Business Life Insurance and Life Settlements
Issue No. 137, October 8, 2024
Business Life Insurance and Life Settlements
Business-owned or business paid-for life insurance policies are frequently overlooked prospects for life settlements. Since business policies are not necessarily purchased for estate planning purposes, the need to keep such a policy in force may not be for the insured’s entire life. As a result, there often comes a time when business-owned policies or personally owned business paid-for policies become candidates for a life settlement.
Life insurance policies are purchased by businesses for a variety of reasons: to fund a buy-out of the owner’s interest under a stock redemption arrangement, for key person purposes to offset the financial loss that would have been sustained by the business had this person died prematurely, for creditor protection purposes to secure loans that may have been made by the business, or as a fringe benefit.
In some instances, the policies are not owned by the business itself but rather by co-owners of the business to fund a cross-purchase arrangement or by owners or employees under a bonus or split-dollar arrangement.
When a business owner leaves, whether due to retirement, disability or the sale or liquidation of the business, advisors should be alert to the possibility of a life settlement. Quite often, the business will own or be paying for any number of policies on the life of the departing owner. Although sometimes the exiting business owner will have a use for some of the coverage, a significant portion of the insurance may no longer be needed, wanted or affordable.
Additionally, a very large percentage of policies bought for buy-sell arrangements and key person needs are term insurance. Term insurance policies, that are convertible to universal life, make some of the best prospects for a life settlement. Yet, producers, under the mistaken belief that term insurance cannot be sold in a life settlement, often miss these opportunities.
For an aging retiring business owner, a decreased need for coverage, together with the rising cost of the term insurance, may make keeping the policy quite unappealing and unnecessary, if not altogether unaffordable.
In some instances, it is desirable to keep a portion of the coverage in force. Permanent life insurance, generally, cannot be split for a life settlement. But term insurance has the additional advantage that a portion can be sold in a life settlement and the balance of the policy retained.
In a recent case, a retiring business owner sold his business which was paying for a personally owned $2 million term insurance policy on his life. He did not want, nor could he afford, to continue paying for the policy out of his own pocket. However, he did want to keep $1 million in force, but he wasn’t sure he could afford even that. $1 million of the policy was converted and sold in a life settlement transaction and he was able to convert the balance by using the proceeds of the life settlement which was enough to cover some premium payments on the portion of the policy he retained.
Life insurance funded executive benefit arrangements, such as deferred compensation and split- dollar plans, are also significantly impacted by the departure of a key executive or business owner.
While policies bought for deferred compensation plans are often, but not always, retained to pay benefits or to reimburse the company for those payments upon death, in some situations a life settlement may be a more attractive option.
Split-dollar plans, that were intended to be rolled-out with minimal tax consequences, are no longer being given such favorable tax treatment. A life settlement can provide an attractive exit strategy from a split-dollar arrangement.
Qualified pension and profit-sharing plans also may own policies on retiring business executives. Although these policies must first be transferred to the insured to comply with ERISA, they can also be candidates for a life settlement.
Life insurance policies are often left behind when business owners or executives leave or retire. Such is also the case when business ownership changes hands, is liquidated or is reorganized. A life settlement can bring unexpected value from these policies which could be used to help fund the buyout.
The cash from a life settlement could make a meaningful difference in the lives of business owners and executives. As a trusted advisor, you owe it to your clients to bring this valuable option to their attention, as well as to the attention of their accountants and attorneys. Remember, as we always say, “it can’t hurt to try – it can only hurt not to.”
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Robin and Peter | 220 Boylston Street, #1204, Boston, MA 02116
Robin S. Weinberger, CLU, ChFC, CLTC
(617) 451-3343
Peter N. Katz, JD, CLU, ChFC, RICP®
(860) 937-2936
Ria J. Johnson, CFP®
(619) 920-4000
Rob Haynie
(954) 599-4433
