Most smaller and medium sized companies are owned by an individual, a few partners, or a small group of executives. Some are owned by family members spanning two or three generations. These individuals often own all voting stock, and, with it, control the future direction of the company.

What if something unexpected happens to one of the owners?  Even if an owner lives to a very advanced age, how will the business interest be transferred to successor owners?

Absent a properly structured, legally binding, and properly financed arrangement, the stock of the deceased owner is often inherited by a spouse or children. In many settings, these individuals are not qualified to take on the responsibilities that come with company ownership.

An additional complication may arise from the near-immediate requirement to pay estate taxes. These taxes, due just a few months after the death of a shareholder, can amount to almost half of the value of the stock. The resulting liquidity needs may force the estate to make decisions that will hurt heirs, co-owners, and employees. Liquidity shortfalls can and do destroy companies.

Fortunately, proper business succession planning can address both the structural and funding challenges caused by the death of a business owner, whether that occurs unexpectedly at a young age, or as a result of advanced age.  Since society benefits greatly from a properly executed business transition plan, the tax code has evolved to provide special incentives to business owners who plan an ownership transfer in advance.

One such incentive is the tax-free status of life insurance death benefits.  Policies can be structured to provide tax-free liquidity, enabling the future owner(s) to purchase the stock from the deceased owner’s estate. Life insurance is also an ideal asset to finance estate tax obligations.  Life insurance proceeds enable successor owners to focus on running and growing the company, without having to take on significant debt or being forced into liquidation.

Depending on the value of the company, life insurance requirements often involve tens of millions of dollars. Industry capacity constraints can begin to complicate the acquisition of life insurance policies in excess of $100,000,000, and certainly by the time coverage needs exceed $150,000,000. An intelligent underwriting approach is essential to minimize total policy acquisition costs – and to minimize inconvenience to the busy business owner.

Life Insurance Industry Capacity Limits

All insurers limit the risk they are willing to assume. Even the largest brand name life insurers will limit their internal risk exposure to the $10,000,000 – $30,000,000 range.

Many retail insurers have access to significant lines of reinsurance to boost their ability to offer larger amounts of coverage. But even with effective reinsurance utilization, industry capacity is limited to $300,000,000 – $350,000,000.  Capacity decreases with age and medical underwriting challenges.

One needs to be aware that life insurance underwriting always occurs in the context of total coverage on a given individual – and that does include existing coverage. This rule can lead to complications when an individual, who is already insured for substantial amounts of life insurance, is looking to add significant additional coverage.

This capacity limitation applies even when the new coverage is acquired to replace existing life insurance policies. It is sometimes possible to work-around that limitation via irreversible policy assignments of existing coverage.

Given the above, it is essential to gather data about all existing life insurance already in force. This information should identify the insurers involved, how much each holds on the life of the insured, the type of coverage (term, permanent, single life, survivorship life), the underwriting class, issue date, owner and beneficiary arrangements.

Beyond existing coverage details and the current need, it is also necessary to determine the age of the applicant(s), their health status, and other unique risk exposures that are common with ultra-high net-worth business owners.  Once these variables become known, it is possible to plan for a new life insurance acquisition strategy.

Minimizing the Cost of Life Insurance

Life insurance pricing is highly competitive; yet, product distribution arrangements, insurer product mix of existing blocks of business, and market priorities often lead to significant premium differences from one insurer to the next, even for very similar policy designs and preferred risks.

Premium differentials tend to be even greater once medical impairments are uncovered. One insurer may require a significant additional risk premium for that cardiac stent placed a couple of years ago; another insurer, looking at exactly the same medical data, may see no need to charge an extra premium. Therefore, it is almost always to the insurance buyer’s advantage to survey the market to identify the industry’s best options.

Length of Coverage Requirements / Relationship to Cost

By design, the cost of life insurance is primarily dependent on the likelihood and timing of a death benefit claim. This is why term (temporary) insurance on young individuals is so inexpensive.  The probability of a death benefit payout for a healthy individual in their early 30s who purchases a 10-year level-term policy is near zero.

Conversely, the probability of an eventual claim is 100% for the 75-year-old business owner who has purchased a fully guaranteed permanent life insurance with a lump sum premium.

Thus, one of the most important considerations for business owners is to determine how long the coverage is needed.

Is temporary coverage sufficient, perhaps until the completion of a structured business transfer already in progress? Or is permanent insurance needed to fund the transfer of stock and pay estate taxes following the death of the owner?  In many settings, a combination of temporary and permanent coverage will yield the most cost-effective results.

Preliminary Risk Assessment

Business owners and executives who need large amounts of life insurance often present with one or more unique underwriting challenges. It is best to address those challenges in advance of a formal application, as many of these variables will impact product pricing, insurer selection, and coverage availability.

Medical History

Many individuals who require large amounts of life insurance have reached at least middle age. Some will have been diagnosed with one or more chronic medical conditions.  Sleep apnea, diabetes, heart disease, and a prior history of cancer become increasingly common with age.  All known medical conditions need to be considered in planning a cost effective policy acquisition strategy.

