executive key life - is it important to protect your best assets?
TRANSCRIPT
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Key Person
Life Insurance
Protecting American Small Businesses
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Overview
The Need for Key Person Protection
Key Person Valuation
Choosing the Type of Life Insurance
Next Steps
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
The Need for
Key Person Protection
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Why Insure Key People?
“Take away my factories, my plants; take
away my railroads, my ships, my
transportation; take away my money.
Strip me of all of these, but leave me my
men, and in two or three years I will have
them all again.”
- Andrew Carnegie
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
:
Why Insure Key People?
Four things that happen to key people:
1. They stay with the company
2. They quit – usually to join a competitor
3. They retire
4. They die
Employers can influence, but not really control the first three events
The last three events create problems for the employer
The fourth event is beyond their control and particularly troubling when the key person and the employer are one and the same
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Why Insure Key People?
Key persons with particular talent, experience or ability are vital for the
success of the business
Material loss ensues from their death:
Immediate loss of profits
Loss of sales
Loss of management skill
Losses from securing and training their successor
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Fire vs. Death
A building fire results in a loss of a physical asset
Fire insurance protects against a physical loss of plant, inventory or equipment
Buildings, equipment and inventory can be replaced
Death of a key person is permanent
This loss to the business is the loss of a management asset
The business loses their: Competence, Experience, Specialization, and Technical expertise
Life insurance will protect the business against the loss of its human life value
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Why Insure Key People?
"What corporate purpose could be considered more
essential than key man insurance?
The business that insures its buildings and machinery
and automobiles from every possible hazard can
hardly be expected to exercise less care in protecting
itself against the loss of two of its most vital assets—
managerial skill and experience."
- The court in the Emeloid Co.,Inc. v. Comm`r, 189 F.2d 230 (CA-3, 1951) case
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
What Key Person Life Insurance provides:
Death Benefits provide cash that can help:
Keep the business running
Assure the creditors that their loans are safe
Cover the losses from mistakes the successor will make until s/he gains
experience
Cover the special expenses of finding, securing and training a new person
Pay for needs which cannot be determined in advance because they will
depend upon the unique circumstances of each business
Cash Values provide an emergency reserve for times of uncertainty
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Key Person Valuation
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Who are Key People, Anyway?
Who contributes significant sales?
Who is the “brains” behind:
Marketing?
Product development?
Finance/Operations?
Other areas with significant, positive impact on the organization?
Who has special, difficult to replace skills or experience?
Who holds considerable “Goodwill” in the eyes of the customer?
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
How Much is Enough?
How much key person coverage is needed depends on what the
business stands to lose at the key person’s death
Valuing the potential loss can take a number of avenues:
Multiple of Salary
Cost to Replace Contributions
Cost to Replace Lost Sales Profits
Cost to Replace Experience
Loss of Excess Earnings
Loss of Business Value
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Case Study: Samanta Sales
Samantha Sales is ACME Adhesives #1 salesperson
Total sales for ACME are $1M
Samantha’s sales last year: $375,000 or 37.5%
The average for the other 5 salespeople is $125,000 or 1/3 of Sam’s results
Samantha’s Salary: $100,000
The going rate salary for adhesives salespeople is $60,000
Estimate 7 years before someone could match Samantha’s results
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Multiple of Salary
“Rule of thumb” method
Key employee’s salary multiplied by some factor
Traditionally 10 × Salary
Does not specifically address any particular financial drain on the company
Easy to calculate and to review and generally accepted by life insurance
company underwriters
For these reasons, it tends to be a fairly popular method
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Multiple of Salary
For Sam’s example, let’s assume he also received a $37,500 bonus for
his sales results:
Salary: $100,000
Bonus: $37,500
Total Compensation: $137,500
$137,500 × 10 = $1,375,000 = Key Person Coverage
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Cost to Replace Contributions
A key employee contributes a portion of the company’s gross earnings each
year
Commonly used with salespeople who contribute a distinct portion of the
firm’s annual sales
Lost earnings if the key employee dies
Recognizes that as time goes by, the new employee will replace the lost
earnings
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Cost to Replace Contributions
What would the company lose if Sam died?
Sales: $375,000 offset by new salesperson’s
results of $125,000 = loss of $250,000
They also had to pay $15,000 to find “new guy”
But they saved $40,000 in salary ($100,000 –
60,000)
This loss occurs for 7 years
Loss = $250,000
Loss = $265,000
Loss = $225,000
Loss = $1,575,000
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Cost to Replace Lost Sales Profits
Another valuation related to the efforts of key salespeople
Difference is it measures the lost profits if the salesperson dies
New employee will replace some of those profits, but not all
This method weighs the difference between:
Anticipated profits, and
Profits expected from the replacement employee
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Cost to Replace Lost Sales Profits
What would the company lose if Sam died?
Sales: $375,000 × 60% = 225,000 lost
profits
New salesperson’s results of $125,000 ×60% = $75,000 replaced profits
This loss is occurs for 7 years
Loss = $225,000
Loss = $150,000
Loss = $1,050,000
Using this method calls for another piece of information:
The company’s pre-tax earnings from the prior year
We’ll assume this number is $600,000
Profits = 60% of earnings (600k ÷ 1M)
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Cost to Replace Experience
Used when a key employee performs special duties in addition to his/her
routine duties
Company would lack valuable experience at the key employee’s death
E.g., engineer developed company’s most advanced product and has
certain experience that would be lost
This method determines the extent of the loss
Also, if other executives with similar experience are available, what costs
might be involved to recruit them?:
Recruiter cost
Sign-on bonus
Higher salary to recruit them from present employer
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Cost to Replace Experience
If Sam’s success can be attributed to superior product knowledge
What would ACME lose upon his death?
