1. Key Person Coverage
Mary Smythe, Executive Underwriting Consultant Prudential
Introduction – Read Slide
NOT FOR CONSUMER USE.
© 2016 Prudential Financial, Inc. and its related entities.
Ed. 08/2016 Exp. 02/26/2018

2. Financial Underwriting
Purpose: To determine the economic feasibility of a life insurance contract
The Underwriter’s Major Objectives:
Determine whether there is an insurable interest
No Over-Insurance: To make sure that the amount of insurance applied for is reasonable and in line with the insured’s need(s).
Affordability: To ensure that the client will be able to sustain the future premium expense
Read slide
NOT FOR CONSUMER USE.

3. Financial Underwriting
For the Producer: “DOES IT MAKE SENSE?”
For Underwriters: “DOES IT MAKE SENSE?”
The question that most underwriters seek to answer when evaluating life insurance applications for financial risk.
A carrier’s underwriting formulas & guidelines for a particular life insurance scenario are simply a tool for saying:
“THIS MAKES SENSE”
Does it fit within the carrier’s parameters?
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4. Speeding Up the Process
Application
Full and complete details to each question
Avoid “conflicting statements”
Cover Letter
Large face amount cases
Smaller cases with unusual facts and/or circumstances
Clear statement of purpose
Clear proof of need(s)
Consistency throughout
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5. Who is a Key Person? Specialized technical skills or expertise
Employees with:
Specialized technical skills or expertise
Innovative abilities
Sales track record
Management skills
Financial expertise
Unique contacts
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Coverage should only be considered as key person coverage if the loss of the key individual would impair the continued profitability of the company.

6. Impact to Business on Loss of Key Employee
Management or operational disruption
Loss of customers
Loss of profit
Impairment of credit
Weakened employee morale
Loss of confidence
Hampered product development or innovation
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7. Case Study Hypothetical case facts: Potential concerns:
Dizzy Distributors, Inc.
Successful beer and wine distributor based in Georgia
37 full-time employees
Sole owner: Jack, age 59
Key person: Ray, Vice President of Sales and Distribution, age 47
Ray has close relationships with key suppliers, customers and sales staff.
Ray is responsible for around 33% of annual sales revenue.
Financial and operational impact from Ray’s death.
5 to 6 years needed to replace Ray.
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8. Dizzy Distributors, Inc.
What is Ray’s Key Employee Value? Five common methods for valuation
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Hypothetical Illustration

9. Dizzy Distributors, Inc.
What is Ray’s Key Employee Value?
Hypothetical Assumptions:
Average annual company earnings: $800,000
Average company asset value: $1,000,000
Contribution to Profits Method
Return on tangible assets at 5% $50,000
Earnings in excess of tangible assets $750,000
Portion attributable to Ray at 33% $250,000
Years needed to replace Ray
Ray’s key employee value $1,500,000
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Calculates the profits in excess of the normal return on capital (net book value assets) and is assumed attributable to key employees’ efforts, a portion of which is estimated for each key employee and multiplied by the number of years needed to find and train a qualified replacement.

10. Dizzy Distributors, Inc.
What is Ray’s Key Employee Value?
Hypothetical Assumptions:
Average annual company earnings: $800,000
Average company asset value: $1,000,000
Discounted Value Method
FMV of Dizzy Distributors1 $7,000,000
FMV of Dizzy Distributors
upon loss of Ray2 $5,000,000
Ray’s key employee value $2,000,000
Cost of Replacement Method
Total estimated replacement cost $100,000
Opportunity cost – 6 years of
profits attributable to Ray $1,500,000
Ray’s key employee value $1,600,000
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Applies a percentage reduction to the fair market value of the business that would result from the loss of the key employee after careful assessment of the employee’s contributions and potential loss by the client’s legal and tax advisors.
1. Uses Goodwill Method for business valuation assuming a 5% return on tangible assets and a 12.5% capitalization rate.
2. Same assumptions as footnote 1 but subtracts the profits attributable to Ray from previous slide.
Totals the direct, out-of-pocket expenses involved with finding, hiring, and training a qualified replacement and then adding in the estimated lost opportunity cost.

