How to ensure the death or disability of a key employee doesn’t kill your business Featured

1:40pm EDT July 25, 2011
How to ensure the death or disability of a key employee doesn’t kill your business

If one of your key employees suffered a disability or died suddenly, what would it mean for your business?

A death or disability can signal disaster for many companies, especially if there has been no planning. This is especially true for smaller businesses that don’t have a large pool of employees from which to name a successor.

But organizations can protect themselves from the economic losses that could result from such an event through the purchase of key person life or disability insurance, says John Woloschek, vice president, director of advanced insurance planning at Associated Financial Group.

“Most business owners are aware of the need to insure their businesses against losses due to fire, theft, product liability and other legal perils,” says Woloschek. “But many fail to think about insuring the asset most critical to their business — their key employees.”

Smart Business spoke with Woloschek about how to use key person insurance to protect your business should a key employee become unavailable due to death or disability.

Why do business owners need to think about key man insurance?

Among privately held businesses, a principal cause of financial failure is the loss of a key employee or substantial owner due to death or disability. A discussion about key person insurance is just an extension of the typical risk planning that companies do.

Who qualifies as a key person at a business?

A key employee is typically a person who has a substantial impact on the financial success of a business. This person is generally responsible for management decisions, is highly paid, has a significant impact on sales or has a special rapport with customers and creditors. A key employee could be an owner, but doesn’t necessarily have to be. A nonowner key employee might be a salesperson who services key accounts, someone with special skills such as an engineer or designer, or someone who owns patents critical to the business. In general, if the loss of a particular employee could potentially jeopardize a company’s future, the purchase of key person insurance should be considered.

How can the loss of a key employee impact a business?

Losing the management skills and experience of a key employee can be devastating, especially to an organization without management depth. In addition, the business could suffer from a disruption in sales or business production, depending on the employee’s talents in these areas.

Clients may delay orders or refrain from doing business with a company altogether until they see how it will respond to the loss of that person, and that drop in business could result in credit difficulties, making it harder to make payments due. As a result, many lenders often require key person insurance on owners as a security precaution, especially in cases in which it has extended loans due to that particular employee’s talents or resources.

Finally, the company could lose money as a result of the expenses associated with hiring and training a replacement for the key employee, which can occur even if the company promotes from within, as capital losses may continue until the replacement becomes familiar with the position.

What should a key person policy cover?

The most common form of key person insurance is life insurance. However, the highest probability for loss of services from a key employee is the employee’s disability. Statistically, a person is seven times more likely to suffer a disability that lasts more than 90 days than they are a death prior to age 65.

Most employers are unaware that they can buy disability insurance as key person coverage. In light of the statistical probabilities, they would be better off owning key person disability than life insurance.

How do you determine the right type and amount of coverage?

Both life and disability insurance pay a benefit to the company when the key employee dies or becomes disabled. The policy is typically owned by the company, which pays the premiums and is the beneficiary. The amount and cost of insurance depends on the situation, age, health and role of the key employee.

Two factors determine an appropriate amount of coverage. First, the company must make an estimate of the financial loss that would result from the loss of a key employee. Second, it must convince a carrier’s underwriter that the amount is appropriate.

There are formulas used by carriers to determine maximum issue limits that take into consideration the compensation paid to a key person, the company’s gross and net income, or fees and royalties. An experienced business insurance broker will help a company evaluate the risks and then help create the submission package to the carrier to justify the coverage applied for.

How can you determine if coverage is right for your company?

Determining whether key person insurance is appropriate for your business can be a difficult decision, but it’s one that every business owner should consider. For business owners or surviving partners, having those insurance dollars available at that critical time may be the only thing that will keep that company alive. Despite the cost, key person insurance is definitely worth considering to help protect your company and ensure it survives the loss of a key employee.

Insurance products are offered by licensed agents of Associated Financial Group, LLC (“AFG”). • Insurance products offered are NOT deposits or obligations of, insured or guaranteed by Associated Banc-Corp (“AB-C”) or any bank or affiliate and are NOT insured by the FDIC or any agency of the United States. • AFG is an affiliate of AB-C.

John Woloschek is vice president, director of advanced insurance planning at Associated Financial Group. Reach him at (312) 861-5306 or john.woloscheck@associatedfinancialgroup.com.