Business Owner With a Stale Buy-Sell and Thin Disability Coverage
Owen, 52, owns 45% of a specialty contractor with his partner, Ken, who owns 55%. The company is valued at $6.2 million. Their buy-sell agreement sets a $2.5 million total value and is funded with $1.125 million of 10-year term insurance on each owner. Owen's group long-term disability pays 60% of base salary capped at $8,000 per month, with a 90-day elimination period; his base salary is $240,000 and bonuses average $60,000. He has a $1 million personal umbrella, a $500,000 term life policy, and a 16-year-old son who just got a license. His 84-year-old mother may need long-term care. Owen's wife, Elena, 50, earns $85,000 and has no disability coverage. The term policies on the owners renew in three years at much higher rates. Owen asks whether his insurance program is fine because he has good group benefits.
1. Identify and quantify Owen's major insurance gaps.
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- Life and buy-sell: Owen's 45% interest is worth about $2.79 million based on the $6.2 million company value, but the buy-sell is funded with only $1.125 million on him. The agreement's $2.5 million total value is stale and underfunds his interest by roughly $1.67 million. His personal $500,000 term policy is far below what Elena and the children would need for income replacement, mortgage, education, and estate liquidity.
- Disability: Group LTD covers 60% of base salary only, capped at $8,000 per month. His $60,000 bonus is not covered. After tax, the benefit may be $6,000 to $7,000 per month against a much higher household lifestyle. The 90-day elimination period requires a cash reserve. An individual own-occupation policy with supplemental coverage is needed. Elena has no disability coverage at all.
- Umbrella and auto: A $1 million umbrella may be low with a teen driver and business exposure. Consider $2 million to $3 million and confirm that auto liability limits meet the umbrella's underlying requirement.
- Long-term care: The mother's potential need is a cash-flow risk. Owen and Elena should consider LTC coverage while insurable.
2. Evaluate the buy-sell agreement and its funding.
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The agreement value is inconsistent with the company's current $6.2 million valuation. The term policies expire in three years, and renewal at older ages may be expensive or unavailable if health changes. That creates a funding failure at the exact time the agreement is most likely to be triggered.
Recommendations:
- Update the valuation method and the purchase price, and have counsel review the agreement.
- Fund with permanent insurance, a sinking fund, or a combination. A wait-and-see buy-sell can give the entity and the surviving owner flexibility.
- Define death, disability, and retirement triggers, and specify whether the entity or the co-owner purchases the interest.
- Consider cross-purchase versus entity-purchase tax consequences, including basis step-up and corporate alternative minimum tax issues.
- Coordinate the agreement with Owen's estate plan and with key-person coverage for the business.
3. What should Owen do about the teen driver, the umbrella, and his mother's potential long-term care need?
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Raise the auto liability limits and add the son as a rated driver. Confirm that the $1 million umbrella sits over adequate auto and homeowners limits; with a teen driver and a contracting business, $2 million to $3 million is more defensible. The umbrella should not be the only layer-underlying limits must be sufficient.
For his mother, do not assume Owen must fund all care. Explore her own resources, Medicaid planning, and a family discussion. If Owen expects to help, build a separate cash reserve or consider LTC insurance for Owen and Elena, who are more insurable now. Do not use the business's working capital for family care. Coordinate the plan with the buy-sell so a disability or death does not force a sale of the business.