Protecting Intellectual Capital | September 2001 E2E

E2E: Protecting Intellectual Capital

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Edward Tafaro

Keyperson disability insurance protects the value of a star executive.
Corporate insurance buyers understand risk. They understand that managing it on all levels is a critical component of driving and protecting shareholder value. In today's economy, human intellectual capital reigns supreme.

Intellectually rich companies tend to be highly dependent on the human capital of one or two key leaders who drive shareholder value. Virtually all corporations respond to this risk by securing keyperson life insurance.

But the greater risk is the exposure to a disabling injury or illness that prevents these leaders from executing their plans and realizing their vision.

Statistically, the risk of an individual suffering from a disability during his working years is significantly higher than the risk of death. A 45-year-old executive is three times more likely to suffer from a disability lasting more than 90 days than to die before age 65. In either event, the corporation faces significant loss. Why is it that less than 35 percent of all companies that secure keyperson life coverage fail to purchase the corresponding keyperson disability coverage? In today's competitive business environment, protecting the value of a star executive is more critical than ever. Using markets once reserved for elite athletes and entertainers, carriers like Lloyd's of London and other domestic niche market players have developed keyperson disability products designed to protect a company's most critical assets. These specialty carriers can deliver disability benefits exceeding $100,000 per month and lump-sum benefits of up to $100 million.

Recent case studies

The following case studies highlight and illustrate the importance of buying keyperson disability insurance:

A global public relations firm recently purchased a highly successful "boutique" company. The acquisition was made by paying the two owners of the company in two parts. Part A was a cash payment upon close of the acquisition valued at approximately $10 million each. Part B was a cash payment made to each shareholder over time based on certain performance targets. The acquisition agreement called for $10 million of keyperson insurance on each owner. The intent of this provision was to secure key person life insurance. However, when the broker went back to the CFO and explained that the risk of disability was the greater exposure to the corporation, a second sale was made.

To expand a start-up company, an entrepreneur of an international cosmetics company required additional capital. Three private-equity investors were hesitant to release funds because the success of the enterprise rested exclusively on the CEO's extensive network of industry contacts. Lenders required $3 million of keyperson life and disability insurance as a safeguard against the loss of their key executive. Because there was strong financial justification for the $3 million limit, the underwriting process with respect to the life exposure was straightforward, and the broker had hundreds of life companies and products to choose from. When the broker contacted his traditional disability providers, he was turned down because of the amount of insurance involved. After numerous referrals, the broker uncovered a few niche underwriting organizations that could meet these limits. Utilizing a custom-designed, keyperson disability policy, the insurance broker delivered a contract that would pay the corporation $50,000 per month for up to 12 months if the CEO became totally disabled. If the executive were deemed permanently disabled after that period, the company would receive an additional $2.4 million in one lump sum. Even though the start-up company had few tangible assets, underwriters were able to fund a trust with disability insurance for the purpose of redeeming the investors' shares in the event of the loss of the key executive. With this protection in place, the investors released the funds and the new venture was born.

One of the nation's largest entertainment conglomerates acquired a rapidly growing independent film production company. The production company had two key owners/executives/producers for which the business would have no tangible value other than the existing film library. The acquisition price exceeded the value of their tangible assets by almost $50 million. Prior to closing the acquisition, the corporate risk manager refused to allow the "deal makers" to close on the transaction because adequate disability insurance protection was not in place. With the life insurance already in place, the broker worked to secure two keyperson disability contracts. Both individuals were ultimately insured for a total of $45 million of disability coverage. Coverage was placed for a three-year policy period and a 12-month waiting period, after which benefits were payable in a lump sum in the event of permanent disability.

A hedge fund recently launched a fund that required institutional investors to commit their capital to a 5-year "lock up" period. The fund received over $1.0 billion in capital, which generated in excess of $10 million in annual management fees. The investors could only liquidate their position under specific circumstances, which included the death or disability of the fund manager. The hedge fund quickly realized it had a significant exposure tied directly to its star fund manager. Specialty underwriters worked with the broker and fund executives to design a reducing keyperson disability contract, which would pay the fund $50 million at inception. It would be reduced by $10 million per year over a five-year period. The coverage paid a lump-sum benefit if the executive became totally disabled for the elimination period and was unable to perform his contractual duties to the fund, thereby causing the liquidation by investors and loss of fees to the fund. The client paid a sig!
nificant premium for such a customized definition; however, when the exposures are very large and specific, the policyholder and the carrier leave the table satisfied.

A well-established specialty retailer sought a $2 million loan from a private lender. Because the CEO was the namesake and key manager, the lender required adequate life and disability insurance protection to cover the loan. The loan was to be repaid in 60 equal installments of $33,333 (plus interest). Because cash reserves were low, the elimination period was established at 60 days, and the benefit structure was $33,333 per month for 60 months, reducing by one month with each policy month. Placing coverage in this manner enabled the CEO to keep his existing personal-disability coverage, which he was going to assign prior to applying for this coverage.

The keyperson disability market

In the keyperson disability market, the actual "sale" is straightforward. Often the client has established the "need" for this type of coverage. The next steps are to educate him about the risk of disability versus the risk of death. The key to this market is knowing it exists and developing a relationship with an underwriter who can assist you with a complicated placement. Most brokers do not know this type of coverage is available; so those brokers who take the time to understand this niche have a marketing edge. In today's litigious society, brokers should offer the coverage because it is important protection and a means of protecting themselves if one of their clients loses a key employee to a disability. The statistics bear out the need for the coverage and justification for the cost. Getting up to speed on these niche products does not take much time and can pay big dividends, especially when working with your largest clients.

Marketing and offering these products will add value to your practice and put substantial dollars in your pocket.

Edward A. Tafaro is president of The Hanleigh Companies. He can be reached via email at ttafaro@hanleigh.com or at 800-443-2922.

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