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LIFE

5 Term Insurance Solutions for Small-Business Clients

My father was a small-business owner, a sole proprietor. When he died unexpectedly, there was no one who could step into his shoes as owner, president, top salesman and day-to-day manager.

Luckily for my family, he had purchased two term life insurance policies years earlier. My mom used the money from those two policies to pay off the business loans and gradually close the business. Without the policies, my family would have suffered extreme financial hardship. At the time, I was too young to understand what it meant, but now that I’m a financial professional, I’m passionate about using inexpensive term life insurance to help small-business owners.
 
Whether it’s working with a business owner on strategies for using key person insurance or providing group benefits to workers, financial professionals should never underestimate the potential benefits that term insurance holds for small businesses. While working with small-business owners, I’ve discovered five ways in which term insurance can be an economical business solution.

Buy-Sell Agreements
Most small businesses with multiple owners need a buy-sell agreement to cover situations in which one or more of the owners dies, retires, leaves the business or sells their portion of the business. These agreements normally are funded with a cash value life insurance policy.

In some cases, however, a small business cannot afford whole life premiums, and that’s when I recommend term life insurance. Even though the term life policy does not fund the agreement if an owner leaves the business, it can provide needed funds to help keep the business operating if one of the owners dies.

When there are only two or three owners, I suggest a cross-purchase arrangement in which the business owners hold term policies on each other. When there are more than three owners, it is usually simpler to use an entity purchase in which the business owns the term policies; otherwise, there would be too many individual policies to purchase.

Key Person Insurance
I see fewer circumstances for key person insurance than for buy-sell agreements, but key person insurance is important to small businesses in many of the same ways. It provides funds to help the business keep operating if one of the principals dies.

The delicate part is determining who the “key people” are. Would there be a risk to the business if one of the owners passed away? Does an owner have skills or knowledge that are vital to the success of the company and cannot be replaced?  
And don’t overlook employees who are key to the success of the company but aren’t owners, such as a craftsperson or an expert in a particular field. Also note that not all owners require key person insurance; some owners may be silent partners or simply not involved in day-to-day operations.  

While key person insurance cannot replace the owner or key person, it can provide enough funds to help the business “get over the hump” until a replacement can be found and trained. If the business has to close, the funds can help ensure a smooth transition for the remaining owners and employees.

I recommend term life insurance for key person coverage for the same reasons as buy-sell agreements: Term life is short term and less expensive, and there’s no need for cash accumulation.  

Credit Coverage
Your small-business clients already have discovered that lending institutions often require life insurance coverage on the principal as a condition of obtaining a loan. Again, most business owners prefer term life insurance in these cases because it is less expensive and needed for a short term, which is the life of the loan. We call this “pure insurance” because the insurance doesn’t build equity; its main purpose is to protect against risk, in addition to keeping the cost as low as possible.

One-year term policies are the most popular for credit coverage. Business owners view insurance as an expense to the company – they don’t want to commit to a long-term expense and they want to reduce costs. With one-year policies, they can review their credit coverage insurance every year, determine if it is still needed and drop the expense as soon as it is no longer required.

This also presents an opportunity for you to meet with your clients at least once a year to help them re-evaluate their protection needs. With the costs of term life policies going up and down, you may be able to recommend another product with the same coverage at a lower cost. And if you can recommend ways for your clients to save money, then your clients will treat you as a financial planning partner, not a salesperson.

Estate Equalization
Term insurance also can be used as an estate equalization tool when assets aren’t going to be distributed equally. Let’s say a business owner has three children, and one has chosen to make the business his career. The other two don’t work in the business and have no interest in owning it. Like most parents, the owner wants to divide the estate equally among the kids, but how can he do that without dismantling the business? With term life insurance policies, the business owner can leave the business to the child who works for it and name the other two children as the beneficiaries of the insurance policies. Upon the owner’s passing, the children receive an inheritance of approximately equal value, the business does not have to be sold to divide the inheritance, and no one is forced into – or out of – a family business. Consulting the business owner’s accountant can help you determine the amount of term life insurance needed to equalize the estate. You may want to coordinate with an estate planning attorney as well.

Retain and Reward Key Employees
Finally, term life insurance can be used to retain and reward key employees. Maybe your client’s start-up business has a key engineer, programmer or artist who is central to the success of the business – and whose services are in demand by larger, better-funded operations. How can this small business afford to offer comparable benefits?
The small-business owner can purchase a term life insurance policy to provide the employee and his or her beneficiaries with the protection of a whole life policy, but at a much lower cost to the business. I usually recommend a product with a conversion option. As the business grows and more funds are available, we can later convert the term insurance to a protection product that also accumulates cash value. The long-term employee then can own the policy and become vested in the cash value as well.  

Term life insurance has many uses for small-business owners. It provides needed protection, but at a lower cost to a business than many other products. For business owners, it usually comes down to price. By recommending solutions that address price concerns and provide short-term protection, you can establish yourself as a long-term partner.






 

Erik Dullenkopf, CFP, is a financial services representative with MetLife Premier Client Group in Ventura, Calif. Erik may be contacted at [email protected] .


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