The last two years may go down as one of the more confusing periods ever, both in the United States and throughout the world. The source of that confusion was the coronavirus.
Yet, at the same time, the pandemic brought a better sense of clarity and understanding to the things that are truly important and the fragile nature of life. Indeed, life insurance policy purchases grew considerably in 2020 and have maintained their momentum ever since. According to LIMRA, life insurance policy sales in the U.S. rose 18% in the first half of 2021 compared to the same period in 2020, marking the biggest surge in life insurance ownership in nearly 30 years.
COVID-19 has had a similar impact on business owners. Because the highly infectious nature of the coronavirus forced many business owners to work with skeleton crews, organizations got a better appreciation for just how reliant they are on the health and well-being of their employees, particularly those who have highly specialized skills or strengths.
Do you or your business owner clients have a key individual, someone who is truly indispensable to the organization’s success? If so, key man insurance can help to cover the business’ bases. This article will discuss what key person insurance is, how it works and what the proceeds from key person coverage can go toward.
What is key person insurance?Before diving into key man insurance – or key person life insurance, as the terms are used synonymously – it’s important to define just what a key employee is. As the Insurance Information Institute defines the term, a key person, or key man, is an individual whose skill sets, knowledge or capabilities make him or her critical to the financial health and profitability of a business. This person could be in a host of different positions, such as an executive, partner, board member or someone who is more intimately involved in day-to-day business processes.
The vast majority of small business owners attest to having at least one key person who is indispensable to their business’ survival. In a poll done by the National Association of Insurance Commissioners, 71% of business owner respondents said they were “very dependent” on one or two people. Yet despite this, only 1 in 5 (22%) owned a key man policy.
Key person life insurance functions similarly to a traditional life insurance policy but is geared toward business uses. For example, if that key employee were to pass away or become physically disabled, the death benefit deriving from key person insurance can be used to pay for the costs associated with replacing that individual or minimizing the adverse financial impact. Key person disability insurance is another type of coverage but is specifically designed for instances where a key individual experiences a permanent disability or disfigurement.
What are some of the potential usages for key man life insurance?
TrainingAccording to the Society for Human Resource Management, when an employee decides to leave their employer to pursue another opportunity, the cost of replacing that individual can be in the tens of thousands of dollars. And that’s on average. The cost can be much higher than that when the person being replaced is a key employee. When a policy is in place, the death benefit that covers an insured employee can help to defray some of the expenses related to training the replacement.
RecruitmentAnother cost associated with losing a key employee is recruitment. Whether it’s using the funds to pay for recruitment services, entry fees for job fairs or the costs of hiring a headhunter, recruitment expenses can add up quickly and considerably. Key person life insurance can address these cost concerns.
Offset short- and long-term business lossesWhen a key employee or key person is largely responsible for generating revenue for the company, a sudden death or disability naturally results in less ongoing income and cash flow. The death benefit of key person insurance coverage can plug the gaps resulting from no longer having that employee by offsetting the profit losses the business experienced. In short, if the key man had a unique ability to create revenues for the business, key person insurance can cushion the blow until you find an effective replacement.
What are the other advantages of key person life insurance?Key person life insurance is like any other life insurance policy – you hope you never have to use it, but you’re glad it’s there when you do. But the benefits of key person insurance go beyond those we’ve just outlined. In addition to protecting the business, key person insurance:
- Helps the business owner’s family learn how to continue business operations in the owner’s absence.
- Can be tailored to the needs of the company.
- Pays a percentage of benefits directly to the owner’s family through a split-dollar agreement.
- Offers certain tax advantages for death benefits.
- Policy premium payments can be divided between the business and the key employee.
The only potential problem with key person insurance is not having the funds to pay for the premiums. But that problem is solved with Global Financial Distributor’s Leveraged Planning® solutions. Leveraged Planning® premium financing can provide you or your client with the money they need to pay for the premiums associated with key person coverage. And since the cash value of the policy grows over time, you can use the cash value to pay back the loan when the term or the policy expires.
For more information on key man life insurance and why it’s an important backstop to a business that relies on highly important people, please contact us today.
