Page 303 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 6. Employee Benefits and Perquisites 289

The rules also provided that the unused portion (if any) allowable under the Uniform
Premium Table for the term portion could not be used to reduce the imputed income for the
permanent coverage. The effect of this requirement is to increase imputed income and reduce
the attractiveness of such policies. Furthermore, the rules placed a high value on the cost of
permanent insurance due to the conservative interest rate assumption of 4 percent and the
mortality table specified for use by the IRS. This makes it possible, especially for a senior exec-
utive after a number of years of coverage, to have the imputed income plus dividends exceed
the actual premium cost! Needless to say, these changes by the IRS have significantly cooled
executive interest in Section 79 plans.
Dependent Life Insurance. In addition to insuring the life of the employee, some compa-
nies provide dependent life insurance. Due to heavy restrictions in many states as to the amount
of such coverage for a spouse versus a dependent child, this type of coverage is not very com-
mon. Furthermore, the IRS will allow free coverage for spouse and dependent children only
to a limited amount. Any coverage in excess of that amount and the full value of the policy
will be given an imputed income value, making it still an attractive and inexpensive benefit.
Nonetheless, it is at best of moderate importance.

Voluntary Employee Benefit Associations (VEBAs). The VEBAs described in the
health-care section of this chapter can also be set up for life and accident insurance.

How Much Life Insurance?
In determining how much life insurance an executive should have, the individual estimates
either what is needed to replace lost future net income or what is needed to provide for
survivors. Obviously, life expectancy and lifestyle are critical factors. Let’s examine these two
approaches.
Net Income. Under this approach, income loss is determined by taking the executive’s cur-
rent gross compensation (e.g., $500,000) and subtracting taxes (since life insurance proceeds
are not subject to income tax), own maintenance, and investments. Assume these total
$350,000, leaving a remainder of $150,000. This amount is held constant, or increased by an
assumed growth in compensation, and projected for the remaining working years of the
insured’s life. Thus, while $3,000,000 is adequate if no compensation increases are assumed
over a period of 20 additional working years, as shown in Table 6-16, almost $8.6 million is
required if an annual 10 percent increase in compensation is assumed. However, as can be
seen, this amount assumes no investment growth, whereas if the net investment were
assumed equal to the 10 percent increase in compensation, $3,000,000 is adequate if death is
assumed in the first year. Note, however, that this amount rises over the first 10 years because
the decrease in number of years of payment (e.g., 5 percent when dropping from 20 to 19) is
less than the increase in compensation (e.g., a constant 10 percent in this example). Thus, it
is very important in estimating lost income to adequately estimate future compensation
growth and assumed rate of investment on the death benefit once received. If compensation
growth is underestimated and investment increase overestimated, one will be underinsured;
if compensation increase is overestimated and investment growth underestimated, one will
be overinsured.
While many individuals making these estimates will only project the number of years of
their working life, it is important to also estimate the amount of retirement income and the