Sales of employer-owned life insurance are on the rebound.
That’s the word from financial advisors, who report enjoying a significant rise in demand for the products to meet a range of business planning needs.
“We’re seeing a 50%-plus increase in sales of new EOLI-funded plans and a revisiting of existing plans funded with mutual funds,” says Michael Nolan, president and CEO of Nolan Financial, Chevy Chase, Md. “Since the equity markets recovered, companies are looking at employer-owned life insurance as a more tax-efficient way to fund the arrangements.”
Budd Schiff, a chief executive officer at NYLEX Benefits, Stamford, Conn., agrees.
“The trend line suggests that sales [for EOLI-funded plans] will remain strong through 2010,” he says. “This year, we’re on track to sell between $30 and $50 million in EOLI plans to our target market, mid-size and large businesses. In 2008, we did only $20 million in EOLI sales.”
Fueling the resurgent sales is a much improved business environment, as reflected in companies’ increased cash reserves and confidence about the economic outlook, sources say. That’s a marked change since the recession, when financially distressed firms restricted cash flow to meeting only critical operational needs and minimizing the impact to the bottom line.
Another factor contributing to rising sales is uncertainty about the estate tax, according to Richard Olewnik, a chartered financial consultant and assistant vice president at AXA Equitable, New York. Under the Economic Growth and Tax Relief Reconciliation Act of 2001, the estate tax is ending in 2010 but would reappear in 2011 with an applicable exclusion amount of only $1 million, unless Congress acts before then.
“Due to the lack of clarity about the estate tax, many advisors have sharpened their focus on meeting non-estate-related business planning needs,” says Olewnik. “For a second group of advisors, the uncertainty has availed them of opportunities to broach with business owners the potential impact of the estate tax’s reintroduction.”
Upshot: advisors are seeing an increased leveraging of EOLI to fund buy-sell agreements that provide for the purchase of an owner’s interest in a firm; key person insurance to compensate a business for financial losses arising from the death or extended incapacity of an executive; plus employee retirement and medical benefits.
Why use EOLI? The short answer is the vehicle’s tax-favored treatment. Cash values of permanent life insurance contracts grow tax-deferred. Policy loans and withdrawals can be made without penalty. And death benefit proceeds are distributed income tax-free to the extent they don’t exceed premium contributions.
Experts say those tax advantages are especially attractive to business owners who are looking to recruit, reward and retain top management with non-qualified deferred compensation plans, the largest market for EOLI sales. The chief vehicles for such arrangements are 401(k)-like deferral plans that set aside a portion of the employee’s salary (usually up to 25%) and bonuses (as much as 100%); and supplemental executive retirement plans (SERPs), which mirror defined benefit pension plans by promising a stated benefit at retirement.
A business buys a life insurance plan on directors and executives to be compensated, funding the premiums on the purchased policies. As each executive retires, the firm pays benefits from operating assets for a previously established period. At the executive’s death, the firm, being the sole beneficiary of the insurance proceeds, is reimbursed for some or all of the plan costs.
While sources attest to a rise in demand for EOLI-funded executive comp plans since the recession, industry data indicates the market for non-qualified deferred comp plans has yet to recover to pre-recession levels. A survey from Clark Consulting, Dallas, shows the prevalence of NQDC plans among retailers declining to 85% in 2009, from 95% in 2007. A smaller percentage (67%) of responding companies reported having SERPs, similar to their prevalence in 2007.
Paradoxically, a greater share of respondents–71%–say they informally fund their NQDC plans, up from 62% in 2007 and the highest level since 2001. Most of these firms are funding with employer- or trust-owned life insurance: The percentages for NQDC and SERPs are 61% and 68%, respectively.
“[Executives] are looking for ways to save for retirement above and beyond what they can save in a qualified plan, such as a 401(k),” says Scott Richardson, a business and estate planning specialist at Effner Financial Group, Downers Grove, Ill., which is affiliated with Northwestern Mutual Financial Network. “A non-qualified deferral plan, informally funded with EOLI, is an efficient way to offer that.”
