1. Conversationally Competent – Key Person
Rick Katz
Director, Business Markets Development
AIG Advanced Markets
AIG
As we have stated in previous modules, the most common obstacles to an agent’s success is rarely the technical aspects of the client development process. Your obstacle to getting your business to the next level is most likely not because you cannot describe a loan regime split dollar plan in detail. There are plenty of resources available to explain the legal, tax and other technical elements of a financial solution. Usually, an agent’s obstacle is about either not having enough qualified prospects or not knowing what to say to them once they agree to meet. Wouldn’t you agree? While much of the Business Development Institute focuses on the prospecting and client development, it is at least essential that you have a working knowledge or a conversational competence to present major business concepts to business owners. This module, module 3.3, will focus on being conversationally competent regarding Key Person coverage for small businesses. Hello; I am Rick Katz, the director of the AIG Business development Institute. Let’s get started with Conversational competence for Key Person planning.
Module 3.3
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2. Disclosure
Advanced Markets is a marketing unit of American General Life Insurance Company (AGL), a member of American International Group, Inc. (AIG). No representation or warranty, express or implied, is made by AGL or its affiliates as to the completeness of the information provided. All companies mentioned, their employees, financial professionals and other representatives are not authorized to give legal, tax or accounting advice. Applicable laws and regulations are subject to change and individuals should consult an attorney, tax advisor or accountant. Any tax statements in this material are not intended to suggest the avoidance of U.S. federal, state or local tax penalties. Policies issued by American General Life Insurance Company (AGL) except in New York, where issued by The United States Life Insurance Company un the City of New York (US Life). Issuing companies AGL and US Life are responsible for financial obligations of insurance products and are a member of American International Group, Inc. (AIG). Guarantees are backed by the claims-paying ability of the issuing insurance company. Products may not be available in all states and product features may vary by state.
AGLC © AIG All rights reserved.
As a reminder, AIG does not provide any legal or tax advice. A client should seek their own advice from a tax and/or legal professional.
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3. Opening
To win in the marketplace you must first win in the workplace Doug Conant
You don’t build a business – you build people – and people build the business Zig Ziglar
Retention programs are easier and cheaper than Replacement programs
Doug Conant, the highly successful businessman, who was the CEO for Campbell’s Soup Company, said, “to win in the marketplace you must first win in the workplace.” It is a common belief that customer satisfaction cannot be any greater than employee satisfaction. When it comes to the leadership at a company, this becomes even more crucial. Zig Ziglar said, “You don’t build a business – you build people – and people build the business.” Jack Welch, former GE CEO said there were 5 elements to great leaders. Abundant Energy, Being able to Energize, Having an Edge, Ability to Execute and People with Passion. Other than the owner of a company, who are the special individuals that possess these traits? We call them Key people! And we want them to stay at the company as leaders. After all, retention programs may be easier and cheaper than replacement programs. But, if the company loses a key person, what is the economic impact on the company? How can the company protect themselves against this economic impact? What happens if the key person dies prior to retirement? Let’s check it out.
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4. Who is a Key Person?
An employee who is key to the financial success of the organization.
Typically, businesses have at least one key person. A key person is someone who is key to the financial success of the business. If something should happen to that key person, the business would suffer financially and could even jeopardize the financial future of the business. The potential loss of a key person must be planned for. Life insurance can be part of the small business owner's plan to offset any financial loss stemming from the loss of a key employee.
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5. The Concern: Every business has one or more key people.
Economic importance of key persons
Potential economic impact from untimely loss of a key person
Employers promise ownership to key persons, but may not award it.
Employees generally want cash.
The concern is, Every business has one or more key people responsible for its success. The economic importance of these individuals is not always recognized and there is a potential economic impact from the untimely loss of this key person. Many employers promise ownership to the key person, but are hesitant to award it. Not only that employees generally want cash – or at least recognition now.
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6. ! ! ! ! ! When a business loses a key person
When a business loses a key person, there are several potential implications to the business. First, finding a replacement usually has to happen. Employees could become concerned and business earnings could be impacted by their loss. Customers could begin to shop around for alternatives and financing could be strained.
