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Business Insurance

This text is designed to provide accurate information in regard to

the subject matter covered. The readers of this book understand

that the author is not engaged in rendering legal or financial

services. You should seek competent tax or legal advice with

respect to any and all matters pertaining to the subject covered in

this book.

Copyright 2014

Mark Coleman – author

All rights reserved. This book, or any part thereof, may not be

reproduced in any manner without written permission from the

author. Printed in the USA. First Printing, December 2003

AFTER YOU HAVE READ THE MATERIAL, YOU CAN

TAKE THE TEST ON-LINE BY CLICKING THE

FOLLOWING TEST SITE:

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A grade of 70 or higher is required to receive Continuing

Education credits.

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Table of Contents

Limited Partnership……………………….Unit 1 Notice of transfer of corporate name 7

Limited partnership – key attributes 8

Sole Proprietorship ………………………..Unit 2 Buy–Sell Agreement 11

Survivorship Life 12

Insurance for Buy-Sell Agreement 13

Buying Life Insurance 15

Selling the Business 18

Partnership…………………………………Unit 3 Cross – Purchasing Plans 19

Entity Plans 19

Closed Corporation ………………………..Unit 4 Cross Purchase Plan 21

Stock redemption plan 21

Key person insurance 22

Economic value 24

Business will 27

Fund Options 28

Split – Dollar ……………………………….Unit 5 Background 31

Valuing Life Insurance Protection 31

Rule #1 IRC Section 83 33

Rule #2 IRC Terminating the plan 33

Rule #3 Treatment as a loan 33

Rule #4 Safe Harbor for termination 34

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Compensation Plans ……………………….Unit 6 What compensation are affected? 36

Which executives are affected? 37

Why do companies and executives defer compensation? 37

What are the other major exexutive compensation strategies 37

Health Insurance……………………………Unit 7 COBRA 40

Newborns and mothers health Plan 41

The Mental Health Parity Act 42

HIPAA………………………………………..Unit 8 The Women’s Health & Cancer Act 46

Health Insurance Fundamentals…………. Unit 9 Health Insurance – Short Term Polices 47

The downside of Short Term policies 48

Catastrophic Health Insurance 49

Who purchase catastrophic health insurance? 49

Is coverage the right choice? 49

Traditional Health Insurance 50

Fee for Service 52

PPOs

Introduction 52

Is a PPO the right choice for you? 52

Point of Service (POS) Management Care 53

HMOs 54

Is a HMO the right choice? 54

Group Life Insurance ……………………..Unit 10 Term life insurance 57

Permanent life insurance 57

Group ordinary life plans 58

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The group paid-up plans 58

Group universal life plans 58

Flat benefit plans 58

Other forms of group life 59

Franchise life insurance 59

Credit life insurance 59

Blanket life insurance 59

Multiple Employer Trust 60

Disability Income insurance 61

Jobs & Growth Tax Relief

Reconciliation Act of 2003………………...Unit 11 Introduction 64

Other provisions 65

Health Savings Account 66

Introduction 64

How are businesses handling HSAs 65

Basic requirements of HSAs 67

Cost of servicing HSAs 67

Limited Partnership 1

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A limited partnership is a partnership formed by two or more

persons and having one or more general partners and one or more

limited partners. As the definition indicates, the difference between

a limited partnership and a general partnership is that a limited

partnership has two classes of partners: general and limited.

General partners in a limited partnership have all the rights, duties

and obligations of partners in a general partnership. The limited

partner's status, on the other hand, differs from general partner's

status in several ways. The liability of a limited partner is generally

limited to the amount that the limited partner initially contributed

to the partnership; the limited partner generally does not participate

in the control or management of the partnership; a limited partner

may not contribute services to the partnership, only money or

property; and, upon dissolution, a limited partner has priority over

a general partner in asset distribution.

Many states do not require a limited partnership to have a

partnership agreement. Iowa Code section 487.201 does require the

partners in a limited partnership to execute and file with the

Secretary of State an application for a Certificate of Limited

Partnership. Even though the requirements to form a limited

partnership are minimal, a written partnership agreement is

recommended.

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Limited Partnership - Points to Consider

Limited partner's risk is directly proportional to the limited

partner's capital investment.

Investment by limited partners is a potential source of venture

capital.

No management responsibility for limited partners.

General partner can increase the business's financial resources and

keep personal control of the business without incurring long-term

debt.

General partners remain personally responsible for all liabilities

and debts of business.

Limited partners lack a strong management voice.

Limited Partnership - Procedural Aspects

Formation

Partners should choose a name for the limited partnership. A

limited partnership may also reserve a name according to state

statute by completing an Application for Reservation of Name. A

previously reserved name may also be transferred by completing a

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Notice for Transfer of Corporate Name.

It is recommended the partners create a written limited partnership

agreement.

Partners must deliver Certificate of Limited Partnership to the

Secretary of State's Office. Certificate must set forth information

required state statute.

A limited partnership may amend its Certificate of Limited

Partnership according to state statute. Any amendments made to

the Certificate of Limited Partnership must be filed with the

Secretary of State.

Dissolution - A limited partnership can be dissolved non-judicially,

judicially, or administratively. A limited partnership may also be

wound up according state statute. If a limited partnership is

administratively dissolved, it may apply for reinstatement by

completing an Application for Reinstatement.

Foreign Limited Partnership - If the limited partnership was

created under the laws of another state, then before transacting

business to that state, many states require a foreign limited

partnership to register with the Secretary of State which may be

done by completing an Application for Certificate of Registration

of Limited Partnership. An agent for service of process for a

foreign limited partnership may resign as agent for service of

process by completing a Statement of Resignation of Registered

Agent according to state statute.

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Limited Partnership - Key Attributes

Creation (minimum requirements) - Execute and file a Certificate

of Limited Partnership.

Profits / Losses / Distributions - By agreement or according to state

law.

Liability General - partner according to state statute; limited

partner according to state statute.

Capital / Financing - By agreement.

Duration - By partnership agreement.

Transfer of Ownership - By agreement or according to state statute

Management and Control - By agreement . General partners have

authority to manage and control while limited partners do not.

Taxation –

State: Business owners should call the state for information

regarding state taxation.

Federal: call Internal Revenue Service at 800-829-1040.

Reporting Requirements – According to state statute

Fee - none

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Sole Proprietorship 2

Introduction

The sole proprietorship is the oldest, most common, and simplest

form of business organization. A sole proprietorship is a business

entity owned and managed by one person. The sole proprietorship

can be organized very informally, is not subject to much federal or

state regulation, and is relatively simple to manage and control.

The prevalent characteristic of a sole proprietorship is that the

owner is inseparable from the business. Because they are the same

entity, the owner of a sole proprietorship has complete control over

the business, its operations, and is financially and legally

responsible for all debts and legal actions against the business.

Another aspect of the "same entity" aspect is that taxes on a sole

proprietorship are determined at the personal income tax rate of the

owner. In other words, a sole proprietorship does not pay taxes

separately from the owner.

A sole proprietorship is a good business organization for an

individual starting a business that will remain small, does not have

great exposure to liability, and does not justify the expenses of

incorporating and ongoing corporate formalities.

Sole Proprietorships are the easiest type of business organization to

establish. There are no formal requirements for starting a sole

proprietorship.

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Characteristics of the Sole Proprietorship:

Decision making is in the direct hands of the owner.

All profits and losses of the business are reported directly to

the owner's income tax return.

The startup costs for a sole proprietorship are minimal.

Owner has unlimited liability. Both the business and personal

assets of the sole proprietor are subject to the claims of

creditors.

Because a sole proprietorship is not a separate legal entity, it

usually terminates when the owner becomes disabled, retires,

or dies. As a result, the sole proprietorship lacks continuity

and does not have perpetual existence like other business

organizations.

It is difficult for a sole proprietorship to raise capital.

Financial resources are generally limited to the owner's funds

and any loans outsiders are willing to provide.

The owner could spend unlimited amount of time responding

to business needs.

Most small business owners have a considerable portion of their

net worth tied up in their business. In terms of personal and family

financial security, the "What happens if the principal becomes

disabled or dies?" is of paramount importance.

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In a one person operation, the primary concerns are providing

income for surviving family members, and funds to cover estate

settlement costs in the case of death. In such cases (typically sole

proprietorships), the business will usually cease upon the long-

term disability or death of the owner. For this type of business,

adequate protection may be achieved with life and disability

insurance matched to the projected needs of the survivors.

In contrast, consider the example of a small law firm owned by

four owners, one of whom recently died leaving his interest to his

spouse. The surviving spouse has personal income needs and

wishes to sell her deceased husband's share of the business; the

surviving owners are concerned that the former owner's share may

fall into an outsider's hands. How can both parties satisfy their

needs fairly?

Buy-Sell Agreements

For any business owned by more than one person, buy-sell

agreements triggered by disability or death protect both the

disabled/deceased owner's interest and the interests of the

remaining owners. Simply stated, a buy-sell agreement establishes

the conditions under which one owner (or owners) would buy and

one owner (or that owner's estate in the event of death) would sell

shares of the business.

In many multi-owner businesses (small partnerships, closely-held

C or S corporations, limited liability companies), personal

protection concerns extend beyond the desire of the surviving

partners to continue the business (in the event of disability or

death) to include arrangements for a planned, voluntary withdrawal

by an owner from the business (e.g., retirement).

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In situations in which saving for retirement has been difficult, it is

common for owners to view their shares of the business as equity

for retirement. Many small multi-owner businesses include

retirement in their buy-sell agreements as a way to liquidate a

retiring owner's share on a pre-established, equitable basis.

