Disability Buy-Sell Funding & Valuations Presented By: Lori Boggs Sales Manager MetLife Rich Van Liew Asst. Director Underwriting Principal Life

The Risk of Disability Is High The risk of is 2 to 4 times greater than the risk of death during one’s working years. Age Male Female 25 2.5 to 1 4.0 to 1 30 3.8 to 1 35 3.6 to 1 40 3.5 to 1 45 3.3 to 1 50 3.2 to 1 55 2.4 to 1 3.1 to 1 60 Chance of a disability lasting 90 days or longer compared to chance of death before age 65. Weighted averages based on MetLife disability insurance sales applied to calculations from Milliman, Inc. on disability experience results for 1990 - 1999 from the Individual Disability Experience Committee of the Society of Actuaries.

Risk of Disability Grows with Number of Owners The Chances of at Least One Person in a Group Becoming Disabled for 90 days or Longer Before Age 65 Number of People in a Group Age 2 3 4 30 56% 71% 81% 40 51% 66% 76% 50 43% 57% 68% Weighted averages based on MetLife disability insurance sales applied to calculations from Milliman, Inc. on disability experience results for 1990 - 1999 from the Individual Disability Experience Committee of the Society of Actuaries.

Buy Sell Planning & Buy Sell Agreements

The active business owner may: What Happens To The Business In The Event of an Owner’s Total Disability… The active business owner may: Not be able to pay the disabled owner an income and maintain the business Not have funds to buy-out the totally disabled owner Not want to share business decisions with the disabled owner’s family

The Need for Disability Buy-Sell Planning Protects business owners and their families by obligating active owners to buy out a disabled owner in the event of a disability Protects owners by providing the funding to purchase part or all of the business interest of a disabled owner Minimizes discord among owners by setting the price and terms of a sale in the event an owner becomes disabled Prevents unwanted transfers to parties that might be unqualified or contentious (Family Members, Competitors)

Buy-sell Agreements Minimizes surprises and disagreements when the unexpected happens by addressing: How the business will be valued at any future point in time (Purchase Price) Terms of ownership transfer and payment How long a total disability must last before a buy-out is triggered Should be equal to the policy Elimination Period How a total disability is to be defined or determined. Should match the definition of total disability from policy

Is your client’s Buy-Sell Agreement fully funded? Did You Know? Many businesses have not established proper plans? Many Buy-Sell agreements are not funded? When the buy-sell agreements are funded, most are only funded for death purposes?

Buy-Sell Agreements Current cash flow Establish a sinking fund Funding Alternatives Current cash flow Establish a sinking fund Borrow the funds Disability Buy-Sell insurance

Cost to take from cash flow or sinking fund accumulations: Funding Alternatives Cost to take from cash flow or sinking fund accumulations: Business interest value $500,000 Tax bracket 34% Total cost $757,576 Sales needed to fund from cash flow $7,575,760 Assumptions: $500,000 Business Value, 5 yr repayment schedule at 9% interest, 10% profit margin; 34% corporate tax bracket, 45 year old

Funding Alternatives Principal payments $500,000 Cost to borrow: Principal payments $500,000 Tax on non-deductible principal payments + 257,576 Gross profit needed for principal payments 757,576 Net interest payments + 81,014 Total payments needed for buy-out $838,950 Sales needed to fund repayments $8,385,900 Assumptions: $500,000 Business Value, 5 yr repayment schedule at 9% interest, 10% profit margin; 34% corporate tax bracket, 45 year old

Cost to pre-fund through Disability Buy-Sell insurance: Funding Alternatives Cost to pre-fund through Disability Buy-Sell insurance: Business interest value $500,000 Annual Premium 2,550 Maximum premiums payable $51,000 Sales needed to pay insurance premiums $510,000 Assumptions: $500,000 Business Value, 5 yr repayment schedule with 365 day elimination period, resident of CO, 10% profit margin, 45 year old, non-smoker, male at a top occupation classification.

