©2004 Gerald Katz Disability Buy Sell Your Pathway to Greater Commissions Gerry Katz, MSPA, RHU, ALHC, DABFE Disability Income Concepts, Inc. P.O. Box Weston, Florida (Toll-Free) Fax National Association of Health Underwriters

©2004 Gerald Katz TOTAL U.S. DI MARKET PLACE PENETRATION Individual Disability % Business/Office Overhead % Buy-Sell Disability %

©2004 Gerald Katz What Are The Chances Of Recovery? If Disability Begins At Age Chances The Disability Will Continue 5 More Years % % % Society of Actuaries Disability Tables When Disability Has Continued 1 Year

©2004 Gerald Katz What Are The Chances Of Recovery? If Disability Begins At Age Chances The Disability Will Continue 5 More Years % % % Society of Actuaries Disability Tables When Disability Has Continued 2 Years

©2004 Gerald Katz What is a Disability Buy Sell Agreement? A legally binding written agreement between the owners of a business establishing the terms and conditions of the sale and purchase of a disabled owners share of that business.

©2004 Gerald Katz THE PROBLEM Healthy Partner: Is committed to building business or professional practice – using their talent, time and income. Will take calculated business risks to maximize profits. Disabled Partner: Worried if not scared about the future. Not willing to take any business risks and wants only to conserve the value of that business.

©2004 Gerald Katz THE PROBLEM contd Many small and medium size businesses today recognize the business implications of a premature death to an Owner-Employee. Few businesses have provided for a Long Term Disability to the same Owner-Employee. Their Buy-Sell Agreement is usually missing a page!

©2004 Gerald Katz THE PROBLEM contd When Disability Strikes Can Owner-Employee return to productive work? Will business continue on a profitable basis? When Buy-Out is triggered, will the money be there to purchase disabled owners share, at a guaranteed price? Where will the money come from?

©2004 Gerald Katz THE SOLUTION ESTABLISH A PROPERLY FUNDED DISABILITY BUY-SELL AGREEMENT TO THE DISABLED OWNER: 1.Guarantees that business interest will be purchased at specified price. 2.Allows disabled owner after purchase, to convert business value to cash. 3.No need for disabled owners family to be involved in the business to protect their interests. 4.Creates peace of mind about present & future needs.

©2004 Gerald Katz Solution contd TO THE ACTIVE OWNERS: 1.Guarantees disabled owners interest is purchased at definite price. 2.Guarantees active owners of continued control of business. 3.Gives active owners opportunity to replace disabled owner. 4.Guarantees active owners not forced into business with family of disabled owner. 5.Guarantees continuity of business, maintains credit and employee morale.

©2004 Gerald Katz Methods of Funding A Buy-Sell Agreement 1.Cash Payments Costs - 100¢ Ques: Can business afford large cash depletion? Will cash be required for other business needs? 2. Borrow Money Costs - 100¢ Ques: Is money available and at what interest rate? Is loan plus interest too costly to repay?

©2004 Gerald Katz Methods of Funding A Buy-Sell Agreement contd 3.Establish Sinking Fund Costs - 100¢ Ques: Will there be sufficient time to accumulate money? Are funds required for other business needs? 4. Paid from Future Business Earnings Costs - 100¢ Ques: Will earnings be sufficient? Will future earnings be needed for other purposes?

©2004 Gerald Katz Methods of Funding A Buy-Sell Agreement contd 5.Insurance Costs – Less than 100¢ after tax dollars Answers: Cash available at time of need! Conserves owners capital! Insurance company determines disability! Business credit maintained! Budgeted premium payments! Other business assets maintained!

©2004 Gerald Katz TYPES OF DISABILITY BUY-OUT AGREEMENTS 1. Entity Purchase Plan The business, whether a closely held corporation or partnership, purchases disabled owners interest. Note:Business is owner, premium payer and receives the benefits from insurance policy.

©2004 Gerald Katz ENTITY PURCHASE EXAMPLE # 1 # 2 # 3 50% Owner 30% Owner 20% Owner $800,000 VALUE ABC CORP. PURCHASES $400,000 Policy $240,000 Policy $160,000 Policy on # 1 on # 2 on # 3

©2004 Gerald Katz TYPES OF DISABILITY BUY-OUT AGREEMENTS contd 2. Cross Purchase Plan Non-disabled owners purchase disabled owners interest. Note:Each stockholder/partner owns, is premium payer and receives benefits from disability policy covering the other stockholder(s) or partners(s). When more than two insureds are involved, a trusteed arrangement may be advisable.

