Your business is growing and you’re considering securing your business’s future by adding key person insurance. But is now the right time? And do you really need it?
You won’t be surprised to know you’re not the only one struggling with this decision… According to surveys by the National Association of Insurance Commissioners, although 71% of small businesses are highly dependent on one or two key people for their success, only 22% have key person insurance.
And research by Professor Sascha O. Becker at the University of Warwick and Professor Hans K. Hvide at the University of Bergen confirms that the death of a founder can have a significant effect on a company:
- Sales dipped by 60%, on average, four years after a business owner’s death
- Employment at the firms was down 17%.
- The survival rate of firms where the owner died two years afterward was 20% lower than at similar firms where the owner was living.
- The likelihood of bankruptcy rose at firms where the owner passed away.
I need key person insurance – where do I begin?
What is Key Person Insurance?
It’s an insurance policy taken out by a business to compensate that business for financial losses that would arise from the death or extended incapacity of an important member of the business.
It can include both life insurance and disability insurance or only one of those.
Why do I need Key Person Insurance?
- Continuity – to allow your business to continue and to offset expenses and loss of income if a key person dies or becomes disabled.
- To allow your company to hold onto its revenues and value and avoid bankruptcy.
- Investor Assurance – Some SBA lenders or banks may require a business to take out a key person insurance policy before it can obtain a business loan.
- To stabilize the value of your shares by protecting your business against perceived uncertainty
- To financially aid the difficult transition of searching, hiring, and training a replacement for a key person how has died or become incapacitated for a long period of time.
Is my company is large enough for Key Person Insurance?
Key person insurance isn’t just for large corporations. The fact is that most small to medium businesses depend on 1 or 2 key people for their success. Even sole proprietorships with just a few employees should have key person insurance if the absence of one of those employees would be catastrophic to their business. If you’re a sole proprietor with no employees, a personal life insurance policy is a better option.
Who is considered a Key Person?
- The person that brings in a large percentage of profits or revenues for the business.
- A person that brings special knowledge or talent to the business (e.g. an employee that develops a patentable product for the business).
- The person whose expertise and knowledge mean that replacing him/her in the event of death or disability and training the replacement would be very costly.
In general, anyone whose loss would cause financial strain and have a detrimental impact on your business’s continued financial success.
Who pays for Key Person Insurance?
Traditionally, a key man insurance policy is owned by, funded by, and payable to the business entity.
When does Key Person insurance pay?
Your business will receive a payout if the key person identified in the policy dies or becomes disabled.
The bottom line is, any person whose skills, knowledge, experience, or leadership are important to your business’ continued financial success is a candidate for key person insurance. It’s a responsible investment that can save your business thousands, even millions of dollars when it’s in its most vulnerable state.