Survivorship Insurance Policies

(Joint-Life, First to Die, Second to Die)

Recently, there has been great interest in a type of policy that insures two people (and, in some cases, up to eight people), but unlike a last-to-die policy, it pays a death benefit upon the death of the first insured. Since first-to-die policies have become more common, you may have been wondering whether they make sense within the framework of your personal or business planning. The policy, bought by the business, pays at the first death. The benefits provide the business with enough cash to redeem stock or interest of the partner who died. Typically the insurance is part of a buy-sell agreement.

Dual-income couples and small-business owners are prime candidates for a type of life insurance they may have heard of but may not be familiar with: first-to-die or second-to-die life insurance, commonly called survivorship insurance.

One reason to consider buying a first-to-die policy instead of two single-life policies is cost. Premiums on a first-to-die policy might be from 20% to 40% less than the premiums on two separate policies covering the same two lives. In addition, on a dollar-for-dollar basis, the cash value buildup from one first-to-die policy is claimed to exceed the cash value buildup from two separate policies (you should always review detailed ledgers to see if this will be true in your particular case).

Another major benefit for couples is that if one spouse is uninsurable, but the other is healthy, many policies will provide coverage to both parties, still at costs less than single-life policies.

Aside from issues such as cost and cash value buildup, there is a variety of situations where a first-to-die policy may be used to good advantage. For example, a first-to-die policy may be appropriate for a two-income couple with a significant mortgage -- insurance protection upon the death of the first breadwinner may be essential. The same holds true in a small, closely-held business where creditors require debt insurance. If the business has two principals, the proceeds from the first-to-die policy can be split, with one portion paid to the creditors and the balance retained by the business to indemnify against the loss of the principal's services.

Buy-Sell Funding example

A corporation or partnership with two or more owners often experiences problems of transferring ownership to the surviving owner or owners and paying a fair cash price to the deceased owner's heirs.

This problem is usually remedied with a properly structured "buy-sell agreement," which assures a fair price for the decedent's share of the business and allows the surviving business partner to retain control and ownership of the business.

Life insurance is well established as the ideal method of funding buy-sell agreements. By using a joint-life policy, the company may be able to reduce the amount of cash flow required to pay the premiums, while still guaranteeing that the funds will be available for the buy-out no matter which partner or shareholder dies first.

Key Person Protection Example

The loss of a key employee or executive can have a devastating effect on the future of a business. The use of joint-life policies can reduce the required cash flow to insure against the loss of any one person from a selected group of key persons. Insurance proceeds can be used to find, recruit, and train replacement employees and sustain or strengthen the company's credit position.

Working Couples Example

With the growing percentage of families today relying on two incomes, it is prudent to insure against the loss of either spouse. The joint-life policy should be considered as part of the solution to the loss of income from the prior death of either spouse.

Deferred Compensation

If there is a need to provide deferred compensation, a first-to-die policy can be a very cost-efficient funding vehicle. Should one of the insureds die, the business will have a ready source of funds with which to pay benefits to both the deceased's spouse and the other insured(s). Perhaps the most natural use of a first-to-die policy is to fund buy-sell agreements between business owners. Upon the death of the first insured, the family of the deceased owner can be cashed out through the policy proceeds, while the survivor retains the business free and clear.

Second to Die

Second-to-die insurance (or last-to-die) is the older and more common form of survivorship coverage. Typically this policy is bought by a couple. The policy insures both lives but pays its death benefit when the second spouse dies, not the first. For some couples, this is when the policy is most needed. Because of the unlimited marital deduction, most couples don't have to worry about estate taxes until the surviving spouse dies. For the year 2000, any estate valued over $675,000 could face estate taxes. (Estate taxes are one reason a survivorship policy should usually be placed in an irrevocable life insurance trust, so the policy isn't included in the second decedent's estate.)

The survivorship policy could provide the needed cash to pay any estate tax bill, and expenses associated with settling the estate. This is especially helpful if much of the estate's value is tied up in illiquid assets such as real estate, a farm or small business that you don't want to have to sell to pay the taxes-in essence, "replace" the assets the estate used to pay the tax bill so that the beneficiaries don't find their inheritance substantially eroded by the IRS.

Although second-to-die insurance has traditionally been used by older couples with estate tax liabilities, couples with children, especially children with special needs who will require a lifetime of care, find the insurance attractive because it provides in the event either or both parents die young.

Where second-to-die insurance may not fit as well for couples is if one spouse isn't earning income, or there is a great disparity in income. Then they might want to put their insurance dollars into individual policies, and more heavily on the life of the higher earner so that the survivor will have immediate cash to live on.

Types of Policies

If you decide that survivorship life insurance is appropriate for your circumstances, you'll then need to determine what's the best type of policy. Most policies come in one of three forms: whole life, universal or variable universal. Term insurance is relatively uncommon because of the expense for most older insureds. Variable universal is especially popular these days for the younger or even baby boomer generations, because it allows flexible premiums and stock market investments. For older policyholders, however, many experts recommend sticking with the more traditional whole life with its fixed premium and guaranteed death benefit. Older policyholders usually want to be more certain in the return of their insurance investments.

Beyond choosing the right type of policy, examine and tailor policy features to your circumstances. For example, see if the policy charges a premium for splitting the policy into two separate policies in the event of a divorce, dissolution of the business or a change of tax laws. Also, these joint-life policies can be in effect a long time, so be sure the insurer is financially solvent and the premium illustrations are realistic.

Survivorship policies have come into their own as a life insurance option. It could be beneficial to discuss how your personal or business planning might benefit from the use of a first-to-die or second-to-die life insurance policy.