Buy-sell agreements are typically structured as either cross-

purchase or entity purchase plans. In a cross-purchase agreement,

each owner agrees to purchase another owner's interest in the

business upon the occurrence of a qualifying event. In an entity

purchase agreement, the business entity purchases the stock of the

disabled/deceased/retiring owner. There are advantages and

disadvantages associated with each plan, but one common thread

running through many buy-sell agreements is the use of life

insurance to help ensure that sufficient liquidity will be available

when a death brings about the sale of an ownership interest.

Survivorship Life Insurance

Consider the example of a closely-held business run by a husband

and wife, with a succession plan calling for passing ownership of

the business to their daughter upon the death of the second parent.

The existing estate plan utilizes the unlimited marital deduction at

the first death, meaning all assets (including business interests)

would pass to the surviving spouse with no federal estate tax

burden at the first death.

A significant liquidity problem could arise at the death of the

second spouse. If most of the remaining family wealth is tied up in

the family business, how could it pass intact to the daughter? One

solution to this question might be a survivorship life insurance

policy, which would provide a death benefit when the second

named insured dies. In this example, since the potential estate tax

burden is deferred until the second death, a survivorship policy

could provide liquidity precisely when it is needed most.

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Since no death benefit is paid at the first death, survivorship life

may be most appropriate when the surviving spouse has sufficient

income from other sources. Income needs for the surviving spouse

must be weighed against liquidity needs at the second death. If

income needs for the surviving spouse are greater than funds

available, it is suggested that two individual life policies be

purchased by the husband and wife (co-owners of the business)

with each policy naming the other spouse as beneficiary. This way

the two policies will provide the additional funds needed at the

time of one of the spouse's (co-owner's) death.

Insurance for Buy-Sell Agreements

Sole proprietorships, partnerships and small closed corporations all

need to consider what happens if the owner or one of the partners

or shareholders dies or becomes disabled. Who will purchase the

company or the deceased partner’s or shareholder’s interest? What

is a fair price? When will the sale be made? Will the deceased

owner’s/partner’s/shareholder’s families be given a fair shake and

taken care of? These are real questions every small business should

deal with before the event occurs.

The business itself may also suffer form a supplier’s or creditor’s

perception of the value of the deceased person to the success of the

business. Key employees may consider the deceased’s death as a

reason to move elsewhere. There needs to be continuity and a

smooth transition in the business when tragic events such as deaths

or disabilities occur. The buy-sell agreement is important to

resolve a lot of problems dealing with employees, creditors,

suppliers and the deceased person’s family.

Importantly, where will the funds come from to provide continuity

and a smooth transition?

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Everyone is going to die and sometimes it happens totally

unexpectedly and at a much younger age when expected. There are

no dying rules specific to owners, partners and shareholders.

A buy-out sell agreement is, essentially, the will for the business

and it eliminates a lot of difficulties and heartaches when a key

person dies. A plan needs to be in place and a method of funding

that plan must also be available.

There are several options for business owners to fund a buy-sell

agreement:

They can wait and see – “I’ll worry about that if and when it

happens.” A sole proprietor can say, “I’ll be dead, so no reason for

me to worry about it.” Sure! If it is a partnership, the partnership

dissolves automatically and, “My partner will do the right thing.”

Is that what you want? You can use your personal funds to buy out

your partner’s stock. But what if it comes at a bad time? Your

personal stock portfolio is down, you’ve got two children in

college, and you’ve had to take less income form the business

lately because business has been in a slump. Maybe, after a lengthy

probate the corporation can buy the stock and place it into treasury

stock, if funds are available.

But where does this leave the family of the deceased? Would you

leave it up to your partners to do the right thing for your family no

matter what the personal cost would be to the partner?

They can borrow funds -- obviously, borrowing funds is not an

option to a dead sole proprietor. Could a key employee put

together the money to purchase the company? Can the surviving

partner(s) borrow enough to purchase the assets of the deceased

partner? Maybe they can take out a second mortgage on the house?

Maybe the lost one is the one depended upon by bankers and

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suppliers. Maybe the repayment and interest is simply too

burdensome.

They can set-up a savings account within the company in

anticipation of an event like this happening but, again, if you are a

corporation there may be accumulated earnings tax problems and if

you are not a corporation, it may be difficult to maintain a savings

account or the death may occur prematurely before enough funds

are available.

Buying Life insurance.

Sole proprietor’s, partnership’s and a corporation’s

perspective.

When business people sit down with their lawyer to discuss setting

up a new business, they’re usually thinking about all the great

opportunities in front of them. The promise of unlimited profits,

financial independence, and working for themselves is what they

see. However, one of the most important issues that they need to

examine, an exit strategy, is probably the last thing that they

usually are thinking about.

When business lawyers attempt to discuss this issue with their

business start-up clients, they walk a fine line for several reasons.

During the “dating/honeymoon” stage of new business ventures,

the owners rarely want to think about such negative things as the

death or divorce of their business arrangement. Additionally,

addressing such negative issues as death, disability, dispute

resolution, spousal interference, and business failure are not

viewed as positive karma by most new business people. Finally,

the thought of paying a lawyer to create yet another document that

will never be needed is usually a pretty distasteful thought to most

business owners.

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Perhaps the most important document that a business lawyer can

prepare for business clients is the buy-sell agreement.

Unfortunately, it is also one of the most difficult business

documents to prepare properly.

Buy-sell agreements serve several important functions. First, they

provide a mechanism to preserve the close ownership of the entity

by restricting how the ownership interests (stock, membership

interests, etc.) can be transferred. Second, they provide a market

for the ownership interests of a closely-held business. Third, they

provide the business owners with an agreed upon method for

valuing their ownership interests. Fourth, in the case of S

Corporations, they should provide protections from doing things

that could terminate the corporation’s S election. Fifth, in the case

of limited liability companies and S Corporations, they can provide

a mechanism to ensure that owners receive enough actual annual

distributions from the business to pay the taxes that are attributed

to them. Sixth, they can be used to allocate entity control among

owners and management. Seventh, they can be used as an estate

planning tool.

Each of these functions is extremely important to the ensure that

business owners have a road map for dealing with these important

issues before they become serious problems. Although most

business owners don’t want to address mortality (theirs or the

business), permanent disability, termination of employment, and

business disputes, it is much easier to deal with them upfront when

you’re not actually living through them.

Having a buy-sell agreement provides business owners, their

lawyers, and in those serious cases where the parties are unable to

resolve disputes on their own, judges and juries, with a framework

for dealing with these difficult issues. It also, provides the parties

with an exit strategy if business issues cannot be addressed

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satisfactorily by the parties. Therefore, it serves as a business

prenuptial agreement for the parties. In the litigious society in

which we live, having a buy-sell agreement will not necessarily

prevent litigation when disputes occur, but at least it provides a

mechanism to try to resolve the issues.

There are three types of buy-sell agreements. First, there is the

redemption agreement where the entity is required to purchase the

departing owner’s interest. Second, there is the cross-purchase

agreement where the remaining owners are required to purchase

the departing owner’s interest. Third, there is the hybrid agreement

where the departing owner’s interest is first offered to the

remaining owners and if they choose not to purchase the departing

owner’s interest then the entity is required to make purchase this

interest.

Determining what type of buy-sell agreement is appropriate

requires extensive time and planning. The tax consequences to

each owner and the entity must be considered. Additionally, such

non-tax issues as the complexity of the agreement, ownership

issues and restrictions, and life insurance questions must be

examined. There are also ethical issues that need to be addressed

related to what the lawyer’s role is in preparing the agreement and

who the lawyer actually represents since each of the parties (the

individual owners and the business itself) have differing interests.

The need for a buy-sell agreement is therefore not only a tough

concept to sell to business start-up clients, but it is also a difficult

job for the owners and business lawyers to perform together

properly. However, this investment of time and effort is invaluable

in providing an important tool to assist the owners in their attempt

to assure the successful operation of and exit strategies for their

business.

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Selling the business

Unless a sole proprietor (let’s call the person and “owner”) has a

family member or a close relative to turn the business over to and

feels comfortable the owner’s desires for his/her family members

will be served, the options are limited. The business can be closed,

it can be sold to an outsider, although small businesses are

sometimes difficult to sell, or, if the owner wants his ‘baby’ to

continue, it can be sold to one or more competent and faithful

employees. The buy-sell agreement to a trusted employee becomes

a two-step plan:

An agreement is prepared which sets forth the employee’s

obligation to buy, the price the employee(s) will pay for the

business and the method of payment

The employee takes out a life insurance policy on the owner.

The employee is the owner of the policy, the person who

pays the premiums and the beneficiary.

If the owner dies, the death benefits of the insurance policy would

be used to buy the business from the owner’s estate.

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Partnership 3

Partnerships are automatically dissolved with the death of one

partner; therefore, a buy-sell agreement is very important. In this

case, a buy-sell agreement would sell the deceased’s interest in the

company to the surviving partner(s) at an agreed to price. For

partnerships there are two different plans:

Cross-Purchase Plan – in this plan each partner buys a life

insurance policy on each of the other partners. The partnership

itself is not a participant in the agreement. Each partner owns, pays

the premium payments and is the beneficiary of the insurance

policies on the other partners in an amount equal to his share of the

purchase price set forth in the buy-sell agreement. The proceeds

are used to purchase the partner’s business interest from the heir’s

of the deceased.

