Plunging home prices … severe credit squeeze … cascading failures in the financial markets. Advisors who cater to small businesses might rightfully question whether the increasingly grim economic news of recent months will bring pain to their own practices.
That’s not likely. Such fears, say market-watchers, are misplaced because demand for life insurance-funded small business plans remains largely immune to economic swings. Yes, distressed businesses may slow funding of these plans to satisfy short-term cash flow needs when in a financial pinch. But the case for or against implementing a plan generally will rest on considerations unrelated to the business cycle. This is especially true of the market for compensation packages designed to attract and retain top-tier executive talent.
“Rarely will year-over-year cash flow considerations cause a business not to implement an executive benefits plan,” says Terry Altman, a certified financial planner and president of Altman Group, Bloomfield Hills, Mich. “If I have enough execs for whom I think it’s necessary to compete in an open marketplace, then I’ll do what’s necessary to make sure they’re not hired away by competitors. The existing or non-existence of a recession will not be controlling.”
Roey Diefendorf, a chief life underwriter and principal of Diefendorf Capital Planning Associates, Locust Valley, N.Y., agrees. “What kills business productivity is turnover,” he says. “Especially during economic downturns, you want to limit executive flight using some type of golden handcuffs.”
These sentiments are echoed by others interviewed by National Underwriter, who variously report “good” to “substantial increases” in sales during the past year for life insurance-funded small business plans. Chief among these are executive compensation benefits, notably non-qualified deferred comp and IRC Section 162 bonus arrangements. The positive assessments extend also to key person insurance and succession planning, wherein life insurance is commonly used to fund buy-sell agreements and estate equalization among inheritors to a family business.
Sources declined to project revenues from small business life sales in 2008. But most observe that market penetration for such plans continue to rise, particularly among businesses with 100 or fewer employees.
Among larger companies like the Fortune 1000, the trend line has been on the upswing for several years running for non-qualified deferred compensation plans.
A 2007 survey by Clark Consulting, Chicago, Ill., shows the adoption rate of NQDC plans to be at highest since the survey’s inception in 1993. Of the approximately 180 companies polled, 95% reported having an NQDC plan, compared to 91% in 2005. Similarly, 72% of respondents who informally fund their NQDC plans choose employer-owned life insurance (EOLI) as the funding vehicle, up from 70% in 2005.
Fueling rising interest in life insurance-funded plans at small businesses are changing demographics. Steve Parrish, a second vice president, life and health, at Principal Financial Group, Des Moines, Iowa, says more affluent boomers are “hitting their peak”–both in terms of financial needs and their ability to fund those needs–as they transition from the accumulation to the distribution phase of their life planning. And so life insurance becomes an attractive vehicle to fulfill retirement, estate or succession planning objectives.
“We think the demographics will be in our favor during the coming years as our advisors reach out to small businesses,” says Parrish. “As to the current economics situation, financial products, particularly insurance products, generally don’t correlate either way to booms or busts.”
When in the minority of cases they do correlate, the relationship might actually be an inverse one. Parrish points to employee stock ownership plans, which business owners may adopt as an exit plan in the event they are unable to sell their company to an outside party. That can happen when prospective buyers are unable to secure financing for an acquisition or fail to show interest in a buyout because of depressed market conditions.
During economic downturns, observers say, the question to be answered by business owners who are keen to offer financial incentives to recruit and retain top talent is not whether to offer an executive comp package, but rather how aggressively to fund one. Those firms that are profitably run and cash-rich should have little problem funding policies to the maximum limit. But those that are experiencing cash flow challenges may deem it prudent–or necessary–to cut back on premium payments until their financial situation improves, at which time they can ramp premiums up again.
Hence the value of flexible funding, and of universal life and variable universal life policies, which allow policyholders to vary payments as conditions warrant. To be sure, sources caution, minimum funding (or under-funding) of contracts can cause them to lapse because of dangerously low cash values. But business owners can guard against this eventuality by purchasing policies carrying a secondary guarantee.