3 Reasons Why You Need Key Person Insurance As a Small Business Owner
Key person insurance, is also known as key man, or key employee coverage. As a business owner with more than one employee, you may have certain personnel that you depend on you. These people may be a partner in the business. Maybe they have important skills or knowledge that are necessary for the business to continue functioning smoothly. In short, they're a key person in your operation.
Key person coverage can take different forms, and you have it for different reasons. The main goal, though, is to protect your business (and your income) from the unexpected. As business owners ourselves, we completely understand all the many facets that go along with having your own operation. An owner wears a lot of hats, and every day there are pressing issues that need to be dealt with to keep things on track. Worrying about the unexpected loss of a crucial employee, or partner, shouldn't be one of them.
So, why do you really need to have insurance on the life, or health, of one of your vital employees? There are a dozens of scenarios that we've seen over the years, and in every instance a little bit of planning saved an, already unfortunate, series of events from becoming a death blow for one of our clients.
1: Untimely death
The unexpected happens all-too-often. Unfortunately, none of us has an expiration date, and the reality is that the death of someone close to us can happen at any time. What if that death is your business partner? Or, an employee with a very particular skillset and knowledge of your operation. What if that death is you? What happens to the day-to-day operation of your business when that person is no longer there? How does it effect your other employees, and your clients or customers? If the death is the owner, and there is no one to replace him, it puts the livelihood of all of your employees at stake, which causes hardships for entire families.
The death of one vital person can have a ripple effect that can touch the lives of dozens, or hundreds of people. It can have a dramatic impact on, not only your business, but other businesses that may have also relied on that person's skills, abilities, and relationships. As business owners, it is our job to hope for the best, but to plan for the worst. Insuring the life of a key person is just a responsible business practice.
By doing so, you're ensuring the survival of your business, and that of others you do business with. Not only is it responsible planning, but it will have benefits for your bottom line, while that person is living. What kind of benefits could you derive from paying an additional monthly premium for something, you may wonder?
It has to do with the parties involved in a life insurance contract. The owner, beneficiary, insured, and payor. Life insurance can be owned by anyone that has an insurable interest in the insured person. This means that your business entity can be the owner, as well as payor, and beneficiary of the policy. If the business is all of these, then the premiums you pay can, also, be tax-deductible. You will need to consult your tax professional for the specifics, but that means that what you put into that policy can be a deductible expense.
2: Disability
Accidents and illnesses happen. If they're severe enough, they can take someone out of work for weeks, months, even years. While it may not be as severe as our first case, a disabling condition can still have a long-lasting impact on your business, your employees, and your customers. Imagine that your partner has an accident, and is out of work for 6 months. During that time, you still need his skills. His family still needs income. Medical pays will not pay themselves.
This is where plans for short or long-term disability come into play. In fact, some life insurance policies can be designed to provide for circumstances such as this, as well. In the case of life insurance, these types of benefits come (usually) in the form of accelerated death benefit riders. Let's say that Jack has a heart attack, but is expected to live. The illness may not be terminal, but under the terms of his policy, it qualifies as a critical illness. Now, since the business is the owner of that policy, the business may be able to get an advance of Jack's death benefit. That money can, then, be used to cover jack's salary, help with his medical bills, or contract a temporary employee with the necessary skills to fill in for Jack. If the policy is designed with waiver of premium riders, you may be able to forego premium payments during the period of the disability, as well.
3: Retirement or Separation
Even the best partnerships may not work out in the end. According to the The Balance, people change jobs between 10-15 times, with an average of 12. That could mean that your vital employee may move on to another opportunity, leaving you in need of finding someone to fill their shoes. While this may not seem like something that insurance can help with, that depends on what kind of policy you have, and what your expectations are.
Let's say that you've opted for a cash value life insurance policy, like whole life or universal life. Your employee has worked for you for several years, and now he/she is leaving for another opportunity. You have a several options as to what you can do with this policy. Here are just a few ideas.
A: Cash the policy out for its accumulated value. Depending on the size of that policy, how long it has been active, and how the policy is designed, it could have significant cash value. Your business can use that cash value to put toward hiring and training a replacement, or paying into a severance agreement with the exiting employee. be aware that some policies, like universal life, may have a surrender charge, depending on how long they have been in force. You will need to consult your agent or advisor to determine if this is the case.
B: Whether the policy is a term policy, or a permanent policy, it could be lumped into a severance package for the employee. Perhaps, you agree to continue paying the premiums for the policy, but the ownership of that policy is transferred to the employee, and by agreement you lessen the amount of cash in severance that you need to pay upon them leaving your business.
C: The policy could be used as part of a buy/sell agreement. If the exiting employee owns shares of the company, this kind of agreement could be established so that you are able to recoup the cost of those shares upon the death of this employee.
In summary, there are many good reasons to have a key person plan in place. It's responsible ownership. It's good business. It protects you, your employees, and your customers. It is a multi-purpose tool for situations that you never thought it could help with. Putting a plan in place takes far less time, and money, than most people think. Just find a great advisor, who can work with multiple companies, and let them do what they're good at.
