Insurance policies are a critical component of both personal and business life. While public liability and professional indemnity policies are well-known and widely used, there is another policy that is often overlooked but can prove to be indispensable for your business: key person insurance. This type of insurance provides protection in the event of a serious illness or death of a key employee and can be the difference between business continuity or failure.
So, the question remains: are you prepared to take the risk of leaving your business exposed, or will you take the necessary steps to protect it? With the potential of saving your business from going under, in our view, key person insurance is an investment that very few business owners can afford to overlook.
A recent report showed that 54% of small business owners had insufficient key person insurance coverage, while 20% of company owners were unaware of key person insurance. However, suggestions that 46% of UK businesses would cease trading if a key person developed a long-term illness or died puts everything into perspective.
Understanding Key Person Insurance
Key person insurance protects your business if a crucial employee or executive cannot work. This may be due to illness, disability, or death. The first thing to do is to identify key people in your company and consider their impact on the business if they were not around.
Key personnel are anyone whose loss could have a significant impact on the company’s operations, revenue, or profitability. It’s that broad. This is ideal because the inner workings of two businesses are never the same.
In theory, you would expect larger companies to have backup plans already in place. This is not to say that key person insurance would not be helpful – far from it because the amount of liquidity required to be reserved is that much higher. The smaller the business, the smaller the team and the greater the influence one person can have on the company. Therefore, key person insurance is equally useful across the scale.
These businesses tend to have one or a small number of founders/key personnel who drive the company and are, in many cases, the face of the business. While it may be impossible to replace them like for like, the funding provided by key person insurance can create some breathing space during which alternative plans can be put into action.
The benefits of key person insurance
The practical and financial benefits of key person insurance will differ slightly between different businesses. However, there are several common use cases and positive effects, which are:-
Short-term financial stability
Where someone has been integral to the business, losing them can significantly impact short-term financial stability, either through the loss of new business or by making it more difficult to service existing contracts. As a result, many companies use key person insurance proceeds to plug holes here.
Morale
Aside from the emotional impact of the loss, there may be anxiety amongst clients and staff as to the consequences for the source of their livelihood. The human factors are just as weighty.
Recruitment costs
Whether recruiting an executive or a key staff member, this could incur a considerable expense and take some time to complete. Aside from disruption to the business, there will likely be short-term training costs and even temporary replacement staff expenses.
Creditworthiness
As well as protecting solvency, this financial safety net can be used to pay off outstanding debts or loans. This can help the business to secure additional financing or credit, as lenders may be more willing to provide credit to a business with key person insurance.
Identifying Key People in Your Business
As businesses continually evolve, key personnel can change regularly. Some of the more stereotypical key personnel include:-
- Founders
- Directors
- Sales executives
- Innovators
- Managers
There are three basic ways to identify key personnel, which are as follows:-
- Do they have a significant direct impact on the value of the business
- Would their skills and experience be difficult/impossible to replace
- Do they directly influence future strategy and innovation
An example of how a group of key personnel may change over time is that of a founder. In the early days, they will likely be critical to the business, but their direct participation may be limited as they get older and potentially retire. At this point, it is difficult to see any justification/value in the company continuing key person insurance for this individual.
Setting Up Key Person Insurance
When taking out key person insurance, it is crucial for all parties to appreciate that the business pays the premiums, and any payout will go to the company. These funds are used to ensure the future of the business and assist with cash flow/funding requirements in the immediate aftermath of a key person’s demise.
There are no hard and fast rules when negotiating a key person insurance policy because they will differ from business to business and person to person. Typically, the amount of cover required tends to relate to one of the following:-
- The financial impact of their loss
- Multiple of the employee’s salary
Like any life policy, the premiums will reflect the age, health and even the profession of the individuals involved. Typically, premiums are tax deductible as a business expense, although any payout would likely be treated as a trading receipt. This type of cover is crucial but complex, prompting many to seek professional guidance.
When it comes to protecting your business, it’s important to consider all angles. Key person insurance is not just a business cost – it’s a smart investment in your company’s future. It can mean the difference between weathering a storm and sinking under the waves.
Think of key person insurance as a lifeline for your business. It’s a safety net that ensures you can maintain cash flow and stability even in the toughest of times. With this type of coverage, you can rest assured that your business will be able to continue operations, pay employees, and meet financial obligations in the event of a sudden loss of a key team member.
Summary
While larger companies may have more resources to deal with losing a key employee, smaller companies and start-ups are often more vulnerable. Key person insurance is a popular choice for these businesses because it offers peace of mind and a layer of protection that might not otherwise be available.
Of course, it can be difficult to identify who the key personnel are in your business. But one thing is certain – if you’re struggling to pinpoint them, it could be you! Don’t underestimate your own value to your company. With key person insurance, you can ensure that your business will continue to thrive even if the unexpected happens.
Our team can find the best key person insurance for your situation, providing essential cover going forward. Call us today, and we can discuss the options in more detail.