If the ongoing success of your business depends on one or more key individuals, you may want to consider the role that insurance can play in protecting your business. The death or disability of a key employee—such as an owner or manager—can result in difficulties. However, even amid such troubling circumstances, there will be no grace period: Cash flow must continue, and customers may need reassurance that your goods and services will continue to be available. There may also be the responsibilities of buying out the key person’s shares or interest in the company and finding and training a new executive.
Key person insurance—term or permanent life insurance that makes the business the owner, premium payer, and beneficiary of the policy—may help provide the funds needed to accomplish tasks that will require immediate attention in the event of the key employee’s death, such as dealing with creditors who are concerned about the repayment of outstanding loans and debts during a time of transition.
If you have investors, they, like creditors, may be worried if your company loses an important executive. In fact, they may require that key employees be insured as part of a comprehensive business continuation plan for your company.
Without a business continuation plan, a healthy balance sheet is only a stopgap measure. Keep in mind that insurers may want to see a plan before issuing a policy on a key employee. As with any life insurance policy, the issuance of key person insurance is dependent on the insurability of the individual. The cost of insurance may vary according to the individual’s age, physical condition, and medical history.
Purchasing the appropriate amount of insurance may depend on how much the key employee contributes to the company’s revenue flow. If that figure is difficult to determine, another starting point could be his or her annual salary.
The “Muscle” Behind Buy-Sell
If the primary purpose of the policy is to fund a buy-sell agreement, as opposed to meeting ongoing expenses, then the amount of insurance should be equal to the portion of the business’s total value as stated in the agreement. Life insurance can then provide funds to buy out the key employee’s survivors in the event of his or her death. If the insurance is purchased to accomplish both purposes—fund a buy-sell agreement and help pay business operating expenses—the amount of insurance needed may be higher.
A Policy with “Legs”
Attaching a rider to a whole life policy may allow your company to change the insured, should the key employee leave the company or retire. If it’s time for retirement, the policy can be kept in force by the company and offered to the key employee as part of a retirement package. There could, however, be tax consequences. Generally, insurance premiums are nontaxable to the insured if the policy is purchased for the benefit of the business and the insured has no interest in the policy. However, under certain circumstances there proceeds could be paid to the employee or his or her beneficiary, they could be considered taxable income. Individuals are advised to consult their professional tax advisor prior to entering into these types of agreements.
In determining key person insurance needs, another protective option for businesses is disability income insurance (DI). In the event that a key employee sustains a qualified disability, key person disability insurance pays a monthly benefit that is a percentage of the key employee’s pre-disability earned income. The monthly benefit can then be used for the same business purposes as the term or permanent life policy, such as providing revenue to hire and train a replacement or to strengthen the company’s cash flow.
No matter the insurance vehicle, key person insurance for a valued business partner, executive, or employee may be an ideal way to realistically assess and acknowledge the value of his or her contributions to the success of your business, as well as protect the business from unforeseen circumstances.