Protecting a Businesss Most Valuable Employees
Key employees are central to any business. Without them, the business might never achieve its long-term aims and objectives. However, businesses that might otherwise be very cautious about risk management may overlook protecting their key executives. The result: In the event of an unexpected death, a business may struggle to replace that individuals contribution.
A key employee can be anyonean owner or non-owner. What distinguishes someone as key is that his or her loss would severely impact a business until a replacement could be found and trained. Who might a key employee be?
- Someone who might influence client relationships;
- Someone whose loss might affect a companys credit or reduce business income; and/or
- Someone with special skills or talents.
Life insurance is often used to protect businesses against the loss of such a person. In the event of an unexpected death, the life insurance death benefit can help sustain a business until a replacement can be located, hired and trained.
Things to Consider
Key person life insurance helps a business to maintain operations in the event a key person dies prematurely. The numbers in the accompanying sidebar illustrate the impact the loss of a key person can have on the business.
While nothing can replace a long-time, valued employee, a key person program can lessen strains on business operations. Such a program also can help fund a business continuation program if the key person is an owner.
Cash values of a key person life insurance policy grow tax-deferred and can be used by the business as a balance sheet asset. Post-retirement, the policy can remain as a business asset, but other options are discussed below.
Although the life insurance premiums are not deductible, the death proceeds can be received income tax-free, offering considerable benefits to the company. If the business is a C Corporation, the alternative minimum tax may apply. However, planning and adjusting the death benefit can, if feasible, address that tax concern.
Care must be taken to monitor the death benefit need and the amount of insurance, as these values may fluctuate in relation to one another.
Steps to Take
Setting up a key person program is not complicated. You need to work with business owner clients to determine an appropriate valuation. With that as a guideline, you can work with your clients to apply for the life insurance policy.
Typically, the business owns, and is the beneficiary of, key person policies. One may need to document, in the corporate books, the rationale for purchasing key person coverage. Some regulated businesses may require more detail documenting the need and rationale.
What Happens at Retirement
If the key person leaves, the business may own a death benefit policy it no longer needs. The company can:
- Cash out the policy and retain the after-tax value for other business purposes;
- Maintain the policy as a business asset and receive the death benefit in the future;
- Exchange the policy as the death benefit on a new key person. This is an option available under many life insurance contracts even though such an exchange (to another insured) might be a taxable event.
Most advisors focus on business continuation planning and executive benefits when working with business owner clients. However, key person protection is an important tool that you can bring to these clients. To that end, it may be helpful to work with other advisors or banks that work with, or make large loans to, businesses that depend on key personnel.
The continued success of your business clients depends on their key persons. This is a key risk management tool that should be treated as critically as benefit plans and business continuation planning.
Mark A. Teitelbaum, JD, LLM, CLU, ChFC, is second vice president, advanced sales, at Travelers Life & Annuity, Hartford, Conn. His e-mail address is email@example.com.
Reproduced from National Underwriter Edition, September 9, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.