Key employees are as indispensable as moms

By Kip Walker

Just as moms are often taken for granted for all they do to keep a household running, businesses often overlook the key employees who play a pivotal role in their day-to-day operations, decision-making and overall success. Many business owners don’t realize that they can protect themselves from the loss of these employees with the purchase of key person life insurance. Although key person insurance is typically obtained to cover founders and owners, it can also be purchased for the other people who are crucial to a company’s survivability.

Unlike personal life and disability insurance purchased by the insured, the business buys a key person policy, pays the premiums and is the beneficiary of the policy. If the covered employee dies, the business receives the insurance payoff. There are a variety of ways to use these insurance proceeds, including debt repayment, offsetting day-to-day operating expenses, supplementing lost revenues until a replacement can be hired or, in extreme cases, distributing money to investors, paying severance to other employees, and closing the business down in an orderly manner.

Because it is a form of life insurance, it’s convenient to raise the topic of key person coverage when discussing employee benefit plans with prospects and clients or general business planning concerns. If you’re not talking to your business clients about key person insurance, now is the time to change that. Nearly all companies can benefit from this smart business solution, but it’s particularly valuable to the small- and medium-size enterprises most financial professionals encounter every day.

More than a benefit, key person insurance is a simple but powerful planning tool that helps companies ensure a bright future — despite the loss of crucially-important leaders or employees. According to a 2021 L&G State of the Nation report, 94% of businesses had at least one key person and 52% of firms identified the death of an owner or key employee as the top risk to their business. Whether it’s a sole business owner, a partnership or a senior employee with key responsibilities, no one is invincible when it comes to building and running a business.

Key person insurance is one of those products that is often overlooked, yet, once you explain its purpose, it practically sells itself. Consider these essential talking points — which you can incorporate into your conversations with clients.

Defining key person insurance

As the name implies, key person insurance is life insurance purchased for specific employees —owners, executives, vital contributors — who are necessary to the company’s success and survival.

Key person insurance covers losses to the business that would inevitably result should an indispensable leader or contributor die. It is provided through standard term life, whole life and indexed universal life policies, depending on where you are. The difference: The business pays the premiums and is the named beneficiary, and if applicable, has access to the policy’s cash value as well as any dividends (instead of the insured and the insured’s family).

Key person insurance doesn’t merely benefit a company by giving its leadership breathing room to recover from a loss. By helping to ensure the company’s solvency, key person insurance provides security to employees, clients and creditors.

With less likelihood of deep bench strength due to size, the smaller the company, the more devastating the loss of a key employee is likely to be. For example, one European study on how much entrepreneurs matter to their privately owned business’ ongoing success found that, after a founding entrepreneur dies, on average, 60% of a firm’s sales are lost and 17% of its jobs are cut. Also, these companies have a 20% lower survival rate two years after the founder’s death compared with similar firms in which the entrepreneur is still alive.

How key person benefits can be used

Your business clients ideally will never experience the need to claim key person benefits. According to Zurich mortality and morbidity tables, there is only a 15% chance that in a company with four key people whose average age is 40, one will die before the age of 65.

However, if a client’s business does experience a loss, there are many ways the benefits of key person insurance can work to help offset that loss, including by:

Supplementing lost revenues to offset operating expenses.
Funding the recruitment and training of a replacement.
Purchasing a principal’s ownership interest in the business.
Providing additional funds to the employee’s beneficiaries.

If it’s determined that the best approach to address the employee’s absence is to close the business — for example, if the business is a small entrepreneurship — the insurance proceeds can be used to pay off debts, pay severance to employees and distribute funds to investors.

Knowing how those funds would be used is useful when determining how much coverage is needed. The objective is to calculate the financial impact that a person’s death will have on the company —including lost revenues, profits and the cost to replace them.

Key person insurance is a business asset too

A company that has key person insurance may find it easier to obtain financing or credit from banks or capital from investors, because the preparedness provided by the insurance lowers business risk. In fact, lenders and investors often require key person insurance on members of a management team.

In addition, during the life of the policy, businesses can use policies’ accumulating cash values as loans, whether to finance growth opportunities or use as emergency funds. These policies may also be perceived as assets that improve the company’s balance sheet.

The big picture

There is no question that key person insurance benefits small and medium sized businesses, as well as their employees, customers and creditors. But it benefits their communities and countries as well.

According to the World Bank, smaller companies play a significant role in most countries’ economies, representing about 90% of businesses and more than 50% of employment worldwide. In the U.S., small businesses create two-thirds of new jobs, drive innovation, and generate 44% of economic activity, according to the U.S. Small Business Association.

So when you meet with business clients to discuss concepts to ensure their ongoing success, you’re helping more than that one small business. This is another reason you may want to educate your clients and prospects on this valuable business solution of key person insurance.

Kip Walker, JD, CLU, is regional vice president, midwest region, at Mutual Trust Life Insurance Solutions, the U.S. life insurance division for Pan-American Life Insurance Group. Contact him at [email protected].