Ray co-authors an article about "Key Person Insurance: Think "Multi-LIfe"

Available online at lifehealthpro.com

Key-Person Insurance

By Steve Parrish
and Raymond L. Bening   
Originally Published Feb. 6, 2009

"Insuring that the company is
indemnified for the loss of any and all key
employees is a major element in
a good business plan."


Many agents who work with businesses have enjoyed good sales results with the multi-life key person life insurance concept. As active participants in the business insurance market, we have both seen the financial, business, and emotional toll that occurs when a company loses a key employee. But our experience also tells us that most companies have more than one key person and there is a need for more than just one company-owned life insurance policy. As our economy continues to move from a manufacturing model to a service model, the key asset of business, more and more, is its workforce. Insuring that the company is indemnified for the loss of any and all key employees is a major element in a good business plan.

In many cases, a key person life insurance policy is as much a financial tool as it is an indemnity contract. Although it provides vital liquidity if a company loses a key employee to death, life insurance also can help retain a top performer. For example, if the company offers an attractive "golden handcuff" benefit and funds it with a life insurance policy, the company not only insures against loss from the employee's death; it also insures against losing that person to the competition. This can be even more effective when the plan involves coverage on several key people.
We have found that in presenting a multi-life key person insurance program, a number of financial considerations should be clearly and specifically laid out to the decision makers. The key person sale is much more focused on financial issues than emotional issues, and the buyers need to see the logic of the purchase. The following are some of the financial arguments that can be made for purchasing a multi-life key person life insurance program.

Risk management. Employers typically want to benefit from an employee's skill and know-how until the date the employee retires. Yet the risk exists that an employee could die prematurely. Consider the risk that at least one of a group of key employees dies before his or her respective retirement age. Chart 1, below, shows that among three key employees, there is approximately a 25% risk that at least one of the employees will not survive to retirement. Companies purchase property insurance to indemnify themselves against risks with much smaller odds, such as the loss of a building due to fire. Insuring against the risk of a key employee's premature death is simply good business sense.





Cost benefits. A company with several key employees can insure them as a group and benefit from more favorable underwriting. If enough employees are being covered, the insurance company may offer guaranteed or simplified issue. Further, if the corporate-owned life insurance (COLI) is on executive-level employees, companies that specialize in COLI will offer price breaks. Executive mortality may apply, and insuring the group may allow for lower lapse assumptions. The per-insured cost of the policies can be significantly lower than if a retail policy were purchased on each employee separately.

As a financial hedge. Companies frequently employ hedging in their financial management plans. They hedge against the cost of commodities, fluctuations in interest rates, or other events that they cannot control. Key person life insurance can be a hedge against profits lost from the unexpected death or departure of a key employee. This concept is analogous to a call option. The company pays for the call option in installments (the premium) for a payment (death benefit) if a particular event occurs (death). If the life insurance is permanent, the cash values represent a partial refund feature -- cash available before the call event. A multi-life key person plan simply spreads the hedge over the lives of several executives.

Cash management.Companies need to reserve cash so that they can meet short-term cash needs. When this money is set aside, it is not available for long-term investing in the business. To the extent the cash reserve can be predicted and levelized, it helps free up money for business growth. Consider, for example, employee benefits.

Companies are willing to pay ongoing premiums for employee benefits so that they can fund benefit costs in a predictable and level manner. The same applies to key person protection. Key person life insurance premiums smooth out the costs related to anticipated needs for cash that are tied to a key employee. The cash may be needed at the employee's death or retirement, or when he or she redeems an ownership interest. If the employer can pay for this on a level basis each year, there is no more speculating or second-guessing about whether or when one of those events will occur, and it frees up cash for the employer to invest in the business.

As an asset class. A multi-life key person program can be a useful part of the company's investment strategy. The plan can be funded with policies that are:

            Not market-sensitive (for example, fixed life insurance policies),
            Or correlate to the company's business (variable accounts that invest in related industries),
            Or don't correlate to the company's business, as a hedge.

In addition, COLI policies can represent an effective financing tool by providing both tax and accounting advantages.

Example: ESOP Repurchase          
In one of our recent cases, cash management was a primary motivator for the purchase of a multi-life key person program. The case involved a successful company owned by an employee stock ownership plan (ESOP). The ESOP was a valued retirement and ownership plan for the company, but management was concerned about the liability the ESOP created for the company to its employees. Under ESOP rules, when an employee leaves the company, whether by death, retirement, or early departure, the employee can essentially cash out the stock in his or her ESOP retirement plan account. This is referred to as a "repurchase liability." The company can't predict when an employee will die, retire, or otherwise leave, yet it is continually "on the hook" to cash out the terminating employee's ESOP interest.

Key person life insurance, along with a sinking fund, was the ideal solution. The concept involved purchasing COLI on several highly compensated, healthy employees. The COLI policies provide a tax-advantaged source of cash to fund the repurchase liability. The cash is available either in the form of tax-free death benefits or tax-deferred cash values. Chart 2, above, shows how the overall concept was presented to the employer. The combination of the life insurance premiums and a sinking fund represent a levelized, manageable way to control the otherwise unpredictable cost of the ESOP repurchase liability. The key person policies are an efficient funding source and hedge for the company's obligations.

While key person life insurance has always been a good business insurance sale, a multi-life key person plan can be an even more compelling and successful concept. It offers financial advantages to the employer in a time when companies are focused on containing costs and hedging risks.

Steve Parrish, JD, CLU®, ChFC®, RHU, is a national advanced solutions consultant for the Principal Financial Group®. He began his career as an attorney and advanced marketer in Minneapolis, then became a financial planner and a co-owner of Walker Parrish Financial Group. After serving 12 years as vice president of marketing services for AmerUs Life, Mr. Parrish joined The Principal® in 1997 as head of business markets.

Raymond L. Bening is a financial professional for the Principal Financial Group® and owner/president of Bening Financial Organization. He entered the life insurance business in 1983 and is a Qualifying and Life member of the Million Dollar Round Table. Raymond was honored with the first-ever Individual LIFEtime Achievement Award from the Principal Financial Group in 2011.


While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that Steve Parrish, Bening Financial Organization and the member companies of The Principal are not rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.