It’s not a specific kind of insurance but the application of life insurance to protect a business against key person risk.
What is key person insurance?
Key person insurance designed to protect a business against the significant impact that the death or illness of an individual can have on the entire business.
It can be used alongside buy / sell or business succession cover which focuses on the transfer or change of business ownership upon the death, disablement or trauma of a business owner.
If you are a small business owner, it is well worth considering key person insurance and taking the necessary steps to put an appropriate plan in place to protect you, and any other key people in your business. Not only will it protect you, but it can protect the relationship with your customers and help maintain the goodwill of your business if a traumatic event were to unfortunately occur.
Who is a key person?
A ‘key person’ of a business may be an employee, owner or another individual whose contribution to the success of the business is significant. In the absence of such an individual, the business profitability would be seriously affected. In this regard, an employee is a key person where the build-up of their skills, knowledge and experience is likely to be difficult to replicate or replace because that person is a major part of the success of the business.
What are the benefits of key person insurance?
Insurance cover can help a business to continue to operate upon the death or disablement of a key person. Often injections of cash can keep a bad situation from becoming worse or even catastrophic.
If you were to make a claim on your key person insurance, some of the uses for the insurance payment may include:
- Protection of revenue: minimise or eliminate the potential loss to revenue, sales, profits or any other measure of economic performance, until a suitable replacement is appointed
- Replacement and training costs: help to cover the often significant costs in finding and / or re-training a replacement and the upskilling of existing employees
- Payment of debts: provision for the continued ability to service the business expenses or repay debts if called in
- Replace goodwill: cover the impact of a write-down in the goodwill of the business
- Cover liquidity: some businesses have liquidity problems or a lack of liquidity, and are usually aggravated by the loss of a key person, especially an individual who contributes significantly to the cash flow of the business
- Supplier and staff confidence: a financially protected and stable business can help keep existing staff happy and maintain essential supplier relationships.
Are there alternatives to key person insurance?
A business may have other strategies as part of their overall risk planning strategy to help manage adverse situations should they arise. Risk plans may help to mitigate the consequences of losing a key person and can often be used in conjunction with insurance cover. The risk plan may also come into effect if a key person is uninsurable.
Some alternatives may include:
- Sell assets: this may free up some funds but it is worth considering if you will get a fair price and if there will be delays to realise the sale proceeds if you are operating without a key person. Businesses don’t usually hold unnecessary assets, so a reactionary strategy of selling off useful equipment may result in further financial impacts on the financial performance and stability of the business. It could possibly make a bad situation worse
- Existing staff: depending upon the position and resources of the business, it may be possible to promote staff into the key person’s position or reallocate the workload even if temporarily. Generally, staff training and development would be part of proactive business planning and may be part of the broader risk strategy of the business
- Use company profits: this is dependent upon having a profitable company in the first place – which may not be the case now with the loss of a key person. If funds are available, such a strategy may help cover the immediate needs but may not address future profitability and performance
- Borrowing: applying for a business loan or drawing down existing loan facilities may be possible but pose some difficulties. These may include a potential inability to get finance (especially if it is to replace an existing loan that has been called in) or borrowing at unattractive rates. Also, the additional interest expense may put an unnecessary burden on an already strained business. Also worth considering, is if delays in getting approval may add to the financial woes from which the business may not be able to recover from.
Whilst different risk mitigation strategies are important to consider and have in place, insurance is often the most complete and practical solution to adequately cover business risks should a key person need to make a claim.
Many business owners are busy running their business, keeping customers and staff happy, managing their bookwork, being the decision makers – and so it goes! With day-to-day operations occupying so much of their time they may be unaware of the true cost to their business if they were to lose a key employee or even themselves due to accident or illness.
An understanding of key person planning is essential in helping business owners navigate key person risk but every situation, and every business, is different. That is where qualified financial advice comes into play. This article highlights some of the important things to note when considering whether your business is covered for a key person event but there is so much more. Phone us today and we can organise a time to meet to go through your individual situation and the options available.