As we briefly mentioned in the introduction to this series on the need for business insurance, key person insurance, also referred to as key executive insurance or key shareholder insurance, is a risk management tool that addresses the stability of specialized human capital contributed to a business in the event of an active key person’s death.

Overview of key person insurance

Important to the success of any business is the strength and talent of their employees. Amongst these employees are sure to be certain key personnel who provide unique skills and talents that the business relies upon. These key personnel can include the owners of the company who are active in managing the operations and growing revenue for their business. They are often referred as active shareholders. Losing one or more of these people could have a significant negative impact on the company. Of course, it is not always within the power of the organization to ensure that these employees remain part of the organization forever as unfortunate circumstances can arise, such as a catastrophic injury or death. While a business cannot prevent these occurrences, they can, and should, plan for them.

Identifying key persons within a business

What makes an employee of a business a key person? There are three unique skill sets that can help identify these people:

1. They are focused on generating sales revenue
2. They manage fixed and variable business expenses
3. They aim to produce consistently positive business cash flow

Concerns upon the death of a key person

Your client should consider the fate of their business if a person with a very particular and valuable skill set were to die. Is there anyone else within the business structure with a similar skill set who would be able to immediately, and seamlessly step in? Will a surviving spouse, who may possibly inherit the business, be able to manage the organization? Will clients, afraid of instability or change, leave to do business with a competitor? Will other employees, afraid of a change in management style or losing their jobs, leave to work for a competitor?

The costs to the business of losing a key person

There are two categories of costs a business may incur upon the death of a key person. These are tangible

1. Tangible costs:

These costs can be quantified and may include the following upon the death of a key person:

• Recruitment and training costs for a suitable replacement candidate
• Fees incurred to engage external professionals to help family members in the running the business or managing the sale of the business
• Loss of revenue/sales
• Increased business and operating costs

2. Intangible costs:

While these costs are harder to quantify, they may include:

• The significant additional time required for inexperienced family members to get up to speed in order to manage the business
• Placing additional workload on current employees resulting in costly mistakes, burnout or resignations
• Time and expertise required to negotiate with banks and lenders dealing with current business loans. Demand or partial payment of business loans placed on families. Possible change in the terms and conditions on pending and/or future loans or refinancing of current loans

Clients with businesses should consider what the loss of a key person will do to the organization both in the short term and the long term. As an advisor, you can help your clients understand how key person insurance can help mitigate many of the issues they will face should this occur.

The next article in this series on the need for business insurance will focus how business insurance can help manage corporate liabilities for your clients.