buy-sell says that on death the deceased’s shares will be purchased for that FMV, and they will review the price at least every two years or after a material change (a large contract, a new location, or a downturn).
They apply for $1,200,000 of life insurance on Amira’s life and $1,200,000 on Benoit’s life. The face amount matches the purchase price of that block.
| Item | Amount |
|---|---|
| Fair market value of Northline Precision Ltd. | $2,400,000 |
| Amira’s 50% share block | $1,200,000 |
| Benoit’s 50% share block | $1,200,000 |
| Buy-sell insurance on each life | $1,200,000 |
If they buy only $600,000 on each life, the agreement is half-funded. The survivor still needs another $600,000 of after-tax personal or corporate cash on a deadline the estate will enforce. If they buy $2,400,000 on each life, they have over-funded the share price. That extra might be intentional if they are also covering a key-person or estate-liquidity need, but those are separate needs that should be named, not buried inside one vague “business policy.”
The price in the agreement should be defensible as FMV. An artificial bargain price can leave the estate underpaid and can create tax trouble; an inflated price can over-insure and invite insurer financial underwriting questions. For the Life module, remember the chain: value the block → write the price → fund that price.
Cross-purchase (criss-cross) funding
In a cross-purchase agreement, the surviving shareholder is the buyer. The estate of the deceased is the seller. Insurance must put cash in the survivor’s hands, not in the company’s operating account.
| Insured life | Policy owner | Beneficiary | Face amount | What the death benefit is for |
|---|---|---|---|---|
| Amira | Benoit | Benoit | $1,200,000 | Benoit pays Amira’s estate $1,200,000 and takes her shares |
| Benoit | Amira | Amira | $1,200,000 | Amira pays Benoit’s estate $1,200,000 and takes his shares |
After Benoit dies, Amira receives $1,200,000 personally. Death benefits on personally owned life insurance are generally received tax-free by the beneficiary under the rules taught in this module. She delivers that cash to Benoit’s estate in exchange for his shares. She now owns 100% of Northline. The estate has cash instead of private-company shares, which it can use for the family’s living costs, debts, and tax on Benoit’s final return.
Owner and beneficiary must match the legal buyer. If the corporation is beneficiary of a policy that is supposed to fund a personal cross-purchase, the cash lands in the wrong pocket: Amira still owes the estate $1,200,000, and the company is holding money it is not the purchaser under the agreement. That mismatch is a frequent exam trap.
Cross-purchase scales poorly. Two shareholders need two policies (each owns one on the other). Three equal shareholders need six policies, because each person must be able to buy each other person’s block. Four shareholders need twelve. Premium fairness is also lopsided: the younger, healthier owner pays the higher premium on the older co-owner’s life. Those are planning frictions, not reasons to skip the agreement.
For a partnership, the same structure is a cross-purchase of partnership units (or of the partnership interest). The surviving partner — not the partnership — is owner and beneficiary of the policy on the deceased partner.
Share (unit) redemption funding
In a share redemption plan (corporations) or unit redemption plan (partnerships), the entity is the buyer. The company or partnership purchases the deceased’s interest for cancellation. The surviving owner’s percentage of what remains becomes 100% of the issued shares or units. Insurance must put cash in the entity.
| Insured life | Policy owner | Beneficiary | Face amount | What the death benefit is for |
|---|---|---|---|---|
| Amira | Northline Precision Ltd. | Northline Precision Ltd. | $1,200,000 | The corporation pays Amira’s estate $1,200,000 and redeems (cancels) her shares |
| Benoit | Northline Precision Ltd. | Northline Precision Ltd. | $1,200,000 | The corporation pays Benoit’s estate $1,200,000 and redeems his shares |
After Benoit dies, Northline receives $1,200,000. It uses those dollars to redeem his shares. Amira does not write a personal cheque. She ends up as sole remaining shareholder because Benoit’s shares no longer exist. The estate again receives cash.
Why the business needs the dollars: redemption is a corporate (or partnership) purchase. If the firm has no surplus cash — or has cash trapped in equipment, inventory, and receivables — a redemption funded from working capital can starve payroll, break bank covenants, or force a sale of operating assets. The death benefit is a dedicated pile of cash that arrives because a shareholder died, which is already the moment the firm is losing that person’s work. The entity needs those dollars to complete the purchase without cannibalizing operations.
Corporate-owned death benefits have tax consequences, including how a mortality gain may later be credited and distributed to shareholders. Those mechanics live with business life insurance products. For needs analysis, remember only this: the party that is legally required to write the cheque should own the policy and be the beneficiary, and the face amount should match the redemption price.
A partnership or LLP uses the same funding logic with units rather than shares: the partnership needs cash to pay out the deceased partner’s unit interest so the heirs do not become partners by default.
Why the buy-sell agreement itself matters
Insurance without an agreement is a hope. An agreement without insurance is an unfunded promise. The curriculum treats the agreement as part of the business continuation plan because it answers four questions a will alone cannot:
- Who buys — the surviving owners, the corporation or partnership, or a named key employee — so interests do not drift to heirs who cannot or will not work in the business.
- For how much — a fixed price with mandatory updates, a formula (for example a multiple of average earnings), or an independent appraisal — so the estate is not trapped in a fight over FMV.
- With what money — life insurance at a face amount that tracks the price, plus a stated backup (instalment note, sinking fund) if a shareholder is uninsurable or underinsured.
- On what trigger — death is the Life-module focus; many agreements also cover disability or retirement, which may need different funding.
The agreement also protects people who never sign it. Employees keep a functioning employer. Customers keep a supplier. The bank keeps a borrower whose ownership is not in limbo. Heirs receive a cheque instead of a minority block they cannot sell. That is continuation: the business continues as an operating firm, and the deceased’s family continues with liquidity.
Sole proprietors have no shares to redeem. Continuation is usually a sale of assets or of the business as a going concern to a key employee or competitor. Insurance the successor owns on the owner’s life funds that purchase. Do not force “share redemption” language onto a sole proprietorship.
Review face amount when FMV changes. A company that grows from $2.4 million to $3.6 million and still has a $1.2 million policy on each equal shareholder has a $600,000 hole on each life. Adding coverage later can be declined if health has changed. Choosing term versus permanent is a later product decision; the needs step is to keep the dollar need current.
Northline Precision Ltd. has a fair market value of $2,400,000. Amira and Benoit each own 50% of the common shares and have a cross-purchase buy-sell funded with life insurance. Who should own and be beneficiary of the $1,200,000 policy on Benoit’s life?
Why is a written buy-sell agreement treated as an important part of a business continuation plan even when the owners already intend to buy life insurance?
The same $2,400,000 corporation uses a share (unit) redemption plan and $1,200,000 of life insurance on each shareholder. Who should be owner and beneficiary, and why does the business itself need the dollars?