Life insurance may be a “diamond in the rough” for your business if its ongoing success depends on one or more key individuals. The death or disability of such a person – for example, an owner or manager who brings in customers – can mean tough times. The realities of business do not include a grace period following a loss: Cash flow must continue, and customers will need reassurance that your goods or services will continue to be available.
The dual responsibilities of buying out the key person’s shares or interest in the company and finding a new executive would also loom on the horizon.
Key person insurance – term or cash value life insurance that makes the business the owner, premium payer, and beneficiary of the policy – may help provide the necessary resources to accomplish tasks needing immediate attention. One such challenge may be 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 about your business when your company loses an important executive. It’s likely they will require that key people be insured as part of a comprehensive business continuation plan for your company.
Without such a plan, a healthy balance sheet is only a stopgap measure. Keep in mind that insurers may also want to see a plan before issuing a policy on a key person. As with any life insurance product, issuing the policy will be dependent on the insurability of the individual, with his or her age, physical condition, and medical history all serving as cost factors for the premiums.
Purchasing the right amount of insurance will depend on how much the key person contributed to the revenue flow. Should that figure be hard to determine, one 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 will be equal to the portion of the business’s total value as stated in the agreement. This approach gives muscle to the buy-sell agreement – without such a resource, taking on personal debt may be the only option in buying out the key person’s survivors.
If the insurance is purchased to accomplish both purposes – fund the buy-sell agreement and pay current operating expenses – the amount of insurance needed will be considerably higher.
A Policy with “Legs”
Attaching a rider to a whole life policy will allow your company to change the insured’s name if the key person leaves the company or retires. If it’s time for retirement, the policy can be kept in force by the company and offered to the key person as part of a retirement package. There could, however, be tax consequences. Generally speaking, 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, if any proceeds from the policy are paid to the employee or his or her beneficiary, they could become taxable income.
Although most business executives will typically weigh the value of term versus cash value policies in determining their key person insurance needs, another protective option for businesses is disability income insurance (DI). Key person disability insurance will pay a monthly benefit that’s determined by the key employee’s pre-disability earned income. The monthly DI benefit can then be used for the same basic business purposes as the term or cash value policies, such as providing revenue to hire and train a replacement or to strengthen the company’s cash flow.
No matter what the insurance vehicle, key person insurance for a valued business partner, executive, or employee may be an ideal way to realistically assess, and then acknowledge, the value of his or her contribution to a successful business.