Life Insurance in Business

Part 3: Corporate Life Insurance Strategies

Corporations, just as sole proprietorships and partnerships, use life insurance to protect their financial interests. This article will examine a number of protection strategies that are employed by corporations to shield them against the loss of important company personnel.

Key person life insurance protects a corporation from the financial loss incurred when a key employee -- a major owner, for example -- dies. (A key person can also be a sales manager, a vice president, a CEO, etc.) Due to the loss of a key person, a corporation could also find itself subject to losses of jobs, customers, and even an impaired credit standing. To offset this financial impact, the company may purchase an insurance policy on the life of the key person. Some contracts include a 'change of insured' provision that allows the employer to change the person who's life is insured when there's a change of personnel, without the need to cancel the existing policy and issue a new one. The corporation owns, pays the premiums for, and is the beneficiary of the policy. The policy's face amount is generally commensurate with the amount of lost corporate income plus the costs of hiring and training a replacement for the deceased key person.

A Section 303 stock redemption permits a corporation to partially redeem a shareholder's stock for the purpose of providing cash to cover estate settlement costs. Tax laws generally require that stock redemptions be total and complete in order to avoid taxing the proceeds payable to the surviving family as dividends. The Internal Revenue Service, however, does allow partial redemptions to pay funeral expenses, taxes and other estate-related costs.

Deferred compensation is an executive benefit that enables a highly paid corporate employee to defer the receipt of current income -- such as an executive bonus – until a later time when the employee would likely be in a lower tax bracket. The deferment agreement specifies the payable deferred amount, the conditions under which the compensation will be paid (retirement, death, or disability, for example), and any circumstances by which the benefit would not be paid. Funding for the deferred compensation may be in the form of life insurance contracts, disability income policies, annuities, mutual funds, or other financial instruments.

Split dollar plans are not actual types of life insurance policies, but rather methods of purchasing life insurance. Under a split dollar arrangement, the employer and employee purchase a permanent life insurance plan jointly. Permanent life insurance is used because it provides guaranteed cash values. Split dollar plans are considered to be an attractive benefit by which a key employee can purchase life insurance at much more affordable rates because the premium payments are shared with the corporation.

The employer's share of the premium is an amount equal to the annual increase in the policy's cash value. As such, the employee's cost in the early years of the plan is generally higher than in later years when the policy will contain higher amounts of cash value (and, accordingly, the employer's share of the premium will be greater). The death benefit is also shared between the employer and the employee in proportion to the amount of the premium each is paying. Generally, the employer is the policy-owner and thus has actual control of the policy, including its cash value.