Most business owners understand that assets vital to the success of the enterprise should be insured. Premises are routinely covered for fire and/or theft; vehicles used to make deliveries, insured; machinery needed for manufacturing, also insured. Given that these tangible assets are instrumental in the success of the business, it makes good business sense that the business is protected in the event of a loss. But what about key employees? Many business owners overlook the impact on their business should a key employee die unexpectedly.
If you own or manage a company whose continued success is dependent on key people (it might even be you), it would be prudent to insure all key personnel whose death or incapacity would negatively affect profitability. Key persons are those who contribute to the continuing success and profitability of the enterprise.
What happens when an owner or key person dies or becomes disabled?
- The bank could lose confidence should an owner die, resulting in the calling in of loans and/or restricting on going credit required for the day to day operations of the business;
- If the bank did have outstanding loans with a business now facing continuing without the owner or key individual, the loan agreement could restrict dividends or distributions to the surviving shareholders or family members;
- Even if loans were not called, there would still be pressure put on the business to continue servicing debt while profits may be reducing;
- If the deceased or incapacitated key person possessed special skills and experience, or had a close relationship with the customers, a decline in revenue would most likely result;
- Suppliers might now demand payment up front if their confidence has been shaken;
- There may be considerable training and recruiting costs to replace the lost key employee.
What type of coverage is important?
Insuring against the death, disability and critical illness of a key person are all important.
Life Insurance Coverage
Determining the proper amount is often based on a multiple of earnings or an estimate of how much the business value would reduce with the loss of the key individual. As a rule of thumb, most insurance companies are comfortable life insuring a key person up to five times his or her salary.
A higher multiple could be available in special situations. The life insurance is owned and paid for by the company and should death occur, the proceeds are received by the company free of tax. One of the advantages of corporate owned life insurance is that any of the proceeds not required directly in the business can be disbursed tax free to the surviving shareholders or possibly family members. This would not apply to key person disability or critical illness insurance.
Disability Insurance and Critical Illness Coverage
When determining the amount of Disability and CI coverage an important question to consider is how long the disruption would last and the impact of losing that employee for possibly a long term disability. Key person disability protection or Critical Illness coverage is available that could be used in hiring a replacement, or to maintain company cash flow while the disabled employee recovers.
Having the proper amount of key person life, disability and critical illness insurance can often mean the difference between a company surviving the loss of an owner or essential employee and not. Call me if you feel this is something you would like to investigate in more detail.