Many businesses have one or two people who are the glue that holds everything together. It could be the founder, owner, CEO, CFO, or another essential contributor with specialized skills and knowledge that are critical to the operation of the business.
Not sure who this might be? Think about each major player in the organization, what they do on a daily basis, and what would happen to the organization if they just stopped showing up.
As you go down the list, is there a particular scenario that makes you start to panic? Or envision the demise of the entire company based on that one sudden absence? If so, congratulations! You’ve just identified a key person.
What is key person insurance?
Now that you’ve imagined how difficult and/or costly your key people would be to replace, it’s time to think about how you can help prevent those worst case scenarios from happening. Key person insurance is one way to help protect your business in the event of a tragedy or death.
No one likes to imagine these scenarios, but failing to plan for the unexpected can do much more harm than good.
Key person insurance is an essential part of a comprehensive risk management program, providing you with financial resources during a time of grief and uncertainty. If and when something happens, you may find yourself in desperate need of additional funding while you work to revive, sell, close, or liquidate your business.
How does it work?
This protection is provided when you, as the business, purchase life insurance on one or more of your key employees.
As both the owner and the beneficiary of the policy, your organization pays the premiums directly to the insurance company. The contract’s cash values are considered a business asset, and are available as collateral for securing commercial loans or for direct borrowing from the insurance company at generally favorable interest rates.
If one of your insured key people dies, the insurance company pays the death benefit directly to your business. These funds are treated as an addition to surplus and are free from any direct income taxes.
While nothing can replace your beloved key people, the benefit can be used for a variety of purposes:
- Find a qualified replacement
- Pay expenses or debts
- Provide a financial cushion
- Distribute money to investors
- Make survivor income payments
- Fund stock redemption
- Pay severance
- Offset losses
Key person insurance can give you a little breathing room while you make difficult decisions about what makes sense for your business moving forward. It will also allow you to execute those plans in the best way possible.
How much is enough?
It may feel impossible to put a dollar value on your life’s work, or your key people. Guidelines often recommend using a factor of five to ten times the employee’s salary when making your determination.
Think about what it would take to replace your key person, get your business back on its feet, or close things down in the least painful way. Consider the financial impact of lost time and profits as well as the actual costs associated with doing these things.
Estimate how much coverage you think you’ll need, then consult with a trusted business advisor and your insurance agent to make sure it’s enough. Hopefully, you’re working with an insurance agent who is also a trusted business advisor.
One final note: Be sure not to confuse key person insurance with personal life insurance. If your employees have spouses and/or children who also depend on their income, they should invest in personal life insurance to protect those key people at home.
Tired of working with insurance salespeople who only think one year at a time? Wonder what it would be like to have a broker who looks beyond your annual policy? At Raffa Financial, we’ll provide a corporate employee benefits strategy to help you achieve your long-term your vision. Get in touch to find out how.
Photo by Heather Moore