Key people, key protection - 'key person' life insurance could save a business

Nation's Business, March, 1993 by John S. DeMott

Key-person insurance may be more popular now than ever, although there's no way of telling for sure; groups like the Life Insurance Marketing and Research Association (LIMRA) or the National Association of Life Underwriters don't break out sales totals for key-person insurance, as is done for whole life or term life, for example. In 1989, however, LIMRA did do a study of corporate-owned life insurance, which key-person insurance frequently is, and found that a quarter of small businesses own it.

If anything discourages sales, it would be the alternative minimum tax (AMT), which might come into play on benefits received by corporations from key-person policies. Life insurance benefits are normally not taxable, except for those from policies held by corporations.

To Connecticut Mutual's Sullivan, the AMT presents no big problem; just buy a little more insurance, he advises, to cover what could be the AMT's maximum take of 15 percent.

One other possible problem may not be so easily solved, however The Treasury Department dislikes--and may move to eliminate--the practice of businesses claiming a tax deduction for interest paid on loans against the cash value of key-person insurance.

Although interest on loans against the cash value of corporately owned life insurance (called COLI) is deductible under tax law, the Treasury Department sees it as being used by business mainly to avoid taxes--a loophole that should be closed, the department says--because interest on loans from most other sources cannot be deducted.

Most life insurance carriers underwrite key-person coverage. Others, primarily in property and casualty, also sell it. For independent agents who want to branch from property and casualty to life, key-person is a natural vehicle, and they might work hard for the best deals for new clients.

Bob Tedoldi, a life-insurance agent in Connecticut who writes over one-third of his business in key-person coverage, says: "If you've already insured the buildings and the machines, it's a short leap to people who bring in the business for the machines."

Should You Buy?

If you answer yes to any of these questions, you may want to consider key-person insurance.

* Will my business die if I die?

* Will my business fail if this other person who works with me dies?

* How much will it cost to replace this person, and do I lack that much in the bank?

* If I have a partnership arrangement, will I lack the money to buy out my partner if he or she dies?