The death of a partner or key executive who brings significant value and contribution to an organization can upend a business’ continuity and growth without an effective strategy in place that includes Key Person Life insurance. If, for example, an organization’s brand and strength are tied to a particular employee’s name or reputation (the owner), the market may perceive disruption. Or, if an employee’s role is directly tied to the company’s continued performance, the loss of this employee could trigger a drop in revenue and hinder the organization’s ability to generate new business. Also, for some companies, the loss of a particular employee may affect the company’s credit and cause a business loan to become due. Additionally, Key Person Life insurance on an individual or a number of people affirms the value the company puts on its top employees.
Inside Key Person Life Insurance
With Key Person Life insurance, also known as Corporate-Owned Life Insurance (COLI), the business owns the policy, pays the premiums, and is the beneficiary. It is designed to compensate the business for its financial loss when a key member of the organization dies. The policy proceeds can be used to recruit, hire and train a successor; replace the individual’s sales income; pay off debt; or reassure customers and employees that the business will still operate in the face of the loss of the key person.
Candidates for Key Person Life insurance include top salespeople; partners, executives, directors, and other decision-makers; highly visible employees, and employees with unique knowledge or skillsets. In deciding whom to insure, the key is for an organization to look at the business and think about which individuals are irreplaceable in the short term. It’s important to note that while an employee essentially has no rights or active participation in the policy, the business is legally required to notify him or her of its intent to buy coverage on the employee. The business also must provide the employee with details of the policy, and obtain written permission from him or her prior to purchasing it. The business can cancel a Key Person Life policy and stop making payments at any time, for any reason, including, of course, if an employee no longer works for the organization.
Determining how much coverage to purchase on a key individual involves answering several questions, including: What would happen to the business if a key employee died today? Would it be difficult to replace the key employee quickly because of his or her special talents? How much specialized knowledge does the key person possess? Additionally, while putting a dollar value on an individual’s life is difficult to do, a business can use the following as a guideline:
The death benefit has to be financially justified, typically 10x the key employee salary.
The key employee’s worth in terms of contribution to profits: Multiply this by a factor, such as the number of years or the measure of time it would take to recruit and train a replacement.
- The key employee’s current salary: Multiply this by the number of years it might take a newly hired employee to reach the same skill level.
- Cost of replacing the key employee: Recruiting costs, additional expenditures such as increased salary and expanded benefits to hire top talent.
A business can choose to purchase Term or Permanent Life insurance as the underlying coverage for its Key Person policy. Level Term Life insurance is generally the most popular form of Key Person insurance, and provides guaranteed level death protection at a guaranteed fixed premium for a specific time period. Policy costs are based on the age, gender, lifestyle and health of the employee as well as the length of the guaranteed level term period. Level Term Life insurance is most appropriate in situations where the insurance need is definite over a specific time period. It should be used as a temporary bridge that provides low-cost protection during the period of need but can be cancelled or expires at the point when the coverage no longer becomes necessary.
When Key Person Life insurance is coupled with some other benefit such as a retirement plan for that employee, Permanent Life insurance is typically purchased to meet this objective. The company receives the Life insurance death benefit as compensation for the income loss and/or the increase in expenses resulting from the key employee’s death. If the employee survives to retirement, the corporation can use the cash surrender value to fund a retirement benefit.
Premiums paid on Key Person Life insurance policies are not tax deductible. Death proceeds are generally not taxable to the beneficiary depending on the type of business. If the beneficiary is a C-Corp, for example, the proceeds may increase the corporation’s liability for the alternative minimum tax (AMT).
Key Person Life insurance helps to assure continuity of a business for employees, customers and creditors. Owens Group specializes in putting together Key Person Life insurance solutions for all types of employers. Our team of professionals can provide you with a more in-depth review of the advantages of Key Person Life and what approach is best for your company. Please call Bob Owens or Denise Kligman at 800-26-COVER.