INSURANCE
     

Judy and her mother were driving along Route 460, just a few miles from the RagPickers plant, when a motor home hit them head-on. "It killed them both," says Judy's nephew, Freddie Blair.

photo by Tim Cox Clockwise from the top left, RagPicker's new employee-owners include: Jeff Watson, truck driver; Mike Lester, bailing and unloading; Freddie Blair, president; Jimmie Meadows, laundry manager; Cathy Mercer, secretary and cutting room manager; Curtis Howington, shipping and receiving; and Cathy Ball, vice president.

When the unthinkable happens, you never really get over it, Blair says. But what do you do when lightning strikes twice? Ten months after Judy's death, doctors discovered tumors in Jim's liver. They gave him six months to live, but he died before summer's end. Partners in life and work, the Lesters got the idea to start their burgeoning Southwest Virginia business from 10 bags of quilting scraps they found in Grandma Lester's attic back in the early 1980s. The company blossomed from that first transaction -- trading a box of rags for a box of Joy dishwashing detergent -- into one the fastest-growing small companies in Virginia. RagPickers, which cleans and recycles industrial rages, breathed new life into an economically depressed coal mining area.

Jim inherited Judy's half of the business when she died, but once he became the sole owner, he moved quickly to assure corporate continuity. Lester willed RagPickers to seven of the company's 47 employees. "It was his wish that we continue to run the business," says Blair, one of the seven owners. "He wanted us to run it as a team. ... Everybody still does their old jobs, and we make decisions together."

Now that RagPickers has seven owners, succession planning isn't as easy as rewriting one man's will. "We have a corporate attorney, and we've all had wills processed and life insurance for succession planning," Blair says. The new owners purchased enough life insurance to allow the company to finance buy-sell agreements that kick in as owners kick the bucket. "I'm married and my wife doesn't know anything about the business, and she doesn't have any interest in it," Blair explains. "If I die, there is a provision that RagPickers buys out her shares."

SPLIT-DOLLAR LIFE INSURANCE

Insurance is perhaps the most flexible of financial instruments: Businesses still use it primarily to limit liability and transfer risk, but it's also becoming an important tool for things like succession planning and executive compensation.

When the tax laws changed in 1993, Chris Nowell was already looking for executive compensation ideas to fill the gap left by new limits on qualified retirement plans such as 401(k)s.

Nowell is the treasurer of Charleston, S.C.-based Cameron & Barkley, a $650 million distributor of industrial electronic and safety devices with offices in Hampton and Danville. The new restrictions placed on qualified retirement programs "became a case of reverse discrimination," Nowell says. "We knew we wanted some sort of executive deferred compensation, so we put out a request for proposal and interviewed three groups."

Under the new tax laws, qualified retirement plans -- ones that survive even if the company goes under -- cannot be applied to compensation above $160,000. "They have capped the amount of compensation that can be included in any pension formula," explains Rick Webster, managing director of Princeton, N.J.-based J&H Marsh & McLennan Financial Services. "Many times executive bonuses ... are cut from qualified plans."

To make up for that, J&H Marsh & McLennan helped Cameron & Barkley devise a nonqualified plan that uses split-dollar life insurance to facilitate deferred compensation. The company and its executives split the cost of life insurance that increases in value without being taxed as compensation. If the executive cashes in the policy, he pays the taxes, but if he dies before doing that, his heirs get the money free of income taxes.

"For example, if I defer $10,000 [per year], that gives me $400,000 in life insurance, and if I die, $10,000 gets paid to Cameron & Barkley and $390,000 goes directly to my family tax-free," Nowell says.

In some scenarios, spit-dollar life insurance can deliver more compensation for the buck than a traditional stock-option plan. Estate taxes and income taxes combined can gobble up 85 percent of an executive's deferred compensation, says John H. Milne, executive vice president and general counsel for the Todd Organization of Virginia, a Richmond-based firm that specializes in nonqualified benefits plans. "If an executive had $5 million in stock awarded by compensation, if he dies, $4 million could go to estate taxes."

With split-dollar plans, it's easy to avoid estate taxes, says Scott Fiedler, an executive benefits consultant at Rich-mond-based Slabaugh Morgan White & Associates. "Just have someone other than the executive own the policy," he advises.

Milne says the main things companies need to consider in designing split-dollar plans are the four Rs of benefits: recruit, retain, reward and retire. And as companies try to match their needs with those of their executives, it can get costly. But attractive benefits programs act as golden handcuffs to keep key executives in place. "If the executive stays," Milne says, "there's a pot of gold at retirement."

