Proactive business leaders anticipate future setbacks and take steps to mitigate them. The death or incapacity of a critical employee is one possible setback. Given the probability of death or disability among working-aged adults, as well as the financial setbacks that can result from the loss of an important employee, key man insurance is an instrumental element of business continuity and succession planning.
Understanding Key Man Insurance
Key man insurance (also called key person insurance) is a type of policy that gives businesses a financial safeguard against the unexpected loss of a critical employee due to health-related issues. There are two main types of key man insurance:
- With key person life insurance, the insured is a key worker (such as a business owner, executive, top salesperson, or critical employee) and the business is the policy owner, meaning the business pays the premiums. If the covered individual dies while the policy is in force, the business receives the death benefit.
- With key person disability insurance, many aspects are the same: the policy insures a key employee, and the business is the owner of the policy, pays the premium, and receives the benefit. The difference is that key man disability insurance pays a benefit when covered individuals experience a covered illness or injury that prevents them from performing their work duties. Key man disability insurance policies typically pay for disability periods of up to two years.
Securing Business Protection with Key Man Insurance
According to the Social Security Administration, more than one in eight of today’s 20-year-olds will die before reaching age 67 and around one in four will become disabled.
When a business loses a critical individual to death or disability, the financial consequences can threaten business stability. Key man insurance provides protection against the financial risk.
- When a business owner dies, the business may have more debts than assets. Key man insurance can settle these debts.
- When a key employee dies, the business may lose clients and revenue. Key man insurance can offset the losses.
- Hiring and training a new worker can be expensive and time consuming. According to SHRM, the average cost of a new hire is $4,700, but soft costs (such as time) can increase the total costs substantially. By some estimates, the cost could be three to four times the hire’s annual salary. Key man insurance can cover these costs.
Why Business Leadership Should Consider Key Man Insurance
When considering whether to secure key person insurance, business leaders should consider the following scenarios. If something similar could happen to your business, key person insurance may be a smart investment.
- Scenario: A woman is the sole owner of a tech company. The business is growing rapidly. It is currently losing money, but this is expected to change dramatically in the coming years. Then, the business owner passes away unexpectedly.
- Exposure: As there is no successor, the business dissolves, and since there are currently more debts than assets, there is nothing left.
- A better outcome: Key person insurance could cover the debts. If the business used key man insurance in conjunction with a succession plan, it could also ensure its continuation and the founder’s legacy.
- Scenario: A manufacturing company is growing rapidly thanks to the highly productive and successful Vice President of International Sales. Then, the VP has a severe stroke, becomes disabled and cannot work.
- Exposure: Many of the international clients sever relationships, meaning the company’s future is suddenly in jeopardy.
- A better outcome: Key person insurance could provide a benefit to offset the losses, allowing the company to invest in a new strategy or hire a suitable replacement.
- Scenario: A large accounting firm uses accounting software that it has developed in-house. The software is excellent and helps the company efficiently serve its clients.
- Exposure: When the individual who developed and maintains the software passes away suddenly, the company struggles to manage needed updates and the software quickly becomes obsolete.
- A better outcome: Key person insurance could offset the resulting losses and provide funding to train a new hire or purchase a new system.
Key Man Policy Selection Tips
When selecting a key man insurance policy, business leaders should review their options carefully to ensure they’re buying the right coverage for their needs. Ask the following questions:
- Who should you insure? You can use key man insurance to insure business owners as well as critical employees. Your business may need to purchase multiple policies to cover multiple individuals.
- Do you need key man life or key man disability insurance? The unexpected death of a business owner or employee can be devastating, but disability can also lead to financial hardship and is statistically more likely among working-aged individuals. Ideally, you should have coverage for both exposures if your business could not easily absorb the financial losses which would be caused by death and disability scenarios.
- How much coverage do you need? Calculate the expenses and losses you are likely to face after the loss of a business owner or employee. Keep in mind that this number constantly evolves, and you should plan to update your coverage annually, at a minimum. .
- How much will coverage cost? Costs vary according to multiple factors, including the age of the person insured, the benefit amount, and the type of policy. When buying a policy, it’s important to balance the cost of the premiums with the value of the coverage provided.
- What is the claim process? Understand which conditions and scenarios trigger a claim, the information you’ll need to file a claim, and the amount of time that will lapse before payout occurs. Also be aware of any policy exclusions.
Just as families buy life and disability insurance to protect against the loss of a breadwinner, businesses can buy key man insurance to protect against the loss of a revenue-earner. Any business that depends on the work of one individual should seriously consider securing key person insurance.
Contact Watkins Insurance Group to obtain key man coverage for your business.