Wealth Matters: Insurance on the Person Who Makes the Business Run

After Mr. Manfredi sold the company at the end of 2004, the buyer allowed him to take the policy with him. It was a $20 million term policy, which meant he had to continue paying the rising premiums to keep it in place. Mr. Manfredi, who was 65 at the time, figured he’d hold on to the policy for a while and see what happened.

Three months later, he learned he had melanoma and was given a 50/50 chance of living four years. Through a combination of aggressive treatment and experimental drugs, Mr. Manfredi survived. All of a sudden, though, the cost of the policy, whose premiums had gone to more than $200,000 a year from $94,000, didn’t seem like such a good deal.

“Once I heard it was melanoma I figured I should hold on to it if I’m going fast,” Mr. Manfredi said. “But when I kept living, it didn’t seem like a good investment.”

He started looking for options to sell the policy, and that was when he considered a life settlement. Life settlements are perceived by many in the insurance business as a dark corner of the industry. Generally, they’re used by older individuals who need money right away and whose life insurance, usually in the form of a permanent, cash-value policy, is one of their primary assets.

But as the industry has matured in recent years, life settlements have also become a way for a company — or in many cases, a small-business owner — to extract value from an often-overlooked asset.

“I’d say 70 percent of the time people let these policies go,” said John P. Keenan, a partner at Signature Estate and Investment Advisors. “We’ll talk to the executive and say, ‘If this is something you want to carry, we can go back to the company and ask if they’ll release the policy,’ ” he said. “We tell them that as an executive you had a need for it and you probably got it cheaper than you could today.”

In Mr. Manfredi’s case the settlement worked out well. He agreed to split the policy into four smaller ones. In 2012, he said he sold three policies with a combined death benefit of about $10 million for $1.35 million. In April, he sold the remaining $10 million policy for $1.2 million.

“I was relieved not to have to pay the premiums,” he said.

W. Scott Page, president and chief executive of the Lifeline Program, which negotiated the purchase of Mr. Manfredi’s policies, said in general a policyholder would be paid 10 to 75 percent of the death benefit of a policy. His company will pay to convert a term policy to permanent insurance and make any future premium payments.

To calculate the payment, life settlement companies require anyone looking to sell his key-man policy (or any life insurance policy, for that matter) to submit to a health exam as if they were being underwritten for a new policy, he said.

The process is not as ghoulish as it may sound. Mr. Page is not betting on any one person’s life, but pooling at least 100 policies together and selling interests in that pool as he would any type of securitized debt. He said that helped smooth out the returns, since it balanced out the people who live longer than expected with those who die sooner.

“Normally people in their late 60s or early 70s, regardless of their impairments, we can pretty much project what their life expectancy is going to be,” Mr. Page said. “But when you have a healthy 40-year-old you’re not going to be able to project how long they’re going to live.”

For that reason, life settlements are not an option for younger executives. But there are other ways to monetize key-man policies short of dying. Mr. Keenan said he often talked to former business owners or executives about how these policies could fit into their investment plan. If the person has a net worth in excess of the estate tax exemption — now $10.5 million for a couple — the key-man policy could be used to pay the taxes.

The policies themselves can also be used as a deferred-compensation plan or a way to retain an executive for a certain number of years. Christopher O. Blunt, president of the insurance group at New York Life, said there were generally three ways to structure key-man insurance so it was seen as a benefit to the person being insured.

A company could set up what is called a 162 executive bonus plan, where the company pays the premium and the executive is the owner and the beneficiary of the policy. Or it could pay for what is called an endorsement split dollar policy, where the company retains the cash value but gives the employee life insurance to protect his or her family.

A third way is to use the policy as the basis for a supplemental employee retirement plan, where the policy would become a key-man policy if the executive died while working for the company. Otherwise, the employee would get access to the cash value after a certain number of years.

Mr. Blunt said these policies needed to be seen in their primary role first. “When you own a small business, it’s a highly valuable, but uncertain and illiquid asset,” he said. “Small-business owners say, ‘I have a business that is worth millions.’ It’s only worth millions in a nondistressed situation.”

For that small-business owner, these policies can also be seen as assets (even though they’re not on the balance sheet) in negotiating the sale of a company. “If I buy your company and along with it, I get the key-person coverage, that makes the company more valuable,” said Robert H. Garner, executive vice president of CBIZ Life Insurance Solutions. “If someone has had a health issue or is 10 years older, the price doesn’t go up.”

He added that those policies also showed the buyer who was important. “Part of, ‘What is the company worth?’ is what are the people worth,” he said.

But executives should be careful about drawing benefits directly from such policies. For one thing, there are limits to how much life insurance people can get, and a key-man policy reduces what they could buy themselves to benefit their families.

And there can be taxes on these policies that people need to understand, whether they are trying to sell a policy or they receive one as a benefit.

For Mr. Manfredi, whose hobby is gambling, having the cash now meant more than a big death benefit for his family down the road.

“If I go in the next 10 years, it’s not a great investment,” he said. “But I saw it as a good time to do it.”

Article source: http://www.nytimes.com/2013/11/30/your-money/insurance-on-the-person-who-makes-the-business-run.html?partner=rss&emc=rss