A colleague of mine, Barry Thomas of Principal Financial Group, recently forwarded me some important information on buy-sell insurance policies. Barry's update highlighted some problems brought up in a recent Indiana court case, Hilliard v. Jacobs.
Hilliard and Jacobs owned a business together and as-is common they purchased life insurance policies on each other's lives. This is done so that if one partner dies the other will receive life insurance proceeds to buy the deceased's interest from his family. The only problem here is that Hilliard and Jacobs sold the business and no one did anything about the insurance policies.
We don't know the exact details, but it sounds like Hilliard's health started failing and, sensing the inevitable, Jacobs refused to exchange policies with Hilliard and kept paying the premiums. Hilliard sued, died, and his widow later lost the case. Jacobs collected $2,500,000 of life insurance. Fair? No. Legal? According to the court, yes. Indiana does not have an insurable interest requirement. Therefor Jacobs did not need to justify having an insurance policy on someone with whom he had no real ties, at least none that would indicate the need for an insurance policy.
The court told Hilliard's widow that there were two opportunities to do the right thing with the life insurance policies. First, the partners could have addressed the disposition of insurance policies in the buy-sell agreement. Second, there was a settlement agreement between the two partners at the time the business sold. Neither document made mention of what should be done with the policies once the business relationship terminated.
The lesson here is that we spend a lot of time encouraging owners to draft and fund buy-sell agreements, but rarely do we talk about what will happen to things like funded insurance policies if the relationship ends. It is easy to do at the outset, but as Hilliard proves it can be very difficult to fix later.