FILE 23: Key-Person Insurance

FILE 23

Wilson Engineering Limited is a small firm that specializes in projects for the oil and
gas industry. The owner, Chuck, is 64 years old. There are two other shareholders in
the firm, which is incorporated. Chuck is the majority owner with 60% of the shares;
Ralph and Ed are equal minority shareholders with 20% of the shares each. Ralph and
Ed are both 60, and their energy level is waning. The firm has an excellent reputation
for its work, even though the amount of work has been scaled back. Randy Woods
calls Chuck one day. Randy has been an independent engineering consultant for the
past 23 years, and has just heard of an incredible opportunity to tender on a
government contract for gas drilling in the Arctic. He needs the backing of a firm like
Wilson Engineering to proceed with a bid. Chuck agrees to prepare a bid, with Randy
as lead man on the project, on the condition that Randy joins the firm if they are
awarded the project. Beating much larger firms, Wilson is awarded the $5.5-million
project. It must be completed within three years. Randy joins Wilson Engineering at
an annual salary of $245,000.
Who needs insurance Chuck, Randy, or Wilson Engineering? If so,
what type and how much?
Question:

Recommendations

Randy is clearly essential to the project Wilson Engineering has been awarded.
Wilson should put key person insurance on Randy.
A one-year renewable term policy will allow the firm to renew the policy over the
period of time the project takes until completion.
The amount of the policy should be $1 million (between four and five times
Randys salary).
Wilson Engineering will pay the premiums and be the beneficiary of the policy.
While the premiums will not be tax-deductible, the death benefit will be paid taxfree to the business to find a replacement for Randy if he dies during the contract
period.
Agents Course of Action

The Agent writes a one-year renewable term policy with a $1-million face value.
The agent visits Wilson on each policy anniversary to renew the policy.
The agent discovers, through her annual visit, that, at the end of the project, Randy
is to assume the CEO role formerly filled by Chuck. Chuck, however, still owns
60% of the shares. Chuck and Randy structure a buy-sell agreement, only using a
term-to-100 policy with a value of $3.2 million (the value of the shares as
determined by a business valuator) to buy Chucks shares. Randy pays the
premiums and is the beneficiary of the policy. When Chuck dies, 18 years later,
Randy uses the death benefit of the policy to buy Chucks shares from his estate.
Randy becomes the majority shareholder of Wilson Engineering.
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