If the man (or woman) in the executive suite drops out due to health problems, it can become critical for the GmbH. What to look for.
In a nutshell – a medium-sized limited company cannot afford the disability of its managing director. – A BU component built into the entire supply contract has disadvantages. – Especially shareholder-managers of a GmbH have problems with the realization of a commitment.
The case: A typical medium-sized limited liability company finds itself in a crisis situation because a managing director suddenly becomes incapacitated. In practice rather rare? No, because according to the observations of insolvency administrators, it is becoming increasingly apparent in practice that the occupational disability of the managing director leads to insolvency. What is the result of having an occupational disability insurance policy? What liability traps and issues might be involved then? A typical medium-sized company will not and cannot afford the invalidity of the managing director financially. His occupational disability leads to financial obligations that can trigger insolvency. Business economists speak of “incongruent reinsurance” if a managing director’s pension commitment includes an occupational disability pension but there is no special reinsurance for this risk. In the event of damage, the Mittelstands-GmbH must then bear the financial expense alone. In the past, occupational disability insurance with a resulting pension was often included in the pension commitment. However, an occupational disability component built into the overall contract has the following disadvantage: there are insufficient financial resources available in old age for the savings component of the insurance, which is needed to finance the old-age pension. In other words, if only a savings portion of 70 to 80 percent flows into the reinsurance for the old-age pension, the capital required to finance the pension at the start of the pension is usually not available. This is a vicious circle, because if the company cannot be financed, the tax office can possibly point to hidden profit distribution, which in turn can lead to insolvency.
Design risks It is not uncommon for a comparative calculation to be missing in order to optimise the tax burden. Two design errors are typical here. 1) In the sample calculation for the determination of needs, it was simply overlooked that such pensions must also be taxed. The manager will then ask whether the model calculation was incorrect and consider whether he can claim the capital missing for the annuity to pay the tax from the insurance intermediary. 2. in individual cases it may be “on balance” cheaper to cover occupational disability privately via a pure risk insurance, i.e. not via a pension commitment in the company. Probably the greatest danger in the event of premature occupational disability of the managing director is, however, the balance sheet risk. This is because, in principle, a relatively high disability pension as part of a pension commitment by the GmbH to the managing director is problematic. In the event of disability, the GmbH is exposed to high risks, which are then generally to be covered by a reinsurance policy. Unfortunately, however, disability is not usually indisputably ascertainable and, moreover, is subject to a large number of conditions. The insurer often initially does not recognise the obligation to pay the disability pension. The obligation to perform must then be enforced with disputes and protracted legal disputes. Recent rulings on this controversial occupational disability issue show that it can be almost impossible, especially for shareholder-managing directors of a limited liability company (GGF), to actually receive such a pension.
Reorganisation of the business In a recent decision, the action of a restaurant owner against the occupational disability insurer was dismissed (18 February 2005, Hamm Higher Regional Court, Case No. 20 U 174/04). Reason: A self-employed person is only then incapable of working when there are no longer any areas of activity open to him in his business in which he can still work to a conditional extent with his health impairment. The judges stated: In the event of a health impairment, a self-employed person is obliged to reorganise his business if necessary. In plain language: If a business has fields of activity which are still reasonable for the owner in terms of health, the court is convinced that this excludes a conditional occupational disability (provided that a possible reorganisation of the business would open up corresponding possibilities of activity). Any reorganisation would have to take into account redundancies and new recruitments. According to the judges, the owner and operator of a restaurant who can no longer lift and carry heavy things, who can no longer walk and stand for long, still has a wide range of employment possibilities; a supervisory job, for example. In individual cases, however, it will be difficult to reconcile the conditions of the reinsurer and those of the pension commitment. In the event of disability, the employer (the GmbH) must pay the disability pension under the contract between it and its GGF. The insurer will defend itself against this; possibly even successfully. In such a case, the GGF would insist on the provision of the benefits promised to him. Consequence: The GmbH must provide a substantial capital sum as cover for the disability pension.
Shift to private sector And if the GGF were to waive its claims? This could be construed adversely to him for tax purposes. The IRS would hold him accountable for the cash value of the disability pension with a hidden equity contribution subject to payroll taxes. For this reason, it is advisable as a matter of principle to exclude disability or occupational disability pensions from a company pension commitment. This applies in particular if the GmbH is managed by several participating managing directors in such a way that the remaining partner in each case has to deal with this problem. It would be better to shift the occupational disability insurance to the private sector, because then the GmbH would not be burdened. A pure risk insurance for occupational disability is also often much cheaper and, depending on the BU rating of the insurance company, can also offer better insurance cover. A sensible alternative for executives or managing directors is also a Keyman policy against serious illness (dread disease), which provides an immediate high capital sum and can be claimed as a tax-reducing business expense. Such a policy would make more sense in many cases because it would immediately provide the GmbH with a high level of liquidity. Disputes in court can usually be avoided. Because: a heart attack is a heart attack and the illnesses clearly defined in the contract automatically lead to the insurer’s obligation to pay benefits.
Johannes Fiala and Andreas Bosl About the authors: Johannes Fiala is a lawyer in Munich and a certified financial advisor (www.fi ala.de). Andreas Bosl is a corporate consultant for occupational pension schemes, Mittelstands Beratungs-Dienst (www.mbd-ub.de).
(PERFORMANCE 12/06, 54)
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Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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