Buy - Sell Disability Insurance
Example: Bob, Joe, and Dave run a successful widget business together as partners. As
such, they have done their due diligence in putting together a buy-sell agreement (also known as a shareholder's agreement) in order to protect both their respective shares of the business as well as the company as a whole.
One of the clauses of the agreement surrounds disability. See, if Joe becomes disabled such that he can't do his job (which happens), then Bob and Dave have to pick up the slack. Joe might have his own personal DI policy which protects his salaried income. (However if he is paid with bonuses and dividends, he won't even qualify for a personal DI policy - that's another can of worms entirely). Either way, for a few years Bob & Dave can probably keep the company above water for the time that Joe needs to recuperate.
But if Joe's disability is long term or "permanent" in nature, the company has a whole new set of issues on its hands. Joe is no longer contributing to the success, growth, and maintenance of the company due to his disability. Should he rightfully continue to remain an owner, reaping the benefits of a business that is growing independent of his own efforts? Or is it time for Joe's share to be bought out so Bob & Dave can move on with the business, or take on another partner? (Again, Joe should have a personal DI policy, so it's not like he is being left in the dust if he's planned properly for himself).
Assuming the three of them agree, standard buy-sell agreements usually state that after a partner is disabled for "x" amount of time (usually a year), and/or if it is determined that the disability is permanent in nature, the disabled person's shares are to be purchased by the other owners or sold back to the company.
Most companies and business owners don't have the money kicking around to pay for such things, especially as the company grows and prospers over time and the amount required to buy out an owner becomes substantial. There is however a solution: to fund the agreement with a special type of Buy-Sell Disability Insurance.
The premise of Buy-Sell DI is to comply directly with the terms of the buy-sell agreement. In fact, the insurance company may require a copy of the agreement to process the application.
One of the easiest ways to implement this arrangement is to have cross-owned policies. Bob & Dave personally own a policy for Joe. Joe & Dave own for Bob, and Bob & Joe own one for Dave. It works best for partnerships of only two or three owners; more than three partners, and the cross-ownership strategy gets a little too complicated.
Once Joe has been disabled for 1 year (for example), the agreement states that his share of the business is to be bought out either in a lump sum or over a period of 2 years. The DI policy is structured to pay Bob & Dave exactly the money required to satisfy the terms of this agreement to the letter.
You can also structure this policy so the company owns it and is the beneficiary of the cash to pay out Joe, however taxation issues become a little more prevalent in this case (depending on the corporate structure).