Contributing to the market recovery is a favorable regulatory environment. Reflecting a view widely shared among experts interviewed by NU, Schiff says the recently finalized Internal Revenue Code section 409A, governing NQDC plans, has been a “good thing” for the industry. The reason: The code has clarified how businesses can structure the plans without running afoul of IRS scrutiny that could render the plans invalid and result in financial penalties.
An outgrowth of the 2004 American Jobs Act, 409A codifies rules for the design and operation of NQDC plans. The payment of benefits, for example, is permitted only following certain distribution events (e.g., the death, retirement or disability of a key executive). And the plans must follow restrictions on both the timing of deferrals and changes to distribution elections. The legislation also prohibits plan language that accelerates benefit payments, such as withdrawal (or haircut) provisions.
As a result of the requirements, the design of SERPs and NQDC plans changed as plan sponsors revised their arrangements to comply with the new statute and related regulations. But most of the adopting firms are mid-size to large businesses that have the financial wherewithal to deal with the cost and complexity of plan administration, observers say.
For many small businesses, alternatives to EOLI-funded NQDC plans, notably Section 162 executive bonus arrangements, are more attractive because they’re exempt from 409A. Chartered financial consultant Elizabeth Samson, Beverly Hills, Calif., says that she’s doing a brisk business marketing these plans. Though funded like deferred comp arrangements by the employer, the plan policies are owned by the executives. The benefit to employers: They get a tax-deduction when benefits are paid.
Michael Nolan, who has compared Section 162 bonus and NQDC plans under the current tax regime, observes also that executives enjoy a “substantially higher” pre-tax and after-tax income when receiving a bonus plan. This advantage, combined with a lower cost of administration, makes the plans especially attractive among pass-through entities–S-corps., limited liability companies and partnerships–that treat the business’s income as that of the individual owners or investors.
But Nolan says that NQDC plans are a superior employee retention tool.
“If the goal is to keep executives loyal for the long term, then nonqualified plans are the better option because you’re not paying out the benefit right away,” says Nolan. “I think we’ll continue to see an increase in the adoption of bonus arrangements among small businesses and EOLI-funded deferred comp plans at medium to large public and privately C-corporations.”
Richardson agrees, saying the expertise required to administer NQDC plans should not deter advisors prepared to specialize in a promising market niche.
“Once the eligible participants are identified, the fun begins with designing a plan,” Richardson says. “Don’t let 409A intimidate you. Within that complex set of rules is a fairly open playing field.”
To be sure, not all businesses are funding their NQDC plans with EOLI. NYLEX’s clients use EOLI-type (institutionally priced) contracts that are owned by the plan participants, says Schiff. The policies thus are portable, afford executives protection from employers and creditors, and let them draw against the cash value through loans and withdrawals on tax-free basis.
“These contracts effectively provide the after-tax benefits of a Roth IRA,” says Schiff. “The policy values grow tax-deferred and can be accessed tax-free. Employee-owned contracts also appeal to executives who are hesitant about funding a deferred plan, because they believe they’ll be in a higher tax bracket when they take the money out and have to pay tax on the benefit.”
However structured, sources say, new and revamped executive comp plans are increasingly being tied to performance metrics, such as growth in gross sales. Typically, says Schiff, a percentage of the compensation is based on overall company results, but at least 60% of pay will hinge on the executive’s own performance.
To insure the plans perform as expected, many firms since the recession have adopted a more conservative investment orientation, using whole life, universal life and (depending on cash flow needs) term life from AAA carriers to fund their EOLI plans, according to sources. The more conservative tilt has been in evidence, too, among businesses that continue to use market-driven variable and variable universal life contracts.
“Businesses still want variable life policies to fund non-qualified executive comp arrangements, but since the downturn, many have been directing more premium dollars to the contracts’ fixed accounts,” Nolan says. “Other firms are offering synthetic fixed accounts: They bear the investment risk of the variable policies and guarantee a certain rate of return to executives. These arrangements are quite popular among our clients.”