The number of policies required for a partnership with multiple

partners would be the number of partners X (number of partners-

1). For example, a plan for a partnership with three partners would

require six separate insurance policies. Each partner would need a

policy on each of the other parties.

Let’s say a business worth $600,000 is owned by three partners in

equal shares. Each partnership would be worth $200,000 and if one

of the partners died, the other two partners would have to provide

$100,000 each to equally purchase the deceased person’s share.

Therefore, each partner, in this case, would take out a policy on

each of the other two partners in the amount of $100,000 each.

Entity Plan – in this plan partners enter into an agreement with the

partnership who owns, pays the premium payments and is the

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beneficiary of the policies. When a partner dies, his/her interest is

purchased from his/her estate by the partnership at the buy-sell

agreement price and the interest is then divided among the

surviving partners in proportion to their own interest.

In this case, the $600,000 business discussed above would

purchase a $200,000 policy for each of the three partners. If one of

the partners dies, the business pays the deceased partner’s share

from the death benefit of the policy and distributes those shares

equally to the two remaining partners. The remaining partners, in

this case, would then each own 50% of the business.

Because of origination funding, buy-ins, etc., not all partnerships

are owned equally by the partners. In those cases, both the

insurance policy’s amounts and the benefits distributions would be

made on the basis of each partner’s proportionate share in the

business.

Additionally, none of the premium payments in the above plans are

tax deductible; however, the benefits are tax-free.

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Closed Corporation 4

Unlike a partnership, a closed corporation (i.e. a small number of

shareholders who run the business) does not cease to exist with the

death of one of its shareholders. For closed corporations, there are

also two different plans:

Cross-purchase plan – each stockholder owns, pays for and is the

beneficiary of life insurance on the other stockholders in amounts

equivalent to his or her share of the purchase price. The

corporation is not a party to the agreement. The surviving

stockholders purchase the interest of the deceased stockholder as

individuals from the estate of the deceased stockholder. This plan

is like the cross-purchase plan described in the partnership section

above. Obviously, the more shareholders the more difficult this

plan becomes.

Stock redemption plan – the corporation, rather than the

stockholders, purchases the insurance policy, pays the insurance

premiums and is the beneficiary on the lives of each shareholder.

The amount of insurance on each stockholder is equal to the

proportionate share of the purchase price. Upon the death of one of

the stockholders, the death benefits are paid to the corporation who

then buys the deceased’s stock from the deceased’s estate.

Premiums are not tax deductible but the proceeds are received

income tax free. Any agreements and insurance polices within a

business must be integrated with the overall plan and objectives of

the business. Careful consideration must be given to the selection

of the plan which is right for your business and to the method of

funding your plan.

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Key Employee Insurance

Key employee insurance is life insurance purchased by the

company on the life of an employee or employees whose loss

would have adverse effects on the company. Employees are

valuable assets and the loss of some key employees could

significantly impact the profitability, stability and progress of the

company.

Often times certain employees or executives are hired because of

their own specific expertise they bring to the company. Other

employees just seem to represent the persona of the business and

have earned the respect, loyalty and credibility of customers,

vendors, suppliers, creditors, etc. The loss of those persons could

result in some business interruption in some fashion. Small

businesses are just that way. Those intangibles are what make

many small companies successful.

The objective of key employee insurance is to financially protect

the company from adverse impacts if one of those key employees

suddenly dies or becomes disabled. The finances available from a

key person insurance policy would:

provide funds to find, recruit and train a replacement

help replace any profits the company may have earned had

the employee not died

strengthen the company’s working capital and balance sheet

to help assure creditors and suppliers about the continuity of

the business.

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What if the key employee is the owner? Key employee insurance

can be purchased for him also and can resolve the sole proprietor

issues discussed in a buy-sell agreement.

There is no easy formula for determining the value of a key

employee. Anticipated profit losses, replacement costs, and a

compensation-multiple formula, are typical methods of estimating

a loss. Good planning should examine all these concepts to

develop a program which is right for the company.

The company is the owner of the policy, pays the premiums and is

the beneficiary upon death or disability of the key employee.

Premiums are not tax-deductible but the death benefits are received

tax free.

Clearly, of the four methods of attempting to fund the financial

impact of the loss of a key employee (i.e. wait-and-see, borrow

funds if you can without that employee, set-up a savings account,

or buy insurance), the insurance option is clearly the best option

and the most rewarding to the company.

Any agreements and insurance policies within a business must be

integrated with the overall plan and objectives of the business.

Careful consideration must be given to the selection of the plan

which is right for your business and to the method of funding your

plan.

In every successful small-to-medium business, there are a handful

of men and women who rate the honor of being a key person--the

truly committed men and women, the ones who hold keys to the

company’s success. These gifted managers skillfully guide the

business through operations, sales or financial decisions. They

possess the technical minds whose innovative ideas lead to market

edges. They are the relationship builders who guarantee client and

supplier commitment.

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The loss of their practical experience, their expertise, their

leadership skill is likely to have such a fundamental effect on the

business that economic loss is certain. That’s the downside risk of

having great people—the continual peril of losing them. Why

would a business take precautions against fire, natural disasters,

theft and vandalism, yet neglect the risk of losing the knowledge

and experience of the people who made it successful?

The Economic Value

Most business owners will claim to have contemplated the loss of

key people and even taken steps to indemnify the company. But it

is rare that the real cost of the loss has been accurately measured,

so the company remains at risk. The cost attributable to the loss of

such key employees through disability or death can be difficult to

quantify since so many components of the business are likely to be

affected. It goes far beyond a job function. Companies must

consider the loss of

• Sales revenues.

• Client goodwill.

• Market share.

• Proprietary knowledge and systems.

• Production capacity.

• Credit standing with lending sources and suppliers.

• Time and money to recruit and develop replacements.

• Cash flow.

Life and disability insurance protection can provide funds to meet

debt obligations offset lost sales and cover the expenses of

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recruiting, hiring and developing replacement personnel. They are

essential components of any risk management plan for any

business.

Determining the amount of insurance coverage is not a precise

science. Some advisors favor using salary as the starting point, but

the fact that the range runs from 2x to 10x annual salary shows that

the calculation is largely a comfort-level guess. The mid-point ends

up being most typical, so it is hardly a sophisticated approach.

Replacement cost calculation offers a more rational basis. This

begins with the search fees and other costs associated with

bringing a new person onboard, such as a moving allowance.

Salary is still the primary consideration. But the lost key person

might turn out to have been a bargain from a salary perspective—a

leftover from older salary structures—with perks and bonuses

making up the real value. Or, a new person might come at a much

higher base price tag, since performance-based incentives, which

became habitual with the previous employee, can seem like a high

risk to someone new on the job.

Also, the company might consider whether the key person’s

function can really be handled by one replacement. If the key

person wore many hats, the company could be better served by

splitting the roles and hiring two less experienced people. Another

important measure should be a calculation of the impact to sales

and profits of the loss of the key employee. If client relationships

are jeopardized by the loss, there may be costs to rebuilding them.

This is also true with relationships with suppliers and credit

sources.

All of these factors are multiplied when the key man is the owner

of the business. Typically, though, the owners of small-to-medium

companies rarely consider measuring their own loss. They see

what happens when they are gone for the day or the week, and

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their solution is to never be gone again. But not all absences are a

matter of choice.

Some owners die while they are still active in their businesses. A

greater percentage becomes disabled in a way which forces them to

withdraw from active participation. The rest eventually do retire.

The withdrawal of the owner is not a contingency but a certainty.

The only uncertainty is when it will happen. At that time, some

form of ownership and/or management transfer must take place.

No matter when or how it happens, that transfer must be designed

so it does not cripple the business.

The role of the continuity plan is to separate the life of the business

from the life of its owners, to anticipate possible future events in

the life of the business, and to guarantee that it will continue to

exist in a manner that meets the owners’ goals.

An owner looking ahead to scaling back direct involvement in

anticipation of retirement is likely to form a mental picture in

which the business draws upon his expertise and influence in

return for consulting fees of some kind. If the owner considers the

possibility of a disabling condition, he or she probably expects that

the business will continue to pay a salary for a number of years.

And if he or she contemplates the eventuality of death, there is

probably a mental picture of family members receiving cash for the

business interest so that their income will not be dependent upon

the decisions of surviving partners.

Surviving partners naturally have their own agendas and mental

pictures. Typically, they do not want inexperienced, non-active

members of their partner’s family to be involved in the operations

of the company. Of additional concern is the effect the loss of the

owner could have on credit and bonding capacities.

The owners may actually share these personal scenarios and come

to consensus on alternate futures. But until a plan is drafted that

27

makes these desires contractual, there is no guarantee the desired

future will ever come to fruition. From experience, there is a better

guarantee that it never will.

The Business Will

The most common business continuity tool is a funded buy-sell

agreement, sometimes referred to as a business will. The buy-sell

agreement is inexpensive to draft and less complicated than other

ways of transferring ownership and management of a closely held

corporation. It can be responsive to changing circumstances, since

alteration is possible with the consent of all parties.

The agreement is a legal contract restricting the right to dispose of

a business interest to specified parties according to specified terms.

It typically requires the sale of a business interest at a

predetermined price or by a predetermined formula, triggered by

death, disability, retirement, withdrawal from the business, or

involuntary transfer of one of the owners.

For the family of a retired, disabled, or deceased shareholder, the

agreement provides an orderly transfer of ownership and continuity

of management, freeing it from business worries and assuring a

fair price. If it is funded with life insurance, the agreement

generates liquidity for the payment of the debts, expenses and

taxes of the estate. The family will not be dependent on the

business and its remaining owners.