11. Dizzy Distributors, Inc.
What is Ray’s Key Employee Value?
Hypothetical Assumptions:
Average annual company earnings: $800,000
Average company asset value: $1,000,000
Assumes the employee’s value is reflected by his total Assumes the maximum amount of coverage an
compensation and the replacement cost is a multiple insurance company will issue on the key employee
of that amount depending on the type of business and equals that employee’s value.
The estimated difficulty in finding a qualified replacement.
Ray’s total compensation $200,000
Multiple factor according
to owner, Jack
Ray’s key employee value $1,200,000
Multiple of Compensation Method
Insurability Method
Ray’s total compensation $200,000
Insurance company’s maximum
multiple of compensation
Ray’s key employee value $2,000,000
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12. Case Study #1 $4,000,000 Application Female, age 61 (Jane)
Owner and Beneficiary: Good Foods
Occupation: Sr. VP for Ingredient Innovations
and Director of Good Foods plant based manufacturing program at Good Foods
Income: $350,000
Recently issued $6,000,000 key person coverage
(not replacing)
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13. Concerns? Amount applied for is over 5-10 x income Her age is over 60
Jane appears to be over-insured for key person coverage noting $6,000,000 in force that is not being replaced
Jane has been working for the company for about 9 months.
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If this is all we received, we would need to obtain more information from the field as to how the amount was arrived at, does she have additional compensation (bonuses etc) to clarify the need for $10M of coverage.

14. Cover Letter Jane holds multiple food patents
Jane has over 30 years experience in the Food Industry
She has a PhD in Chemistry, is a contributor to various food industry trade magazines, technical journals etc.
Included background information on Good Foods, noting their contracts with major food brands
The owners of the company are long time clients of the broker, and they have purchased other key employee contracts over the years.
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We received an 8 page cover letter that was well layed out with a lot of helpful information. Read slide.

15. Purpose Good Foods is expanding their product and
strategic positioning as an ingredient manufacturer,
and they have hired Jane to lead this initiative.
They are constructing additional facilities to
accommodate Jane’s initiative with a $5M to $7M
construction budget and total project cost of $12.9M
They are wanting $10M to $12M of key person
coverage on Jane due to her expertise being so
critical to their expansion.
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16. Additional Items Received
Employment Contract:
Company has intellectual property rights and patent use agreement with Jane
Jane has a profit sharing formula that will position her to earn millions of
dollars in the near future
Project Objectives and Scope Description
Project Capital Cost Tracking vs Budget Report
These additional documents fully described the buildings being constructed equipment being purchased etc.

17. Success Financially approved !
Well written cover letter explaining her expertise and reason for the coverage
Supporting financial information on the company
Employment Agreement showing additional ways she will be compensated outside salary
We were able to determine that she is directly involved in bringing patents and intellectual property to the company, and her employment appears to have led directly to the planned company expansion. We allowed the $4M.

18. Case Study #2 Female, age 52 (Chris) Occupation : Senior Pastor
$2.5M Term application
Female, age 52 (Chris)
Occupation : Senior Pastor
Income: $140,000
Owner and Beneficiary: Lakeview Church Ministries and Training Center
$2.5M in force that will be replaced
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19. Concerns ?
This is over the 10 times income guideline for key person coverage. Is there anything else we can take into consideration noting her occupation?
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20. Additional Information
Pastors are responsible for the church’s revenues and growth.
Many of the pastor’s personal needs might be funded by the church in
exchange for a lower salary and these “perks” should be taken
into account (especially housing costs)
Key person needs is more appropriately evaluated as a measure of the church’s revenues.
Debt protection for large mortgages on church properties is not unusual.
The Pastor’s relationship with the congregation is hard to replace. It may take a long time to find a replacement pastor that can establish a good relationship to the church members to continue and grow the church revenue.
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21. Additional Information
Lakeview Church FMV $1,650,000
Lakeview Church gross annual revenue $680k
Lakeview Church has a $1M mortgage
Chris was the Founder of the church
Chris’s salary $142,750 plus housing allowance
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22. Success!
Taking into consideration her unpaid “perks” along with her income allowed us to use an income figure higher than $140k
Mortgage protection need was taken into account as well (70% of the $1M mortgage)
Noting that she was the Founder of the church and is Senior Pastor, she would be hard to replace quickly, so we would be willing to allow more than 10 x income.
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23. Thank you!
Questions?
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