The Loyalty Sale

The creation of business organizations as separate entities has always been a significant driver in the growth and prosperity of a free market. A company, such as a corporation, allows for things like serial ownership, limited liability and the accumulation of pooled capital that makes possible projects, industry, ventures and all forms of risk-taking enterprises that would not be possible or practical for one individual.

But a paradoxical aspect of such undertakings occurs when, despite the freestanding legal identity of the company, there is nonetheless a primary mover and shaker who is an indispensable element of the organization—the ghost in the machine, if you will. Such an individual is often the face of the company and is often the focus of the loyalty of those around. To many, especially key employees, that person is the brand and the company is, as a practical matter, that person’s alter ego.

This common case of blurred identity can create an unfortunate scenario, especially in smaller to mid-sized businesses. To wit, a young, intelligent, business- minded person senses and takes hold of the vision of an aggressive and prospering entrepreneur and devotes many early working years to riding the momentum and contributing to the success of the capable person, who has become his employer, mentor and, perhaps, role model and inspiration. In the process this person, the loyal employee, has foregone other more immediate benefits and opportunities to remain with the organization and eventually benefit from what he views as the greater longterm advantages of the current situation with “the Boss.” Then the Boss dies. New company leadership emerges or enters the scene, and doesn’t know or care or choose to recognize the importance or contributions of the loyal employee, who now finds the need to look for a new situation.

Those who are more altruistic among the ranks of company leadership not only appreciate the allegiance and ardor of such employees, but also recognize their vulnerability in the event of their own demise. Consequently, they want to take steps to protect those who have wagered their future and fortune on the Boss’ longevity.

If the beneficent Boss is insurable, there is an easy and efficient way to achieve this end, which we will refer to as loyal employee insurance. The Boss simply purchases life insurance on his life for the benefit of the loyal employee. Even when the person is at a more advanced age, this can be a relatively economical proposition because the period of need can be defined, making term insurance a good vehicle for funding.

Keep It Simple? Maybe Not! In an actual case study a particular Boss wanted to protect a loyal employee and, in an attempt to keep the benefit arrangement as uncomplicated as possible, requested that the loyal employee apply for and own the insurance on his (the Boss’) life. The Boss would pay for the coverage and report premium amounts as a bonus to the loyal employee. The Boss was worth several million dollars and the coverage requested was $250,000. On the surface it would not appear to be a big deal.

Nonetheless, all carriers were concerned about the existence of a legitimate insurable interest and denied any coverage that would be owned by the loyal employee. There was no blood relationship between the two and the employee had no ownership interest in the company. From a practical standpoint, the employee had a significant economic interest in the ongoing existence of the Boss. Unfortunately, the question of insurable interest is often more a legal question than a practical one, and carriers must consider how circumstances might play out under scenarios constructed on the worst possible circumstances.

Despite the seeming insignificance of the amount of coverage, it doesn’t take much imagination to create situations in which the Boss may be worth more to someone dead than alive. There is no guarantee that the loyal employee will always be an employee or loyal. And if termination of the relationship was the reason with an unpleasant ending, all sorts of possibilities suggest themselves in which a quarter million might look better than the insured living to a ripe old age. Consider a situation in which the loyal employee, in a fit of passion, grants the object of his affection beneficiary status under the policy, only to later experience a contentious end to the relationship. Now, at least for a brief period, a completely disenfranchised and vengeful ex-spouse or sweetheart may hold the beneficial interest in the coverage. In such a case the Boss would do well to check under the hood before starting the car each morning.

Such speculation makes one more inclined to sympathize with the seemingly picky legal underwriting considerations with which carriers must contend.


But There Is a Better Way Anyway A more advantageous method, which avoids all the underwriting concerns and the potential angst of relationships gone bad, is to structure the arrangement completely within the business organization. The loyal employee insurance can be funded through ordinary key person coverage on the Boss. The loyal employee can be provided for through a simple, legally enforceable agreement under which he is entitled to a certain amount in the event of the Boss’ death while in the employ of the company.

Under such a plan the after-tax effect of premium payments is about the same as if the Boss had double-bonused the premiums under the loyal employee owned arrangement. However, a client may object that since the payout at death must be recognized as income by the loyal employee, the benefit must now be grossed up to achieve the same after-tax result. Answer: Not a problem! In fact, the income tax-free nature of the policy death benefit and the deductibility of the payment to the loyal employee make this structure more profitable to the Boss, as long as the company (or the owners in the case of a pass-through entity) is in a higher marginal tax bracket than is the loyal employee. Consider the insightful illustration above.

In the example, the result to the company is a $25,000 increase in after-tax/ after-transaction revenue. This advantage will always hold if the employer’s bracket is higher than the employee’s. In addition, the company is in control of the destiny of the policy, which, as discussed earlier, could be important if the employee leaves the company.

Prospects Abound All-star Pittsburgh Steeler and Hall of Fame wide receiver Lynn Swann once commented, perhaps with much justification, that NFL franchise owners often used a player’s loyalty to a team or to a city to avoid paying them what they were truly worth. You want to convince your business clients to not make that mistake and, when adequately providing for those loyal employees, to be sure to protect the employees against the risk they may have assumed by “hitching their wagon” to the dreams and ambitions of your client.

Tom Virkler, JD, CLU, is directorof CPS Advanced Markets


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