How Life Insurance Can Totally

Protect the Business from

Top to Bottom: The Different Levels
of Business Protection
Insurance Selling Master Class

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Levels of Business
Protection
The Business Shareholders
Top Level: Insuring Transfer of Ownership
For Business Succession

•The death (or permanent disability) of a business owner, if it does

not cause the termination of the business itself, will at least cause
changes in ownership and management personnel. And often create
havoc not only within the business but also in the deceased business
owner’s estate.

• In this case, life insurance can:

• Give them the money to purchase the interest of the deceased;

• Pay the decedent’s debts, costs and taxes, & otherwise permit
the heirs to carry on a viable business;
• Be helpful in offsetting the peso loss that occurs when a
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business is liquidated.
The Key Men

Mid Level: Insuring the Key Man

For Business Continuity • Businesses are guided to success by a handful of key people. Often, the key
people are largely responsible for the firm’s good credit, its product line or its
goodwill.

Levels of • The death of such a person is bound to leave its mark upon the business -- an
interruption at the least, termination at the worst.

Business • To offset some or all of these losses, a business can carry life insurance on its

Protection
key people. This insurance, payable to the business, indemnifies it against the
loss of the key people.

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 The Key Men
Who are the Prospects for Key Man Insurance?

Levels of Business Protection

•A Key Man can be:

• Either one of the owners or key worker in a key position

• Someone who possess some expert knowledge of a company process, or a particular executive’s ability, or a marked managerial skills

• Someone who has broad experience in a business field

• Whatever the special quality this person possessed, it makes him a very important asset to the business and his death would
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destruction of that asset which is purely personal.
 Levels of Business
Protection
The Key Men

BUSINESS OWNERS AS A KEY MAN

• Active business owners are a company’s most

valuable person.

• When a close corporation or a partnership is

organized, it is usually the combined talents of the
organizers who are instrumental in making the
business a success.
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Levels of Business Protection
The Key Men

The death of a business owner or co-owner have various

other side effects on the company such as:

• Financial assistance from banks and other creditors may be restricted because they are
concerned about the company’s future;

• The business will slow down due to customer’s concern about the future of its services and
products;

• The business might lose customers who utilized the company’s services or products only
because of their relationship with the deceased man;

• The business will lose due to competition. 6

 Levels of Business Protection
The Key Men
NON-OWNERS AS A KEY MAN

• A company usually has one or more non-owner key

man whose expertise is vital to the company’s overall
success. His or her death would likely be reflected in
reduced profits for the business.

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Levels of Business Protection
The Key Men

The death of a non-owner key man , besides possibly

reducing profits, also could incur costs such as:

• Cost od finding and attracting adequate replacement

• Cost od training the new person to take over certain duties;

• Sunken cost from the mistakes of the inexperienced replacement until he or she attains
the skills of the deceased person.

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Levels of Business Protection
The Key Men

Uses of the Key Man Insurance

Life Insurance can provide the business with:

• Cash to keep the business running

• Cash to assure the creditors that their loans are safe

• Cash to cover special expenses of finding, securing, and training a new man to take the
deceased’s place

• Cash to cover the mistakes and errors of the deceased’s successor will make until he learns the
things the deceased knew from experience

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• Cash for many uses that cannot be determined in advance because they depend upon the
particular circumstances of that particular business at that particular time.
Levels of Business Protection
The Key Men

Mechanics of THE PLAN

• There is no particular form of agreement or special contract needed by the business to carry key man life
insurance on a key owner or employee. The insurance contract is purchased to indemnify the firm and
speak for itself.

• The only requirements needed are:

1. Insurable interest
2. Applicant, premium payer, owner, and beneficiary
3. Type of policy
4. Board Resolution

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Levels of Business Protection
The Key Men

Requirements of a Key Man Insurance Plan

INSURABLE INTEREST

• A corporation or other business has an insurable interest in the life of any man or employee
associated with the firm, whose death would cause it tangible loss.
• Likewise, a corporation has an insurable interest in the life of a shareholder who owns a
large portion of the corporate stock, and whose skill and experience are relied on to a great
extent to continue the business successfully.

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Levels of Business Protection
The Key Men

Requirements of a Key Man Insurance Plan

WHO IS THE APPLICANT, PREMIUM PAYER, OWNER & BENEFICIARY

• The applicant is the business. The application is signed by an officer of the business other than the insured.

• The premiums should be paid by the applicant - the business.

• The business will own the policy and possess all the incidents of ownership.

• The business will be the beneficiary, because it is purchasing the policy for its own benefit.
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Levels of Business Protection
The Key Men

Requirements of a Key Man Insurance Plan

THE TYPE OF POLICY

• The type of policy should be one that BEST suits the needs of the firm.

• Temporary life insurance is often used in many key-man situations because when the man retires /leaves
the company, the company ceases premium payments. It can be renewed every year and converted into
a whole life plan which the retired/resigned key man can continue out of his own pocket.

