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Financial Underwriting Beyond the Formulas

Financial Underwriting Beyond the Formulas. John Valickus FALU, FLMI, CLU Divisional Chief Underwriter Lincoln Financial Group. Agenda – Beyond the Formulas. Focus on 4 Primary Financial Scenarios Key Person Income replacement Buy–Sell Estate Planning

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Financial Underwriting Beyond the Formulas

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  1. Financial Underwriting Beyond the Formulas John Valickus FALU, FLMI, CLUDivisional Chief UnderwriterLincoln Financial Group

  2. Agenda – Beyond the Formulas • Focus on 4 Primary Financial Scenarios • Key Person • Income replacement • Buy–Sell • Estate Planning • Three Case Clinics Per Scenario • Prerequisite we have audience participation and fun

  3. Key Person Coverage

  4. Parameters of the Key Person • Vital to the success of the company • Success depends on the expertise the person brings to the company • Recognition / reputation in the industry • What are the qualities that person brings to the company

  5. Key Person Coverage Historically based on a factor of… • Income • Bonuses • Stock Options • Benefits

  6. Other Factors to Consider on the Key Person • Experience in the Industry • Stage of the organization… Developmental, Growth, Maturity, etc • Money reinvested back into the company • Size of the organization

  7. Case Study #1 – Key Person Coverage • 76/M, $5,000,000 • President / CEO • Income is $500,000, Net Worth $10,000,000 • ‘Brains behind the company’ – started 30 yrs ago • Oldest son is his successor and VP of the company • Company valued at $9,000,000 • Retirement is not in his vocabulary per the detailed cover letter

  8. Case Study #2 – Key Person Coverage • 45/F, $10,000,000 • CEO of start up internet company 3 yrs ago • Company lost $1.3 M in 10’, $2.5 M in 09’ • Income is $300,000 • ‘Outside investors have provided $10,000,000 in income over the past 3 years • History of starting up two companies, both which she sold for over $20,000,000 each

  9. Case Study #3 – Key Person Coverage • 52/M, $5,000,000 • Pastor of the ‘Church of Vegas Chapel of Sin’ • Since he became pastor 20 years ago, church has grown from 300 parishioners to over 30,000 • Published and authored books and tapes • Value of church estimated to be worth $30,000,000 • Net income in the church in 2010 of $4,000,000 • Net income reinvested back into the church • Income is $200,000 - church provides home, car, etc

  10. Income Replacement

  11. Income Replacement • Income replacement typically uses the multiple of income approach to justify the death benefit • Less than age 35…..… up to 30x income • 35 – 50……….……....up to 20x income • 51 – 60……………….up to 10x income • 60 – 70 ………………up to 5x income • 70 and over…………..up to 3x income

  12. Income can be based on… • Earned Income • Percentage of unearned income • Bonuses • Benefits… deferred compensation, healthcare, 401k

  13. Other factors that may be considered for higher death benefits • Expected future increase in salary • Single or married • Number of children • Product type… what about variable? • $ for $ replacement • Outstanding debt / mortgage

  14. Case Clinic #1 • 56/M, $1,000,000 Term • Unemployed, out of work for 6 months collecting unemployment • 25 year history employed as a systems analyst • Prior income of $100,000 prior to being downsized • $250,000 of permanent coverage in force

  15. Case Clinic #2 • 23/F, $1,500,000 Term • First year of Medical School at UNLV, undergraduate degree from BYU • No coverage inforce • Earns a total income of $15,000 as a waitress • Annual premium is $1,250

  16. Case Clinic #3 • 45/M, $3,000,000 – UL • Stay at home Dad, father of 5 children • $0 income • Spouse is a pediatrician, earns $200,000 annually • Spouse has $3,000,000 inforce

  17. Purpose of Buy–Sell Coverage • What happens to the future of the company when a partner dies • Some partnerships dissolve • Lack of funding to purchase partners share • Heirs do not have the skills to operate a business • Provides for succession planning

  18. Buy – Sell Coverage • How many being insured and for what amount • Consistent with the ownership of the company… 50/50, 70/30 • Coverage is equal to the business or stock ownership based on the book or fair market value of the business • Financial documentation is the key, income and balance sheets over the past two years • How was the value of the business determined

  19. Business Evaluation Methods Viva Las Vegas • Book Value • Market Value • Capitalization of Earnings Method

  20. What helps push you over the fence… Things to consider: • Number of employees / size of company • Number of years in the business • Product • Website

  21. Case Clinic #1 • Two brother seeking $500,000 each… ages 45/44 • Sandwich, subs business, opened 6 months ago • Start up business, no profits… expect to earn a profit in year #2 • Amounts determined base on their profit expectations and expansion • Previously were construction workers

  22. Case Clinic#2 • Two partners… age 56 and 70% owner, other partner age 62 and 30% owner • 2010 Revenue of $241 million • Net income of $2,100,000 • Company established in 1925 What’s an acceptable face amount? Can you justify??

  23. ‘Team Value of $1.2 billion dollars’

  24. Estate Planning

  25. Estate Tax Law Changes for 2011 • $5,000,000 individual exemption • $10,000,000 joint exemption • Maximum tax rate of 35% • 2013 reverts back to $1,000,000 individual & $2,000,000 joint exemption in 2013

  26. Folks who avoided Estate Taxes in 2011 $600,000,000 in estate taxes $500,000,000 in estate taxes $300,000,000 in estate taxes

  27. Calculating Estate Taxes • Determine an acceptable interest growth rate • Younger the age, higher the growth rate • Determine the years of growth based on percentage of life expectancy • Any growth rate at ages 80 and up? • Deducting the exemption amount

  28. Underwriting Estate Planning Cases • Biggest area of concern for STOLI/IOLI/Fraud • Older ages, table shave programs were abused • Need for more personal balance sheets, tax returns • Verification of bank statements, brokerage statements, real estate appraisals • If not survivorship, why individual cases • Evolution of smaller face amounts at older ages for ‘estate planning’

  29. Case Clinic#1 • 79/F, $250,000 – UL • Standard Risk • $100,00 in force • Pension and SS income of $30,000 • Estate is valued at $800,000 • Premium is $15,000

  30. Case Clinic#2 • 73/F, $4,000,000 – UL • No coverage inforce • Joint net worth of $10,000,000 • Tax returns note an income of $175,000 • Premium is $89,000 • Table 2 risk

  31. Case Clinic #3 • 51/F, $17,000,000 • Total line of $46,000,000 to be placed with several companies • Homemaker, previously a nurse • Spouse is a doctor • Joint net worth of $24,000,000 • Mother in law looking to reduce her estate and pay a single premium on all policies… total of $3,500,000 • Preferred Risk

  32. Any Questions?

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