Personal protection may not be enough

It is human nature for business owners to focus protection planning on personal needs, such as: making sure a spouse and dependents are provided for in the event of death or disability; and converting business equity into liquid assets with a buy-sell agreement and life insurance funding.

But is this enough? Experience shows, time and again, that it may not be enough to keep a healthy business running smoothly through times of stress. Specifically, this level of planning doesn’t protect the business itself against the death or disability of a key person.

Lack of planning for the potential loss of key people can be more costly than most business owners imagine. In some cases, there is little awareness of who the most important people are, or what it would cost to replace them. Suddenly, the loss of any one key person can leave the business in shock – vulnerable to lost management skills, momentum, revenue and key customers.

Identifying key people

Fortunately, there are strategies to address this vulnerability, and they all begin with an in-depth evaluation of just which people are key to the company’s continued success. As a financial professional, you can add value by helping business owners inventory human resources and assess the cost of replacing key people and covering any business costs and losses, until replacements are up-and-running.

Here are three important questions to ask your business owner clients:

• Which of your company’s owners, employees or contractors would you least want to lose for an extended period of time?
• What actions would you take to replace those people – temporarily or permanently?
• What costs and losses would your business absorb? (Losses can include sales, customers, goodwill, knowledge and skills.)

This isn’t a quick, simple or intuitive process for most businesses owners – because they don’t think about the mundane impacts of losing key people. However, this evaluation process can be valuable in its own right, similar to planning for business continuity in the event of natural disasters. It can give business owners new insights into where real human value and business vulnerabilities lie.

Strategies for protecting the business

The next step is to implement insurance strategies to protect the business against the loss of a key employee or owner:

• Key person life insurance on the life of each key employee usually is owned and controlled by the company. It provides liquid funds upon the death of the insured key person, which the company can use as it sees fit. The policy’s death benefit should be sufficient to recruit a competent replacement and/or cover losses resulting from the key person’s death.
• Key person disability income insurance pays either a steady income or lump-sum if a key person suffers a disability and can’t work. It may be owned by the company or an owner/partner. For example, disability payments can be used to recruit, train and pay a key person’s replacement for the duration of a long-term disability.

Key person life insurance

Key person life insurance can be tailored to each key employee’s value and the estimated replacement cost/loss. It also has these other advantages:

• The death benefit is immediately available to the company at the key person’s death, and it is generally paid income-tax-free to the company.
• In a permanent insurance policy, cash value is a balance sheet asset of the company. For example, it also can be used to cushion the company’s transition costs when a key person retires.
• Having key person life insurance in place, on all key employees, makes the company more valuable for purposes of the owner’s succession planning or a business sale.
• Key person life insurance is one way to let valuable employees know they are important. It can be supplemented by non-qualified executive benefits – “golden handcuffs” that help to attract or retain key people.

Planning ahead

Evaluating and eliminating key person vulnerabilities is one of the most important ways you can help to assure the continuity of a business. After the initial evaluation, you can help companies add key person life insurance coverage one employee at a time, starting with owners.

As a side benefit, this process helps business owners understand how important they are personally to their companies, and how devastating their loss could be to the value they have created. Thus, it can lead the business owner directly into a succession planning process.