Every business, no matter what the size, has certain people that are crucial to its success. Nowhere is this more evident than in a small business. These key people are the ones whose absence would put the company in jeopardy because they are involved in every aspect of the operation. Because their value is immeasurable, it is vital to cover these people with key man insurance.
The concept behind key man coverage is quite basic. A company purchases a life insurance policy on that person, whether it is the owner or a staff member, pays the premiums and is the beneficiary of the policy. If that person unexpectedly dies, the company receives the death benefit. What makes this coverage so important is that the death of a key person in a small business can often lead to the demise of the company itself if no line of succession has been established. And, as is usually the case, small companies find themselves completely occupied with day-to-day operations so they seldom think about grooming someone to take the place of a key person.
Key man insurance can help the company buy some time after losing the person who makes the business work. The company can use the money received from the death benefit for expenses until it can recruit and/or train a replacement person. It can also be used to close the business down if that is the course of action decided upon by providing money to eliminate debts, pay investors, and give severance to employees. After an unexpected event such as the untimely death of a valuable person, key man insurance gives the company some alternatives other than declaring bankruptcy.
To determine who needs to be covered by this type of insurance, begin by evaluating your business to see who is irreplaceable to operations in the short term. In many small businesses it is usually the founder/owner who understands all of the day-to-day workings. They generally are the ones who keep the books, manage the employees, and service the largest customers. If that person were to die, it would mean finding immediate replacements to perform all of these tasks; otherwise the business would grind to a halt.
Determining how much key man insurance you need depends on your business’ market capitalization, but in general you should get as much coverage as possible. Ask your insurance carrier to evaluate the person you want to insure so they can establish a premium on that person. The evaluation takes into consideration the current health of the employee, medical history, and age.
The next step is to calculate how much money your business would need to remain in operation until you can replace the key person and normalize again. Most small businesses find that simply matching the key person’s base salary will not give them enough of a cash resource to get back on an even keel. The general consensus is you will need a benefit that equals at least two to three times the key employee’s salary.
If you research this information, it will not only make it easier to find a policy that fits into your budget, but also it will help you select one that will fill your short-term cash needs should the worst happen.