Losing key people, especially those with special contacts or talents, can destroy a company, adds Tony Tringale, president of Fairfax-based Insurance Consulting Group. "This is a big part of selective benefits, especially in times of low unemployment."

And while cash is still the key component of most executive compensation packages, innovative benefits that protect present and future wealth can help attract top talent. "There's been an explosion in nonqualified plans," says Greg Ordonez, vice president of the executive benefits practice of J&H Marsh & McLennan. "We want to protect their wealth."

DIRECTORS & OFFICERS INSURANCE

In the days of flappers and bootleggers, the stock market was a ruthless game. It wasn't uncommon for top executives to flat out lie to their shareholders.

"They might tell them that they were getting a contract or that their sales were going up 50 percent, when actually they were losing a contract," says Ken Robson, vice president of Finpro, a subsidiary of J&H Marsh & McLennan. "Everyone would go out and buy the stock, and the company's directors and officers could then sell all their stock at the last minute."

Federal regulators, however, clamped down on such shenanigans following the stock market crash of 1929. The Securities Exchange Act of 1934 "made directors and officers directly accountable for what was said to investors," Robson says. And the insurance industry responded by creating D&O coverage -- primarily to protect top executives from shareholder suits.

But over the years -- as the business world has become more litigious -- D&O insurance has become increasingly important, and most companies now carry this coverage whether they are publicly or privately owned.

"In the mid-80s, with leveraged buyouts, we started to see an increase in litigation, and the pressures skyrocketed. There was an overnight change," says Michael Thomas, assistance vice president of Philadelphia Insurance Comp-anies, which provides a D&O plan called executive safeguard.

Thomas says that about 90 percent to 95 percent of corporations have some form of directors and officers liability insurance. And in recent years they have expanded that coverage to protect, not only the decision-makers, but the entity they control.

This practice became more prevalent, Thomas says, following a civil suit between Nordstrom and Chubb & Son. In that case Seattle-based Nordstrom settled a $7.5 million securities fraud class-action suit that had been brought against the department store chain and several of its directors and officers. But Nordstrom's D&O carrier, a Chubb subsidiary, agreed to reimburse the company for only a portion of the claim, allocating some of the liability to the store.

Nordstrom won that important point on appeal in 1995, but the case demonstrated that the mere presence of D&O insurance is not enough. Executives need to understand what's covered and what's not covered, and they must make sure that they are protected from the high-dollar jury awards that are becoming more common. "When a risk manager goes to a board of directors with a benefits plan," Robson says. "They ask: 'Are the D&O limits high enough?' If there's a suit, their personal fortunes could be in jeopardy."

Executives are learning to ask the right questions about D&O insurance in the corporate world, but they sometimes forget to inquire about D&O insurance when they become officers or directors of nonprofit organizations. Their personal assets can be at risk -- even in the nonprofit sector, Robson says. "A number of people have come up to me and asked about participating on boards, and I've said, 'The first thing you should do is ask, do you have D&O?'"

KEY-EMPLOYEE LIFE INSURANCE

Retired DynCorp CEO Dan Bannister has flirted with death more than once in his 67 years. But what would have happened to his Reston-based technology services company if news reports in April 1996 were accurate?

Those initial reports listed Bannister among the missing following the crash of a military plane that was carrying U.S. Commerce Secretary Ron Brown, members of his staff and American business leaders en route to Dubrovnik in Croatia. All 33 died and many people thought Bannister was among them, but the accounts of his death were greatly exaggerated. At the last minute, because of mounting business pressures, he decided to remain in Northern Virginia.

Laurie Emmerichs, a spokeswoman for DynCorp, says she doesn't know of any insurance held by the company that would have protected it from the loss of Bannister. But that doesn't surprise Fiedler at Slabaugh Morgan. "You see key-employee life insurance more in small, closely held companies," he says. DynCorp is one of the largest private companies in the commonwealth.

The coverage would be more important for a small construction company that needs the cash-flow to service its debt in the interim. In addition to compensating for the loss of leadership, key-person coverage can provide collateral for corporate debt or help fund the hiring of a replacement.

"You have to look at it [this way]: 'If I lost that person, what would be my replacement cost?'" asks Tringale of the Insurance Consulting Group. "The reality is, if dollars are available, there are more potential solutions."

And if that key person is also the sole owner of a small company like Rag-Pickers, life insurance can become exponentially more important. "You want to make sure the business doesn't die with its creators," says Ordonez at J&H Marsh & McLennan.

That's the goal of the seven new owners of RagPickers in Tazewell. They were incredibly lucky that Jim Lester survived his wife long enough to change his will. They have since decided that the best policy -- in their case -- is an insurance policy.

© DECEMBER 1998, VIRGINIA BUSINESS MAGAZINE