Charles de Gaulle once remarked, “The graveyards are full of indispensable men.”¹ While we know that life goes on regardless of the loss of any “indispensable” person, for a small business, the loss of a key person is not only a human tragedy, it can also represent the potential for significant financial loss.
Though business owners cannot protect themselves from the unexpected and sudden loss of a key employee, they may be able to protect themselves from the financial consequences of such a loss through the purchase of what is called “key person insurance.”
Who’s Key?
There is no legal definition for who a "key person" is, but think of someone whose loss, due to death or disability, would cause a material financial setback to the business. For example, a key person may be a top salesperson whose production would take considerable time to replace. Or perhaps it’s someone whose rapport guarantees the business access to needed future capital or a manager whose expertise will be hard to replace.
Key person insurance is a standard life insurance policy normally owned by and paid for by the business These premiums are generally non-deductible. The benefits are paid to the business tax-free in the event the insured key person dies or becomes disabled. (Coverage for death and disability are most often separate policies.)
Calculating Costs
To consider the amount of coverage, the business owner must calculate the financial impact of the loss of that key person, usually interim workaround costs plus the hiring and training of a replacement. The next step is to ascertain the cost of insurance for that amount. The business owner will then be able to make a decision that balances his or her protection needs with what the business can afford.
The proceeds may be used freely as the business requires. For example, they may be needed to meet day-to-day expenses, pay off debts, or to recruit new talent to the organization or --as expected-- to replace the lost key employee.
For most businesses, their most important asset is definitely their people. Yet, while they insure their other assets—such as buildings and cars—they often overlook the wisdom of doing the same for those individuals who are critical to their success.
- Brainyquote, 2017