Key Person Insurance

Business key person insurance – risk management

The success of your business depends on its people.

Most businesses have key people whose contributions are critical to the performance of the business.  These are often customer relationship managers or technical experts, or owner-managers.

Objective

You would like to help ensure your business doesn’t lose its key people

If you do lose a key person, you would like to help ensure that your business is able to continue with minimum disruption.

Problem

Generally, it is not possible to avoid the risk of losing a key person to disability or death

The cost of losing a key person would be a significant burden on your business

The total financial impact on the business could be five to 10 times the employee's annual compensation.

Your business may not be able to absorb this cost.

Recommendation

An insurance policy on the life of your key employee can help protect your business.

The annual cost of the policy is a fraction of the amount of the risk.

Most businesses have one or more people whose contributions are critical to the performance of the business. Aside from the business owner-manager, these are often customer relationship managers or technical experts

There are three main sources of cost resulting from the loss of a key person

Reduced cash flow – Loss of the key person’s efforts may interfere with production or customer service. Customers may defect as a result. Cash flow will suffer because revenues drop just when efficiency is reduced. Business performance will take some time to recover. Other employees may be enticed to other career opportunities during the confusion and uncertainty, compounding the problem.

Recruiting and training costs – It may be costly to find a competent replacement in short order. Search firms often charge about 25 per cent of the new employee’s compensation. It may be necessary to offer incentives such as a signing bonus or above-market compensation to attract a qualified individual from their current place of employment. Even then, additional training may be needed for the new person to be as effective as possible.

Restriction of business credit – Lenders and suppliers may call loans or tighten payment terms due to uncertainty about cash flow. This could be catastrophic, particularly in a period of time when cash flow may already be reduced by the absence of the key person.

Alternative solutions

There are three strategies available to deal with the risk of losing a key person. These are risk avoidance, risk retention and risk transfer

Generally, it is not possible to use a risk avoidance strategy to deal with these risks. For instance, one can take measures to live a healthy and safe lifestyle, but one cannot categorically avoid the possibility of total disability or premature death.

Risk retention is an option. However, the impact of the loss of an owner-manager or other key person can often be sufficiently catastrophic to destroy the viability of the business. That is, the business may not have the cash flow or available credit to withstand the losses and credit contraction that will occur.

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Recommendation

The option most often selected is risk transfer. Key person protection involves transferring the risk to an insurer through the purchase of a life, disability or critical insurance policy on the key person. The annual cost of the insurance is typically a fraction of the cost of the loss insured.