With the agreement, remaining owners are assured that the stock

will not fall into the hands of anyone not connected to the company

or without an appropriate interest in running it. It may comfort the

potential fears on the part of creditors or bonding companies. The

agreement may also provide a method for withdrawing funds from

a family corporation other than as dividends.

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In short, the buy-sell agreement controls the disposition of all stock

in the corporation in the event of a spectrum of contingencies. An

effective buy-sell agreement should protect all parties from

disadvantage by including all essential provisions key to the

success of the arrangement. These provisions include, but are not

limited to the following.

• A statement of purpose of the agreement, outlining the intentions

of the parties and objectives for the smooth transfer of the business

interest.

• The promise to purchase/sell, identifying the purchasers and

sellers of the interest and the percentages or shares to be

purchased, as applicable.

• A valuation provision that establishes an agreed-upon price with

provisions for re-evaluation at predetermined times, a formula for

valuing the business at the triggering event, or procedures for

selecting and using outside appraisers.

• For life insurance funded agreements, instructions for the

purchase of the life insurance and requirements for keeping the

policy in force.

• For disability funded insurance funded agreements, a definition

of disability that reflects the provisions of the policy itself and

outlines the circumstances under which, and at what point, the buy-

sell will be activated.

• For installment purchases, the terms and conditions of the

payment plan.

Funding Options

The terms of the buy-sell should specify how the purchasing party

will pay for the business interest. Broadly, options include cash

29

payments from savings, borrowing, installment sale, disability

insurance proceeds, or life insurance proceeds.

Planned saving can be impractical since triggering events are likely

to occur with little or no notice, and complete funding cannot be

assured. Borrowing can be equally impractical since much of the

lender’s security depends on the stability of the company, which

may be threatened by the shareholder’s withdrawal.

Installment sales by themselves can place a burden on both parties

to the transfer. The payments will drain current earnings as well as

forcing the departing owner or heirs to rely upon the future success

of the business, over which they no longer have management

control.

Installment sales are often included among the provisions of buy-

sell agreements to provide for payment beyond insurance funding

solutions. This may be done as a two-pronged payment plan or as a

fail-safe mechanism, should insurance be allowed to lapse or if

increases in the value of the business overtake the amount of the

insurance policy proceeds. Typically, in an installment plan the

estate of the deceased takes a note from the corporation or

remaining co-owners.

The heirs may actually feel very comfortable with this

arrangement, since it provides an income stream for them. But, as

an unfunded obligation of a corporation or its owners personally,

installment payment plans must be carefully analyzed and

periodically reviewed.

The potential mistake of this kind of clause in the buy-sell

agreement is no different in concept from the common mistake of

credit card debt. The business cannot simply expect that future

revenues will be able to support the installment agreement. In

some cases—particularly in businesses with narrow profit

margins—the increased sales needed to generate cash for the

30

payments can far exceed any reasonable revenue expectation or

historical model. Even more sobering is the fact that, since the

installment payment is not deductible, revenue calculations must

reflect after-tax dollars.

Given these potential problems, the combination of disability and

life insurance typically proves to be the least costly of these

options. The most significant advantage is that complete financing

is guaranteed from the beginning. A lump sum payment to the

deceased stockholder’s estate is generally feasible only if life

insurance proceeds are available to fund the payment.

Furthermore, life insurance proceeds are received by the

beneficiaries free from income tax, except for the corporate AMT.

Cash values in the policy can also be utilized for a buyout of a

retiring or disabled partner and allow the withdrawing partner to

keep the policy. However, the trade-off for the tax free proceeds is

that the insurance policy premiums are not tax deductible.

Life insurance funding avoids bank and bonding company

problems. The credit position of the firm is not affected by a

deceased shareholder’s stock in the firm, and the selling

shareholder does not need to depend on the credit-worthiness of

the company for an extended period.

On the disadvantage side, insurability may be a problem or, due to

age differences among shareholders, premiums may not be

equitable. This can usually be addressed with appropriate

compensation measures.

In summary, how much is the company’s key employeeworth?

Measured by his or her potential loss, the employee can be worth

as much as the company, and only key employee coverage and a

funded buy-sell agreement will secure its value.

31

Split-Dollar 5

Background

All pre-January 28, 2002 split dollar insurance agreements must be

reviewed immediately and the income tax, gift tax and

employment tax implications of those agreements ascertained in

light of a safe harbor for terminating such agreements or

converting to a loan by December 31, 2003.

For almost 30 years, the IRS had been relatively silent on the tax

treatment of split-dollar insurance arrangements. Then in 1996, the

IRS began a series of statements and retractions that ultimately

ended with the issuance of a significant Notice in February 2002

and the adoption of final regulations in September 2003.

Concurrent with the issuance of the final regulations applicable to

split-dollar arrangements, the IRS issued Revenue Ruling 2003-

105. This revenue ruling provides the latest guidance on the

taxation of split-dollar life insurance arrangements. Revenue

Ruling 2003-105 provides as follows:

Treasury Decision 9092 issued new regulations. These regulations

directly apply to split-dollar life insurance arrangements that are

entered into after September 17, 2003 or any existing split-dollar

arrangement that is materially modified after September 17, 2003.

Various prior revenue rulings were declared obsolete, including

RR 64-328.

For pre-September 17, 2003 split-dollar arrangements, taxpayers

may continue to rely on Notice 2002-8 (and to the otherwise

obsolete revenue rulings to the extent provided in Notice 2002-8).

32

The purpose of this alert is not to describe how new arrangements

should be constructed, but to describe rules and options applicable

to existing arrangements pursuant to the guidance provided in

Notice 2002-8.

In Notice 2002-8, the IRS provided rules for valuing life insurance

protection and provided four specific transition rules that would

apply to any split-dollar arrangement entered into prior to the date

of the issuance of final regulations applicable to split-dollar

arrangements. However, the last transition rule only applies to

split-dollar arrangements entered into prior to January 28, 2002.

Valuing Life Insurance Protection

For many years, the income tax focus for split-dollar arrangements

was the determination of the value of the annual insurance benefit.

The annual insurance benefit is comparable to the cost of a one-

year term life insurance policy. For many years, the determination

of annual insurance benefit was derived from an IRS schedule

commonly referred to as PS 58 or possibly a lower value issued by

the insurance company. The IRS determined that the old PS 58

values required updating because of the changes in mortality risks

over the past 45 years. A new table to replace PS 58 was set forth

in Notice 2001-10 (although the old PS 58 rates will be applicable

to arrangements that specifically require that rate). As to values

provided by insurance companies, the IRS now requires that the

values be “published premium rates that are available to all

standard risks for initial issue one-year term insurance.” The IRS

added special rules to confirm that such rates are actually

available.

33

Rule #1: IRC Section 83 Inapplicable

Under the first transitional rule, the employee will not be taxed on

any policy equity accruing from interest or dividends that increases

the equity in the portion of policy that is not to be repaid to the

employer. A simple example is as follows: an employer has paid

$500,000 in premiums on a policy held by a trust created by the

employee. The employer is entitled to receive the premiums back

upon termination of the arrangement or death of the insured. In

year 5, the cash value is $600,000 and the cash value is increasing

at $20,000 per year. Under this transitional rule, each year as the

trust’s share of the cash value of the policy increases, the employee

will not be treated as having received any taxable income under

IRC Section 83. However (except as discussed below), the

employee would still be taxed on this amount if the plan is

terminated or the funds are borrowed from the policy. Continuing a

split-dollar plan under this transitional rule results in a plan without

an exit strategy (other than the death of the insured).

Rule #2: Terminated Plan Without Recognizing

Transfer of Assets

If a split-dollar arrangement is terminated, but value of the life

insurance protection continues to be recognized as income, the IRS

will not assert that there has been a transfer of property to the

benefited person by reason of termination of the arrangement.

Accordingly, under this option, the employee will continue to

include in income the annual value of the current life insurance

protection. The negatives of this option include:

The annual income to be recognized can become quite high

as the insured ages.

34

The company probably would not be entitled to an income

tax deduction for the income recognized by the employee.

If the owner of the policy is a trust, the employee will likely

be treated as making gifts to the trust for the value of the life

insurance protection.

Rule #3: Treatment as a Loan

Under this option, the amount owed to the employer can be treated

as a loan. Although somewhat ambiguous, guidance we have

received indicates that this transitional rule only approves the

conversion to a loan and treatment as a loan (whether occurring in

the past or the future). However, this transitional rule does not

protect against other income tax consequences that could arise

upon termination of the arrangement.

This transitional rule requires that all employer outlays for

premiums must be picked up as the beginning loan balance at the

beginning of the taxable year in which the treatment as a loan

began. These loans may be interest-free or low interest loans and

taxed under Internal Revenue Code (IRC) Section 7872 and

Sections 1271-1275.

Rule #4: Safe Harbor for Termination of Arrangement

Under the last transitional rule, a safe harbor for the termination of

insurance arrangements is provided. However, this safe harbor is

only available to split-dollar arrangements entered into before

January 28, 2002. The critical components of this transitional rule

are as follows:

35

If there is a pre-January 28, 2002 split-dollar arrangement and the

sponsor is owed a refund of all payments made (less refunds

already received)

The IRS will not assert that there has been a taxable transfer of

property to the benefited person upon termination of the

arrangement if either (i) or (ii) applies :

(i) the arrangement is terminated before January 1, 2004

(ii) for all periods beginning on or after January 1, 2004, all

unrefunded payments by the sponsor from inception of the

arrangement are treated as loans for Federal tax purposes, and the

parties to the arrangement report the tax treatment in a manner

consistent with this loan treatment, including IRC Sections 1271 -

1275 and IRC Section 7872. Any such payments by the sponsor

before the first taxable year in which such payments are treated as

loans for Federal tax purposes must be treated as loans entered into

at the beginning of that first year in which such payments are

treated as loans.

