Small Business Financial Article
Rich Best has spent 28 years in the financial services industry, as an advisor, a managing partner, directors of training and marketing, and now as a consultant to the industry. Rich has written extensively on a broad range of personal finance topics and is published on several top financial sites. Recent books include The American Family Survival Bible and Annuity Facts Revealed: What You MUST Know Before You Invest.

Insuring Your Most Valuable Assets – Your Key Employees

Insuring Your Most Valuable Assets – Your Key Employees

Businesses are often built on the know-how, skills, or goodwill of one or two people whose unexpected absence could threaten the business’s survival. Suppose a business relies heavily on these "key" people for a significant portion of its revenue. In that case, their loss due to death is likely to impact the business’s revenue and profits. In certain situations, the cost to replace a key person could be prohibitively expensive in terms of lost revenue or the search required to find and hire a suitable replacement. Many businesses couldn’t recover from such a financial hit without key person insurance.

What’s the Real Value of a Key Person?

Most businesses are aware of the importance of their key people. They could be behind the development of a key product or technology. Or they could have generated the most goodwill among its major customers. They could be one of the founders responsible for much of the business’s current success. It could also be a sales executive or operations manager with high skill levels developed over years of experience.

However, few businesses place a value on their key people in terms of what it would cost to replace them after their unexpected death or disability. While no one is totally irreplaceable, the costs to replace a key person could be much more than the business realizes, including

  • The lost revenue due to business interruption during the time it takes to find a replacement
  • Lost future revenue due to the loss of goodwill generated by the key person
  • Lost future revenue due to the loss of product or technology expertise of the key person
  • The cost of buying out the business interests of a surviving spouse
  • The cost of hiring a search firm
  • The cost of a highly competitive compensation package that will attract the right person

When all potential costs are considered, a business could be looking at a seven-figure hit to its bottom line. Just the cost of a search firm and a competitive compensation package could run well into six figures.

Like any risk exposure, many small businesses need a way to transfer that risk to protect their bottom line. For the risk of losing a key employee, businesses can turn to key person insurance for financial protection.

How Key Person Insurance Works

A key-person insurance plan is a simple arrangement. The business purchases a life insurance policy on the key person as the insured and the business as the owner and beneficiary. The cost of premiums for key person insurance is not tax-deductible; however, the death benefit proceeds are tax-free to the business.

For most smaller businesses, the most efficient way to purchase key person insurance is with term life insurance. For just cents on the dollar, a business can buy enough financial protection to cover all potential costs. For example, depending on the insured’s health, a 20-year term policy with $1 million of coverage on a 35-year-old male could cost as little as $600 a year.

Don’t Forget Key Person Disability Protection

While a key person life insurance plan is key to the financial protection, the more likely financial risk is the loss of a key person due to a disability. The risk of a disability due to an accident or illness is far more likely than premature death.

A disability lasting six months or longer could significantly impact a business’s ability to fund its operations. A key-person disability protection plan, where the business is the owner and beneficiary of a policy on a key person, can ensure the continuation of cash flow while the key person recovers.

Although key person insurance plans are simple arrangements, it is essential to work with an insurance professional specializing in business insurance. Key person arrangements need proper documentation, and it’s important to determine the cost of replacing your key employee properly.

With its relatively low cost and simplicity, a key person protection plan can be the best risk management investment your business can make.

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