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Key person insurance: It can keep you in business

By Robyn A. Friedman    

What would happen if one of your key employees—a top salesperson, manager, product developer, or IT guru—suddenly died or became disabled? Would the business survive?insurance1

It would—if you had purchased key person insurance.

“Every business—no matter how small—has to plan from almost the time the business is put into place how you’re going to cover the death or incapacity of an individual who’s mandatory to the success of the business,” says Robert A. Sullivan, author of The Small Business Start-Up Guide (Information International, 2000). “You have to develop a worst case scenario.”

Key person insurance is a type of life insurance that protects the business if an invaluable employee dies or becomes disabled. If that person is the company’s rainmaker, for example, it might cover lost sales; if the key employee is a product developer, it could cover the cost of finding a replacement.

Key person insurance is just part of what should be a comprehensive business succession plan, says David Phillips, a financial services professional with Financial Design Associates in Jacksonville, an agency of Massachusetts Mutual Life Insurance Co. “It helps makes sure that you don’t lose momentum at the loss of a person,” he says. “It’s one of the elements every small business owner should address.”

Yet, strangely, although 71% of small businesses say they’re very dependent on one or two key people, only 22% have key person insurance, according to the National Association of Insurance Commissioners.

“It’s not as common as it should be,” Phillips says. “Most business owners are so busy running their business that they postpone it. Unfortunately, that can create a problem.”

John Ruoss and his partner, Steve Rushing, recently purchased key person insurance to protect their company, TOPSSCo Sales and Service, which sells pumps and industrial parts in Florida and Georgia. Each partner plays a unique role in the business, so the insurance provides the survivor with time to regroup in the event of a tragedy. “We sat down and looked at the cost to bring in someone else if something happened to one of us,” Ruoss says. “To bring someone on, train them for two or three years—that cost would be covered by the money we got from the insurance.”

Like other forms of life insurance, the cost of key person insurance varies based upon the age and health of the insured. Using term insurance keeps key person affordable, but other life insurance products can be used as well.

How much insurance do you need? That depends upon the business and the employee insured. “It could be a million for a senior individual that’s literally running the business,” says Sullivan. “If this guy can no longer perform his duties, it may take up to a year to replace him–that could easily cost even a small business a million dollars.”

Dan Dearing, president of Jacksonville-based Professional Retirement Services, says small businesses might not be able to survive the loss of a key employee and may have to hire multiple people just to replace him or her, thereby incurring much higher costs. So he recommends it to his clients—particularly due to its low cost. Still, he says there are some businesses—such as those based on commissions—where key person insurance may not be, well, as key. “If you are paying someone a salary, but it’s essentially coming from sales they make, and they disappear, you’re no longer making revenue from that person—but you’re also no longer paying that person,” he says. “It’s not like a fixed expense.”

Thinking about purchasing key person insurance? Here are some tips:

• Shop around. Premiums vary widely, even by companies with the same safety rating. “It can literally be X or six times X for the same age person, depending on what their health is,” Dearing says. Get quotes from different companies, or use an independent agent, who will do the legwork for you.

• Find an insurance agent you can trust. If you don’t already have a relationship with an agent, interview a few to find one you’re comfortable with. Make sure the agent has experience in writing business insurance.

• Determine who needs to be insured. Don’t overlook employees who aren’t top managers or owners of the company. “It could be Fred down in the shop,” says Sullivan. “He may be the only guy who knows how to put A and B together.”

• Write a succession plan. Without proper planning, a small business may not survive if an owner or manager suddenly dies or becomes incapacitated. Many small businesses are sold—at fire sales, for less than their full value—due to lack of proper planning. But those devastating results can be avoided by consulting an attorney, accountant or financial planner to set up a succession plan that includes, at a minimum, key person insurance and a buy/sell agreement.

• Do it today. The cost of life insurance increases with age. “You’re never going to be younger than you are today, and you’re probably never going to be healthier than you are today,” says Phillips. “If you wait too long, the person may become uninsurable, and then you’re stuck between a rock and a hard place.”

Nick Furris, a co-owner of Spectrum Films, a Jacksonville-based film, video and interactive production firm, is “strongly considering” the purchase of key person insurance not just to protect his two partners but his 16 employees as well. “We have a responsibility to our employees to keep the business safe and healthy so they can continue to have employment,” he says. “Just as you protect your business with insurance from flooding or theft, you have to protect the key people who make your business successful. Or else, God forbid something happens, the business will not survive.”

Robyn A. Friedman is a contributing editor to Jacksonville Advantage. She can be reached at RAFWriter@att.net.


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