Buy-Sell Insurance Policy Design Business Overhead Policy Benefit period should equal the Buy Sell Policy Elimination Period. Match policy parameters to buy-sell agreement terms Benefit Amount (Purchase Price, Fairmarket Value) Elimination period Benefit Period (Lump Sum, Monthly Installments and Down Payment-combination of the two) Structure (Cross Purchase, Entity Purchase, Trustee Purchase) Rider (Future Insurability Option)

Business Valuations & Case Studies

Formulas for Business Valuations Disability Insurance Underwriting - MetLife CPA valuation 2 times Salary + business profit + book value 150% of gross earnings + plus book value Professional services valuation

Formulas for Business Valuations Disability Insurance Underwriting - MetLife Manufacturing/Construction Firm Valuation Book Value Assets – liabilities + retained earnings Capitalization of Earnings: Average after tax earnings times a reasonable multiplier low risk/high growth = high multiple (usually a factor of 4 to 7) high risk/low growth = low multiple (usually a factor of 2 to 4) Price/Earnings Method: Average after tax earnings + Owners Salaries – replacement salaries x reasonable multiplier (see above)

CPA Firm Case Study Disability Insurance Underwriting Valuation - MetLife 2 equal owners salaries total: $1,000,000 $50,000 net profit $100,000 book value 2 employees 2x’s Salary + Profit + Book Value $2,000,000 + 50,000 + 100,000 $2,150,000 total business value Each owner is eligible for a benefit up to $1.1 million *Maximum Benefit Amount depends on payout method and elimination period

Construction Firm Case Study Disability Insurance Underwriting Valuation - MetLife 4 equal owners Company been in business for 6 years and is showing growth Book Value of $2,000,000 2007 Profit of $ 150,000 2008 Profit of $ 250,000 2008 total Owners Salary of $400,000 Price Earnings Method Average after tax earnings + Owners salaries – replacement salaries X a reasonable multiplier $200,000 + $400,000 x 3 $1,800,000 Business Value ------------------------------------------ Capitalization of Earnings Method Average after tax earnings X Multiplier x 3 $600,000 Business Value Book Value Method Assets – Liabilities + Retained Earnings = $2,000,000

Formulas for Business Valuations Disability Insurance Underwriting - Principal Capitalization of Earnings + Book Value 100% of officer compensation + business profit x Multiplier of 1-5* + Book Value *The capitalization factor (multiplier) is dependent on the industry as well as factors including years in business, net income, size of business and profitability.

Physician Firm Case Study Disability Insurance Underwriting Valuation - Principal 2 equal owners salaries total: $1,274,626 20 employees $4.3 million gross sales $29,225 net profit $155,429 book value Salary + Profit x 3 + Book Value $1,274,626 + 29,225 x 3 + 155,429 $4,066,982 total business value Each owner is eligible for $1.5 million* *Maximum I&P for physicians

Manufacturing Firm Case Study Disability Insurance Underwriting Valuation - Principal Salary + Profit x 4 + Book Value $396,265 + 983,900 x 4 + 4,318,346 $9,839,006 total business value Each owner is eligible for $3 million* *Maximum I&P for DBO 2 equal owners salaries total: $396,782 120 employees $19.7 million gross sales $983,900 net profit $4,318,346 book value Principal Life will consider Disability Buy-Sell on businesses of up to $20 million in value, with no one owner having over $5 million ownership interest.

Benefit Payment

Disability Buy-Sell Insurance - Principal Benefit Payment Disability Buy-Sell Insurance - Principal The monthly amount payable is equal to the lesser of: For Monthly Actual monthly Buy-Out Expense the Owner incurred, or Maximum Monthly Benefit For Lump-Sum Actual lump sum Buy-Out Expense or the Owner incurred or Maximum Lump Sum Benefit For Combination Lump-Sum & Monthly Actual lump sum Buy-Out Expense the Owner incurred or the Maximum Lump Sum Benefit is paid, then monthly payments, using the same above guidelines, will begin.

Disability Buy-Sell Insurance – MetLife Benefit Payment Disability Buy-Sell Insurance – MetLife The Buy Out Benefit amount payable is equal to the lesser of: Face Amount of the Policy Shown on the Policy Schedule Page Purchase Price The purchase price can be found in the Buy Sell Agreement which is not required until the end of the Elimination period Fair Market Value Completed by an independent CPA

For more information contact your local Plus Group office How to get started For more information contact your local Plus Group office To find a Plus Group office near you: Go to www.plusgroupus.com and click on the agency locator map or call 1(800) 831-1018

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