Businesses desiring to minimize risk and prevent the potentially devastating effects of the death or disability of a top employee or executive should own key man insurance. Other reasons businesses should consider key person insurance include succession planning for business owners as well as benefit planning for key employees.
Keyman Life Insurance
Key man life insurance, often term life insurance, is designed to protect the business if a key employee dies unexpectedly. To secure key man insurance, the business must apply for a life insurance policy on the life of the key person. Once secured, the business is the premium payer, policy owner and beneficiary. In the event that the key employee dies, the proceeds of the policy are paid to the business, usually tax free. The business can use the proceeds at its own discretion but the primary use of fund is to hire a capable replacement.
Keyman Disability Insurance
Keyman disability insurance is designed to protect the company or business in the event that a key employee is disabled through injury or illness. The process of obtaining key man disability insurance is similar to the key man life application process. The policy is owned and paid by the business and the business is the beneficiary if the key person becomes disabled. When a claim takes place, after a brief waiting period, the policy will pay a predetermined monthly benefit for as long as the key employee is disabled or until the policy term expires. The monthly income received from the policy can be used to fund ordinary expenses or to secure and train a replacement for the disabled key employee.
Business Continuation Planning using Key Person Insurance
Business succession or business continuation planning attempts to avoid potential problems that may arise if a business owner, partner or shareholder dies or is disabled. Either event will cause a significant strain to the future ability of any business. Some of the concerns in business continuation planning include:
- What are the goals of the business owner’s and how will the company continue operations?
- Where will the funds come from to buy out the deceased owner’s family?
- If disability occurs, how will the business continue to provide income to the disabled owner?
- How can an owner retire and receive fair market value for his interest without affecting the operations of the company?
- Will the business have to be sold to pay estate taxes?
- Can the firm continue successfully with the addition of the deceased owner’s heirs as new owners?
The answers to these questions will determine the strategy to implement to protect the company and business owners if there is sudden death or disability. In many cases, key man insurance is an ideal solution to many of the problems with business continuation planning. Both key man life and disability insurance can be acquired on the lives of the business owner so if the unfortunate occurs liquid funds would immediately be available. For specific details on business continuation planning see, “What is Business Continuation Planning?”
Executive Benefits and Key Employee Compensation
The more success a company attains, the more important it becomes to take care of key employees who are responsible for the company’s success. Rewarding these key employees becomes crucial if the business is going to retain its talented people. If key employees are not rewarded, they may feel under-appreciated and begin to consider other employment or business alternatives. An executive benefit or employee compensation agreement can be implemented to assure that these key executives receive their proper financial incentives. With many executive compensation arrangements, the advantages of life insurance make life policies an ideal vehicle to provide these benefits. For more specific information on executive benefits and key employee compensation see “Key Executive Compensation Strategies Using Life Insurance”.