Using Life Insurance Effectively

Insurance. One of the more boring products out there but also one of the most essential, especially in a privately-held business — even more importantly, in a business that is growing. Here are five creative ways life insurance impacts a growing, closely-held enterprise.

1. Key man insurance

This is the one use for life insurance that most business owners know and apply. Its application is pretty self-evident. While you can replace anyone, some members of the team are more critical than others.

The owner is a key person. Employees with proprietary knowledge are key. Employees with unique and difficult-to-find skill sets are key. Employees with important relationships with clients are key.

The point of insuring a key person is to protect the business in the event that person leaves, becomes incapacitated or dies. While the loss of a key person can be mitigated over time, in the short term, the loss of a key person is acutely felt. In some instances, devastatingly so.

Hence, buy life insurance for key people. It’s smart, short-term money spent to avoid acute, business threatening losses that inevitably happen.

2. Buy-sell or cross-purchase agreement insurance

This is another well-known use for insurance. It is for owners of the business, and it protects each owner and the business in the unfortunate event that one of the owners passes away prematurely.

In essence, each owner buys a policy on each of his or her partners. Easy with two owners — two owners, two policies. More complicated with five owners — five owners, 20 policies; each owner having a policy on four co-owners (5 x 4 = 20).

However, this insurance is important. The cross-purchase part of the agreement obligates an owner’s heirs to sell the deceased owner’s stake in the company back to the business. 

The policy proceeds pay the heirs for their shares of the company. The company continues operations without bringing on a next-generation of new owners, possibly disrupting the business in unforeseen and dramatic ways.

3. Stock-redemption plans

When there are a lot of shareholders in a closely-held company, or even an employee stock option plan (ESOP), a stock-redemption plan makes sense. This plan is similar in concept to the cross-purchase agreement, only with more shareholders in play.

The company is the owner of individual policies on each shareholder. Each shareholder agrees to sell his or her stake in the company back to the company in the event of their death. The company uses the proceeds of the policy to pay the deceased owner’s heirs.

A stock-redemption plan is easier to manage than a cross-purchase agreement. As described earlier, with five owners there are 20 policies to buy in a cross-purchase agreement. In a stock redemption plan, there are only five policies to buy; one policy on each owner.

4. Employee attraction and retention

A life insurance policy with vesting is a good incentive tool for employees. The policy is for the employee, and owned by the employee. The cash value of the policy grows tax-deferred.

The employee can take out loans against the cash value of the policy. The employee can withdraw cash from the policy if and when needed. The employee sets the death benefit of the policy. The employee controls the investment strategy for the policy. The employee determines the contribution level to the policy on a pre-tax basis.

This type of deferred compensation program is a strong incentive when looking to hire a key employee and/or retain a key employee. This kind of policy can be an integral part of a person’s retirement package, and offers powerful security to an employee’s family.

5. Group life insurance

A group life insurance program uses insurance as an employee benefit for attracting and retaining employees. However, the flexibility and strength of group policy is not as strong as an individual policy for a key employee.

With a group program, the policies are usually for five-year renewable terms. The benefits are usually tied to one year’s salary for an employee. However, employees can contribute on their own to a policy in order to increase death benefits.

The attraction of this kind of policy is two-fold. One, the rank and file employees all get life insurance. This is often not something that most people would buy on their own. Two, if someone might not qualify for life insurance on their own, with a group program they would automatically qualify. That’s a strong incentive for someone with poor health now, or a poor health history.

The bottom line? The next time you sit down with your CFO, head of HR and insurance advisers, realize that with some creative thinking life insurance can be an important part of your financial and workforce strategies.

Yes, insurance is boring in many ways. But, it can also be that one differentiator that sustains a business in a bad time, attracts that one key employee you want to hire, and can contribute to your business being a best place to work.