Treatment of Life Insurance Proceeds in Buy-Sell Agreement Valuation
Life insurance is sometimes purchased by corporations on the lives of their shareholders. Frequently, the reason for the purchase of life insurance by a corporation relates to its buy-sell agreement with its shareholders. The November 2006 issue of Value Matters™ was titled "Life Insurance Proceeds in Valuation for Buy-Sell Agreements." That article discussed two polar treatments of life insurance proceeds in buy-sell agreement appraisals:
- Treatment 1 - Proceeds Are Not a Corporate Asset. One treatment would not consider the life insurance proceeds as a corporate asset for valuation purposes. This treatment would recognize that life insurance was purchased on the lives of shareholders for the specific purpose of funding a buy-sell agreement. Under this treatment, life insurance proceeds, if considered as an asset in valuation, would be offset by the company's liability to fund the purchase of shares. Logically, under this treatment, the expense of life insurance premiums on a deceased shareholder would be added back into income as a non-recurring expense.
- Treatment 2 - Proceeds Are a Corporate Asset. This treatment would consider the life insurance proceeds as a corporate asset for valuation purposes. In the valuation, the proceeds would be treated as a non-operating asset of the company. This asset, together with all other net assets of the business, would be available to fund the purchase of shares of a deceased shareholder.
Again, under this treatment, the expense of life insurance premiums on a deceased shareholder would be added back into income as a non-recurring expense.
The November 2006 article provided an example of the two distinct treatments for a sample software company owned by Harry and Sam. Harry died. Tables One and Two are sufficiently self-explanatory to illustrate the polar results: