How Much Key-Man Insurance?

The amount of insurance that should be carried on the life of a key man is determined by many factors, notably the purpose for which the insurance is intended, the amount the business can afford, and the size, value, and profitability of the business. Here is a list of considerations for reference:

1. The tangible value of the business, figures an investment return on that tangible value(say 7%), deducts that from average profits after taxes, capitalises the difference at a multiple of 5 or 6, and treats the resulting figure as the earning power derived from key man onto the business. If there are more than 1 key man, divide this figure according to their estimated contribution to the profitability of the business.

2. The amount of personal guarantees undertaken by the key man for the business.

3.The value of the share owned by the key man.

4.The cost of an appropriate annuity or his/her family.

5. The cost of paying death benefits or continuing salary payments to his/her family for some agreed period of time.

6. The estimated business operating cost for 1 to 2 years.

7. The estimated HR replacement cost for this key man to the business.

8. The estimated business liquidation cost at the death of key man. This applies to business with limited scope to continue if the key man dies.

All responsible businesses ought to have a key man insurance to provide assurance to their clients, banker, employees, and business partners. Strangely, the take up rate is not very high in Singapore.

What Insurance Does When a Key-man Dies

Success in business never just happens. It is achieved through purposive action by men who have the drive to develop a high-quality product, and aggressively seek out customers. In short a key man is one who gets things done and meets the challenge of expanding markets.

Key-men make profits. When a business loses them, it can lose money. When a business insures its key-men, it protects the company and can make money on the deal.

In my experience in working with accountants in providing key-men insurance to their clients, below are my notes on the actual used of the cash proceeds of an key-man policy:

1. Compensate for any reduction in the ability to get credit.

2. Discharged guarantor liabilities from estate of deceased key-man.

3. Help carry on the business.

4. Assured employees' salaries and CPF are paid during re-adjustment period of the company.

5. Discharge outstanding mortgages.

6. Protect the surviving owners of a closely held business from losing control to outside interests.

7. Continue compensation to the family of the key-man for some period of time.

8. Cover the loss of the re-adjustment period.

9. Pay the price for competent and experienced replacements.

Insurance companies got to buck up!

2 days ago, the newspapers reported a case on endowment policy, where the policyholder (elderly man) found that the maturity proceeds was lesser than the total premium he put in for the past 18 years. Professionally, i found that the explanation given by the spoke person of the insurance company unacceptable. This incident highlight a few short-comings of life insurance companies in their communication with policyholders.

Short-coming number one: Like to use complex wordings which are technically correct but completely confusing to the policyholders.

I got this feeling that the staffs of insurance companies churning out the anniversary statements assume that ALL their policyholders have a degree in actuarial science. The word "reversionary bonus" has a total difference meaning with the word "bonus" as understood by laymen. As policyholders, they want to know how much cash value their policies worth at any point in time, so that they can make appropriate decisions, or manage their expectations. Strangely, this simple data does not readily appear in most insurance companies' anniversary statements to their policyholders since the beginning of time.

Interestingly, many financial advisor representatives also do not understand the difference between "reversionary bonus" and "bonus".

Short-coming number two: Insurance companies assume that ALL policy-holders bought their policies for protection purpose.

The truth is some policyholders bought policies, not for protection purpose, but to accumulate retirement fund. Especially so for endowment policyholders. To this group of clients, insurance protection feature is a "good to have" item, but not the main requirement as expected from the policy. In above newspaper report, the affected insurance company explained to the elderly client that much of his premium has gone into protection charges because of his old age while acquiring the endowment policy. But, who cares about the protection item, when the purpose of the policy was to accumulate retirement fund and not for protection.

Short-coming number three: Insurance companies don't like to update policyholders on the current cash value projections unless being asked.

Above incident would have been mitigated if the insurance company had sent a cash value projection to maturity to the client every year, so that the client can make inform decision and manage his expectation. To realise the problem only after holding the policy for 18 years (and faithfully paid the premiums) is unfaired to the client. Again, this simple information is guarded like state secret unless being asked by clients or advisors.

Life insurance is a noble product that help solve many family and business problems. But the way insurance companies communicate with their clients is far from satisfactory and lacks common sense, this is something they got to buck up. The existence of a life insurance company is due to the support of the clients, and not the otherway round.

Sharing by Karol

The following is a sharing by a medical insurance policyholder, Karol:

"I was hospitalised last weekend due to gastroenteritis. An observation: I would be compensated sufficiently for medical expenses & lost income, so could concentrate on getting well. I was certain there were insufficiently covered people around me at the A&E ward who would have to worry about their medical bills."

This epitomises the role of medical insurance: to provide a sense of security in the midst of life problem(s).

Using Life Insurance to Solve Business Problems.

And here is a list of how life insurance may solve business problems:

1. Improve business credit
2. Underwrite key men
3. Attract important executives and other employees
4. Hold executives and other employees
5. Underwrite deferred compensation commitments
6. Underwrite lease commitments
7. Underwrite capital requirements for successor management
8. Guarantee the retirement of stock
9. Guarantee a market for a business
10. Fund pension commitments
11. Guarantee the accumulation of profit-sharing funds
12. Provide for the liquidiation of business interests
13. Underwrite the capital growth that can be conservatively expected on the basis of a business's earning performance
14. Underwrite the capital value inherent in the owner's skill and following
15. Underwrite the ability to exercise stock options

Source: Life Insurance Desk Book, Institute for Business Planning(IBP).

Using Life Insurance to Solve Family Problems.

Yesterday, there was an interesting article in the Chinese newspapers. The author wrote that while life insurance is so common today, it is also the least understood financial product (or the most mis-understood product). I agree with this statement, and would like to re-introduce life insurance to you.

Life insurance is a financial product that primarily creates capital and provide liquidity to solve certain family OR business problems. I will illustrate the family problems first.

The following is a list of ways in which life insurance can help solve family problems:

1. Financing a child's education
2. Underwriting a saving program
3. Building retirement income
4. Guaranteeing that children will have income during years of dependency
5. Guaranteeing that a spouse will have income for the balance of his/her life
6. Guaranteeing that a mortgage on a home will be paid off
7. Guaranteeing a lease obligation
8. Underwriting that additional tax liabilities that will accrue upon the death of a spouse
9. Guaranteeing the capital accumulation an employee expects to receive upon the vesting or payout of a profit-sharing account
10. Guaranteeing the future profits an executive expects to realise from a stock option or executive bonus plan
11. Guaranteeing gifts or bequests to a church, school, or chaity
12. Guaranteeing the transfer of existing capital to children while releasing funds for spending or risk investments.
13. Funding estate duty liabilities
14. Accumulating capital in a trust for children, parents, or grandchildren
15. Accumulating a secure, creditor proof investment return
16. Underwriting the money value of a housewife to the household.

Source: Life Insurance Desk Book, Institute for Business Planning (IBP), Research and Editorial Staff.

Permanent Whole Life Insurance in action.

One of my client passed away on 29 Sept 2006. He was 56. As I was helping his beneficiary to claim the death benefits, i found the information professionally educational.

This client purchased a permanent whole life policy in 1985 when he was 35. The premium was guaranteed to be S$2781 per year for a guaranteed assured sum of $100,000. The policy was arranged to be a Section 73 policy. When he passed away at age 56, the policy was inforced for 21 years. The accumulated reversionary bonus since 1985 till today is $73,584. The total premium he had paid was $58,401. The total sum his beneficiary received is $100,000 + $73,584 = $173,584. When i less off the $58,401 total premium paid, this permanent life policy effectively CREATED $115,183 for the widow of my client.

At the time of death, the client had substantial assets in properties, unit trusts, stocks, and fixed deposit. These assets are now frozen pending the grant of probate. The lawyer adviced that the estimated time to extract the grant of probate to be 1 to 2 years. As the policy was arranged as a section 73 policy. The proceed can be paid out without the grant of probate. Within a week, the widow got the cheque of $173,584, which was badly needed for the family.

This is permanent whole life insurance policy in action.

What gives you fulfillment?

Follow up on my last blog entry, I assisted the client in resolving the CPFIS and HDB matter. A partial liquidation of the ILP policy was done to sustain his mortgage for the next 12 months, while his CPF is building up.

As expected, he looked unhappy. I asked :"Have you forgiven your brother in law?" He looked at me as though i have asked a stupid question. "How can I forgive, it is money you know...."

I pull out a ten dollar note from my wallet, a family photograph and i placed them side by side. I asked him: "Brother, man to man talk, what gives you fulfillment? The dollar note or the family photograph?" He stared for a moment, and pointed towards the family photograph.

I said:"I know how you feel, your brother in law has failed you and your wife professionally. But it is only money, and not a huge amount. You were also at fault when you signed on the dotted line you did not seek complete clarifications. In life, relationship gives us fulfillment, not money. However, money is always the object that separate relationship. Forgive, and let go. Enjoy your family."

After that, we had a great fellowship over coffee talking about other man's favourite topics except money.

Please grow up!

Today I received a call from a client of an orphan policy-holder. The original advisor, his brother in law, has left to join a reputable IFA firm in Singapore.

He wanted to know the value of his CPF investment-linked policy, as he needed the fund to sustain his mortgage. When I dutifully reported to him the information, he was upset. The current value is lower than the initial capital he put in 2 years ago.

"I was told by my brother in law that when I need the fund, I can cancel this anytime, and I won't lose the capital and 'interest'......, and now I need the money to pay my mortgage ..." The client told me. I felt a sense of deja vu. A young advisor trying to make a quick sale on investment, withhold important information to the client, and did not study the client's financial position in depth enough.

A few lessons I want to share:

1. Investment using CPF is a serious affair. Don't fall into the sales pitch: "no cash involve, anyway you can't touch your CPF, invest lah...."

2. If you really cannot reject the person uttering above sales pitch, because he/she is your football buddy or dream girl, use only a small portion of your CPF, i.e. not more than $5,000. And demand your football buddy or dream girl to write down all the heavenly promises of the "investment" for you to file. So that if the investment don't behave what is being promised, you have something to fall back on.

2. If you forsee a liquidity need on your CPF within 5 years, don't invest. Any serious investment needs time to generate the result. In Singapore context, make sure your mortgage is provided for before investing.

3. You earn interest on deposits, you make returns on investment. In deposits, your capital is preserved. In investment, your capital is not preserved. (capital guaranteed products will be discussed at another time, they are different and have their pros and cons)

To that advisor who did this to your sister and brother in law. I wish you well in your new career in the reputable IFA firm in Singapore, and please grow up!

On Will.

I was working on a wealth transfer case with a business owner recently. There were some confusions on the function of will.

In simple term, a will is a document to specify who (i.e. executor) is going to take on the responsibility to wind up your estate, pay the necessary costs, and distribute your estate to your intended beneficiaries.

Otherwise the court is going to decide for you. The point is, when this happen, the administration process is usually long and costly. At the same time, disputes will arise amongst family membes, as each has his/her own opinion on how best to settle the estate issues.

Having a will DOES NOT mean your estate can be protected from creditors, or avoid estate duty. In an unplanned situation, all your assets will go through a "probate or administration funnel" to pay for the relevant debts (i.e. tax, estate duty, probate cost, liabilities). Your beneficiaries will only get the balance of your estate. In my experience, it is not uncommon that such balance of estate are not financially meaningful for the beneficiaries. Imagine distritubing $10,000 amongst spouse, parents and children.