How to monetize key-person insurance
Key-person life insurance policies are often sizable in value and premium expense. What happens when a key-person life insurance policy no longer serves the purpose it was originally purchased for? The beneficiary (usually the company or partnership) is left with the option of continuing to pay the premiums — without the original need for protection. More common is that the beneficiary ends up lapsing the policy or surrendering it, and getting nothing or a portion of a built-up cash value for the paid-in premiums (and sometimes paying hefty surrender charges).
Another option worth considering is a life settlement: the sale of the life insurance policy to a third-party investor. If the policy qualifies, an investor can pay a present value of the death benefit to the policy owner, in exchange for transferring ownership rights to the investor. That investor then continues to make the annual premium payments until the insured person passes away, at which point, the investor collects the death benefit.
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Policy owners generally receive anywhere from 10% to 70% of the death benefit in a life settlement offer. The offer incorporates the death benefit, the expected premium payments, the life expectancy of the insured, interest rates and a variety other factors. The largest factor is the life expectancy of the insured, and they must be either a minimum of 65 years of age or have a terminal illness (as life expectancy is important) for the transaction to work.
An example case
Our company, Ovid, recently helped an East Coast company with their two key-person policies that collectively had a death benefit of $11.5 million. The two insured executives were in their 80s and the company was the beneficiary of the policies. Due to a decline in value of the business, the executives felt they were over-insured. Furthermore, they were paying more than $150,000 in premiums annually.
The company decided to pursue a life settlement and ended up receiving $1.5 million in cash for their policies. The company was then able to put that cash toward other growth initiatives. The process took a couple months from start to finish and required the executives to take a short health exam.
If you think one of your clients might benefit from this, first determine if there is a need. Some common reasons for selling a key-person policy are:
- The insured executive has exited the business. Their death is no longer a risk to the firm.
- The policy is owned by a partnership that is dissolving. Often, a partnership will insure an executive so that in the event of their death, the remaining partners use the proceeds to buy out their family’s stake in the partnership.
- A decrease in value of the firm led to an executive being over insured — meaning the company is paying too much for too much insurance relative to the value of that executive.
Once a need has been established, find a life settlement company to work with that understands how to guide you and your client through the transaction process.