Key
In every business – large or small, public or private – there is a small number of employees upon whom the performance and success of the organization is highly dependent. These can be the owners, senior executives, leading sales people, or others with specialized skills or talents.
Key person insurance protects a business against the economic loss incurred when one of these critical people can no longer perform. These losses can occur as a result of the premature death of a key employee or when an employee sustains a permanent disability preventing them from contributing.
The Impact of Losing a Key Person
Business can suffer from losing a key employee in several ways such as:
Loss of sales or income associated with that employee.
Disruption of business due to loss of confidence among clients, suppliers, and investors.
Weakening of the company’s credit rating.
Increased financial cost and time associated with hiring and training a qualified replacement.
Loss of management skill and experience, especially in a business without an extensive management department.
When the key person who passes away is an owner of the business, additional problems may exist:
Disagreement between heirs and surviving business owners or key employees.
Lack of cash to buy out the interest of the deceased owner, which may require the sale of the business to an unknown third party – often below true market value.
Surviving owners and executives may be forced to work with a family member who is either not competent or not motivated enough to make the business thrive.
The business may have to be sold to pay estate taxes.
Valuing and Financing Key Employee’s Replacement
While there is no single formula to accurately value a key employee, frequently used methods include a multiple of compensation, the employee’s contribution to profits, and the costs to recruit, train, and hire a replacement. Such methods can yield wide variations in the replacement value, so businesses should evaluate factors that are most relevant to their circumstances when determining the value of key persons.
Insurance Protection
Business owners and corporate risk managers often will protect the company by purchasing a key person life insurance policy on the critical person. This allows the business to insulate itself from the financial loss if the key individual should die prematurely. It is particularly attractive when one considers the lump sum benefits immediately available when the loss of a key person occurs.
Often overlooked in the process, however, is the adverse impact and potential economic loss when a key person becomes disabled and can no longer perform or contribute to the business. The financial issues confronting the business are usually the same ones it would face if the person died. In fact, statistics indicate that the risk of disability among individuals age 30-55 is three to five times greater than the risk of dying before age 65.
Key person disability insurance programs are designed to protect the business by providing funds to help address these risks. Generally, the company will receive a lump sum benefit after a key person has been totally disabled for 12 months. Lump sum benefits are available up to $50 million. Occasionally, monthly benefits are payable to the firm for a short period, followed by a lump sum.
We work with companies to assess the potential risks and financial impact their business would face in the event a key person is lost. Key person life insurance and disability insurance ensures that our clients are well prepared to keep the business running when a personal tragedy occurs.
If a key employee or owner of your business dies or becomes disabled tomorrow:
• Would this death cause a forced sale of the business?
• Would a major client be lost or profitable projects shut down?
• What would be the impact on your company’s goodwill and reputation?
• What portion of the firm’s revenues and or net profit would be at risk?
• How long will it take for a new person to achieve the effectiveness and contribution rate of this person?