Finding a replacement becomes necessary
Employees become concerned
Business earnings can be reduced
Customers shop around
Financing is strained
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7. At the loss of a key person, employer needs CASH
Maintain profitability
Readjustment
Pay loans or strengthen credit
Pay current bills
Continue the business plan
Salaries
Attract a replacement employee
If a key person would die unexpectedly, the business will need cash. Cash to maintain profitability and make loan payments, pay bills, make payroll, continue the business plan, etc. One of the primary needs could be the need for cash to find a replacement. In order to attract a replacement, the business owner might have to offer a higher salary or signing bonus.
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8. Identifying a Key Person
Who do you rely on the most?
Who runs the business when you are gone?
Who is in charge of sales?
Who is going to replace you when you retire?
Who brings in the most revenue?
Who do you really miss when they are out?
Most business owners know who the key employees are, but if you don’t, here are some questions that might help. Who do you rely on the most? Who runs the business when you are gone? Who is in charge of sales? Who is going to replace you when you retire? Who brings in the most revenue? Who do you really miss when they are out?
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9. Valuation of a Key Person: Common Methods
Replacement cost
Discount or loss of value
Multiple of salary
As a small business owner, when they realize they have a key employee and the business would suffer if he/she died unexpectedly, how can a specific value be placed on a key employee? There are a couple options depending on the situation, however you have to keep in mind that insurance underwriters are also going to have a say. At AIG, an underwriter will typically allow a business to buy 5 times the key employee’s salary as key person coverage.
Lets look at 2 of these methods.
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10. Valuation of a Key Person
Replacement cost
Is special training required?
Are the skills readily available?
If a replacement is found, are additional salary and bonuses required to attract him/her?
Determine how long it will take to find and train a replacement, and how much compensation a replacement will require.
The first one to discuss is replacement cost. You would use this potentially if the key employee could be replaced. Not all key employees are replaceable. If they are, you could use this technique to determine a value. Is special training required? Are the skills readily available? If a replacement is found, are additional salary and bonuses required to attract him/her? Determine how long it will take to find and train a replacement, and how much compensation a replacement will require.
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11. Operational inefficiencies
Valuation of a Key Person
Loss of value
Lower Production
Lost Sales
Operational inefficiencies
Additional costs
The next valuation formula looks at how much lost earnings will the business experience before a replacement is found, if ever. The reduction in earnings could be used to determine the loss in company value, if a replacement can’t be found.
The business could estimate the amount of lost earnings if a replacement is not identified quickly.
Estimate the amount of lost earnings if a replacement is not identified quickly.
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12. Key Person Options for Funding$ $ $
Sinking Fund
(savings account)
Current profits
Life Insurance
Once it has been determined that the business will suffer an economic impact following the loss of a key person and the business has decided to protect themselves against this loss, they have to determine how to fund this exposure. Here are three options. Create a sinking fund or savings account. Just pay for the loss and expenses out of current profits and cash flow. Or, fund it with a life insurance policy.
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13. Advantages of Key Person Life Insurance
Be there on time
Help preserve company stability
May accumulate tax-deferred cash values as asset of the company
There are several advantages to the Key Person Life Insurance solution. First, Insurance will be there on time at the very moment it is needed. Insurance may help preserve company stability. The policy may accumulate tax-deferred cash values as asset of the company. If a death benefit is paid as a result of the death of the key person, they could receive potentially income-tax free death proceeds. Of course, Business owners should consult their tax and legal advisors prior to purchasing life insurance on his/her employees to determine what specific actions and documentation may be required.
Potentially income tax-free death proceeds*
*Policy owners should consult their tax and legal advisors prior to purchasing life insurance on his/her employees to determine what specific actions and documentation is required.
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14. How does it work? Policy owner/applicant: Employer
Insured: Key Employee
*Policy owners/employers should consult their tax advisors for specific questions.
