The Key to Your Business Continuation Plan
Every business owner envisions what it will take to help the company succeed for years to come. They spend time projecting sales and analyzing the market. Unfortunately, many business owners don’t think about what would happen to their company if a key employee passed away.
The primary purpose of key person life insurance is to protect your business against financial loss if a key employee dies. Typically, the business owns the policy, pays the premiums and is the beneficiary of the key person life insurance policy.
Who is considered a “key employee” varies by the company, but it could be the owner, another leader on the executive team or anyone else who is crucial to your operations, such as a top producer or a business development associate with deep relationships.
What key person life insurance covers
Policy cash values and death benefits may be used by the business for any purpose.
Businesses often use the proceeds to cover cash needs that can result in the death of a covered key employee, such as:
- Expenses related to recruiting and training a new employee
- Losses that occur when a less inexperienced employee tries to fill in
- Business operating expenses
- Loans that become due upon the key person’s death
Estimating the value of key employees
Putting a dollar value on a key employee’s worth may be difficult, especially because there are no particular rules or formulas to use. Two of the most common methods for determining the policy amount include:
- Key employee’s current salary. Multiply the key employee’s salary by the number of years it might take a newly hired employee to reach the same skill level. One rule of thumb is to multiply the salary three to 10 times.
- Cost of replacing the key employee. There are replacement costs in both time and money, whether you invest the time yourself or hire a placement firm. It may take more than one person to fill the employee’s shoes.
Business succession planning
Before you can purchase key person insurance, an insurer may require you to have a business continuation plan. Outlining how your business will survive the premature death of an owner or other key employee is critical to determining what type of insurance protection you need.
For example, a buy-sell agreement may be necessary if you do not want a business partner’s family to inherit the key person’s ownership. Such an agreement can stipulate that upon a person’s death, the company will buy their share of the business. The money obtained from the key person life insurance can be used to pay for this person’s share to make sure the company can afford the buyout.
Please consult your insurance advisor or financial planner for specific information regarding your business’ situation.