The loan treatment under transitional rule #3 and the loan

treatment under transitional rule #4 have two different purposes.

Under transitional rule #3, loan treatment is approved for all

existing split-dollar arrangements, but transitional rule #3 does not

provide any special protection from recognition of gain if the

arrangement is terminated. Under transitional rule #4, if the

arrangement is a pre-January 28, 2002 arrangement (with certain

other attributes) and it is converted to a loan prior to January 1,

2004, upon later termination of the arrangement the IRS will not

assert that there has been a transfer of property.

Summary

36

Because the safe harbor for terminating arrangements created

before January 28, 2002 or converting them to loans on a tax

favorable basis only lasts until December 31, 2003, it is important

to identify existing split-dollar arrangements and perform the

analysis necessary to determine whether any actions should be

taken.

Compensation plans 6

Section 162(m) of the Internal Revenue Code establishes a

$1,000,000 cap on deductible compensation. However, with

proper planning, companies can provide substantial compensation

to their executives while minimizing adverse tax consequences.

Here are short answers to some of the most common questions

about managing executive compensation.

What Companies are affected?

Generally, the $1,000,000 deduction limitation applies to

corporations which, on the last day of their taxable year, are

subject to the reporting requirements of Section 12 of the

Securities Exchange Act of 1934 (public companies).

Significantly, there are transition exceptions for new public

companies. Those on an IPO track should adopt executive

compensation plans prior to the IPO, and grant stock or other

awards under the plan as soon as possible in a way that qualifies

under the transition rules to avoid undesired tax liability.

37

Which Executives are affected?

The deduction limitation applies to compensation received by the

CEO or one of the corporation's other four highest paid officers, as

of the last day of the corporation's taxable year.

What is included in "Compensation" for this Purpose?

"Compensation" generally includes all amounts otherwise

allowable as a deduction to the corporation, with respect to

services performed at any time by the executive.

Why do Companies and Executives Defer Compensation?

Deferred compensation is generally counted in the year received.

If a corporation pays a set amount to an individual in installments

over a period of years (with such amounts being deducted only as

paid), only the amount of the current installment will be included

in the dollar limitation for each year. Thus, deferred compensation

is one strategy for compensating executives in cash while

maintaining tax advantages.

What are the other major Executive Compensation Strategies?

There are several other methods of compensation that are not

subject to the deduction limitations. These provide other strategies

for transferring compensation to executives without adverse tax

consequences:

Contributions to qualified pension and profit sharing plans and

deferred compensation programs, benefits paid under health and

welfare plans and other amounts generally excludible from gross

income; and "Qualified Performance Based Compensation, "

which is one of the most important executive compensation tools.

38

What is Qualified Performance Based Compensation (QPBC)?

QPBC is a payment made upon reaching one or more pre-

established objective performance goals. These goals can be based

on one or more business criteria that apply to the individual

executives, a business unit, or the corporation as a whole.

Examples of these goals are increases in stock price, sales,

earnings per share and return on equity, reductions in costs and the

successful completion of specific employment related targets.

What are the rules for Establishing Performance Goals?

Performance goals must meet complex requirements to qualify

under the tax code, and the programs and goals may require

stockholder approval. Some of the key rules for establishing

performance goals are:

1. A performance goal must be "pre-established"--that is, written

within the first 25% or first 90 days of the performance period,

whichever comes first, and before it can be determined with

substantial certainty whether the goal will be met.

2. The goal must be "objective" such that an unrelated third party

with access to company records could calculate the amount to be

paid under the formula. However, the company can maintain some

flexibility by retaining the right to reduce the payment for

subjective reasons. For example, if an incentive program provides

for a maximum payout of 15% of compensation under an objective

formula, but allows the employer to reduce the benefit all the way

to 0% for subjective reasons, it will still pass the "objective goal"

test.

3. Special rules apply to stock options and stock appreciation

rights. These types of awards satisfy the performance goal

requirements without the establishment of an "objective"

performance goal if: (a) the grant or award is made under a plan

39

stating the maximum number of options or rights that may be

granted during a specific period to any executive; and (b) the

compensation upon exercise is based solely on appreciation of the

stock after the date of grant (in another words, the exercise price

must be at least fair market value as of the date of grant).

4. A performance goal must be established by a compensation

committee composed solely of two or more "outside directors" and

receive at least general stockholder approval. The outside directors

must qualify under specific tax law requirements, and must certify

satisfaction of performance goals before each payout.

When should a qualified Executive Compensation program and

other Compensation Strategies be established?

It's usually a good strategy to implement the framework to support

these programs well before they are needed, and while control of

the company is closely held. For more strategy ideas, and to find

out how the general rules above apply to your situation, consult

experienced executive compensation counsel.

40

Health Insurance 7

The Consolidated Omnibus Budget Reconciliation Act

(COBRA)

If an employee loses his job, this law -- commonly called COBRA

-- will help them keep their group health coverage while they make

the transition to a new plan.

COBRA requires most employers to offer employees and their

families the opportunity for a temporary extension of health

coverage under certain circumstances -- such as job loss, job

transition, job reduction, divorce or death of the covered employee

-- after which their health plan coverage would ordinarily end.

These instances are called "qualifying events," and the extension

can last anywhere from 18 months to 36 months, depending on

the situation.

If the reason that you are losing coverage is because you quit your

job, because your employer reduced your hours or because your

employer terminated you (for reasons other than "gross

misconduct"), you can continue coverage for yourself, your spouse

and your dependent children for a period of 18 months.

If you were covered under your spouse's health plan and if you are

losing that coverage because of divorce, separation or the death of

your spouse, you can continue coverage for you and your

dependent children for a period of 36 months.

If you were covered under a parent's health plan and are losing that

coverage because you are no longer a dependent of your parent,

you can continue coverage for yourself for a period of 36 months.

41

Unfortunately for your pocketbook, COBRA is not free coverage,

nor is it a government benefits. The person must pay for the

continued coverage himself. Still, COBRA ensures the person that

he will pay for that coverage under the group rate that was paid by

your employer, which might be less than individual rates.

Employees, employers and the health plan all have responsibilities

under the law. For example, the plan must inform all employees

generally about their rights under COBRA. Employers must notify

the plan of an employee's death, termination of employment, or

reduction in hours. The employee or covered family member must

notify the plan of a divorce, legal separation or disability. The

employee or covered family member must also notify the plan

when a child loses dependent status. If person wants to continue

coverage under COBRA, he has 60 days from the date when his

employer-paid coverage would end to notify the plan that you want

to continue coverage.

The Newborns' and Mothers' Health Protection Act

This Act, signed into law in 1996 and effective for group health

plans since 1998, protects a woman and her newborn child from

being prematurely released from the hospital after childbirth. It

guarantees that a woman and her newborn baby will be allowed to

stay in the hospital for at least 48 hours after a vaginal delivery or

96 hours after a cesarean delivery.

A mother can leave the hospital after a shorter length of time only

if she and her attending healthcare provider -- such as a physician

or a nurse midwife -- agree that the shorter stay is sufficient.

However, the law prohibits health plans and insurers from giving

the mother or the provider any incentives (either positive or

negative) that might encourage a shorter stay.

42

The Mental Health Parity Act

This law seeks to end the practice by health plans and insurers of

providing less coverage for mental disorders than they do for

physical disorders. Data from the federal Bureau of Labor

Statistics indicate that, prior to the Act, approximately 90% of

policies offered fewer benefits for mental health than for physical

health. Indeed, the typical caps for mental illness coverage were

$5,000 per year and $50,000 over the course of a lifetime. These

caps may seem high until you compare them to the caps for

physical disorders: no caps per year and $1 million over the course

of a lifetime.

One key limitation of the Act is that it applies only to health plans

and insurers that cover mental disorders in the first place. It does

not mandate coverage for mental disorders where none is provided.

Another limitation is that the law does not cover businesses with

50 or fewer employees.

An additional limitation is that the Act covers only mental illness;

it does not cover treatment for substance abuse or chemical

dependency. Because the law is about parity, and not about

mandating coverage for mental illness, the law does not define

mental illness. Rather, the law applies to "mental health services"

as the term is used by the individual health plans. Whatever mental

health services the plan covers, it must cover at the same level as

physical health services.

Critics of the Mental Health Parity Act have argued that it has too

many loopholes and too many exclusions to truly end the practice

of providing less coverage for mental health than for physical

health. Fortunately, many states have passed their own parity laws,

many of which provide broader protection. To learn whether your

43

state has a more comprehensive law, visit insure.com at

www.insure.com/health/mentalstate.html.

The Act took effect in January of 1998, and was originally set to

expire in September 2001. But in 2002, Congress extended it for

one more year, and in 2003, bills were introduced to continue and

expand mental health insurance parity. To check the status of these

bills, see the legislative website at http://thomas.loc.gov.

