The most valuable part of a business is its staff and people. Their unique and diverse skills can help build the business and take it to new heights. Their thought leadership can drive it forward through thick and thin.
While they keep your business working like a well-oiled machine, greasing and running the wheels, their sudden unavailability can spell disaster for you. It may not be the most pleasant aspect of business planning to think about, but it is important to consider how your business will cope under extenuating circumstances.
For example, what would happen if one of your key people were to pass away, become unavailable for an extended period of time or be diagnosed with a terminal illness? How would this impact the business? Especially the business operations? Would the partners and stakeholders be able to cope financially? Or would you need to shut down?
Key person insurance can help address and mitigate these uncertainties. It is meant to help the company survive the blow of losing the person who makes the business work and is crucial to its running.
In such a case, the company can use the payout from the insurance to cover expenses until it can find an appropriate replacement or, in extreme situations, proceed to pay off debts, distribute money to stakeholders, pay severance to employees and close the business down in an orderly manner. In a catastrophic situation, key person insurance gives the company a fighting chance and an option to make an orderly closure while protecting shareholder value rather than a declaration of immediate bankruptcy.
Here in this week’s blog post, we discuss key person insurance down to its very last detail. We answer the critical questions – How do you determine “who” is a key person? What does it cover for a business? And, does your business need key person insurance?
What is key person insurance?
Simply put, key person insurance is life and disability insurance on the key people in a business.
A business may purchase a life insurance policy on its named key employees, pay the premiums and set itself as the beneficiary of the policy. In the event of a claim, it’s usually the business that receives the proceeds from the insurance.
Typically, policies can cover death, total and permanent disability (TPD), and trauma or critical illness. Some policies may also offer income protection cover. The reason this cover is important is because the unavailability of a key person in a small business can cause severe financial difficulty including, in the worst case, ultimately, the business' collapse.
How do you determine “who” is a key person?
Look at how your business is structured and give a thought to who there may be irreplaceable in the short term. Key persons can be the owners, the founders or one or two of the employees.
These persons have the ability to hold the business together – have insights into the financial structuring, may keep the books and maintain accounts, maybe in charge of devising strategies and keeping the business competitive, have the ability to manage the employees and handle the key customers themselves.
What does it cover for a business?
It is often difficult to act when tragedy strikes, and it may be helpful to decide and document the main purpose of your key person policy as a part of business planning. And, it may also be a good idea to review these documents annually and keep them up to date.
For a business, any benefits received from key person insurance can be used for revenue purposes, capital purposes or for both revenue and capital purposes.
Revenue purposes:
If the business is reliant on its key persons for generating revenue, then insurance for revenue purposes may be suitable. This can be used to cover the business against any losses in revenue and/or against increased costs.
Capital purposes:
If the key persons in your business contribute towards the value of the business and its assets, then insurance for capital purposes may be appropriate. This can be used towards paying off loans that the key persons guaranteed or offsetting any loss of goodwill.
Dual purposes:
It is possible to purchase cover for both revenue and capital purposes. However, this can be a significantly complex matter and talking to a financial adviser is recommended.
Business planning with Oakmont
We understand that the operational demands of running a business can be all-consuming. At the same time, we know that it is absolutely vital that business leaders take the time needed to assess their business and create a robust and strategic plan.
The long-term survival of your business and the preservation of the wealth that you have painstakingly built will likely depend on it.
For private, owner-managed, or family-owned businesses such as yours, a solid succession plan can drive the growth of the business, reduce taxes, and set the stage for accomplishing more.
Invest in an obligation-free consultation with Oakmont, today. Let us help you protect your legacy.
General Advice Disclaimer
The information contained on this website and in this blog-post is general in nature and does not take into account your personal situation or circumstance. It is recommended that you consider and use the information provided responsibly, and where appropriate, seek professional advice from a financial adviser.
Although, every effort has been made to verify the accuracy and correctness of information, Oakmont Financial Group, together with our consultants, officers, agents, and employees, disclaim all liability for any loss or damage suffered by any persons directly or indirectly relying on this information.