Many of the disability and accident and sickness (A&S) insurance plans dealt with in earlier
chapters of this Module relate to income protection and health benefits of individuals, whether owners or employees of businesses, or the self-employed. There is also a whole field of disability insurance (DI) designed to protect the businesses themselves in the event of the disability either of an owner or of an employee who is critical to the success of the business. These plans include:
Disability business overhead expense (BOE) insurance;
Business loan protection;
Disability buyout coverage;
Key person coverage.
Before looking in detail at how these plans work and the benefits they provide, it is important to understand the different types of business structures and the various risks faced by business owners.
Forms of business ownership
The type of business structure an individual (or group of individuals) chooses for business
operation can impact a wide variety of issues, including the simplicity of operating the business, the administrative costs of operating the business, the tax rate at which business profits are taxed and the degree to which the business owner is personally exposed to the liabilities (including creditors) of the business. The following types of business structures and some of their advantages and disadvantages are described in detail in this section:
1. Sole proprietorship
A sole proprietor is the only owner of an unincorporated business. Sole proprietorships encompass a wide variety of business enterprises, from consultants to independent tradesmen to artists and so on. In fact, by far the majority of businesses operating in Canada are sole proprietorships. The main attraction of a sole proprietorship is that it is inexpensive and easy to set up and operate. Some provinces require that a sole proprietorship business be registered with the province, for a relatively modest fee.
The primary downside to operating a sole proprietorship is that the business financial affairs of the proprietorship and the personal financial affairs of the sole proprietor are inseparable. The net income of the proprietorship is income of the proprietor, to be reported on his personal income tax return. There is no opportunity for the business income to be taxed at a separate, lower rate as there is with an incorporated business. And the personal assets of the sole proprietor are exposed to the business creditors of the proprietorship.
A partnership involves two or more individuals carrying on a business together with a view to
making a profit. The partners share in the net profits or losses of the business.
Partnerships are more complex than proprietorships. Revenues and expenses are computed at the partnership level and net income is reported to the individual partners, pro rata, according to the terms of a partnership agreement. Income tax is not computed at the partnership level, but the net income is reported to the partners and taxed at each partner’s personal marginal tax rate.
The prime disadvantage to the partnership structure is that partners may be jointly liable for debts and liabilities of the partnership. For example, a lawsuit filed against the ABC partnership as a consequence of the negligence of partner A could also be the responsibility of partners B and C, even though they had no role in creating the liability.
A corporation is a separate legal and tax entity – separate from its owners – the shareholders. The corporation itself carries on business through the efforts of its owner/operator(s) and employees.
Ownership of the corporation is in the form of shares, which represent a pro rata interest in the net value of the corporation. For example, someone who owns 5% of the outstanding common shares of a corporation owns 5% of its net value. Control of the corporation is affected through share voting rights. Corporations may be small, closely held businesses (with as few as one shareholder) or large, multinational operations, with perhaps hundreds of thousands of shareholders.
Corporations are legal entities separate from their shareholders, such that the liabilities of the corporation do not become the liabilities of their shareholders. Corporations are taxed on their net income, often distributing their after-tax income to shareholders in the form of dividends, which are taxed in the hands of the business owner at substantially lower rates than salary or interest. Corporations are divided into two general categories: private and public.
3.1 Privately held
Privately held corporations do not offer their shares for purchase to the general public. The shares are owned by a limited number of shareholders, sometimes only one, who are typically owners/operators of the business. A private (or closely held) corporation is generally established to operate a business either for tax advantages and/or protection for owners from the creditors of the business.
In Canada, the net income of a private operating company is taxed at a low rate. If a shareholder, who may be in a 45% marginal tax bracket, does not require current access to all of the net income generated by the business, the corporation can be an effective tool for deferring tax on the profits of the company.
3.2 Publicly held
Public corporations, like Bell Canada, often have tens (or hundreds) of thousands of shareholders and their shares are usually traded freely on a public stock exchange. Their shareholders are not owners/operators, but merely investors, who hold the shares for their income (dividends) or growth (capital gains) potential. As such, the shareholders are not exposed to the liabilities of the corporation.
Risks to the business owner
In the operation of a business, business owners must often deal with three risks specific to the operation of a business, all of which are related to the risk of disability:
Risk of being unable to work due to disability;
Risk of being unable to sell the business – a need triggered by disability;
Loss of a key employee to disability.
All three of these risks need to be examined in some detail and all can be mitigated through the use of proper documentation and specific forms of disability insurance.
Insurance to address owners’ inability to work
Disability business overhead expense (BOE) insurance
Business loan protection disability insurance
Insurance to address the owner’s inability to sell the business
Disability buyout insurance
Insurance to address the loss of a key employee
Key person insurance
Other types of business insurance plans:
Health and welfare trusts (HWTs)
Employee health trusts (EHTs)
Personal health spending plans
Grouped disability/critical illness plans