We all know people who have had cancer, a heart attack or a stroke. In fact, every 26 seconds, someone in the U.S. is diagnosed with cancer. Every 29 seconds, someone suffers a coronary event. Every 53 seconds, someone in the U.S. suffers a stroke.
This means your business-owner clients know people who have suffered these conditions as well.
Are you prepared to discuss how the occurrence of one of these illnesses might impact not only your clients personal life plans, but also their business plans?
It is impossible to predict how we might react if diagnosed with a life-threatening condition. Some may choose to return to normalcy as soon as possible, while others may make drastic changes to life and work routines. Unfortunately, some have no choicebecause of their medical circumstances.
Critical illness insurance, which provides a lump-sum benefit amount upon diagnosis of certain medical conditions, benefits different individuals in different ways upon such a diagnosis. The proceeds from a CI policy can provide needed funds for those wanting to change their lifestyles and financial security for those whose medical conditions prevent them from having much choice.
That is the essence of insurance: It funds security and it funds choice.
Following are some business applications where this particular insurance can help.
CI and Buy-Sell Planning: Many insurance professionals are familiar with buy-sell planning in the life insurance context. Business owners enter into a legal agreement requiring the purchase of their ownership interest upon their death. The most common structures for these agreements are the entity purchase (the business buys the interest) and the cross purchase (the co-owners buy the interest). In these scenarios, life insurance proceeds are used to effectuate the agreement.
Firms also can set up an agreement that is triggered and funded upon the diagnosis of a critical illness. Which type of planthe entity or cross purchaseis better for a CI buy-sell agreement? The answer is: It depends.
A cross-purchase agreement using CI insurance has the same benefits as the cross-purchase agreement that uses life insurance. The remaining owners have the funds to purchase the shares without incurring precarious debt. Also, they receive an increase in basis equal to the amount they pay for the shares. All of the owners have the security of knowing that, should they be the one to incur a critical illness, they wont have to accept installment payments or worry that the business will collapse before the purchase price is paid.
An entity-purchase agreement may be the solution if flexibility is the primary concern. With this option, the proceeds would be paid directly to the corporation. The shareholders can agree in advance under which circumstances the critically ill shareholder could or must be bought out. Further, they may also wish to include a “waiting period” to allow the critically ill shareholder the time to decide whether he or she wishes to remain in the business post-diagnosis. The key to using this strategy effectively is to plan in advance who is to decide whether and when the purchase will be carried out.
CI, Disability, and the Buy-Sell: CI insurance may have a role even if your clients do not wish to include a CI “trigger.” This role may be to help fund the disability provision in the buy-sell agreement. (Note: The vast majority of buy-sell agreements will require a buyout upon the disability of a shareholder.)
Traditionally, business owners have attempted to pay for the disability buyout with 1 of 3 methods: payment from current cash flow, a traditional disability income policy, or a lump-sum disability policy.
Each of these 3 funding alternatives has drawbacks. The worst, of course, is the no-funding option. With this option, the shareholders confidently explain that if a disability occurs, they will execute the buyout from then-current cash flow. Of course, none of the shareholders will have assurances that funds will be available to purchase their interest should a disability occur. After all, what if the business is less profitable due to the loss of one of the owners? Will the remaining owners be able to make the payments to the disabled owner and still run a profitable enterprise?
A traditional disability income policy is difficult as well. These policies are designed to replace income, not equity. To illustrate, many small business owners may limit the amount they pay themselves so they can grow their businesses; therefore, the benefit amount may be completely unrelated to the value of their ownership interest in the business. Purchasing a disability policy that pays a lump-sum benefit commensurate with the disabled persons ownership interest would better suit the need. But lump-sum buyout policies may be prohibitively expensive. Consideration should also be given to whether the business owner has any medical conditions that would prevent the issuance of a disability policy.
CI policies can provide partial coverage in these situations. If the disability is caused by one of the CI policys covered conditions, the policy will provide the needed funds, in a lump sum, to finance the buyout. (Make sure clients understand that the disability is covered only if caused by one of the covered conditions.)
There are many factors to consider when establishing a comprehensive business continuation plan, so the financial advisor should ensure that clients consult with legal and tax advisors regarding their specific situations.
No one can control uncertainties and contingencies of life. However, advisors can help clients have security and choice when these unfortunate contingencies occur. Using CI coverage in buy-sell agreements allows for both.
Ronald J. Lee, JD, CLU, ChFC, is an advanced markets specialist with Mutual of Omaha, Omaha, Neb. His e-mail address is [email protected]
Reproduced from National Underwriter Edition, August 19, 2004. Copyright 2004 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.