International Travel

Some business owners are global entrepreneurs who travel to undeveloped or other higher risk regions of the world. Life insurers view such travel with caution, given the potentially limited availability of immediate urgent medical care following a medical emergency or accident. This is especially relevant for individuals with existing chronic medical conditions.  Terrorism and kidnappings for ransom are of concern with travel to some parts of the world.

Avocations / Hobbies

Successful business owners often own their own aircraft. Some employ professional pilots – others fly their own. How often do they fly? To where? How much experience do they have? What certifications do they hold? All of these variables will be considered in life insurance underwriting.

Entrepreneurs are inherent risk takers.  Their appetite for adventure leads many to engage in risky sports or hobbies beyond their professional lives. Helicopter skiing in exotic locations or SCUBA diving to explore shipwrecks are not uncommon. Those with near-unlimited financial resources occasionally fund record-setting adventures, most recently including travel to outer space, potentially causing underwriting challenges.

The proactive and full disclosure of these risks in advance of formal underwriting is required to develop a successful underwriting strategy.

Completing the Risk Profile

Some high networth business owners undergo regular executive physicals.  These medical exams can often be used to underwrite coverage up to about $100M of death benefit, without the need for an insurance physical.

In some settings, an insurance physical is required to complete a risk profile.  Fortunately, modern underwriting increasingly relies on lab analysis, making it easier for applicants to obtain coverage.  For example, lab testing for NT-pro-BNP (enzymes that can be released by the heart muscle under stress) has mostly replaced traditional emphasis on cardiac stress testing. 

Insurer Selection

The primary consideration for most applicants for life insurance is cost. The goal is to leverage the lowest premium outlay into the most death benefit. The following variables need to be considered with that objective in mind:

• The cost of insurance can vary considerably by product and insurer
• Insurance company medical testing requirements
• Inconsistent underwriting results
• Insurer capacity limits

While there are thousands of life insurers, in practical terms, for these very large risks, there are only a couple dozen insurers with the ability to offer coverage of $5,000,000 or more.

Sequential Layering of Life Insurance Applications

Many applicants prefer the convenience of applying for all coverage at once.  For younger super healthy applicants that’s a reasonable approach.

For older clients, or those with known medical conditions, it can be more cost-effective to proceed with sequential applications and policy placement, based on required medical evidence.

In a typical case for a 60 year old applicant, it may be possible to line up $100,000,000 of coverage at preferred rates based on existing medical records, and perhaps a basic insurer-ordered paramedical exam.

One of the most competitively priced insurers has $20,000,000 capacity – but may require an EKG for any amount above $10,000,000.  Does it make sense to order the EKG before existing offers are placed?

Insurance companies ask for medical testing to uncover the unknown.  What if the new EKG gives reason for concern?  Unless the existing offers of insurance are placed in advance of completing the EKG, all bets are off.  In other words, the desire for convenience “let’s get all testing out of the way at once,” can have a significant impact on all coverage.  A more prudent approach would be to place existing offers in force before ordering additional medical evidence.

Reinsurance Considerations

In the quest to identify the lowest total premium outlay for the largest amount of insurance, the tactical acquisition of reinsurance is paramount. Reinsurance treaties enable most of the larger life insurers to bind up to $65,000,000 of coverage automatically. Beyond that amount, insurance is usually secured via insurer internal retention only coverage, or non-automatic (“facultative”) reinsurance – or a combination of the two.

Internal Retention Coverage

Some of the very largest brand name insurers have the capacity to offer retention only coverage for somewhere between $10,000,000 and $30,000,000. Retention only refers to a life insurer’s ability to accept a certain amount of risk without the use of reinsurance.

Assuming the applicant has already secured $65,000,000 of coverage at the lowest available price, purchasing large chunks of retention-only life insurance from one or more insurers is often the next most cost-effective step. The cost may be a bit higher than what was available for the first $65,000,000.

What if even more liquidity is required to transfer a business interest and/or pay estate taxes at death?

Facultative Reinsurance

For coverage needs beyond automatic reinsurance and retention only coverage, there is another important form of insurance: facultative reinsurance. For this additional insurance, the retail insurer will cede both the underwriting decision making (i.e. pricing determination) and claims risk to one or more facultative reinsurers. All of this happens behind the scenes and is irrelevant to applicants and policyowners.  The retail insurer will issue the policy, taking care of  ongoing policy billing, administration, and eventual claim payment.

Insurance Cost, Convenience, and Policy Issue Speed

Of course, each case is unique and each applicant has their own priorities. In most real-world settings, the ultimate cost of the insurance is given highest priority. For those cases, going through the sequential steps outlined above, will produce the most cost-effective results.

When Speed of Policy Placement is More Important than Cost

In some settings, securing offers of insurance quickly is paramount.  Perhaps a new round of bank financing is contingent upon funding a buy-sell agreement. In such settings, working with an insurer that has lined up large amounts of reinsurance, sometimes referred to as the “super pool,” can facilitate the quickest possible policy issue. The cost of coverage may be slightly higher as policy pricing would be based on the rates offered by that one life insurer.

