When Key Employee Life Insurance Is the Right Tool
By: Randy Riley, Northwestern Mutual Financial NetworkIf you own or manage a business, you probably understand the importance of a good business plan – a plan you and other key staff members can regularly revisit and revise as your company’s market and customer base evolves.You also know you need a sound personal financial plan that ensures that you’ll have the resources to retire when you choose, support your loved ones if you become disabled, or leave them with adequate financial resources in the event of your death.Similarly, your business’s ability to weather a crisis may depend on your ability to go beyond basic cost and revenue forecasts and anticipate areas of significant financial risk such as the loss of a key employee having such a plan in place.Five years ago, the attack on the World Trade Center shut down much of the country’s business activity for more than a day. Many businesses in Lower Manhattan were closed for much longer. During the months following the attack, the people who owned these businesses faced the difficult task of maintaining them despite the loss of colleagues with essential skills and unique knowledge about customers and business operations. The fate of these businesses depended on the capabilities and resources of their remaining employees, who were also struggling with grief and fear.Fortunately, few businesses will ever face a crisis of that magnitude. But the World Trade Center disaster underscores a key point to remember when you assess your business’s financial risk: The most important income-producing asset of any company is its people.Businesses that depend on a particular piece of equipment typically insure it. Key employee life insurance is an essential component of a business financial plans’ long-term success, because businesses recognize that the loss of a key employee can have a serious financial impact. In addition to the human tragedy, the loss of a key person often means the loss of important customers, skill sets or business relationships.A key employee is anyone who makes a significant contribution to your company’s financial success – a company president, talented sales director, a product designer, a partner who makes key management decisions, or an executive who is a TV advertising personality. And, unlike a machine, key employees are not so easily replaced.Businesses purchase life insurance to protect against several different types of risk related to the loss of a key employee:Loss of skills or experience. Small or family-owned businesses are particularly susceptible to this risk.Business financing or credit protection. Some financial institutions require businesses to purchase key employee life insurance to secure business financing, particularly if the business’s credit is contingent on the experience or reputation of an owner or partner. Life insurance also offers credit protection to partners who might otherwise be saddled with additional debt should a partner die, and a policy’s cash value can be used as collateral to secure funding.Transitional expenses / disruption in business. Key employee life insurance can provide badly needed funding if your company anticipates a short-term revenue gap after the loss of a key employee due to a drop in sales or during the time required to hire and train a replacement.Buy/Sell Agreements. Life insurance can provide partners with funding to resolve the thorny issue of business ownership should a partner die unexpectedly.Additional needs that can be addressed through key employee life insurance include:Retirement funding. A life insurance policy can serve as a funding mechanism for a senior partner’s retirement – a particularly effective strategy for family businesses since the senior generation’s assets are often tied up in the business.“Golden handcuffs.” Supplemental executive benefits are often informally funded through key employee life insurance. Such benefits provide an added incentive for valued employees to stay with the company.Key employee life insurance is a business planning tool, not a business plan. Before you buy life insurance for key employees, devote some time and careful thought to a comprehensive “discovery” process determining your business’s needs. Assemble a team of trusted advisors – including a qualified financial professional who understands the uses and flexibilities of key employee life insurance, your attorney and your CPA – and work with them to identify your key employees and areas of risk.Your goal is to develop an insurance plan that not only anticipates your employee-related financial risks and provides the funding you’ll need to address them, but also sets out strategies for assuring your business’s long-term survival through comprehensive succession planning.