Employee Life Insurance:
Key to Your Business Continuation Strategy
Todd E. Binder
Suppose you received a
phone call at your firm one afternoon – a key partner or associate
has passed away unexpectedly. This loss would hit hard both personally and
professionally. Not only have you lost a friend and colleague but a person
of critical importance to your firm as well. So many emotions and thoughts
course through your mind. First your heart goes out to the family and loved
ones. Then you stop and think of your management team and your firm. Do you
have a plan of attack for this situation? Have you outlined your business
continuation strategy and how you will replace a key employee?
Many times these questions
are asked too late. Employers are often caught off guard, and a tragic event
can have a devastating impact on the vitality of a business. The passing
of a key employee can be an enormous loss to your firm. There may be the
loss of know-how, the loss of a cultivated skill set and –
possibly the most important loss – that of business relationships that
have developed over many years. All too often, the loss of a key employee also
has a serious financial impact on a business.
Employee Life Insurance
What many business owners
fail to realize is that this situation can be easily avoided by implementing
plans for dealing with the loss of a key employee. Although no one can totally
prepare for or prevent the sudden and unexpected loss of a vital employee,
a key employee life insurance policy can help. It can provide funds to a
business in the event of the loss of a valued employee. The life insurance
proceeds can help sustain the company and allow for its continuation during
this time. The proceeds can provide funds to recruit, hire and train a qualified
replacement. It also can assist the business in paying off loans and help
secure the relationships it has with its customers, clients and lenders.
Value of a Key Employee
It is important to establish
the value of a key employee. The valuation may be based on an estimate of
the probable loss of income that might result from the employee’s death
or an estimate of the additional expense of hiring and training a replacement.
Generally, there are three different approaches used to determine the amount
of key person insurance that is necessary: a multiple of the key employee’s
compensation, an amount equal to their contribution to profits and the cost
of replacement of the key person.
Business owners should
consult with their financial advisor to help determine who should be covered
under a key person policy and to help determine the appropriate amount of
life insurance coverage that should be purchased on these individuals. The
financial advisor can assist in determining which valuation method is most
appropriate for the company’s situation.
In most cases when the
firm or business owns a key employee life insurance policy, it pays the premiums,
which are typically not tax deductible, and the death proceeds are received
by the company income tax-free. These funds can have a substantial impact
on the financial health of a business and help assure its continuation.
[The information in this
article is not intended to be interpreted as specific tax or legal advice.
Consult your own personal legal or tax counsel for specific tax or legal
Todd Binder, MBA, is an
associate with Franklin Morris, exclusive coordinating broker for the Bar
Associations Insurance Agency, Inc.