Choices, opportunities Featured

7:00pm EDT January 31, 2007

Where there are choices, there are opportunities. Certainly, this is the case in the life insurance industry as a wide spectrum of plans are available ranging from basic term insurance to key-person insurance.

In addition to combing through the assortment of selections and determining which plan is best suited for your needs, it is also wise to periodically review your life insurance portfolio. “Policies should be reviewed every five to 10 years in order to doublecheck beneficiary designations, owner designations and the performance of the policy,” says John Cookman, area executive vice president for Arthur J. Gallagher & Co. “People’s needs and income levels change so there may be a need for additional life insurance or a need for a different type of policy.”

Smart Business spoke with Cookman about obtaining life insurance policies, considerations that should be taken when planning for the succession of a family business and how key-person insurance works.

What are some things to keep in mind when applying for a life insurance policy?

The key to understanding how much insurance and what type of insurance is appropriate for your situation should be driven by a thorough fact-finding process. This doesn’t always happen, but it is the basis for a solid, well-informed purchase. Factors that enter into the process include such things as whether you own your own business or if you are an employee, your economic status and your family status. The length of time that you need the policy is also an important consideration. For example, young professionals often purchase term life insurance because they want to maximize their death benefit for a reasonable outlay of money.

How can common insurance-related mistakes be avoided when planning for the succession of a family business?

First of all, the circumstances of the family involved are paramount. I have a client whose son is being groomed to eventually take over the family business and the daughter is outside the business working in another occupation. It’s obvious that the son will inherit the business, but the issue of parity is key. In other words, how does the business owner balance the inheritance between his son and daughter? It’s not uncommon that a policy is purchased for the benefit of an heir outside of the business so parity is achieved when the business owner eventually dies. There is also a need for the business owner to provide survivor income for his or her spouse if a premature death were to occur. In some cases, life insurance is needed to cover estate taxes, bank loans and other creditor requirements.

What are life settlements and viatical settlements and how do they differ?

Life settlements are a fairly new trend in the life insurance industry. A life settlement can generally be defined as the purchase of an existing life insurance policy by a third party for investment purposes. The purpose for the insured is to receive more cash than he or she would if surrendering the policy.

A viatical settlement is when an insured, with a life expectancy of less than two years, needs cash and sells the policy to a third party. The two types of settlement are similar, but with a life settlement the insured is typically in much better health. Berkshire Hathaway and AIG are two major players in this marketplace, and they are drawn to these investment opportunities because they believe the policies provide high yields and fairly low levels of risk.

How can a business benefit from key-person insurance?

Generally, key-person insurance is purchased by a business to cover a premature death of a business owner, and the proceeds of the policy can be used to pay for a search to find a replacement, to fund a survivor income plan or to retire bank debt. If it’s a public company the proceeds may help stabilize the stock of the company, because the loss of a key person can cause a lot of volatility in the trading of a stock.

What new key-person insurance underwriting requirement should people be aware of?

Corporate-owned life insurance has driven production in life insurance policies where the corporation is the beneficiary and uses the proceeds to fund corporate liabilities and other benefit programs. This aggressive sale of corporate-owned life insurance has caught the eye of the SEC and IRS. There is now a new requirement when one writes a key-person policy that the insured has to sign a statement acknowledging that he or she understands what the purpose of the insurance is and that he or she knows that the beneficiary is not a personal beneficiary, but rather a corporation. This safeguards against ‘phantom insurance’ and aims to reign in this practice that has been abused by certain insurance providers.

JOHN COOKMAN is area executive vice president for Arthur J. Gallagher & Co. Reach him at john_cookman@ajg.com or (818) 539-1260.