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Key Person Insurance: Protecting Key Employees

A company’s success often relies on its key employees. If one of them should abruptly pass away, the company’s future could be in jeopardy. Smaller businesses are particularly vulnerable, as they often depend on a few key people whose knowledge and skills are essential to the company’s operation. According to a survey of small businesses by the National Association of Insurance Commissioners, 71% of firms said they were very dependent on one or two key people for their success. However, only 22% of respondents had key person insurance.¹

Finding the right replacement for a key employee requires time and money. Companies can lose major clients during this transition period if they’re not prepared. Adding key person insurance to your risk management program can help protect your business under the most unfortunate circumstances.key person insurance

How It Works
Key person insurance provides a death benefit that helps businesses cover financial loss in the event of a key employee’s death. Here is a basic breakdown of the policy:

  • The business buys an insurance policy on the life of a key person.
  • The policy is funded by the company and insures the key person while naming the company as the beneficiary.
  • If the key person dies, the business receives an insurance benefit to continue operations, offset lost revenue and recruit / train a suitable replacement.
  • The company can’t deduct the premiums paid; however, death benefit proceeds are generally received income tax free.*
  • If permanent life insurance is used, cash values can be accessed through policy loans and / or withdrawals if the company’s needs change.

Who Needs It?
Key person insurance can protect companies of various sizes and industries. It should be given extra consideration when:

  • The company relies on a few people who have specialized skills and would be hard to replace.
  • The business depends on a key person to produce a significant portion of its revenue.
  • The company has debt that would be hard to repay upon the passing of a key employee.
  • The business is seeking a loan or investors (some loans are contingent on the use of key person insurance).
  • The company plans to merge or go public (some arrangements require top executives and board members to be covered).

Determining Appropriate Coverage
Various methods can be used to determine the amount of coverage needed for each key person:

  • A “multiple of compensation” approach insures the key person for two to five times their annual compensation.
  • A “contribution to profits” approach calculates lost revenue attributable to the key person, minus expected revenue from the replacement.

It’s also important to estimate all costs related to locating and onboarding a replacement. All of these factors should be considered when determining the appropriate coverage amount.

The Key to Continued Success
Key person insurance is a business asset that can enhance a company’s creditworthiness. It can provide financial stability and peace of mind following the loss of a critical employee. When coping with a team member’s death, the last thing you or your employees should need to worry about is the viability of the company. You can proactively manage this risk now with some help from the Executive Benefits Team at SilverStone Group. If your organization is missing key person insurance, contact one of our experts today.

¹ “Life Insurance for Key Employees.” 2018. Insurance Information Institute website. Accessed on October 14, 2018 at www.iii.org/publications/insuring-your-business-small-business-owners-guide-to-insurance/specific-coverages/life-insurance-for-key-employees
* For federal income tax purposes, life insurance death benefits generally pay income tax-free to beneficiaries pursuant to IRC Sec. 101(a)(1). In certain situations, however, life insurance death benefits may be partially or wholly taxable.

This material is not intended to present an opinion on legal or tax matters. Please consult your attorney or tax advisor as applicable.

This article originally appeared in the 2018 | ISSUE THREE of the SilverLink magazine, under the title “ Protecting Key Employees | Key Person Insurance” To receive a complimentary subscription to the SilverLink magazine, sign up here.

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