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When
Key Employee Life Insurance is the Right Tool
By: Andy King
If you own or manage a business, you probably
understand the importance of a good business plan
– a plan you and other key staff members can
regularly revisit and revise as your company’s
market and customer base evolves. You also know you
need a sound personal financial plan that ensures
that you’ll have the resources to retire when
you choose, support your loved ones if you become
disabled, or leave them with adequate financial resources
in the event of your death.
But do you have a business financial plan that goes
beyond basic cost and revenue forecasts to identify
areas of significant financial risk and develop strategies
to address them? Your business’s ability to
weather a crisis may depend on having such a plan
in place.
Two years ago, the attack on the World Trade Center
shut down the country’s business activity for
more than a day. Many businesses in Lower Manhattan
were closed for much longer. During the months following
the attack, the people who owned these businesses
faced the difficult task of maintaining them despite
the loss of colleagues with essential skills and unique
knowledge about customers and business operations.
The fate of these businesses depended on the capabilities
and resources of their remaining employees, who were
also struggling with grief and fear.
Fortunately, few businesses will ever face a crisis
of that magnitude. But the World Trade Center disaster
underscores a key point to remember when you assess
your business’s financial risk: The most important
income-producing asset of any company is its people.
Businesses that depend on a particular piece of equipment
typically insure it. Key employee life insurance is
an essential component of a business financial plan,
because businesses recognize that the loss of a key
employee can have a serious financial impact.
In addition to the human tragedy, the loss of a key
person often means the loss of important customers,
skill sets or business relationships.
A key employee is anyone who makes a significant contribution
to your company’s financial success –
a company president, talented sales director, a product
designer, a partner who makes key management decisions,
or an executive who is a TV advertising personality.
And, unlike a machine, key employees are not so easily
replaced.
Businesses purchase life insurance to protect against
several different types of risk related to the loss
of a key employee: Loss of skills or experience. Small
or family-owned businesses are particularly susceptible
to this risk.
Business financing or credit protection. Some financial
institutions require businesses to purchase key employee
life insurance to secure business financing, particularly
if the business’s credit is contingent on the
experience or reputation of an owner or partner. Life
insurance also offers credit protection to partners
who might otherwise be saddled with additional debt
should a partner die, and a policy’s cash value
can be used as collateral to secure funding.
Transitional expenses / disruption in business. Key
employee life insurance can provide badly needed funding
if your company anticipates a short-term revenue gap
after the loss of a key employee due to a drop in
sales or during the time required to hire and train
a replacement.
Buy/Sell Agreements. Life insurance can provide partners
with funding to resolve the thorny issue of business
ownership should a partner die unexpectedly. Additional
needs that can be addressed through key employee life
insurance include:
Retirement funding. A life insurance policy can serve
as a funding mechanism for a senior partner’s
retirement – a particularly effective strategy
for family businesses since the senior generation’s
assets are often tied up in the business.
“Golden handcuffs.” Supplemental executive
benefits are often informally funded through key employee
life insurance. Such benefits provide an added incentive
for valued employees to stay with the company. Key
employee life insurance is a business planning tool,
not a business plan.
Before you buy life insurance for key employees, devote
some time and careful thought to a comprehensive “discovery”
process. Assemble a team of trusted advisors –
including a qualified financial professional who understands
the uses and flexibilities of key employee life insurance,
your attorney and your CPA – and work with them
to identify your key employees and areas of risk.
Your goal is a plan that not only anticipates your
employee-related financial risks and provides the
funding you’ll need to address them, but also
sets out strategies for assuring your business’s
long-term survival through comprehensive succession
planning.
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