Chess Moves for CFOs

Eliminating duplicate costs are a big part of a CFO’s job. Companies are spending money on bonding and benefits as they search for more efficient ways to manage cash flows, taxes, and costs. Most companies are required to have a strong balance sheet for bank covenants or bonding purposes and are missing an easy way to accomplish this and save key employees tax costs at the same time.

Surety bonds are acquired to protect against mismanagement, malpractice, performance, project completion, or fraud by private companies and government agencies. These are a contractual obligation that guarantees the contract will be completed according to the terms and that financial assets are available to compensate for losses, if the obligation is not met. Three parties are involved with these bonds: the principal, the surety, and the obligee. As surety bonds are offered by insurance companies, they are underwritten based on different variables: the strength of balance sheet, liquidity, and credit history. The amount of bonding is a correlation to overall financial condition. These bonds are sold in a direct leverage of a business’s working capital.

Most bonds can be offered at between one half and two percent of the contract amount. Some bonds in high risk categories can charge more. The contractor pays the premium at the time of bond execution. It is important to provide a stable income, good cash flows, and conservative liquid assets. The problem in the last five years is low yielding, conservative assets usually earn less than 1% and are taxable. Institutionally priced cash value life insurance can be used to offset some of these challenges. Life insurance cash values are usually counted as liquid working capital by surety underwriters. Banks are currently booking this as a separate asset class on their call reports and have been since the late 70’s.

High cash value contracts exceed premiums on day one and are often available on a guaranteed issue basis. This is preferable for a low hassle and expedient policy placement. The cash value can be a preferable bondable asset with tax free benefits in the event of a death.

Where the multiple efficiencies are usually missed in a corporate setting is in relation to any current group term life insurance offerings by the company. These are a common form of benefit and are usually offered on a formula basis. Two times salary up to $250,000 or three times salary up to $500,000 are common formulas.

Group life insurance is a valuable benefit for the participant and inexpensive to the company. The first $50,000 offered is free to the participant with the additional expense being taxed on the value in excess above that amount. The amount charged to the employee is the government Table I rate, instead of the actual company cost and is put on the W-2 at the end of the year. This rate can be as high as 40% more than the actual rate paid by the company.

There is the opportunity: By carving out the executive group in excess of the $50,000 and using the insurance benefits provided by company owned life insurance through a split dollar program, multiple advantages are achieved.

1)    The company can provide the same benefits to the participant without the annual additional insurance costs.

2)    The participant will pay less using the insurance companies lowest one-year term rates. This could add up to thousands of additional dollars in their pockets.

3)    The yield on the cash value is higher than current short-term rates.

4)    The balance sheet is stronger with a highly rated asset.

5) The aligning of cash flows is accomplished by having a flexible premium chassis. Most of my smaller business clients have unpredictable cash flows and this allows the company to skip a payment or two and catch up later.