Lowering costs with first-to-die - life insurance for small business owners

Nation's Business, Oct, 1994 by John S. DeMott

Brothers Raymond and Richard Shelton run R.L. Shelton Trucking Inc. in rural Virginia, employ about 35 people, and generate sales of $2 million annually. Their trucks carry furniture from manufacturers in the East to outlets in the Midwest and on the West Coast.

The Sheltens also have a form of life insurance that's catching on with small businesses. Called "first-to-die," the policy will pay $225,000 to the trucking company should either brother die. The payment would give the corporation money to buy the deceased person's interest in the business.

The Sheltons had been carrying two $50,000 policies and paying about $2,000 a year in premiums. When they bought their first-to-die (FTD) policy, their premium did double-to $3,922--but their coverage jumped by 41/2 times.

The brothers also could have bought a form of insurance called "key person" (see "Key People, Key Protection," March 1993), but that would have been more expensive. Keyperson protection is usually just that-- coverage of an individual whose loss could endanger the survival of the company. First-to-die policies by their nature cover two or more people and assume the continuing presence of other capable managers. The choice between the two types of coverage is made by the company on the basis of expected need.

A third category is "second-to-die" or "last survivor" coverage, which is frequently used to give a business liquidity to pay estate taxes after the death of the widow or widower who had inherited the firm from a spouse.

Charles Daniel, an agent for the New England Mutual Life Insurance Co. of Boston, who had sold the Sheltons insurance for years, sold them their FTD policy when New England was approved to write this coverage in Virginia in June 1993.

As a single policy covering multiple lives, FTD pays when the first covered person in a group dies. Insurers can offer it for less money than other forms of life insurance, largely because of reduced administrative costs. The actuarial figures are complicated, but generally it's about 30 percent cheaper to insure eight people collectively for $8 million under a first-to-die policy than it is to issue eight separate policies for $1 million apiece.

Under an FTD contract, the surviving partners have the option of renewing the policy within 60 to 90 days without having to prove their insurability, even after the passage of many years when the health of one partner may have deteriorated. Any other person who is added to the policy, however, must pass medical muster. (If the newcomer is rejected, the agent might be able to find another carrier that would accept the risk.)

In the case of small businesses, which insurers see as a major market for first-to-die policies, the proceeds from the policy can be used to buy out the deceased partner's share of the business.

In small corporations like R.L. Trucking Inc., the corporation pays the FTD premium on behalf of the insured executives. It then collects the payout upon the death of either of them, free of federal income taxes--like any other payout of insurance benefits.

A national survey in 1992 by the Tillinghast unit of the New York-based Towers Perrin consulting firm found that 11 companies had sold 4,700 FTD policies for $13.8 million in premiums. A follow-up study this year found 20 companies had sold 8,100 such policies for $24 million in premiums.

Craig Wilkey, a consultant for New England Mutual Life, attributes the rising sales of FTD to price consciousness and a greater competitive drive within the insurance industry. "There's a little more pressure on the agents and the industry itself," he says, "to give people a product that gives greater perceived value."

Allan Hancock of the Allan Hancock Agency in Altoona, Pa., incoming president of the National Association of Life Underwriters, sells the first-to-die policies of the Prindpal Financial Group, in Des Moines. "I'm designing a case for it right now," he says. "A partnership. Two business owners who own a shopping center together, $500,000. It's absolutely ideal for a lot of situations. I love it."

In March, CNA, based in Chicago, began offering a first-to-die policy called Co-Life. Bob Miller, assistant vice president of Co-Life distribution, says the product offers the comprehensiveness of two individual policies '"while lessening the cost significantly." New England Mutual Life's version, called First Provider, is sold in all but three states.

One complex version of First Provider uses riders to reflect each executive's value to the firm. If Executive A dies, the policy would pay, say, $350,000. But Executive B's death would bring only $150,000. In another version, there are minimum and maximum premium amounts that a company can pay each year, so it can effectively reduce premium payments in bad economic times.

The appeal of FTD coverage is also assisted by technology. Tillinghast consultant Larry Stern, in Hartford, Conn., suggests that it's a bit of a trick to offer a life policy on a group of people, and he says that the industry did not have the capability to keep track of more than two people on one policy until the late 1980s. Now, computers allow this with far greater ease, contributing to FTD's new popularity.