BV Benefit #7 - Life Insurance Coverage

Many business owners utilize life insurance as an integral part of their exit and contingency planning.  Without life insurance the overall family wealth management plan may be incomplete.

Life insurance is often used for income replacement or to alleviate the burden of estate and probate taxes upon death.  However, when business owners use life insurance to fund a buyout or redemption of the shares of a deceased shareholder it is important to ensure that the death benefit will be adequate to:

1. Fund the buyout or redemption of the deceased shareholder’s shares (Buy/Sell Insurance); and


2. Ensure the continued survival of the business upon the loss of a key person in the business (Key Person Insurance).

As a result, the life insurance coverage should at least cover the current value of the business.  Privately held business owners spend significant time managing and building their businesses.  When asked, however, many grossly overestimate or underestimate the value of their business.

An independent business valuation provides business owners with third party evidence for ensuring adequate life insurance coverage.  This in turn provides the shareholders with peace of mind and comfort that they and their businesses are sufficiently protected.

Not only is an independent business valuation useful to the insured, it can also be beneficial to the insurance advisor.  An independent valuation will help the advisor:

1. Manage and control the process in creating the application file - insurance companies are increasingly requiring support for the amount of coverage requested; and
 
2. Solidify trust and cultivate the relationship with the client - providing the insured with third party evidence regarding the value of their business eliminates any pre-conceived notions the client may have with respect to being over sold or under estimated as far as coverage. 

The business valuation can be updated annually or semi-annually and can also be used as a benchmark for a value enhancement initiative, among many other possible uses and benefits.   The adequacy of the life insurance coverage should be reviewed annually in light of any growth or other changes to the business over the prior year.  Ideally, this process should be agreed to and formalized in the company’s shareholders agreement, which for many business owners, may not exist or may not have been updated for many years.

The importance of a shareholders agreement can not be overemphasized.   Next week we turn our attention to the need for an independent business valuation in shareholder disputes.