Cerson: Funding a continuity agreement

Recently, I met for a scheduled coaching session with one of the independent advisors I support. He has a successful and well-established financial-planning practice. He was concerned with the potential impact on the value of his books of insurance policies and mutual funds should he die or become incapacitated.

As Vince Valenti pointed out in a recent column ‘Protecting your client book’, a well thought-out and drafted continuity agreement could protect the value of one’s book in the event of one of these contingencies, assuming a willing purchaser can be found.

Until such an agreement is put into place, the risk of not realizing full value for years of equity and ingenuity is very significant. Even if a continuity agreement can be put into place whereby there is a buyout in the event of death or disability, where will the purchaser come up with the funds to complete the agreement if a triggering event occurs? Insurance would seem to be the obvious answer so let’s take a look at the options.

As with buy/sell agreements between business partners, insurance is regularly used to fund these agreements. However, as an independent advisor, one may not have a business partner sharing profits from a book of business. Could one enter into a continuity agreement with a purchaser with whom there is no business relationship? Of course, they can but would insurers be willing to underwrite life and disability policies on the life of the seller owned by the purchaser? Recent inquiries with the underwriting departments of several major insurers found differing opinions. Some insurers felt there was sufficient insurable interest in insuring an agreement for otherwise unrelated parties. Others were not comfortable with this approach.

It seems that there is a need for advisors to educate and influence some underwriters until they understand and are comfortable with the business reason for insurance funding under these circumstances.

In his article, Vince also suggests that the dealership/MGA might be party to the agreement. One would think that since the advisor is contracted with the dealership/MGA, there would be an insurable interest. The buyer (in this case, the dealership/MGA) would own insurance on the life of the advisor to fund the continuity agreement. Again, responses from insurers have varied with some agreeable to insuring such an agreement while others not.

If, for whatever reason, it proves difficult to get a policy underwritten for a continuity agreement, consideration could be given to transferring the ownership of an inforce policy on the life of the seller to the buyer who subsequently makes himself/herself the beneficiary. If this is a recently issued policy without cash value, there are not likely to be any significant adverse tax consequences attributed to the seller. However, transferring ownership of a policy that has been inforce for some time or contains significant cash value could trigger a taxable disposition or give rise to policy valuation issues. So, careful consideration should be given before doing so.

In the absence of a continuity agreement, an independent advisor could simply buy sufficient, life, disability and critical illness insurance to mitigate the potential loss caused by these events occurring. This gives either the advisor or his/her estate options at a time of crisis rather than being forced to sell the book of business at a fire sale price.

As advisors, we encourage business people to use insurance for risk management purposes. Aside from protecting the value of our practices, we should be a model for our business owner clients by implementing these types of insurance solutions for ourselves.

Casey Cerson, CLU, CH.F.C, is an advanced case consultant at IPG Insurance Inc..