44

The Health Insurance Portability and 8

Accountability Act (HIPAA)

Introduction

This Act provides a range of protection to millions of working

Americans who have some sort of health-related condition or

characteristic that makes them vulnerable to exclusions, limitations

and discrimination in group healthcare coverage. HIPAA applies

mainly to employer-based health coverage. Therefore, if you get

your health insurance through your employer, and if you have what

is called a "pre-existing condition" (see below) or some other

health-related characteristic that makes you "undesirable" in the

eyes of an insurance company, you should get to know HIPAA so

that you can use it to protect yourself and your family.

A pre-existing condition is a condition for which you received

medical advice, diagnosis, care or treatment in the six months prior

to enrolling in your current health plan. Cancer and high blood

pressure are common pre-existing conditions. For example, you

may have received treatment for breast cancer in June, and

enrolled in a new group health plan in July. Prior to this Act, you

faced the possibility that your new health plan would not cover

your breast cancer treatment for several years -- or at all -- simply

because you received treatment for it previously.

The intent of HIPAA is to turn the tables on health plans and

insurance companies by limiting the ways in which they can

exclude coverage of such conditions:

Pregnancy is no longer considered a pre-existing condition.

Therefore, if you are pregnant and want to switch group health

plans, you can do so without risking a break in your coverage. But

be careful: There are some large loopholes in this protection.

45

HIPAA applies only to women who switch from one group health

plan to another. Therefore, if you had no coverage and then

obtained group coverage through a new job after you got pregnant,

your pregnancy may not be covered or you may have to wait for a

period of time before it gets covered. (Ironically, this waiting

period may last longer than your pregnancy.) Similarly, if you had

individual coverage and then switched to either group coverage or

to another individual plan after you got pregnant, your pregnancy

may not be covered at all or for a specified period of time.

Health plans and insurers cannot apply the pre-existing condition

exclusion to newborns or to children younger than 18 who are

adopted or who are put up for adoption so long as the newborn or

the child entered the health plan within 30 days of birth, adoption

or placement for adoption.

The Act places a six-month "look back" limit on identifying pre-

existing conditions. This means that if you have a condition for

which you received medical advice, diagnosis, care or treatment

longer than six months prior to enrolling in your new plan, that

condition is not pre-existing and cannot be excluded from coverage

on that basis.

If the employee does have a pre-existing condition and he has

group health insurance, he faces a shorter pre-existing condition

exclusion periods than he would have faced prior to HIPAA. In

other words, the employee can get covered for his condition faster

than before. The maximum exclusion period is generally 12

months from the date on which you enrolled in the plan.

If the employee switches from one group health plan to another as

the result of a job change, he will not face new pre-existing

condition exclusions so long as there is no more than a 63-day

break in your health coverage. This enables him to switch jobs

46

despite his health status without fear that he will lose coverage for

certain conditions.

In addition to protecting employees from exclusions based on pre-

existing conditions, HIPAA also protects them from discrimination

based on health-related characteristics. The Act prohibits health

plans and insurers from excluding employees from coverage or

charging their coverage because of their health status.

Finally, HIPAA requires health care providers, including doctors

and hospitals, to improve their efforts to keep patients medical

records and health information confidential.

The Women's Health and Cancer Rights Act of 1998

If a woman with breast cancer who has had a mastectomy, this law

places some requirements on how your group health plan,

insurance company or health maintenance organization must treat

you:

Employees are entitled to reconstruction of the breast on

which the mastectomy was performed.

Employees are entitled to reconstruction of your other breast

to produce symmetrical appearance.

Employees are entitled to prostheses and treatment of

physical complications at all stages of the mastectomy,

including lymph edemas.

The Women's Health Act applies only to plans that already provide

medical and surgical benefits with respect to a mastectomy. If the

plan does not provide such benefits, then it is not covered by this

Act and employees are not entitled to the Act's protections.

47

Health Insurance Fundamentals 9

Today's health insurance market is broken into many segments.

Some are highly specialized in their coverage and others are more

comprehensive. The more comprehensive and inclusive the health

insurance is the higher the premiums.

Many experts believe that it is in the employee’s best interest to

purchase group coverage (through an employer) when available.

Group coverage is generally more comprehensive and group rates

are generally lower because there is strength in numbers.

However, group plans are almost always managed care programs

and have lots of restrictions.

If group coverage is not available then employees will have to

purchase an individual plan. Individual plans are medically

underwritten and there are no guarantees that an insurer will

approve your application. Premiums for individual policy holders

are more in line with their expected health care cost than in group

coverage. That means, the premiums will be higher for those who

are older or less healthy.

Health Insurance "Short-Term"

As its name implies, short-term health insurance is temporary

coverage and lasts from one to six months. Some companies may

allow the insured to renew the policy one time but the total length

of coverage will not exceed twelve months. This is perfect for

someone who just dropped off their parents' policy because they

graduated from college or maybe they hit that age limit and need

health insurance before they find a full-time job-or maybe for

somebody between jobs.

48

Coverage is generally comparable to that of an HMO or similar

plan and typically includes various hospital charges, office visits,

diagnostic tests, and prescription drugs. Maternity costs are not

covered, however. Unlike an HMO or PPO, though, a short-term

plan is an indemnity plan, which means you have the freedom to

go to any doctor; you're not confined to a network of doctors.

Plans are typically offered with a number of deductibles ranging

from $200 to $2,000. Most young adults choose the $500

deductible or the $250 deductible. Older adults generally choose

higher deductibles to offset their higher premiums.

The Down Side of Short-Term Policies

In many short-term policies, the deductible you pay is per injury or

illness. That means employees must meet the deductible all over

again each time they are treated for a ear infection or other illness.

After the deductible is met, the company pays 80 percent of the

next $5,000 in expenses and then pays 100 percent.

Short-term policies also have certain strict eligibility requirements,

although they will vary from insurer to insurer. If an employee has

ever been denied health insurance, he won't be eligible for short-

term insurance because a denial indicates you might have

significant health problems. In addition, if he has a pre-existing

condition (an illness or chronic condition within the previous five

years), it won't be covered under most short-term plans. That

means if he has leukemia, a stroke, or even allergies or asthma

within the last five years, those illnesses won't be covered under

the employer’s short-term policy. Pregnancy is not covered either,

although complications arising from pregnancy generally are.

And what happens if a person bought a three-month policy only to

find that the job he hoped to land - with health benefits - has not

49

materialized? He may not be able to renew he short-term policy,

because it doesn't work that way. He will have to go through the

application process all over again and take out a new policy. If he

has any illnesses or injuries during previous policy period, those

now become pre-existing and he won't be eligible for coverage.

People should shop around and compare rates and benefits from

several companies to make sure they get a plan that's right for

them.

Catastrophic Health Insurance

Catastrophic health insurance policies are intended only to pay for

major hospital and medical expenses, not routine visits to the

doctor's office or trips to the ER to get stitched up. A catastrophic

plan would cover things like treatment in an intensive-care unit for

10 days after an auto accident or complications from a pregnancy

that land you in a hospital.

Catastrophic health insurance policies typically come with a very

high deductible from $500 to $15,000 and a high maximum benefit

payment, such as $1, $2 or $3 million.

Who buys catastrophic health insurance?

There are two groups of individuals who commonly purchase

catastrophic health insurance. The first is the young adults who are

self employed or do not have coverage through their employer.

They are healthy on no medications and would rather pay their

own office visit and save the premium. The second group is

primarily made up of individuals between the ages of 50 - 65. They

typically choose high deductibles $5,000 and up and are primarily

concerned with catastrophic losses associated with heart attacks,

cancer and other such illnesses.

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Is Catastrophic Coverage the right choice?

As with all insurance people are gambling that they are going to

need the coverage. With catastrophic coverage they are eliminating

coverage to reduce premiums. They should be careful not to take a

deductible larger than they can afford and plan for what they are

comfortable with in the worst situation. They should shop around

or talk to an independent insurance agent to make sure they get a

plan that's right for them.

Traditional Health Insurance

Up until about 30 years ago, most people had traditional indemnity

coverage. These days, it's often known as fee-for-service.

Indemnity plans are a bit like auto insurance: people pay a certain

amount of medical expenses up front in the form of a deductible

and afterward the insurance company pays the majority of the bill

Advances in modern medicine increased the cost of providing

health care and made it possible for people to live longer. Those

advances caused many insurance companies to look for ways to

reduce their costs of doing business, giving managed care the boost

it enjoys today.

Fee-For-Service

For years, indemnity or fee-for-service coverage was the norm.

Under this type of health coverage, the insured has complete

autonomy when it comes to choosing doctors, hospitals and other

health care providers. He can refer himself to any specialist

without getting permission, and the insurance company doesn't get

to decide whether the visit was necessary.

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Insureds don't, however, have complete autonomy. Most fee-for-

service medicine is managed to a certain extent. For instance, if the

insured is not already incapacitated, he may need to get clearance

for a visit to the emergency room.

On the down side, fee-for-service plans usually involve more out-

of-pocket expenses. Often there is a deductible, usually of about

$200, before the insurance company starts paying. Once the

insured pays the deductible, the insurer will kick in about 80

percent of any doctor bills. The insured may have to pay up front

and then submit the bill for reimbursement, or his provider may

bill the insurer directly.

Under fee-for-service plans, insurers will usually only pay for

reasonable and customary medical expenses, taking into account

what other practitioners in the area charge for similar services. If

the doctor happens to charge more than what the insurance

company considers reasonable and customary, the insured

probably have to make up the difference himself.

Traditionally, preventive care services like annual check-ups and

pelvic exams have not been covered under fee-for-service plans.

But as the evidence mounts that preventive care can prevent more

costly illnesses down the road, some insurers are including them.

