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Show Your Investment Bankers and Finance Companies Your Buy-Sell Agreement Assets
The Private Capital Market Business Insurance Buy-Sell Series: February 7, 2012
The Cash Values In Your Company Buy-Sell Agreement Insurance Policies Are Going to Become A Lot More Valuable, For Many Different Reasons
Getting Ready For The Next Fed-Induced Asset Bubble
No matter how much the Federal Reserve has lowered the interest rates or how much cash the Treasury has injected into the economy, the FDIC commercial banks and commercial lenders, have not extended the necessary business credit to worthy small business that are desperate for growth capital. Now, the Fed has announced that it is going to hold interest rates at zero, for the foreseeable future. The ostensible reason is to provide more economic certainty for private sector decision-making.
The outcome of this policy, given the open global flows of money and capital, and the fixed and non-movable capital equipment and real estate in the domestic U. S. economy, is yet another Fed-induced asset bubble. The Fed’s interest rate policy lever does not work in a globally-integrated financial market because the other players can anticipate the Fed and take profitable contra positions in the international currency market.
Just like the asset bubble in tech stocks in 1998. Just like the asset bubble in real estate in 2005. Just like the asset bubble in commodities in 2007.
All of which led up to the financial melt down in October of 2008. All caused by a 20-year devil’s brew of government intervention and political manipulation of economic forces that should have been left to the free markets.
Witness now the elites in Europe trying to make decisions about the Greek debt, and decide for yourself if you have confidence in the ability of a tiny handful of U. S. political elites to manage the national economy.
The next Fed-induced asset bubble will make it even worse for small private U. S. technology companies to obtain growth capital from U. S. financial firms.
A Perverse Economic Benefit of Global Corporate Socialism
Oddly, one outcome of the Fed’s policy manipulations is that the main sources of capital for funding U. S. small business growth in America will likely be foreign lenders, who are seeking deals in the U. S. small high technology business sectors.
One effect of global financial integration is that the socialistic, collectivist policies in European countries have effectively killed technology innovation in their home economies. Both corporations and banks in the U. S. and the rest of the world are dependent on new ideas that are commercialized and the best place to find ideas for technology commercialization is in the U.S.
To paraphrase one of President Obama’s favorite lines, there are millions and billions of dollars sitting in foreign bank accounts waiting for a good investment idea in America.
Which makes the Obama philosophy of turning the U.S. into a benevolent totalitarian European state all the more stupid, from an American exceptionalist point of view. Technology commercialization is the unique initial factor endowment that gives the U. S. economy a global comparative advantage, and having the President of the United States destroy that cultural advantage by turning the U.S. into a socialist state is not exactly the hope and change citizens were hoping for.
The main technique of foreign corporations gaining U. S. technology will be from buying the small companies outright, or loaning them money.
Loaning small companies capital is not such a bad thing if the baby of American technology innovation does not get thrown out with the nasty bathwater of European international socialism. In order for very small private companies to get on the global deal screening radar screen, the small business community is going to need to promote themselves on a global PR platform.
One good way to get on the global radar screen of foreign lenders is to show them an asset that they understand. In other words, show them the cash.
In this case, the cash value assets of your corporate owned life insurance that funds your buy-sell agreements.
Generally Accepted Accounting For Corporate Owned Life Insurance Assets
In the United States, the Financial Accounting Standards Board (FASB) released a policy statement on the appropriate financial reporting treatment for life insurance owned by a company. (Technical Bulletin 85-4). The section states that an asset should be recorded on the financial statements at the amount that could be realized under the insurance contract at the financial statement date.
The balance sheet entry for the corporate owned insurance is described as an asset, at a specific date. In determining the expense or income to be recognized for the period, the premiums paid would be adjusted for the change in the cash surrender value.
If the life insurance contract were to be surrendered, the insurance company would issue the cash surrender value to the corporate policyholder on that date. The cash surrender value is the total balance of the accumulated value in the policy reduced by the charges that apply if the policy is cancelled in the early years of coverage. In order to be recognized as an asset on a company’s financial balance sheet statement, the policy must be owned and controlled by the company and must have the potential for providing a future economic benefit to the company.
A company obtains control of a life insurance policy when it purchases the policy as the owner and deposits premiums into the contract. The death benefit proceeds on the life of the company official who is insured could be considered a future economic benefit, although receipt is contingent on the contract remaining in force and the death of the life insured.
It is the cash surrender value of the life insurance contract that is recorded as an asset on the balance sheet of the company, however, and not the future value of the death benefit. Each year the change in the cash surrender value either goes up or down, and this changes the value of the asset on the balance sheet.
The GAAP treatment of corporate owned insurance as a balance sheet asset originated in a November 1970, AICPA Accounting Interpretation entitled “Accounting for Key-Man LifeInsurance.” That Accounting Interpretation identified the cash surrender value method as generally accepted accounting for purchases of life insurance.