Current Salary: $100,000
Minus replacement salary: $60,000
Loss = Cost of Experience: $40,000
This loss is occurs for 7 years
Loss = $280,000
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Cost to Replace Experience
Alternatively, if other executives with similar experience are available, what
costs might be involved to recruit them?:
Recruiter cost ($15,000)
Sign-on bonus ($50,000)
Additional salary to recruit them from present employer (assume $20k)
– × replacement years ($20,000 × 7) = $140,000
Loss = $205,000
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Loss of Excess Earnings
Excess earnings are the difference between:
Actual earnings and
What owner’s equity would earn in an ordinary investment
The loss of the key employee could spell the loss of these
excess earnings
The employee being valued has a direct impact on the
company’s earnings
Typically used for upper managers who make the strategic
decisions
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Loss of Excess Earnings
In Sam’s case we assume:
$2M business “book” value for ACME
“Ordinary” investment returns of 7% (owner’s expectation)
– $2M × 7% = $140,000 expected return
Sam’s sales = $375,000
Total Salary for all Key Employees is $250,000
Management earnings = Key Person’s sales minus expected return
375k – 140k = 235k
Sam’s salary = 40% of all KP salaries (100k ÷ 250k)
Sam’s excess earnings = 235k × 40%, or $94,000
Again, the loss carries forward for 7 years
$94,000 × 7 = Loss of $658,000
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Loss of Business Value
The loss of a key employee can result in a loss of market value
Method used when the loss would cause a market value drop of 20% or more
Percentage of the market value drop depends on:
# of other key employees, and
Goodwill generated by the key employee
E.g.:
The only sales person or the top sales person by a wide margin,
Clients generally have a very good rapport with him/her,
Founder/catalyst of the firm,
– the loss in value could be much higher from diminished ability to attract business
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Loss of Business Value
Assume Sam’s death results in a 20% reduction in value:
Prior Market value: $10,000,000
$10M × Reduction (20%)
= Loss of $2,000,000
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
So How Much Is Enough?
Summary of Valuation Results:
Multiple of Salary $1,375,000
Cost to Replace Contributions $1,575,000
Cost to Replace Lost Sales Profits $1,050,000
Cost to Replace Experience $ 280,000
Loss of Excess Earnings $ 658,000
Loss of Business Value $2,000,000
Average: $1,156,333
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
So How Much Is Enough?
The value depends on which method most closely depicts how the key
person’s death will impact the business
If more than one valuation method “fits,” use a weighted average of the
applicable methods
E.g., assume the business owner feels Sam’s greatest impact will be on lost
market value, but loss of his sales and experience factor in as well:
Lost Market Value: $2,000,000 × 50% weighting = $1,000,000
+ Lost Experience: $280,000 × 25% weighting = $70,000
+ Lost Contributions: $1,575,000 × 25% weighting = $393,750
= Total: $1,463,000
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Choosing the Type of
Life Insurance
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Selecting the Appropriate Kind of Life Insurance
Term
When cost is a major consideration, term insurance is typically used
Provides needed coverage
Lacks advantages of various types of “permanent” life insurance
May cost more over long haul if needed longer than anticipated
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Selecting the Appropriate Kind of Life Insurance
Permanent Life Insurance
Like term, provides needed coverage
In addition,
– Policy cash value is a capital asset of the business, not “sunk” cost
– Cash values available for loans, regardless of the business’ financial condition
• Tax deferred cash values may be used as collateral for loans
Absorb earnings that may be subject to the Accumulated Earnings Tax (C-Corps).
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Selecting the Appropriate Kind of Insurance
Considerations for selecting the type of Permanent Coverage
UL
– May be lower cost than VL and WL
– Premium flexibility
– Useful when business cash flow availability varies
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Selecting the Appropriate Kind of Insurance
Considerations for selecting the type of Permanent Coverage
VL
– Offers upside potential of market performance, balanced with downside
market risk
– Using Option 2 type of design potentially allows policy face amount to
rise with general equity market. Potentially help track general rise in
costs.
– Like UL, cash values and flexibility are key
– Greater employer risk tolerance
– Useful for coverage for loss of business value (using funds in the
business’ sector)
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Selecting the Appropriate Kind of Insurance
Considerations for selecting the type of Permanent Coverage
WL
– Tends to be highest cost
– Best when business cash flows are consistently strong
– Use when guarantees are especially important
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
More Life Insurance Funding Considerations
Riders:
Waiver of premium:
– If insured becomes permanently disabled, re-direct premium payments to coverage on replacement
– Gross up waived premium cost and pay to executive as a disability benefit
Substitution of Insured if key person leaves company
– Does not qualify for §1035 exchange
– Insurability typically required
Our mission at Roper Insurance & Financial Services is:
To help people & businesses gain more value & understanding from their benefits.
Roper Insurance and Financial Services does not provide tax or legal advice.
Clients should consult with tax and legal professionals on these matters. All
guarantees are based on the claims-paying ability of the insurance company. All
examples are hypothetical illustrations and do not depict a particular investment or
policy. The numbers are not guaranteed to be accurate and should only be looked
at as a hypothetical illustration.
© 2010 Roper insurance and Financial Services
Important Notes