Fee-for-service plans often include a ceiling for out-of-pocket

expenses, after which the insurance company will pay 100 percent

of any costs. Traditional fee-for-service coverage offers flexibility

in exchange for higher out-of-pocket expenses and is not for

everyone.

Shop around or talking to an independent insurance agent can

assure the person that he is getting the right insurance.

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Preferred Provider Organizations (PPO'S)

"Managed Care"

A Preferred Provider Organizations is the least restrictive type of

managed care. PPOs have made arrangements for lower fees with a

network of health care providers. PPOs give their policyholders a

financial incentive to stay within that network.

For example, a visit to an in-network doctor might mean the

insured has to pay a $10 co-pay. If he wants to see an out-of-

network doctor, he has to pay the entire bill up front and then

submit the bill to his insurance company for an 80 percent

reimbursement. In addition, he might have to pay a deductible if he

chooses to go outside the network, or pay the difference between

what the in-network and out-of-network doctors charge.

With a PPO, an insured can refer himself to a specialist without

getting approval and, as long as it's an in-network provider, enjoy

the same co-pay. Staying within the network means less money

coming out of pocket and less paper work. Preventive care

services may not be covered under a PPO.

Exclusive Provider Organizations are PPOs that look like HMOs.

EPOs raises the financial stakes for staying in the network. If the

insured choose a provider outside the network, he is responsible

for the entire cost of the visit.

Is a PPO the right choice?

Rates and coverage vary form state to state so people should shop

or talk to an independent insurance agent to make sure the plan is

adequate

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Point-of-Service (POS) "Managed Care"

A Point-of-Service plan is a little more least restrictive type of

managed care. Point-of Service plans like PPO's have made

arrangements for lower fees with a network of health care

providers and give their policyholders a financial incentive to stay

within that network.

However, Point-of-service plans introduce the gatekeeper, or

Primary Care Physician. Insureds need to choose their primary care

physician (PCP) from among the plan's network of doctors.

As with the PPO, they can choose to go out of network and still get

some kind of coverage. In order to get a referral to a specialist,

though, they usually must go through their PCP. They can still

choose to refer themselves, but it'll mean more hassles and more

money coming out of their pocket.

If a PCP refers a doctor who is out of the network, the plan should

pick up most of the cost. But if the insured refers himself out, then

he probably have to deal with more paper work and a smaller

reimbursement. He may also have to pay a deductible if you go

outside the network.

POS plans may also cover more preventive care services, and may

even offer health improvement programs like workshops on

nutrition and smoking cessation, and discounts at health clubs.

Health Maintenance Organizations (HMO's)

"Managed Care"

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HMOs (Health Maintenance Organizations)

A Health Maintenance Organization plan is the most restrictive

type of managed care. Like Point-of Service and PPO's, HMO's

have made arrangements for lower fees with a network of health

care providers and give their policyholders a financial incentive to

stay within that network.

HMO plans also utilize a gatekeeper, or Primary Care Physician.

Insureds need to choose their primary care physician (PCP) from

among the plan's network of doctors. HMO's require that they only

see their doctors, and that they get a referral from their primary

care physician before they see a specialist. In most cases they need

to get clearance before they can visit the emergence room, if they

are able. In general, they must see HMO approved physicians and

use HMO approved facilities or pay the entire cost of the visit

themselves.

HMO plans generally cover more preventive care services, and

may even offer health improvement programs like workshops on

nutrition and smoking cessation, and discounts at health clubs.

Is an HMO the choice?

HMO coverage is a trade-off between premiums paid and plan

flexibility. HMO's offer some very attractive rates but are very

restrictive when it comes to coverage. Rates and coverage vary

form state to state so people should shop around on their own or

talk to an independent insurance agent to make sure they get a plan

that's right for them.

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Group Life Insurance 10

Introduction

Finding quality employees is only part of the challenge of running

a successful business. Maintaining a well motivated staff is

probably a more difficult challenge. In today's labor market the

quality of benefits offered by the employer is a substantial

consideration of both prospective and current employees. They are

also interested in retirement and security for their families and

often times they look at the size of the benefit in contrast to their

out-of-pocket costs.

There are many plans to choose from and there is no right or

wrong answer in selecting a program for the company. Employers

have to think about how they would like to fund the plan, how

much they and their employees want to contribute, and how much

they want to contribute for their employees, if any. employers have

options. they can look at pure term life insurance which is fairly

cheap and provides substantial amounts of insurance or they can

look at a whole life program which provides cash value for

retirement purposes.

Just less than half of all life insurance in force in the United States

is group life insurance and the amount of coverage is in the

trillions of dollars. Many people rely on group insurance as their

primary insurance coverage.

In group life insurance a single contract is issued for a number of

people. In fact, each individual may not even be named in the

insurance contract. The employer will receive the master policy

and the employees will receive a Certificate of Insurance which

summarizes the coverage terms and explains the employee's rights

under the contract.

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The employer is the applicant for the insurance plan and generally

provides the insurance for its employees as a benefit. The

employer selects the type of coverage and determines the amount

of coverage for each employee. The plan can be a "non-

contributory plan" which is funded entirely by the employer or a

"contributory plan" paid in-part by the employee.

The group must meet the underwriting requirements which rely on

the experience of the group as opposed to mortality or morbidity

tables.

Generally, a group plan has a lower cost than individual insurance

plans because the administrative, operations and selling costs are

much less to the insurance company. The employer either pays the

premiums, if the plan is non-contributory, or collects the funds

through pay-roll deductions and advances the funds to the

insurance company if the plan is a contributory plan.

As long as the "group" was not formed for the purpose of obtaining

insurance, almost any kind of group qualifies for group coverage.

For example, labor unions, trade associations, fraternal

organizations, creditor-debtor groups, and single-employer groups

can be issued group coverage although some states restricts the

groups to a minimum number of participants. Normally, at least 10

people must be enrolled; however, this number may be more or

less in different states.

As noted above, plans can be contributory or non-contributory.

Where the employer pays the premiums for all employees (the

non-contributory plan) it is assumed all employees will participate.

If the employee contributes to the premiums (the contributory

plan), some employees may not wish to participate because they do

not feel they can afford the smaller paycheck or because they have

coverage elsewhere.

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In order to avoid burdensome and potentially unnecessary

administrative costs for employees who may only be employed a

short time, it is normal to have a probationary period of one to six

months before the employee is eligible to participate. After the

probationary period, a set enrollment window is provided for the

employee to participate. An employee who fails to sign-up during

the enrollment period may be required to provide evidence of

insurability if they should decide to enroll at a later time. Other

normal requirements for employees to qualify are that they must be

full time employees and, if contributory, they must authorize the

employer to deduct their share of the premium payment from their

paycheck (i.e. payroll deduction).

There are basically two types of insurance plans for group life

insurance programs:

Term Life Insurance – an annual renewable term (ART) policy is

the most common plan and provides the lowest cost life insurance

coverage. Participants do not have to provide evidence of

insurability each renewal period. The low costs results from the

fact the insurer has the right to increase premiums each year based

on the group’s experience during the previous year. The

policyholder also has the right to renew coverage each policy year.

Permanent Life (Whole Life) Insurance – there are several

variations of the permanent life insurance option:

Group Ordinary Plan – normally, if the employees contribute to

the plan they are allowed to own the cash portion. However, it may

be set-up that if an employee terminates employment, the cash

value will be forfeited and used to help fund the plan for the

remaining employees.

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Group Paid-Up Plans – these plans are a combination of term life

insurance, paid by the employer, and whole-life insurance, paid by

the employee. The death benefit is a total of the two plans. At

retirement or termination the employee is entitled to the cash value

(paid-up) policy.

Group Universal Life Plans – these plans offer a greater degree

of flexibility than is usually found in other group life plans. The

employee pays most of the premium payments; however, they are

given certain latitude in selecting the amount of insurance and the

premium amount to be paid.

There are several methods of determining how much insurance

each employee can obtain through the group plan.

Flat benefits – usually when the employer wishes to provide a

small amount of insurance to the employees in order to maintain a

minimum contribution they will provide the same benefits to all

employees regardless of seniority, earnings, or position in the

company.

Earnings – another way to determine the amount of insurance for

each employee is a method based on their earnings. For example,

the plan may provide coverage calculated as a percent of earnings

(2.5 times annual salary).

Position – the position within the company may also be used to

provide different levels of insurance. For example, laborers or

operators may be allowed to participate in a $30,000 policy,

managers in a $60,000 policy and vice-presidents in a $100,000

policy.

Once the plan becomes effective and the employee is enrolled in

the plan, the employee remains qualified until the employee leaves

the plan or the plan is terminated. The plan must allow a

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conversion privilege to a terminated employee which allows them

to convert their enrollment from a group plan to an individual plan

without providing new evidence of insurability. There is a 31 day

window for the employee to determine if they wish to exercise the

conversion period. If the terminated employee dies within that 31

day window, the benefits would be paid to the beneficiaries even

though cost of the 31 day conversion window is not paid by the

employee. Many group policies require the terminated individual

to enroll in a whole life policy.

Other forms of group life insurance include:

Franchise Life Insurance – used where participants are

employees of a common employer (i.e., the employer may operate

several companies) or are members of a common association or

society. The employer/association/society is a sponsor of the plan

and may or may not contribute to the premium payments. Unlike

the employer’s group plan, each individual will be issued an

individual policy which will remain in force as long as premiums

are paid and the employee/member maintains their relationship

with the sponsor. These are used by small groups who individually

do not meet the state’s minimum numbers laws.