In October 1984, the AICPA’s Accounting Standards Executive Committee (AcSEC) approved an Issues Paper entitled ”Accounting for Key-Person Life Insurance.” In the Issues Paper, AcSEC reaffirmed support of the cash surrender value method as the only generally accepted method for the treatment of corporate owned life insurance.
Corporate Insurance Cash Value Assets In The Event of Your Untimely Demise
In their article “Business-Owned Life Insurance: Opportunities and Pitfalls, David M. Cordell and Ted Kurlowicz explain what happens to the cash value of corporate owned insurance if you or the insured employee dies. (FPA Journal, Sept 2006).
In order to insure an employee or key executive, a company must demonstrate that it has an “insurable interest.” Without this documentation and evidence of insurable interest, a new tax law provision would cause the death benefit policy proceeds for employer-owned coverage to be treated as taxable as ordinary income.
In other words, in order to show the assets of cash value, the company must first demonstrate the logic of buying the insurance policy on the life of the employee or key executive. As Cordell and Kurlowicz explain, a corporate insurable interest is often described as the need to fund certain key employee benefits since the business will have an obligation to provide the benefits under the company compensation plan.
Another beneficial use of the corporate owned insurance, in the first instance, is the funding of a buy-sell agreement covering the lives of the participating owners. As they note, a critical qualification in the buy-sell agreement is that for the business to be the policy owner and beneficiary of the death benefit.
This means that the company must have the obligation to be the purchaser of the ownership interest at the time of the untimely demise that triggers the buyout. For example, a stock redemption agreement with insurance on the lives of participating owners would be an appropriate use of life insurance for funding the buy out.
Finding A New Purpose For Your Cash Value Assets
The importance of using corporate owned cash value as a multi-functional asset is big and getting bigger. In his testimony before Congress, David M. D'Agostino, Director, Financial Markets and Community Investment for the GAO, describe why the asset was so important (Testimony Before the Committee on Finance, United States Senate, October 23, 2003, Business-Owned Life Insurance: Preliminary Observations on Uses, Prevalence, and Regulatory Oversight).
As D’Agostino noted in his testimony, “Generally, business-owned life insurance is permanent, lasting for the life of the employee and accumulating cash value as it provides coverage. Attractive features of business owned life insurance, which are common to all permanent life insurance, generally include both tax-free accumulation of earnings on the policies’ cash value and tax free receipt of the death benefit.”
He described how banks use the cash value of corporate owned insurance to meet Federal Reserve capital asset requirements. He testified that, “As of December 31, 2002, 467 banks and thrifts reported business-owned life insurance holdings in excess of 25 percent of their tier 1 capital. The GAO asked the bank regulators to explain their oversight of 58 institutions with the largest concentrations, all in excess of 40 percent of tier 1 capital. Bank regulatory officials said that their agencies were monitoring these institutions’ levels of holdings, had conducted preliminary reviews or detailed examinations, and concluded that major supervisory concerns do not exist.”
Non-financial corporations also use corporate cash values for a variety of purposes. D’ Agostino described research from 2002, and stated that. “In the 2002 results from its survey of Fortune 1000 corporations, Clarke/Bardes reported that 65 percent of those companies that fund nonqualified deferred compensation plans and 68 percent of those that fund nonqualified supplemental executive retirement plans do so using business-owned life insurance.”
The audit and accounting guidelines for the larger, SEC reporting companies in showing the value of the assets in their financial statements was also described by D’ Agostino. “The SEC,” he noted, “requires public companies to prepare their financial statements in accordance with generally accepted accounting principles (GAAP), which would require them to disclose information about business-owned life insurance policies when such information is material.
According to SEC officials, however, following GAAP would rarely require purchases of and earnings from business ownedlife insurance to be shown as separate line items because they typically are not financially material to the company.”
The main idea is that cash value assets of life insurance are currently used by very large, public, global companies in a wide variety of business purposes and strategies, and their model can easily be adopted by very small private companies, and turned to their advantage in the global market.
Making Your Cash Value Life Insurance Perform A Dual Business Purpose
The cash value of corporate owned life insurance is an asset that foreign lenders can easily see and easily value. It is, after all, cash value held on the balance sheet of the company, according to GAAP.
Unlike the fluctuating or imprecise values of some other corporate assets that an asset bubble will obscure, that type of cash is going to become even more valuable. With the coming of the next Fed-induced asset bubble, the value of that cash sitting on your company balance sheet will be one asset that very few lenders will question when they go about their task of figuring up how much money you can borrow.
What the foreign corporations really want is your American technology, but show them your assets, and you may get the benefit of their capital without giving away the intellectual property of your company.
Thomas Vass is an independent licensed insurance agent, located in Raleigh, N. C., with a special focus on helping small companies implement buy-sell agreements. .
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About the Author
I help CEOs of small technology companies raise capital. I created an internet tool, called The Private Capital Market, that is categorized
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