3 Questions to Ask About Business Insurance

By Brad Thomason, CPA

 

For reasons that have never been quite clear to me, the insurance industry seems to love the middle of the country when it comes to offices and headquarters.  I just came back from a couple of days of meetings at the US headquarters of a large insurer, located in one of the “fly-over states” (which I flew to…how’s that for irony?).

The agenda covered a wide topic area – and no, it wasn’t as boring as it sounds (my baby sister was decidedly unimpressed with this latest port of call…which I could tell because her response was even more derisive than usual).  The folks in their R&D department wanted my input on a new product line they were thinking about launching (and now won’t if they listen to my advice).  I also spent some time with members of their advanced cases team.

Everyone sort of knows about the premise for basic life insurance coverage.  What is less widely understood is how various life insurance products – which often have preferential tax and legal protections which can’t be found elsewhere – serve as the chassis for some very complex financial instruments which can be deployed across a wide range of needs.  As a result, most of the big insurance companies have in-house teams of accountants, lawyers, and propeller-heads of other ilks, who do nothing all day but work with business owners and high net worth types to craft and customize some of the most sophisticated financial tools out there.

As you might imagine, this can be a complicated area to get your head around.  Especially for the lay person.  But the folks I met with have done as good a job as any I’ve seen in reducing the important issues down to their most basic level.  So I wanted to share with you some of their thoughts on a topic which has wide application:  When should a business consider the purchase of a life insurance policy? 

They identified the following 3 circumstances where doing so is likely to be a good idea:

 

  1. Does the company have more than one owner?  Just because you want to be in business with person X, doesn’t mean you want to be in business with that person’s spouse.  But that’s what often happens – albeit inadvertently – when a business partner dies unexpectedly.  The interest in the business passes to the heirs, and even if they do not want to remain involved, there may not be any way for the business, or the other partner(s), to fund the buyout.  Angst ensues.  In order to avoid this risk, a business can purchase insurance on the principals, who mutually agree that the proceeds from the death benefit will count as the money for a buyout if one of them dies prematurely.  (In industry lingo, this is called a “Funded Buy/Sell Agreement”)
  2. Would the company suffer a loss if it had to replace a given employee?  In some companies, it’s not just the owners that are the star performers.  Especially as a company grows in size, there is an ever-increasing likelihood of having one or more team members who are important enough to the operation, that their sudden departure would cause the company to be at risk of a loss.  The thing that makes a key person key (whether in sales, operations, technical knowledge, or whatever), is that they perform critical functions for the company.  If they were to die, it would impact those critical functions (perhaps for several months until a suitable replacement could be located and hired), which could financially harm the company.  Plus, there would be the replacement costs themselves, like head-hunter fees and relocation expenses.  All in all, the loss of a key employee could legitimately cost a company several hundred thousand dollars or more.  So it’s a risk that merits consideration for insurance coverage.  (This is called “Key Man Insurance”)
  3. Is there a need to create a special benefit for an executive or owner?  This could be part of an incentive package designed to make sure a top performer doesn’t go elsewhere.  Or there could be a need for the owners or executives to be able to funnel more dollars into retirement savings than what’s allowed under the company’s conventional retirement plan.  Properly structured, there’s a whole other world of employee benefits that can be built on the framework of certain insurance policies.  And unlike the more traditional qualified retirement plans which have to cover everyone in a company equally, the options available in this area can legally be “discriminatory” – that is, reserved for just the people the company wants to include.  In practice, that’s usually the owners and the executives, not the rank and file.  (Popular names include “Executive Benefits” and “Deferred Compensation,” though the possibilities are almost endless when it comes to the specific benefits being conveyed)

So, a complicated topic, reduced down to three pretty simple categories.  If one or more applies to you, might be something you want to look into.  Now, to be candid, cases of this type are usually way over the head of your average basic insurance agent.  But if you can get to the right people there is a lot of help to be had from very educated, highly-focused professionals who work with this stuff every day and have seen enough different permutations that they should be able to give meaningful input, regardless of the special features of your situation.

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