When most people think of life insurance they imagine someone who wants to provide for a loved one in the event of their death. At it’s most basic, life insurance is designed to pay out a death benefit to the insured person’s beneficiaries. What’s not so commonly known is that life insurance is an effective means to create protection for your business. Think of the key members within a business: founder(s), the CEO, the president, vice-president, and so on. Every business has a few key players whose sudden loss would significantly impact everyday operations. Small and medium-sized businesses can be particularly devastated by the loss of a founder, owner or top executive. Properly structured life insurance can offer a level of financial protection to the business in the event of such a loss.
Life Insurance Uses for Business Protection
- Key Person life insurance
- Buy-Sell agreements
- Living benefits
Key Person Life Insurance
Key person life insurance (aka key man life insurance) is life insurance on a critical member of the business. The business owns the policy, pays the premiums and is the beneficiary of the death benefit. It’s up to the business to determine which individuals are considered key contributors and should be covered by key person life insurance. Term Life is a popular option for those looking to be conservative with costs and only cover a death event. However, other policy types can be used, including Indexed Universal Life and Whole Life for the fact that cash value that can also be leveraged by the business during the life of the key person. Another benefit of these permanent policies is that you can gift the policy to the insured upon retirement.
In the event of the insured’s death, the business can use the funds to continue operations until a replacement is found.
Life Insurance’s Role in Buy-sell Agreements
A buy-sell agreement (aka buyout agreement) is a legally binding contract between co-owners or business partners. It spells out what happens to each partners’ shares in the business if a business partner dies or otherwise leaves the business. In the case of death, life insurance can be used to allow the other co-owners/partners to purchase the shares or for the business itself to do so. There are two ways a buy-sell agreement can be structured:
In a cross-purchase agreement, each co-owner is the owner and beneficiary of a life insurance policy on each of the other co-owners’ lives.
In a redemption agreement, the business itself owns the policies and is beneficiary.
It’s not uncommon for a buy-sell agreement to contain a blend of cross-purchase and redemption language.
Buy-sell agreements are most commonly used by sole proprietorships, partnerships, and closed corporations. Language preventing the sale of shares to an outside investor is typically included.
Life insurance benefits to startup businesses
Most startups only have a handful of key players who hold much knowledge during their early years in business. This makes them especially vulnerable to the loss of a founder or executive. Life insurance proceeds won’t help with knowledge transfer, of course. But it can be useful to keep the lights on while executing a contingency plan or, in the absence of a plan, deciding on a course of action after the loss of a key player.
Living benefits are features of Whole and Index Universal life insurance policies. They allow for the owner of a policy to request a portion of the death benefit while still living if diagnosed with specific medical conditions. Most policies that include living benefits will cover terminal, critical, and chronic illnesses. Obviously the insured individual must not have the condition at the time of applying for life insurance.
Living benefits can help relieve the financial strain on the business if an insured key player is diagnosed with a qualifying condition and can no longer work. If this option is exercised, the death benefit is reduced by the amount paid out under the living benefits feature of the policy. This is not the same as disability insurance.
If you’re interested in learning more about a policy, please call 512-922-1273, use our contact form, or schedule a time to speak.