Key person protection is important for ensuring that your client’s business overcomes the loss of a vital employee. What is your client doing to protect their business if a key person is no longer there to help drive business? Unfortunately, many business owners don’t consider the risks of losing a key person until it is too late.
Key person protection is a life insurance-based program designed to help your business owner client value the loss that their business would face if they lost a key person. The business owner purchases a life insurance policy insuring each key person’s life and holds that policy as an asset of the business. It protects the business owner in two ways:
If a key person wishes to retire
Your client has a life insurance policy that becomes the funding for a selective non-qualified benefit program for their key person, usually offering enhanced retirement benefits. The program becomes a “golden handcuff” to entice them to stay on with the business. And, as an added benefit, they can always offer the key person a death benefit paid to the family in case he/she dies prematurely.
There are many approaches to valuing a key person. These can range from:
• Multiple of salary
• Loss of value to the business
• Cost to replace the key person’s sales profits
• Cost to replace the key person’s contributions to income
If a key person unexpectedly dies
A key person protection program can provide your client’s business with the funds needed to help withstand the financial shock and sustain their business following an unexpected death. It can help with a source of funds to cover debts and operating expenses in the face of lost sales, as well as hire a qualified replacement. And they receive the death benefit in the form of tax-free cash when they need it most.
What types of business might need key person insurance? Look for businesses with any of these characteristics:
Strong entrepreneurial owners: Often a business is dependent on its owner or founder. While the loss of this person will be substantial, frequently businesses will continue in the hands of heirs or employees. A loss might trigger credit and cash flow issues, licensing issues (in the case of businesses depending on state contracts or professional skills) or management issues.
Key sales personnel or managers: The loss of key sales personnel can trigger a loss of revenue or clients. With the death of a manager, critical projects or divisions may lose direction.
Businesses that hire skilled professionals: The loss of skilled professionals could reduce business income until their expertise or niche practice is replaced. Examples include: physicians, attorneys, architects, engineers, skilled artisans, writers, real estate brokers or business managers with select clients.
Businesses that run specialty products or services: Where a business is dependent on a special line of products, or offers services that are key to its operations, the loss of its key personnel will result in reduced income or trigger credit issues until operations can return to normal.
Editor’s Note: This post was originally published in May 2014 and has been reviewed and updated.