9 Feb 2023
Key Person Insurance: A Valuable Business Benefit That’s Often Overlooked
Estimated read time: 3 minutes
If you’re not talking to your business clients about key person insurance, now is the time to change that. While nearly all companies can benefit from this smart business solution, it’s particularly valuable to the small and medium size enterprises you encounter every day.
More than a benefit, key person insurance is a simple but powerful planning tool that helps companies ensure a bright future—despite the loss of a crucially-important leader or employee. Because it is a form of life insurance, it’s seamless to raise the topic when discussing employee benefit plans with prospects and clients.
Ironically, key person insurance is one of those products that is often overlooked, yet, once you explain its purpose, practically sells itself. Consider these essential talking points—which you may wish incorporate into your conversations with clients.
Defining Key Person Insurance
As the name implies, key person insurance is life insurance purchased for specific employees—owners, executives, vital contributors—who are necessary to the company’s success and survival.
Key person insurance covers losses to the business that would inevitably result should an indispensable leader die. It is provided through standard term life and whole life policies, depending where you are. The twist: the business pays the premiums and is the named beneficiary—and if applicable, has access to the policy’s cash value as well as any dividends.
Key person insurance doesn’t merely benefit a company by giving its leadership breathing room to recover from a loss, but—by helping to ensure its solvency—provides security to its employees, clients and creditors.
Obviously, the smaller the company, the more devastating such a loss is likely to be. For example, one seminal European study found that, after a founding entrepreneur dies, a company’s sales plunge by an average of 60%. In addition, the company’s likelihood of survival falls by 20% for two years following the loss.
How Key Person Benefits Can Be Used
Ideally, your business clients will never experience the need to claim key person benefits. However, if they do, there are many ways they can put them to work to help offset their loss, including by:
- Supplementing lost revenues—say, to offset operating expenses
- Funding the recruitment and training of a replacement
- Purchasing a principle’s ownership interest in the business
- Providing additional funds to the employee’s beneficiaries
If it’s determined that the best course of absence is to close the business—say, in the event of a small entrepreneurship—the insurance proceeds can be used to pay off debts, pay severance to employees and distribute funds to investors.
Knowing how those funds would be used is useful when determining how much coverage is needed. The objective is to calculate the financial impact that a person’s death will have on the company—including lost revenues, profits and the cost to replace them.
Key Person Insurance Is a Business Asset, Too
A company that has key person insurance may find it easier to obtain financing or credit from banks or capital from investors, because it lowers business risk. In fact, lenders and investors often require it on members of a management team.
In addition, during the life of the policy, businesses can leverage policies’ accumulating cash values as loans, whether to finance growth opportunities or use as emergency funds. They may also be perceived as assets that improve the company’s balance sheet.
The Big Picture
There is no question that key person insurance benefits small and medium size businesses, as well as their employees, customers and creditors. But it benefits their communities and countries, too.
According to the World Bank, smaller companies play a major role in most countries’ economies, representing about 90% of businesses and more than 50% of employment. In the U.S., for example, small businesses create two-thirds of new jobs, drive innovation and generate 44% of economic activity.
So, when you give a group client tools to help ensure its ongoing success, you’re helping more than that one small business. This is another reason why you may want to educate your clients and prospects on this valuable business solution.