Many young insurance agents are intimidated by the business insurance market. Perhaps it is their fear of having to deal with the business owner's CPAs, attorneys and other advisors, or perhaps it is their limited experience in reading business financial statements. While these are, indeed, challenges -- and I would recommend working with more experienced agents in this area every chance you get -- there is no reason why these challenges cannot be overcome and why agents should not aggressively prospect among small-business owners.
The fundamental risks a business owner faces -- loss of income due to disability or death -- are simply variations of insurable risks that agents help salaried employees protect against every day. Any insurance agent can break into the small-business marketplace by focusing on a few key areas that will provide the confidence to make some sales and earn many lifetime business clients.
I find that the most effective way to discover a business owner's concerns and to open a dialogue with that owner is to ask questions. In this article, I have identified five questions every agent can ask a business owner to determine insurance opportunities. I also share a hypothetical example, which can be used with a business owner to illustrate the risk of doing nothing.
Question No. 1: Do you have a properly designed buy-sell agreement that can guarantee a market and fair price for every shareholder if there is a loss of a shareholder due to death, disability or retirement?
If the answer is yes, then ask if a funding mechanism is currently in place.
There is a good possibility that the agreement is not properly funded. If the answer is no, you have created not only an opportunity for a future sale, but also the chance to create a referral relationship with an attorney who can help the client draft the agreement.
Life insurance can provide an instant buyout fund when there is a triggering event. Either the company or co-owners can own policies on fellow shareholders and use the proceeds to buy out the interest from the deceased's family. Life insurance can provide the assurance that surviving owners can maintain control of their company and protect their operating cash flow from the buyout requirement.
Question No. 2: Do you have business loans? And, if so, did you have to guarantee them personally?
For most small businesses, a business loan will require personal guarantees. This means the owner's personal assets could be at risk in the event of a business default. Business loans should be insured. Many bank loan agreements will have a clause allowing the bank to call the loan at any time. That risk is heightened when the guarantor is out of the business due to death or disability. Life and disability insurance can protect against that risk by assuring the creditor that outstanding loans can be paid in full in the event of a tragedy.
Question No. 3: Can the business afford to pay you a salary if you are unable to work due to a prolonged sickness or injury? Additionally, if your role is critical to the business, how would the company afford the services of a replacement executive?
A 45-year-old business person making $100,000 per year would earn $2 million over the next 20 years, even with no salary increases or bonuses. Can most successful small businesses support such a large, non-deductible drain on cash flow? Agents should understand that disability income protection is as important for business owners as it is for salaried employees.
Question No. 4: Who are your most valuable employees? Additionally, what would be the impact on the operations (sales, expenses, etc.) if you lost any of these key people? How easy would it be for the company to find a comparable replacement in short order?
A company that relies on two or three key salespeople to generate a majority of sales, for example, would be significantly impacted by the loss of any of those employees. Ask the business owner how long it would take before a new hire could replace the lost revenues and resulting profits. The potential net loss to the company might dwarf the premium cost of purchasing life insurance policies on these key people. It would be a relatively easy calculation and conversation.
Question No. 5: Have you considered "golden handcuffs" to create additional incentives for your key people to stay? Having a management succession plan is critical to the value and continuity of a business. The strategic buyers, private-equity firms or family members in line to take over the company will typically desire some continuity of talent to ensure the business's ongoing success. Properly designed incentives could serve a dual purpose, providing a valuable financial incentive for management to stay with the company and creating a funding vehicle for a potential management buyout, should the current owner choose such an exit strategy. Permanent insurance as part of a nonqualified deferred-compensation plan can be an ideal vehicle to address both purposes.
The cost of inaction
As these questions illustrate, an effective strategy in any life insurance sales opportunity is helping the prospect understand the cost of inaction. When working with a business prospect, share this example as a way to motivate the business owner into action.
What happens when an unfunded buy-sell agreement has been triggered for a small business? Assume the following:
- The business is valued at $2 million.
- A recently deceased shareholder had a 20% ownership stake.
- A buy-sell agreement exists with the company's requirement to purchase the estate's interest at pro-rata value (no discounts for lack of marketability or lack of control). This 20% interest is valued at $400,000.
- The agreement allows for a five-year installment note at 6% interest. The principal payments alone would be $80,000 per year for five years or $400,000 in total.
- The business has a tax rate of 35%.
- The business has historically achieved a net profit margin of 5%.
- The deceased shareholder is also a key employee whose position will need to be filled (in other words, the payroll expenses will continue).
- The deceased shareholder was a male, 50-year-old non-smoker in standard, normal health.
- Current sales and net cash flow are required for the operations of the business and would not be sufficient to pay out a shareholder.
- The company has reached its debt capacity.
What volume of additional sales will this small business need to generate in order for it to make the required installment payments over the next five years? The following table reflects the additional annual sales that would need to be achieved just to remain cash-flow neutral while the business meets its obligation.
In the first year alone, the note will require an $80,000 principal payment plus $24,000 worth of interest (6% of $400,000). To meet the principal payment alone, the company would need to generate $123,077 in pre-tax earnings in order to net $80,000 after tax. Adding in the $24,000 in interest, the company would need to generate $147,077 in pre-tax earnings in the first year. Given an average net margin of 5%, the company would need to generate $2,941,538 in new sales in order to make the first year's principal and interest payment to the deceased's estate. How likely is it for such a small company to generate $2.9 million in new sales in the year following the death of a key employee/shareholder?
Can the surviving owners afford to take this risk? Compare this risk to the annual premium cost necessary to provide a $400,000 15-year term life policy that would immediately fund the buy-sell liability in the event of an untimely death. Such a policy would have a total premium of approximately $1,500. The new sales necessary to support this non-deductable expense each year while the premium is payable would be $46,154.
This is just a single, hypothetical example; the actual costs would vary based on age, gender, relative health and the issuing insurance company.
Small-business owners are an attractive market for insurance professionals. There are many opportunities for insurance sales, and the premiums can be significant. Asking pointed questions to expose the dangers of inactivity or lack of planning can position any agent for a lucrative sales opportunity while offering critical protection to business clients. Keeping the conversations simple and focusing on what we as agents know best -- protecting income from a loss due to death or disability -- can open the door of this market to almost any agent.
Chris Hirschfeld focuses on helping families build and protect their personal wealth while assisting business owners with their executive compensation, business continuity and business succession plans. He is a registered representative with OneAmerica Securities and an insurance representative with American United Life Insurance Company, both OneAmerica companies. Hirschfeld has an undergraduate degree from the University of Notre Dame and a Master of Business Administration degree from the University of Chicago. He resides in Indianapolis with his wife and two children. Contact him at firstname.lastname@example.org.