©2004 Gerald Katz CROSS PURCHASE EXAMPLE ABC Corp. $800,000 VALUE # 1 # 2 # 3 50% Owner 30% Owner 20% Owner Purchases Purchases Purchases $120,000 Policy On #2 and $80,000 Policy On #3 $200,000 Policy On #1 and $80,000 Policy On #3 $200,000 Policy On #1 and $120,000 Policy On #2

©2004 Gerald Katz Typical Buy Sell Disability Policy & Underwriting Requirements

©2004 Gerald Katz FORMS OF DISABILITY BUY SELL INSURANCE POLICIES A.Lump Sum Benefit Pay-Out B.Monthly Benefit Pay-Out C.Combination of A & B

©2004 Gerald Katz Typical Policy (2) Policy Design Issue Ages:18-57/60 Elimination Periods (Trigger Point):12 Mo., 18 Mo., 24 Mo., 36 Mo. Minimum & Maximum Issue:$5,000 - $1,500,000 to $2,000,000 (usually limited to 100% ownership interest)

©2004 Gerald Katz Typical Policy (3 ) Pay-Out Periods: 1.Lump-Sum Paid in Full After Trigger Point 2.Monthly Installments 12 Months to 120 Months Installments

©2004 Gerald Katz Typical Policy (4) 3.Combination of 1 and 2 Initial Down-Payment Plus Installment Period OR Flexible Funding – Up To 10 Yrs. Pay-Out Usual No. of Insureds: Usually Limited to 10 Limited Options Available

©2004 Gerald Katz Typical Policy (5) Underwriting Requirements: A.Executed Buy Sell Agreement usually necessary before company issues B.Must specify Definition of Total Disability C.Trigger Point for Benefits D.Formula or Method to Calculate Purchase Price E.Commencement Date of Agreement F.Insurance Company usually requires 1-2 years Balance Sheet and Profit & Loss Statements

©2004 Gerald Katz G.All owners must usually apply for coverage. H.Buy Sell coverage usually limited to full-time Owner-Employees. I.Executed Buy Sell Agreement or Proof of Sale needed at claim time. NOTE:There must be an obligation never an option to buy and to sell insureds entire business interest at trigger point. Typical Policy (6) Underwriting Requirements (contd):

©2004 Gerald Katz Disability Buy Sell Valuation Formulas I. Professional Corporations 100% of Net Worth + 1 Times Salaries or Income of Owners/Partners (Not to Exceed Specific Maximum) OR 1 ½ - 2 Times Salaries or Income of Owners/Partners (Not to Exceed Specific Maximum) = Value of Professional Service Corporation

©2004 Gerald Katz II.Commercial Businesses A. Net Value Method 100% of Net Worth OR 1 – 1-1/2 Times Salary or Gross Income of Owners/Partners = Value of Business Organization Valuation contd

©2004 Gerald Katz B. Capitalization of Earnings Method Times Net Earnings (Depending Upon Length of Business Existence And Growth of Earnings) = Value of Business Organization Valuation contd

©2004 Gerald Katz Problem With Using Traditional Disability Income Insurance Policy To Fund Buy Sell Agreement They are designed to provide personal income to purchase food, clothing and other necessities of life. They cannot also provide additional benefits to complete Buy Sell agreement. What happens if disabled insured recovers after buy sell is triggered? Burden of remaining payments shift to business and active owners. Amount of coverage available is limited to normal issue and participation limits and is based on insureds income, not value of business interest.

©2004 Gerald Katz TAXATION OF DISABILITY BUY SELL PLANS Premiums:Not deductible by either corporation or partnership (IRC Sec. 265) Benefits:Received income tax-free (IRC Sec. 104(a)(3) NOTE:Disabled Owner-Employee is taxed only on the gain from sale of business interest. May qualify for installment sale tax treatment if at least one payment is received by seller after close of tax year.

©2004 Gerald Katz Prospecting For Disability Buy Sell Clients & Sales 1.Look for closely held small corporation or partnerships with 2-5 active working owners. 2.Firms should be profitable business in existence at least two to three years. 3. For professional corporations (physicians, dentists, attorneys, CPAs, etc.) they generally do not have to be in business more than one year. 4. Do not prospect in mom & pop business arena or in blue-collar businesses. They generally are not offered buy sell.