By

Washington, D.C.

At the recent annual meeting of the Association for Advanced Life Underwriting, Stephen O. Rothschild shared some of the techniques he has used when planning the continuation of a client’s business.

One method explained by Rothschild, who is president of Rothschild and Sale in St. Louis, Mo., was the use of a business irrevocable life insurance trust (BILIT(TM)). A BILIT is an irrevocable life insurance trust holding the policies that will fund the cross-purchase buyout at the time of an owner’s death.

“Most advisors you deal with haven’t heard of this term,” he said.

The example Rothschild used had 3 business owners, all owning equal shares of a $15 million business. He explained that under a traditional cross-purchase arrangement, each owner holds insurance policies covering the remaining 2 owners for their respective share (in this instance, each owner would own a policy insuring each of the other 2 owners for $2.5 million).

This design has been widely used and results in the inclusion of all business ownership in each respective estate. Rothschild showed how use of a BILIT can remove the buyout share from the estate of the surviving owners.

Each owner forms a BILIT, which holds the policies on the other two owners.

At the first death, Rothschild explained, the BILITs of the surviving owners purchase the deceased owner’s shares. Then, each BILIT increases coverage on the remaining two owners.

At the second death, the BILIT of the last surviving owner again purchases the deceased owner’s shares with the proceeds from the life insurance policies.

While the end result gives no estate tax advantage to the first owner to die, Rothschild explained that the ownership interest that was purchased by the BILITs will remain outside of the estates of the other owners.

“It’s never good to die first,” said Rothschild.

Another idea with which Rothschild has had some success is the addition of a common disaster provision to business continuation agreements.

“This is a great way to score points in discussions with attorneys,” he said. “Ask some attorneys how many times they’ve done this, and most will tell you none.”

Rothschild used the previous example to illustrate the importance of a common disaster provision. If 2 of the 3 owners were involved in the same automobile accident, and one owner was killed immediately while the other died 13 hours later, the heirs of the first to die would receive the $5 million buyout from the other 2 owners. The second to die’s family would receive a $7.5 million buyout from the last surviving owner.

Rothschild asked, “Does a 13-hour difference in death justify a 50% difference in proceeds?”

Heirs of the first owner to die will most likely feel slighted due to the inequity of proceeds. This can create problems–especially when dealing with a family-owned business, he said.

In these cases, Rothschild explained that an equalization clause can be built into the buy-sell agreement. “It may say that if death occurs within 4-5 months, you split the proceeds,” said Rothschild. “The longest you would likely go would be 6 months.”

Some of the other tools Rothschild described were the use of guaranteed survivor purchase options, non-transferred cross-purchase policies, first-to-die riders, designated life riders, second-to-die policies, and guaranteed purchase options.

“These are the tools that when mixed and matched can help form better equality for your clients,” he said.

“You need to make people aware and think through the first death. They never know which death they are going to be, so I want people to think it through and make an informed decision,” said Rothschild.


Reproduced from National Underwriter Life & Health/Financial Services Edition, April 29, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.