The above discussion highlights the importance of clear communication regarding an applicant’s priorities. The applicant should be aware of the various options so that they can balance the variables of cost, convenience, and coverage effective date requirements.

Competition is Counter-Productive

Some life insurance applicants believe it is in their best interest to invite several advisors to compete for their business. That might work for small amounts of life insurance – but it is always counterproductive in the context of large amounts of life insurance.  Let’s review why it is unwise for an applicant to “shop” for life insurance via multiple advisors in an uncoordinated fashion.

Interconnected Insurance Market

Part of the life insurance industry’s stability comes from its global interconnectedness. Some retail insurers have significant reinsurance operations that also insure the risks of their competitors. Even relatively small policies are often reinsured by one or more reinsurers.

Avoiding Overinsurance and Fraud

A sophisticated reporting system protects the industry from the attempts to game the system, especially attempts to purchase life insurance coverage significantly in excess of financial need, sometimes for the profit of unscrupulous institutional beneficiaries.

The moment insurers get wind of multiple uncoordinated applications to cover the same applicant, they will “freeze” the underwriting process until they can gain a clear understanding of the ultimate goal.  By then, many of the strategic cost-saving strategies outlined earlier will have evaporated as the industry protects itself against attempts at over insurance or outright fraud. 

Coordinating Multiple Advisors

Some high net-worth applicants have the understandable desire to involve several of their trusted financial advisors with the acquisition of significant new life insurance. In that case, the most effective strategy is to appoint an experienced insurance coordinator who represents the interest of all parties. A carefully coordinated strategy that complies with the ideas outlined above can work well, even in a multi-agent environment.  Full disclosure from the start is key to avoiding an “insurance freeze.”

Questions for the Applicant

By now it should be clear why it is highly advantageous to gather relevant pre-underwriting details in order to establish the most intelligent underwriting approach.  Answers to relevant questions listed below provide a good starting point for discussion:

• How much life insurance do you need to take care of your family?
• How much life insurance do you need for business purposes?
• How much life insurance do you need to pay for estate taxes?
• How much life insurance do you already have in force?
• What type of policies are those? If permanent, obtain a current statement of coverage.
• Do you plan to keep that coverage or plan to replace some or all of it?
• Who owns your current coverage? If trust-owned, who are the trustees?
• Who will own the new coverage? If trust, does it already exist?
• How long do you need insurance coverage?
• Have you applied for life insurance in the past two years?
• Have prior life insurance offers been approved at premiums higher than expected?
• Who are the healthcare providers you have seen in the past 5 years (including specialists)?
• Do you complete annual executive physicals? Where? Date of the last one:
• Do you have easy access to your current medical records?
• What prescription medications are you taking? Which condition does each treat?
• Do you have any chronic medical conditions, like sleep apnea or diabetes?
• What medical devices are you using (e.g., CPAP to treat sleep apnea, pacemaker or defibrillator to regulate heartbeat)?
• Have you been hospitalized, or undergone outpatient treatment, for any reason in the past 5 years? If yes, please provide reason, dates, and outcomes.
• Have your mom or dad been diagnosed with, or passed away from, heart disease, cancer, or stroke prior to age 65? If so, who, what happened?  At what age were they diagnosed?  If they passed away, how old were they?
• Have you used any form of tobacco, nicotine, or marijuana products in the past 3 years, including chewing, cigars, dipping, edibles (brownies, gummies), gum, joints, vaping, pipe, cigarettes, patch, or similar? If yes, please list each, including type, frequency, and date last used.
• Do you have any medical goals, like losing weight or to stop smoking?
• Where have you traveled for business or pleasure in the past two years?
• Have you booked any international travel for the upcoming year?
• Do you fly commercial or by private jet? Do you own a plane?
• Do you have a pilot’s license? If so, what certifications do you have?
• If you fly your own plane, list total hours, hours past year, hour likely this year:
• What sports do you enjoy (e.g. mountain climbing, skiing, SCUBA etc.)?
• Do you pursue any unique hobbies (e.g. exploring shipwrecks)?
• In the context of this life insurance application, how would you prioritize the competing variables of convenience, speed, and ultimate total cost of coverage?
• Who are the other advisors we will be working with (e.g. CFO, CPA, attorney, banker, investment advisor)?

Underwriting Strategy for Jumbo Life Cases

Underwriting very large amounts of life insurance requires a thoughtful approach to lining up cost-effective coverage at the industry’s high capacity insurers.  Decades of relationships with medical directors and chief underwriters go a long way to arranging for the smoothest possible policy placement.

When you have the opportunity to develop a jumbo life insurance case for one of your most important clients, you’ve come to the right place.  Let’s put our heads together to structure an effective underwriting approach.  Connect with your CPS Advantage Representative or feel free to request a strategy call (or Zoom) via email.  We look forward to learning about your client’s priorities and applying our expertise.  We’ll take good care of you and your client.