VideoAndrew Morrison, CFO of American Science and Engineering Inc., passed away in August at the age of 52, a year after joining the $70 million manufacturer of X-ray detection and imaging systems. At the time of Morrison's hiring, AS&E chief executive officer Ralph Sheridan said the CFO brought "a wealth of international treasury finance experience" that was "invaluable" to AS&E in broadening the global reach of field operations. Yet, while his death left a void, AS&E had elected not to insure Morrison — or any other company officer for that matter — with key-person life insurance. "It just didn't make sense," says Paige Cochran, vice president of human resources at the Billerica, Massachusetts-based company.
AS&E is not alone in forgoing key-person life insurance, employer-paid coverage that provides a payout to the employer in the event of a key person's death. While it is routine for corporations to insure their physical assets, many do not insure their human assets, believing key-person life insurance to be pointless, if not inappropriate. They contend that prudent succession planning obviates the need for the insurance — the argument at AS&E.
Vendors of key-person life insurance policies maintain companies are wrong about this. They note the policies' wide-ranging utility, relative inexpensiveness (costs are based on standard actuarial tables), and tax-free benefits. Moreover, they point out that the insurance payout from the policy not only defrays the costs of replacing an executive, but also can finance employee-benefit obligations and absorb financial strains caused by a key executive's death, from an impaired credit rating to lost customers.
Such benefits are part of a renewed campaign by insurers to sell key-person insurance to the C-level suite. And given the new responsibilities bestowed upon them since the Sarbanes-Oxley Act was passed, some are convinced that policies for CFOs will be a major new market. "The role of the CFO has taken on an importance post-Enron and post-Sarbanes-Oxley that is greater than at any other time in history," says Patrick Smith, director of advanced marketing at Hartford-based insurer The Hartford, adding, "We believe that key-person life insurance on CFOs will be a growing phenomenon, given their expanded responsibilities."
Smith is not alone. "Key-person life insurance on a CFO makes sense today," says Robert Hartwig, chief economist at the New York-based Insurance Information Institute. "CFOs' reputations and potential freedom are at stake in the wake of Sarbanes-Oxley. Consequently, companies will seek higher-quality CFOs — individuals whose integrity is unimpeachable and whose skills are broad. These CFOs would be more costly to replace in the event something happened to them."
Still, key-person life insurance promises to be a tough sell. Many public companies are loath to buy insurance that pays a large sum of money when a C-level executive dies. And, given the strain on cash-strapped budgets from skyrocketing insurance premiums, beleaguered risk managers are not about to add another policy to the mix. "Insurance is not a good substitute for high-quality management teams," says Richard Inserra, assistant treasurer and director of risk management at Praxair Inc., a Danbury, Connecticut-based industrial gas company with $5.2 billion in 2002 revenues. "When you lose a general, the colonels take over until a new general is put in place."
Game of Life
While key-person life insurance has been around since the 1960s, it has been eclipsed in recent years by the insurance industry's push toward corporate-owned life insurance (COLI) policies. The controversial product covers more than just key executives; it's designed to cover the entire rank and file, hence its more colloquial name — janitors' insurance.
The problem with COLI policies, which were born in the 1980s as a tax-advantaged way for companies to fund rapidly rising employee health-care costs, is that actions by Congress, the Internal Revenue Service, and the courts have removed some of their gleam. In 1999, for instance, Congress phased out corporate deductions for interest on loans against COLI policies. Negative publicity about how companies were benefiting financially from employees' deaths — especially in relation to September 11 — has slowed growth in a line that traditionally accounts for up to 30 percent of the life insurance market.
With COLI policies losing their luster, insurers are returning to key-person life insurance as a risk-transfer strategy for critical human assets. The benefit of having such coverage, vendors contend, is that it helps defray the cost of recruiting and training a replacement executive. In addition, the insurance also helps fund any financial promises made to a deceased executive's spouse, such as salary continuation or deferred compensation. And on the softer side, the insurance proceeds also can counter the financial impact of distracted employees — missed deadlines, deteriorating morale, and personality conflicts, according to W. Thomas Lobaugh, a senior vice president in the Chicago office of insurance broker Willis Group Holdings.
The case for having such coverage, says Lobaugh, is often clear. "The impact of a key executive's death is many-fold," he comments. "It can cause a loss of confidence among suppliers and customers, and an inability to seize upon a business opportunity, because cash reserves are being used to train the new employee. There's also the potential of impairing a company's credit standing and its ability to secure financing."
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