Beneficiary:
Employer
Premium Payer:
Employer
The structure of the key person life insurance policy is fairly simple; however, the structure should only be undertaken after consultation with a tax or legal advisor. The employer/business is the applicant, the owner, the premium payer, and the beneficiary. The insured is the key employee. Your client should consult their tax and legal advisors regarding requirements associated with key man coverage. Those requirements include (after August 17, 2006) a Notice and Consent by the employee prior to issue. If not obtained, the death benefit above basis could be taxable to your business. This Notice and Consent form does not need to be provided to the insurance company. In addition to the Notice and Consent, the business must file form 8925, which is an informational report required by the IRS. It shows the life insurance policies that the employer owns. As noted earlier, they should consult your own tax and legal advisors about these requirements (and any other requirements) associated with ensuring the lives of their key employees.
Additional form required: Notice and Consent for Employer Owned Life Insurance (IRD section 101(j) and IRS Form 8925) is required to be filed by the employer annually with their tax*
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15. Premium (not deductible)
The Structure:
Premium (not deductible)
Consent
Death benefit
Key Employee
Employer
Graphically the Key Person concept is fairly simple.
The employer buys a life insurance policy on the key person employee after complying with the Notice and Consent and any additional requirements.
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16. Permanent, Cash Value Life Insurance
Policy Type Options
Term Life Insurance
Permanent, Cash Value Life Insurance
Can be perceived as low cost
The need may be perceived as temporary
Losing a key person is a long-term risk
Cash value is a business asset
Term insurance might make sense if the business is young and cash flow is tight. If Term insurance is purchased, you should review the coverage from time to time to determine if you would like to covert the policy to a cash value life insurance policy. Based on availability and policy terms.
Just like in the personal market, permanent cash value life insurance offers many advantages. One of the primary advantages is that the cash value is a business asset and can be used for any need they see fit and provides a lot of flexibility.
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17. What do you do with a Permanent Policy if a Key Person leaves the company?
Maintain cash value as an asset on the books
Consider surrendering the policy for cash value
What happens to the cash value policy if the employee leaves the company? The company gets to decide. They could maintain the policy and use the cash value for any other purpose they may want. One option would be to use the cash value to fund benefits of other key people. They could consider surrendering the policy for its cash value too.
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18. What do you do with a Permanent Policy if a Key Person retires?
Option to transfer policy to the Key Person when they retire
Transfer of policy has tax implications that should be discussed with a tax advisor
What do you do with a Permanent Policy if a Key Person retires? They have an option to transfer policy to the Key Person when they retire. Transfer of policy has tax implications that should be discussed with a tax advisor.
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19. Next Steps Conduct a Survey of 10 Businesses
“How many key people do you have including the owner?
If o DO NOT KNOW, ask who they would miss most if they didn’t show up for work on Monday
Record Type: o o o o o 5+
“Have you ever calculated the cost of replacing them?”
Next module: Conversationally Competent – Executive Benefits
Here is your call to action – or, next steps to reinforce what we have discussed in this module. Perhaps you can conduct surveys. Select 10 business owners either that you know well or not. Get feedback on a unique couple of questions. Remind them that you are not selling anything. You are just learning about the habits of business owners. Ask them the following questions. First, “How many KEY PEOPLE do you have including the owner?” If they know, record their answer and follow up with, “Have you ever calculated the cost to replace them if they didn’t show up for work on Monday morning?”
The next module, module 3.4, is called Conversational Competence for Executive Benefits. While you don’t have to be the expert, you have to know enough to have a meaningful discussion about helping a business owner formulate and execute their plans, including how to attract and retain the best talent.
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20. Questions or Comments? AIG Advanced Sales Business Development Institute BDI@aig.com 855-323-6923
If you have any comments, questions or feedback about this module or anything else regarding the AIG Business Development Institute, please contact us by at Or, you can call our AIG Advanced Sales team at This is Rick Katz for AIG’s Business Development Institute. Remember, the more small business owners you help, the more successful you will be.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT FOR PUBLIC DISTRIBUTION.