You're just getting ready to leave the office for the evening when the home office underwriter sends you a fax requesting more information on a life insurance case that you submitted. It's a business case involving a buy-sell agreement between three members of a limited liability company (LLC). The agreement is a cross-purchase agreement with each member requesting coverage on each of the other members for $1.5 million. The application was complete, and the members are all in reasonably good health. So why, you ask, is the underwriter asking for more information? So goes another battle of sales versus underwriting.
Specifically, the underwriter is asking for a cover letter providing more details of the transaction and a complete explanation of the purpose of the coverage. Additionally, the insurance company's home office is asking for a copy of financial statements and the calculations used to determine the amount of insurance requested.
This certainly seems like a lot of information to justify a life sale to a group of individuals that runs a successful software company. However, sometimes it is important to take a step back from the case to fully understand what the home office is trying to accomplish.
More documentation
In today's world, a life insurance policy worth $1.5 million may not seem like a lot of money. In terms of personal insurance, it is not difficult for someone to qualify for $1.5 million if they have a few kids and a mortgage and fall in the upper-middle-class income range. However, this case is not about whether or not the individuals could qualify for $1.5 million in personal insurance. This is an entirely different type of case and requires more documentation. Let's review what the underwriter requested in order to understand how it would help justify the case.
The cover letter is an important aspect of any case that involves special circumstances. It provides a narrative explanation of the important details. In a buy-sell case, it is essential to properly structure the life insurance to match the type of agreement. Each type of agreement has its own requirements and requires different owners of the life insurance policies. Additionally, the cover letter in a business-planning case should detail as much information about the business as possible. This helps the underwriter understand your client's needs. At a minimum, the cover letter should provide this information in a business-planning case:
- Purpose of the insurance
- Estimate of the value of the business
- Whether the buy-sell agreement is an entity purchase or cross-purchase agreement
- The names of the proposed owner, insured, and beneficiary of each policy
- Whether the business is a C corporation, an S corporation, a partnership, LLC, etc.
- The percentages of ownership in the business
- The type of business and how it operates
- Any other insurance on the proposed insured(s)
A well-written cover letter provides the bridge between the client and the insurance company. It provides important details, puts the pieces of the case together, and presents the client's "story" to the underwriter.
Balance sheet and income statement
Ideally, an independent appraiser provides an appraisal of the company. The report supplies an objective evaluation of the company's fair market value. In this situation, the report should be given to the underwriter.
Because an appraisal is not always completed, the underwriter should receive the financial statements, also known as the balance sheet and income statement. The income statement shows the results of the financial operations over a period of time. It shows how the company is creating profitable income through its sales. The balance sheet, by comparison, provides a financial snapshot at a given moment. It shows how affluent the business is, its assets and how liquid they are, and its debt and how the debt is financed. The underwriter can use this information to evaluate the business and determine if the amount of insurance requested is appropriate.
If for some reason financial statements are not readily available, the underwriter may ask for tax information from the business. If the LLC has chosen to be taxed as a corporation, then the tax returns for the business are required. If the LLC has chosen pass-through taxation (taxation as a partnership), then the tax returns for the owners are necessary. Pass-through taxation treats the partnership or business as its own separate taxable entity (although the entity does not actually pay taxes) with income and expenses passed on to the owners of the LLC. Financial statements are preferred, but, if nothing else is available, tax returns provide some relevant information.
Reasoning behind the numbers
Finally, the underwriter may ask to see the calculations used to justify the amount of insurance requested. If there was a method used to quantify the need for insurance, it is helpful for the underwriter to review it. As with the other information, the calculation shows the reasoning behind the numbers. It indicates that the number was not just an estimate of the need. It also shows that the producer applied an objective formula to arrive at an answer and gives more credence to the figure.
Underwriting a business planning case is more complex than your standard life insurance sale to an individual. It requires more time and due diligence from all parties -- not only because the amount of insurance is relatively high, but also because there are more parties involved and more difficult calculations of life insurance requirements.
If the home office receives all the relevant information detailed above, the underwriter will have a better understanding of the case. Consequently, there will be less time spent on the application, the case has a better chance of being issued in a timely manner, and the client will benefit from matching their true needs to the insurance plan. In the end, this is a winning situation for all parties involved and heads off yet another battle between the field and the home office.
Thomas J. Fridrich JD, CLU, ChFC, CLTC, is an advanced markets specialist with Mutual of Omaha focusing on retirement planning, charitable giving, and estate and business planning. He can be reached at tom.fridrich@mutualofomaha.com.
