“While small-business owners face numerous challenges
on the road to success, few are more dramatic than the
unexpected death of an essential employee.”
ployee is well-known in the industry
for his or her expertise. And replacing
a key employee has a number of costs,
including recruiting, hiring and training.
One cost-effective way to protect
against the financial impact of the loss
of an owner or other essential employee is through key person life insurance. This specialty insurance is a
policy owned by the company on the
life of an employee — with the employee’s consent — and in which the
company is the sole beneficiary.
Key person life insurance is an of-ten-overlooked product in an insurance producer’s portfolio. Tapping
into existing client relationships and
local business networks, producers
can provide a valuable service to their
small-business community and expand their own businesses — all by
using existing life insurance products
in their repertoire.
Weighing the options
Businesses have several options
for preparing to weather the financial
storm in the event of the death of a key
employee. The business can establish a
sinking fund, setting aside cash to use
in an emergency. This gives the company money when it is needed, but it
also may result in lost business opportunities and may not be an advisable
deployment of cash. The business also
can borrow the funds. This approach
assumes the loss of the key person has
not damaged the credit-worthiness of
the business. Finally, the business can
purchase key person life insurance.
A key person policy provides coverage on the life of a business owner
or other key employee. The company
owns and pays the premiums on the
policy. If the key person dies while the
policy is in force, the business receives
the death benefit and uses the proceeds
to keep the business afloat.
Proceeds can help replace lost profits, protect the company’s credit position, provide a financial cushion, recruit a qualified replacement, or offset
lost business value. Benefits also are
frequently used in conjunction with
buy-sell agreements to buy out the key
person’s shares or interest in the company. If ultimately not needed by the
business, the proceeds can provide income payments (salary continuation)
to a surviving spouse.
Choosing the right coverage
Key person life insurance protection can be structured from any type of
policy. Permanent policies are more expensive but may allow cash value to be
available to the business should unforeseen needs arise. Term policies are cost
effective and allow for the greatest flexibility, including scheduling the term to
last until the employee’s retirement.
Another option is to use a return-
of-premium term life policy. If the
key person survives the policy, the
business recovers the entire premium
expended. The returned premium is
received income-tax free and may be
used by the business to replace the re-
tiring key person. Or the business can
consider directing the money to the
key person as a retirement bonus.