Insurance Stakeholders and Terms

• Beneficiary – The person or entity designated by a policy owner to receive a death benefit. There can be one or more beneficiaries associated with a policy; the primary beneficiary is the first to receive the payment. In the event primary beneficiary pre-deceases the insured individual, the death benefit will be paid to the contingent beneficiary or beneficiaries.
• Death Benefit – The sum of money distributed to the beneficiary upon the death of an insured individual.
• Insured – The natural person whose life is insured by a life insurance policy. If the insured individual passes away while there is an in-force life insurance policy on their life, then a death benefit will be paid by the insurance company to the beneficiary per the terms of the insurance contract.
• Insurer – The insurance company that underwrites the life insurance contract thereby taking on the liability of paying the death benefit to the beneficiary upon the death of the insured. To compensate for this risk, insurers collect premium payments from the policy owner on regular intervals (monthly, quarterly, semi-annually, or up front).
• Policy Owner – The person or entity that takes out a life insurance policy on an individual’s life. Policy owners can be the insured individuals themselves, the insured’s family members or the insured’s employer. Importantly, employers may not take out life insurance policies on employees without their consent.
• Premium – The amount of money that a policy owner pays the insurer to keep a policy in-force. Term life insurance premiums generally cost less than whole or universal life policies, however term life policies do not accumulate a cash account and will lapse if a scheduled premium is not paid.

Example Scenarios:

Beth and Bob are married and have two children. Beth is an executive at Superchips, a technology company, and Bob is a freelance photographer. Beth serves as the main breadwinner for the family.

1. 1. Since the family relies on Beth’s income, Beth purchases a term life insurance policy from Green Insurance Co. that will reach the end of its term the same year as Beth and Bob’s youngest child is expected to graduate from college. Per the terms of the life insurance contract, the death benefit amounts to 4x Beth’s annual salary. Beth names Bob as the beneficiary for this policy so that he may receive the death benefit to pay for family expenses if Beth were to pass away while the children are still in school. In this situation:
      1. Beth is the insured individual and policy owner who is responsible for paying the premium,
      2. The insurance contract is a term policy which will only remain valid for the duration of time stipulated in the contract and as along as the premiums are paid,
      3. Green Insurance Co. is the insurer, and
      4. Bob is the beneficiary who will receive the death benefit if Beth passes away (a trust established for the children is listed as contingent beneficiary).
   2. In her role at Superchips, Beth is responsible for overseeing the engineering and development of the company’s flagship product – to say the company heavily relies on her expertise would be an understatement. Since Superchips is so reliant on Beth, the company decides to purchase a key person, also known as “key man,” life insurance contract on Beth. Before Superchips can purchase the policy, it must receive consent from Beth. Superchips contracts with Red Insurance Co. to purchase a term life policy on Beth that is designed to remain in-force until Beth’s 65^th birthday. Additionally, Superchips names itself as the beneficiary of the contract's $2 million death benefit. In this scenario: 
      1. Beth is the insured individual,
      2. The key person policy is a term life insurance contract which will remain valid until Beth's 65^th birthday, so long as premiums are paid, 
      3. Red Insurance Co is the insurer, and
      4. Superchips is the policy owner that is responsible for paying the insurance premium, and the beneficiary that will receive a death benefit when Beth passes away, as long as the policy is still in-force.

These scenarios depict real-world situations and rationale for acquiring life insurance coverage. It is important to recognize that multiple life insurance policies may be taken out on an individual by different policyholders for different reasons and that these policies are completely independent of one another. Further, in these scenarios the insurance policies are issued by different insurers, but it is feasible that separate policies can be issued by the same insurer.

Executive Benefit Plans

• Voluntary Deferred Compensation/401(k) Excess Plans – the Internal Revenue Code sets dollar limits on the amount that may be contributed into a 401(k) savings plan each year. These dollar limits cause the maximum percentage of compensation contributed by highly paid employees to be less than that of lower paid employees. And in some cases, higher paid employees cannot get the same proportionate company matching contribution as lower paid employees. Therefore, many companies establish nonqualified voluntary deferred compensation or 401(k) excess plans to allow highly paid employees to contribute a greater portion of their income into a tax-deferred retirement account and to receive a restoration of lost company matching contributions.
• Supplemental Executive Retirement Plans (SERPs) – company paid deferred compensation benefits, typically with a service based vesting schedule that encourages employee retention. SERPs may be designed with a “defined benefit” formula, whereby the ultimate benefit is a pre-established amount, or a percentage of final compensation. Alternatively, SERPs may be designed with a “defined contribution” formula, whereby a specific amount or percentage of compensation is contributed by the company each year to an account of behalf of the employee, and the account is adjusted for earnings or losses based on the performance of an investment index.
• Pension Restoration Plans – company-paid supplemental retirement benefits designed to make highly paid employees “whole” on pension benefits that are reduced due to qualified plan limits on eligible compensation and contributions. When combined with the qualified pension benefit, the pension restoration benefit provides the highly paid employees with the same benefit they would have earned under the pension plan alone if not for the limits.
• Section 162 Executive Bonus Life Insurance Plans – employer-paid life insurance policies that are owned by an individual company executive who can designate the beneficiary. The premiums for these policies are paid by the company and treated like a bonus, which is considered taxable compensation to the insured executive. As owner of the policy, the insured executive typically has access to the cash value on a tax-favored basis, or, when the insured passes away, the beneficiary will typically receive the death benefit tax free.
• Split Dollar Life Insurance Plans – a method of purchasing and using a life insurance policy whereby two parties, such as an employer or an employer-sponsored trust and a key employee, agree to terms on how the premium payments and policy benefits are shared or “split”. The two most common forms of split dollar plans are endorsement method and loan regime.
  • Endorsement method refers to employer-owned life insurance policies which insure the life of a key employee. However, in these plans, the employer assigns rights to the employee to name a beneficiary to receive a portion of the policy’s death benefit, with the balance payable to employer; under this arrangement, employers typically recoup premium payments made, or a modest return greater than premiums paid, and the employee’s family receives the balance of the death benefit. The employer paid life insurance coverage results in imputed income for the employee, which is subject to ordinary income taxes.
  • In a loan regime split dollar plan, key employees own their own life insurance policies but the premiums are paid by their respective employers. The employer’s payment of the premium is considered a loan to the employee for which a reasonable rate of interest must be charged or added to the loan balance. Until the loan is repaid, the employee grants the employer a “collateral assignment” of rights to a portion of the policy cash value and/or death benefit equal to the loan balance. The loan is typically repaid upon the employee’s retirement by means of a withdrawal or loan from the insurance policy, at which time the collateral assignment ends.