At a recent meeting with the founding attorney of a successful law firm, the lawyer lamented, “The trouble with my business is that my key assets all go home at night!”
His point underscores the challenge facing service firms.
Traditionally, we think of the key assets of a business as the capital assets (such as the factory and equipment), or the operational assets (such as the inventory). But if you’re a law firm, a web design company, a literary agent, or … shall I go on? … any kind of firm where human capital is the key driver, the term “key asset” has a different meaning. For so many of these firms, their key assets breathe oxygen, drive their own cars and break down from non-mechanical reasons.
So how do you protect your business when your key assets go home at night? How does Berkshire Hathaway protect itself from the loss of Warren Buffett, and how does the local Smith and Jones law firm deal with a possible loss of its top rainmaker?
First, you have to quantify the risk. Losing a $1 million factory calls for a $1 million indemnity policy. Losing a key salesperson calls for some kind of indemnity plan as well, but for how much? And when does it apply? With the growth of the service sector, we’ve seen a growth in key person life and disability insurance policies — coverages that pay a death benefit if the key person dies or a disability benefit if the key person is no longer able to perform his or her services because of an accident or illness. Insurers have been more willing to issue these death and disability policies, and employers have become more comfortable with adding them to their risk management plan. But again, how to quantify?
In the business environment, we need to remove the emotion involved in assessing the human life value. The fact is that the risk of losing a key employee can be quantified, and insurance can be purchased to protect the company. Let’s take the example of a firm with three key employees: Jane, a 53-year-old smoker; Sam, a 50-year-old nonsmoker; and Chris, a 49-year-old nonsmoker.
Using an actuarial table that assesses mortality risk, the chances that Jane, Sam and Chris all live to their respective ages of retirement (let’s assume that is age 65) is over 75%. But let’s look at this glass from the half-empty perspective: the chances that at least one of these key assets will not survive to retirement is more than 24%.