Small-business owners commit significant time and resources to protecting their businesses from risk. Physical and data security, intellectual property rights and inventory control all play a part, but the primary risk-mitigation tool for businesses is insurance.
Most business owners instinctively understand the importance of insurance in safeguarding their assets. Yet, the asset most important to the success of many businesses is not inventory or intellectual property -- it is a company's key employees.
The sudden death of a company's founder or other essential employee is not only emotionally difficult; it can also result in ongoing financial difficulty for the business. The employee might be a salesperson who is responsible for a large percentage of income. The business may experience a loss in reputation if the employee is well-known in the industry for his or her expertise. And replacing a key employee has a number of costs, including recruiting, hiring and training.
One cost-effective way to protect against the financial impact of the loss of an owner or other essential employee is through key person life insurance. This specialty insurance is a policy owned by the company on the life of an employee -- with the employee's consent -- and in which the company is the sole beneficiary.
Key person life insurance is an often-overlooked product in an insurance producer's portfolio. Tapping into existing client relationships and local business networks, producers can provide a valuable service to their small-business community and expand their own businesses -- all by using existing life insurance products in their repertoire.
Weighing the options
Businesses have several options for preparing to weather the financial storm in the event of the death of a key employee. The business can establish a sinking fund, setting aside cash to use in an emergency. This gives the company money when it is needed, but it also may result in lost business opportunities and may not be an advisable deployment of cash. The business also can borrow the funds. This approach assumes the loss of the key person has not damaged the credit-worthiness of the business. Finally, the business can purchase key person life insurance.
A key person policy provides coverage on the life of a business owner or other key employee. The company owns and pays the premiums on the policy. If the key person dies while the policy is in force, the business receives the death benefit and uses the proceeds to keep the business afloat.
Proceeds can help replace lost profits, protect the company's credit position, provide a financial cushion, recruit a qualified replacement, or offset lost business value. Benefits also are frequently used in conjunction with buy-sell agreements to buy out the key person's shares or interest in the company. If ultimately not needed by the business, the proceeds can provide income payments (salary continuation) to a surviving spouse.
Choosing the right coverage
Key person life insurance protection can be structured from any type of policy. Permanent policies are more expensive but may allow cash value to be available to the business should unforeseen needs arise. Term policies are cost effective and allow for the greatest flexibility, including scheduling the term to last until the employee's retirement.
Another option is to use a return-of-premium term life policy. If the key person survives the policy, the business recovers the entire premium expended. The returned premium is received income-tax free and may be used by the business to replace the retiring key person. Or the business can consider directing the money to the key person as a retirement bonus.
There are few special requirements needed to sell key person life insurance to a business. First and foremost, the insured must sign a notice and consent acknowledging that life insurance is being placed on his or her life. The business applies for and owns the policy, pays the premium, and is the sole beneficiary of the policy. Neither the insured nor the insured's family has any interest or claim to the policy values or death benefits. The business also may want to document its intent to purchase insurance by entering a resolution in its corporate minutes when each application is completed.
Determining the level of coverage for a key employee depends on a number of factors. A multiple of salary can be one component, but the company also must consider costs such as share buyouts, recruiting and training costs for replacement employees; the deceased employee's contribution to the company's bottom line; and quite simply, the level of premium the company can afford. Businesses should understand that premiums are not considered a business expense and therefore, are not deductible.
As with any insurance policy, it is advantageous to purchase the policy when the insured is younger and in good health. Waiting too long leaves the company at risk -- especially when the company also is young and more dependent on a few key employees -- and insurance costs increase with the insured's age.
Key person life insurance is a simple-to-add specialty product that any life insurance producer can sell. There are no special licensing or training requirements, and many potential clients can be found within the producer's existing client base. Individual policyholders may be small-business owners, and networking with other local businesses may generate leads.
Small businesses are key drivers of local economies and employment. While small-business owners face numerous challenges on the road to success, few are more dramatic than the unexpected death of an essential employee. Key person life insurance can help ensure that a tragic loss does not also spell the end of the business.
Karen L. Susac, JD, CEBS, CLU, ChFC, CSSC, FLMI, FFSI, is advanced markets director for Symetra Life Insurance Company. Symetra is a diversified financial services company based in Bellevue, Wash. In business since 1957, Symetra provides employee benefits, annuities and life insurance through a national network of benefit consultants, financial institutions and independent agents and advisors. For more information, visit www.symetra.com.