Credit-Life Insurance – these are set-up by banks, finance

companies, etc., to provide coverage if the insured dies before a

loan is repaid; the policy benefits will be used to settle the loan

balance. The premiums are usually paid by the insured as a means

of collateralizing the loan.

Blanket Life Insurance – used to cover a group of individuals

exposed to a common hazard. For example, an airline may use this

type of insurance to cover the passengers on a commercial flight.

The insured are automatically covered and need not apply for the

coverage and are not issued any sort of policy or certificate of

coverage. At the termination of the hazardous event, the coverage

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is terminated. Schools, sports teams, volunteer fire departments,

etc., are other examples of groups which may obtain coverage for

personnel while engaged in named activities.

Multiple Employer Trusts (MET) – the employer must become a

member by subscribing to the trust and is issued a joiner agreement

which spells out the relationship between the trust and the

employer and the coverage to which the employer has subscribed.

Used for employers who have a small group of employees and may

not meet the state’s minimum numbers laws. Each employee is

provided a certificate of insurance.

Any agreements and insurance policies within a business must be

integrated with the overall plan and objectives of the business.

Careful consideration must be given to the selection of the plan

which is right for the business owners and to the method of

funding their plan. It is important for insurance agents to work

closely with them in order to assure that the selected insurance

policies are suitable for their needs.

Additional Information and Facts

Business health care spending increased more than six-fold

between 1965 and 1994. With medical costs on the rise through

the 1980’s and 1990’s, various management surveys show that

healthcare expenditures remain the single most important concern

for U.S. employers.

Group Insurance Policies

A group insurance policy or master policy is issued to the policy

owner – the employer. Covered employees are issued a certificate

of insurance. The certificate lists what the policy covers, and

explains such things as how to file a claim, the term of insurance,

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and the right to convert from group coverage to an individual

policy.

Group health insurance is generally subject to experience rating,

under which the premium modification factor is determined by the

experience of the group as a whole.

Disability Income

Group disability income coverage provides for loss of income

benefits due to a disability caused by an accident or sickness. The

amount of benefits paid is usually a percentage of the employee’s

weekly or monthly compensation, such as 60 percent or 70 percent.

This is intended to encourage employees to recover and return to

work. If 100 percent of compensation was paid to the injured

worker, there would be no incentive for him to return to work.

Benefits are payable following the policy’s elimination period

(EP). The EP is a waiting period during which the employee must

be totally disabled as defined by the policy. The elimination

period can be 7, 15, 30 days or longer.

Group disability benefits may be short-term or long term. Short –

term benefits are usually payable for up to one or two years. Short

term policies usually have short elimination periods such as 15 or

30 days.

Long-Term disability (LTD) benefits are usually paid out for a

longer benefit period such as five years or until the employee turns

65. Generally, LTD policies will have longer elimination periods

such as 90 or 180 days.

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Accidental Death and Dismemberment

Accidental death and dismemberment coverage pays specific

amounts for specific injuries or for death. Benefits are only

payable if the injury or death is caused by an accident. Injuries

must result in specific losses such as loss of sight, arms, legs or

feet.

This coverage can be written as a separate policy or as a part of a

policy providing other group health insurance benefits.

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64

Jobs and Growth Tax Relief Reconciliation Unit 11

Act of 2003

Introduction

1. The tax rate on long-term capital gains is reduced from 20

percent to 15 percent for taxpayers in the top four tax brackets, and

from 10 percent to 5 percent for taxpayers in the bottom two

brackets, effective for sales and dispositions after May 5, 2003.

The 5-percent rate will drop to 0 percent effective after December

31, 2007, but no change is scheduled for the 15-percent rate. The

new rates are effective for computing both the regular tax and the

Alternative Minimum Tax-these provision sunsets after December

31, 2008.

2. The temporary depreciation “bonus” enacted under the Job

Creation and Worker Assistance Act of 2002 is increased from 30

percent to 50 percent for new depreciable property that is acquired

after May 5, 2003, and generally placed in service before January

1, 2005.

3. The limit on the section 179 deduction for purchases of

qualifying depreciable property is increased from $25,000 to

$100,000 for property placed in service during tax years after 2002

and is indexed for inflation after 2003. The ceiling amount before

the deduction begins to be reduced also is increased, from

$200,000 to $400,000 - these provision sunsets after December 31,

2005. [NOTE the section 179 deduction is available only for

property acquired for use in a trade or business. It is not available

for property held for the production of income – as an investment –

and it is not available to trusts or estates.]

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In other provisions, the Act:

4. Accelerates the reductions in the marginal tax rates for ordinary

income to 25 percent, 28 percent, 33 percent, and 35 percent,

effective January 1, 2003. These rates are effective for computing

both the regular tax and the Alternative Minimum Tax - these

provision sunsets after 2010.

5. Increases the taxable income level from $6,000 to $7,000 for

single filers and from $12,000 to $14,000 for married taxpayers

filing joint returns, effective in 2003. This provision is indexed for

inflation after 2003, but sunsets after 2004.

6. Increases the standard deduction and the 15 percent tax bracket

for married taxpayers filing joint returns to twice those for single

filers, effective in 2003. This provision also sunsets after 2004.

7. Increases the child tax credit from $600 to $1,000, effective in

2003. This provision also sunsets after 2004.

8. Increases the exemption from the Alternative Minimum Tax to

$40,250 for individuals and $58,000 for married taxpayers filing

joint returns. This provision also sunsets after 2004.

9. Taxes dividends paid by both domestic and foreign corporations

at the same rates as long-term capital gains - provision sunsets

after 2008.

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Health Savings Accounts (HAS)

HEALTH savings accounts, let consumers set aside money tax-

free to pay for medical expenses, both now and in the future. But

the accounts have been controversial since their introduction in

January 2004.

Depending on the situation, they can be a wonderful tool to help

Americans become wiser, more price-conscious health care

consumers, or just another way for employers to pass along more

health care expenses to their workers. Many experts contend that

the accounts are basically a tax-shelter for people who are healthy

and wealthy enough to invest in them but don’t have to rely on

them to cover their care costs.

How are businesses handling HSAs? 66

Most businesses have not yet offered the accounts as an option to

their insurance plans. But as health costs continue to climb, some

businesses and individuals are more curious to try the idea. Since

they were established under the 2003 law that set up a prescription

drug benefit for Medicare, more than 425,000 accounts have been

established, according to a survey of administrators by Inside

Consumer-Directed Care, a newsletter based in Washington, and

more than 50,000 are being opened each month.

Nearly a year and a half into the experience, however, it is

becoming clear that while the accounts may be a reasonable option

for some people, there are potential drawbacks.

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Basic requirements of HSAs

A health savings account must be paired with a health plan that

meets certain criteria, including a deductible of at least $1,000 for

individuals and $2,000 for families. Some employers offer them,

although individuals can also apply for a qualifying health plan and

open one of these accounts on their own.

Individuals can deposit money into their accounts to cover the

deductible and other medical expenses, and employers can also

deposit money for employees. Generally, the account balance earns

interest, though some accounts allow holders to invest the money

in mutual funds or other vehicles.

If an employee leaves his job, the money in his health savings

account stays with him. And these accounts, unlike flexible

spending arrangements, have no “use it or lose it” rule, so the

funds roll over from one year to the next. An account holder pays

no tax on withdrawn funds as long as they are used to pay for qual-

ified medical expenses. If the money is used for any other ex-

penses, it is subject to income tax and, for those under 65, to a 10

percent penalty. There are downsides to the Health Savings

accounts. The account balances may shrink even though the money

was used.

Cost of servicing HSAs

Typically, the companies that administer the accounts charge a

set-up fee of around $20, plus a monthly fee of about $2 or $3.

They may also charge an annual fee, as well as a transaction fee

every time a customer writes a check or uses the account’s debit

card. Some charge a fee to close an account. Other health savings

accounts, charges a one-time, $15 fee to open an account, and $36

annually to administer it. There is also a $2.50 monthly service

charge, which is waived if the balance is more than $2,500.

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In the early years of an account, when the balance is typically

low, fees can take a relatively big bite out of the total.

Some companies permit an account holder to invest the balance in

stocks or mutual funds, though a certain minimum balance — say,

a few thousand dollars — may be required to do so. Such

investments, of course, offer a chance for greater returns — but

also the risk of losing money.

There are also ceilings, indexed to inflation, on annual

contributions: in 2005, it is the lower of the deductible or $2,650

for individuals and $5,250 for families. Account holders who are

55 or over can also make catch-up deposits. In 2005, the ceiling is

$600; it rises gradually to $1,000 in 2009.

But even if the investor deposits the maximum amounts and

don’t touch the money to pay for health care before he is 65,

studies have shown that he won’t accumulate enough to cover

medical expenses in old age.

The amount saved is not the only concern. There are other

wrinkles that can trip up consumers. For example, health savings

accounts cannot be used with many flexible spending arrangements

that are offered by employers.

Prescription drug coverage poses a problem for many people who

are considering whether to open health savings accounts. Starting

in January 2006, many prescription drug expenses in qualified

plans will be subject to the deductible. Now, consumers typically

pay only a portion of the drug costs from the outset.

Many major insurers and banks now offer the accounts to

individuals and companies. But details like fees and investment

options vary widely, as do the basics of the accompanying health

69

plans. The biggest drawback about Health Savings Accounts may

be that they can be very confusing. Because these accounts are still

relatively new and changing fast, the best advice may be to read

the fine print before recommending them or opening one.