• Permanent life insurance is also a popular choice in many key-man situations funds accumulated in the
contract provide additional benefit to the insured individual plus a method for the employer to recapture
the cost of the insurance.
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 SAMPLE BOARD RESOLUTION
RESOLUTION

WHEREAS, __________________________ is now and for many years

has been the President of the Corporation and by reason of his unusual ability as
its chief executive officer, the Corporation has consistently earned profits for the
stockholders well above the average for the industry; and

WHEREAS, the termination of the services of the said

_______________________ by reason of his death would result in the loss of
his managerial skill, experience and profit making ability to the Corporation; and

WHEREAS, the Corporation desire to secure its financial position in the

event of the death of the said _____________________ and to indemnify itself
against losses to its earning power which his death would occasion;

THEREFORE, IT IS HEREBY RESOLVED, that the (Corporate Office) be

authorized and instructed to take such action and execute such papers as may
be necessary to secure a policy or polices of life insurance
________________________________________________ on the life of
______________________ having a total face amount of Ps. __________ with
the Corporation to be named beneficiary of such policy and to be the owner of
same; the policies so obtained shall be of the _________________ type. The
Treasurer is hereby instructed to pay all premiums on such policy or policies as
they come due.
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Levels of Business Protection
The Key Men

How to Determine the Economic Value of a Key Man

For an adequate Key Man coverage, the business should buy insurance equal to that
determined capital sum for that represents the loss that will be suffered and which needs to be
indemnified.

In determining the economic value of a Key Man, the following should be considered:

• How much profit is he responsible for?

• How much would it cost the business if he died today?
• How much will it cost to replace him?
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Levels of Business Protection
The Key Men

Methods of Determining the Amount of Insurance of a Key

Man

There are few points that might be considered in reaching a

reasonable figure:

1. Salary test method

2. Contribution to earnings method

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3. Combination method
Levels of Business Protection
The Key Men

Methods of Determining the Amount of Insurance of a Key Man

SALARY TEST METHOD

SALARY Ps. 1,000,000 /yr.

SALARY OF PERSON TO DO ROUTINE DUTIES Ps. 300,000 / yr.

TIME TO FIND & TRAIN REPLACEMENT 3 years

a: Salary - salary of person to do routine duties

Ps. 1,000,000 - Ps. 300,000 = Ps. 700,000
b: Value of managerial talents x time to find & train replacement
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Ps. 700,000 x 3 years = Ps 2,100,000 (Management value to business)
 Levels of Business Protection
The Key Men

Methods of Determining the Amount of Insurance of a Key Man

SALARY TEST METHOD

Another way to estimate the amount of insurance of a Key Man is thru the rule of thumb:

Coverage for keyman = 5 to 7 times annual income.

How does it work?

If your keyman is presently earning Php 1,000,000/year

We set up an account for your Keyman worth Php 5,000,000

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 Levels
The Key Menof Business Protection

Methods of Determining the Amount of Insurance of a Key Man

CONTRIBUTION TO EARNINGS METHOD

Computation based on:

a) Book value
b) Average net income before taxes for the past 5 years

FORMULA:
a) average book value x fair return = investment elsewhere
b) average income - fair return on investment somewhere = management
c) management portion x replacement years = management value
d) management value / # of members of the management group = value of the individual members
of the team.

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 Example:
Average book value of shareholder equity 10,000,000.00
Average income above before taxes (assume 20%) 2,000,000.00
Assume fair ratio of return 10
Time needed to hire and train replacement 3 years
Management teammembers 3

a) Average book value x fair ratio of return

Ps. 10,000,000 x 10% = Ps. 1,000,000.00
b) Average income - investment elsewhere
Ps. 2,000,000 - Ps. 1,000,000 = Ps. 1,000,000.00
c) Management portion x replacement years
Ps. 1,000,000 x 3 = Ps. 3,000,000.00
d) Management value / no. of teammembers
Ps. 3,000,000 / 3 = Ps. 1,000,000.00
(value of individual members of the management team)
 Levels
The Key Menof Business Protection

Methods of Determining the Amount of Insurance of a Key Man

COMBINATION METHOD
A) salary to manage + dividends + additions to retained earning
Ps. 1,000,000 + Ps. 200,000 + Ps. 600,000 = Ps. 1,800,000
B) average annual net earnings - salary of person to do routine duties - earnings on
invested net worth
Ps. 1,800,000 - Ps. 300,000 - Ps. 160,000 (1,600,000 x 10%) = Ps. 1,340,000
C) annual earnings attributable to managerial expertise/management team members
Ps. 1,340,000 / 3 = Ps. 446,667
D) portion attributable to key person x time needed to hire and train replacement
Ps. 446,667 x 5 = Ps. 2,233,335 (value of key man)

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Levels of Business Protection
The Key Men

Rights of the Insured in Key Man Insurance

• The insured key man has no rights in the policy itself. By a separate agreement, though,
the insured could be granted the right to purchase his or her own policy.

• Also by separate agreement, the key individual could be given the right to purchase the
policy owned by the firm in event of termination of employment.

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Levels of Business Protection
The Key Men

Termination of a Key Man

• The majority of court decision support the general rule that the firm has a legal right to
continue to pay premiums on a key-man policy and to receive proceeds upon his or her
death. The question of insurable interest only arises at the beginning.

• The company can also sell the policy to the insured upon termination of the key man. When
the insurance policy is transferred to the terminated man, the company is in a position to
purchase a policy on the life of the insured’s successor.

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Levels of Business Protection
The Employees
Bottom Level:
Insuring the Employees
Life insurance also has its place in the area of employee
benefits. These benefits may be limited to key officers
and personnel, or they may be made available to all
permanent, full-time employees.

Employee benefits may take a variety of forms:

1. Individual life policies may be purchased.
2. Life policies can also be purchased to provide a
deferred compensation plan for the employee.

3. Group life insurance contracts can also be 24

purchased as group term life insurance to provide
a benefit for group of employees.