Page 296 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

282 The Complete Guide to Executive Compensation

A variation on the typical key employee policy is keeping the policy in force until the
executive’s death (even after retirement). Such a policy may be used to provide special pen-
sion payments to surviving retired executives. In structuring such a policy, the company must
attempt to ensure that the proceeds are sufficient to finance the executive benefit. A key vari-
able is life expectancy when the payments are for life rather than a prescribed period of time.
Since the direct linkage of insurance proceeds to pensions would subject the executives to
unfavorable tax treatment (as prefunded benefits), the life insurance and pensions must not
be directly related. Nonetheless, the insurance proceeds provide the financing for the corpo-
ration to pay the pension supplements. Under such an arrangement, the company typically
has heavier cash flow requirements in the early years (i.e., insurance premiums and pension
supplements) than without such a plan. As with traditional key employee insurance, while the
death benefit proceeds are not taxable to the company (since it is the beneficiary), neither are
the premium payments tax deductible! However, interest charges are deductible (if four of
the first seven years’ premiums are paid in cash, not borrowed). By borrowing against the
policy’s increase in cash value, the company is able to lower its cash flow requirements and
deduct the interest charges. Since the policy’s cash values and dividends normally will exceed
the after-tax cost of interest charges, the net result is a positive increase in the value of
the initial company investment. This simple fact encourages the company to borrow the pre-
mium cost (after paying at least four of the first seven annual premiums) to have maximum
leverage on use of corporate funds.
Split-Dollar Insurance. Split-dollar insurance is when ownership of a whole life insurance
policy is split between company and executive with the face value of the policy (less the
amount paid by the company, which it recaptures at the time of the insured’s death) paid to
the executive’s beneficiary. Typically, the employer and the executive also split the premium.
The employer premium is determined one of several ways.
• The PS 58 method requires the employer to pay the portion of the premium that
exceeds that shown in Table 6-14. The PS 58 portion is paid by the executive.
• The cash-value method requires the employer to pay an annual premium equal to the
increase in the cash surrender value of the policy, with the executive paying the
remainder. This is illustrated in Table 6-15.
• The level-contribution method requires the executive to pay the same dollar premium
each year, with the company paying the remaining annual premium. This makes the
policy more affordable to the executive in the early years.
• The employer-pay-all method requires no payment by the executive.

A reverse split-dollar insurance policy reverses the relationship of the employer and employee.
For example, under the PS 58 method the employer would pay the premium equal to
the PS 58 cost, and the executive would pay the remainder and the executive’s beneficiary
would receive the cash value (covering paid premiums). The policy is either owned by the
company or by the executive.
The endorsement method is where the company is the owner of the policy. As such, it is
responsible for payment of the premiums; however, it makes a separate agreement with the
executive stipulating the amount and manner in which the insured will split the premium
with the company. In addition, the company allows the insured to name the beneficiary for
the amount in excess of the payment to the company to recover its costs. Another approach
is the assignment method, where the employee is the owner of the policy and an amount equal