Jeff Moses, president of Auto Custom Carpets, was on his way home from a business trip in Ohio when tragedy struck. The small airplane he was riding in lost control and crashed into a creek near Talladega, Ala. The plane exploded upon impact, killing everyone on board.
Jeff Moses’ death left a huge void in the company’s leadership team. Not only was Moses the president and co-owner of Auto Custom Carpets, he was also a charismatic sales leader whose product knowledge and extensive industry experience were integral to the company’s success. Without Moses leading the way, the company could expect an immediate and precipitous drop in sales revenue.
The future of Auto Custom Carpets—and its 150 employees—hinged on the ability of the two remaining partners to quickly find and recruit a qualified replacement before the company’s working capital dried up.
Thankfully, the executive team had the foresight to purchase a Key Person Life Insurance policy for each of the three partners. Key Person Life Insurance is simply life insurance on a “key” employee in a business. The business owns the policy, pays the premiums and is named the beneficiary. Then, in the event of the death of the key employee, the business receives the insurance payout. This payout allows the company to remain solvent during a time of flux and uncertainty. The money can be used to make up for lost sales revenue, fund a buy-sell agreement or cover the cost of finding and training a replacement.
The infusion of capital from the Key Person Life policy enabled Auto Custom Carpets to sign an experienced sales professional away from one of their competitors. Within 30 days after the tragic crash, the company was back up and running at full speed.
Most organizations employ at least one individual who is essential to the company’s success. This person may be a partner, owner, majority stockholder or another individual who is crucial to the business. If this person unexpectedly leaves the organization—due to a death, disability or immediate resignation—it may be hard for the organization to survive.
If your organization employs individuals who are vital to its success, key-person life insurance or key-person disability insurance can help protect you from chaos caused by their abrupt absence. These insurance solutions can give your organization options other than immediate bankruptcy should you lose your company’s key person, or people, without warning.
Who Needs Key-person Life or Disability Coverage?
Many organizations can benefit from key-person life or disability coverage, including those that:
- Have employees who would be extremely difficult, time-consuming or expensive to replace, such as central decision makers, chief executives, vital sales managers or employees whose ideas have critical commercial impact
- Employ highly-skilled individuals with unique training
- Would lose considerable business and profit without a certain employee
- Employ people with exclusive ties to key clients
- Employ leaders with irreplaceable knowledge
- Have narrow profit margins and would be financially distressed in the event of a key staff loss
- Need to protect their revenue stream from loss (e.g., a hospital protecting against the loss of a high-earning, respected surgeon)
- Would be devastated if a high revenue-producing client died or became disabled and unable to perform
In the event a vital employee becomes disabled or deceased, these types of insurance provide the company with income checks to make up for financial loss or to use for temporary or permanent replacement costs. Business owners should purchase separate policies for each key employee at the company.
How Does Key-person Disability or Life Insurance Work?
- An employer purchases life or disability insurance for key individual(s).
- The employer is the beneficiary of the insurance policy and owns the policy. If the key employee dies, the policy pays out to the employer.
- Tax-free dollars from the policy can be put toward finding, hiring and training a replacement employee. The money may also provide compensation for lost business during the transition and/or financing timely business transactions.
- The policy can also be transferred to a departing key employee as a retirement benefit or to a different key individual upon the retirement of the original key employee
- Can be used to buy out the key employee’s shares or interest in the company
- Premiums are based on several factors, including the key employee’s age, physical conditions, health history and the amount of coverage
Key-person Disability Insurance vs. Key-person Life Insurance
When most business leaders think of purchasing key-person coverage, they turn to life insurance. However, industry leaders point out that the chance of losing a key person to disability is 17 times greater than losing a key person to death. Plus, the costs of hiring a recruiter to replace the key person and training him or her for a short period could be much higher than finding a permanent replacement.
Considerations before Purchasing Key-person Life or Disability Insurance
- Estimate the value of your key employees. Think about the projects that would be lost without these people and the amount of sales that these people generate. Also, consider the costs associated with replacing them.
- Determine if this coverage is necessary, as credit insurance will cover outstanding loans and debts.
- Create a business continuation plan that outlines how your business will function if you lose key employees.
Requirements and Coverage Options
To obtain key-person disability or life coverage, the individual must be a consenting employee. Also, you must demonstrate that your organization would incur substantial financial loss without him or her. To qualify as a key person, most insurers require the employee’s salary be in the top 20 percent of the company. All key-person policies are written specifically for the employee in question.
Is your business prepared to survive the loss of a key employee? Not sure?
Contact S.S. Nesbitt & Co., Inc. at (205) 262-2700 to discuss whether Key Person Life Insurance is the right fit for you.
This content was abstracted from Zywave’s “Benefits Insights: Key-person Insurance” and “CIA: Key Person Insurance” articles.