At some point in their careers, successful producers take their practices to the next level by seeking clients who have a high net worth and hence, a larger problem to solve. Many of these affluent individuals have one thing in common: They own and operate a small-to-medium size business in which their role in operations is critical.
Advisors take classes to help them understand the needs of affluent business owners and the psychology of triggering a decision to exchange money for protection against the unthinkable. The Question is: Are advisors focusing on the right risks? If not, they may be leaving these clients exposed to a potential disaster while overlooking significant revenue opportunities.
The buy-sell agreement
Advisors to business owners focus on how to structure a timely exit from the business under circumstances the business owner knows and controls. These exit plans usually are rooted in a legal document, the buy-sell agreement, which is drafted by an attorney. Usually the agreement will address how the transition is to occur in the event of the owner’s retirement, death or disability. Finding an appropriate and able buyer, and coming to a mutually agreeable price for the business, is paramount.
Once this is determined, protecting both the buyer and seller against premature death or disability becomes the next logical step. Often the actual legal document will explain in detail what is to occur under these circumstances, but the question inevitably becomes, where will the money come from?
Life insurance can cover this obligation and often offers the buyer and seller the most flexibility and peace of mind. The risk of death can be transferred to an insurance company for a fixed cost that can be controlled. And the benefits are well defined. So, there are few or no surprises.
Basic financial planning tells us to save for the small events and insure against the large, unknown, occurrences. One would think those events posing the greatest risks would be addressed first. But in my experience this often doesn’t happen.
Of the underwhelming number of buy-sell agreements that are actually funded, most only address the untimely death of either the buyer or seller. They don’t take into consideration a disability, which is more likely to happen; and, when it does, is more complex.
The living dead
Disabled business owners while still living are “dead” productively in connection with the business. They have not only the same basic need for income, but also increased medical expenses. They clearly would not be interested in investing in the business; however they still want their salary and share of the profits at year-end.
Statistically, the average American at age 42 is 3.5 times more likely to become disabled for 90 days or more. Medical conditions that used to cause death are now much more likely to create a prolonged disability due to medical technology. Assuming the business has four owners whose average age is 50, there is an 80% chance that one of them will become disabled prior to age 65. These statistics, while alarming, do little to increase sales of disability buy-out insurance. Why?
One reason is that financial professionals treat disability income insurance as optional, focusing instead on life insurance as a vehicle with which they can accumulate retirement savings. Additionally, if term life insurance is used to fund the death provision of the buy-sell agreement, the premiums can be significantly lower than for disability income insurance–yet again leaving the risk unprotected.
Second, business owners themselves often assume that, because they are alive and still own their business, they are entitled to continue receiving their salary during a period of disability. This is a common misconception and one that an educated financial professional can easily dispel.
Numerous IRS rulings address the official “definition” of an “employee” and create severe consequences for continuing to pay individuals if they do not meet that definition. These rulings can help advisors convey to business owners the importance of addressing disability issues, including the risks owners face and how to mitigate them.
Many producers also tend to overlook the disability arena because their clients have investments and/or plans that negate the need for traditional income protection. That may be the case, but few small business owners would argue that their involvement in the business is not critical to its success; or that, if they were unable to run the business, the firm’s solvency would not be questionable.
Tapping into the owner’s ego
This may be the one area where financial professionals can use the ego of the business owner as a justification to take action on a plan of protection. The risk is great. The need is easily understood. And the market is ready and waiting!
Brian C. Richardson, CLTC, is a brokerage manager at Berkshire Advisor Resource, Inc., Greenwood Village, Colo. You can e-mail him at email@example.com.