How much Key person insurance do you need?
Impact of Sudden Loss
Lenders (SBA loans) and angel investors often require life insurance to protect its commitment and investment in the Company.
What does it take to service debt and continue operating until a replacement is found, hired & trained?
Consider the Replacement Costs and the Contributions to Earnings
The impact of a sudden lost of a key person and the impact on current and future revenues, earnings, ongoing competiveness and the Company’s ability to continue to service debt service. If the key person is contributing half the profits, how will you service debt?
What would it take to remain competitive in your industry?
Loss of a key engineer or scientist could negatively impact the future competitiveness and intellectual property of the Company. What would it take to replace such a person? Salary, stock options, moving & training costs, employment agency fee?
The loss of a top sales person on revenues & profits could impact the whole enterprise, result in layoffs, lost business to competitors and lost shareholder value. How fast can you find and replace the lost talent and at what costs? How long will you have to service debt before a replacement is found and is up to speed?
Underwriters typically allow 5 to 7 times salary, bonus and percentage share of profits if the key person is an owner. For example, using a 5 multiple, a key person earning $200,000 would allow a $1,000,000 policy. Each case has its merits. A higher or lower multiple may be justified. Some Key people are more valuable to the Company and harder to replace.
In addition to income of the key person, the underwriter will want to know why the key person is valuable enough to the business enterprise to be considered a key person. They will consider the role the person plays in the business, their experience and special skill or knowledge they possess.
If indemnifying a business loan, the underwriter will want to know the history of the business, the reason for the loan, loan terms, loan collateral and financial statements of the business.
If the key person insurance is funding a Buy-Sell Agreements, the underwriter will need to know ownership percentages, copies of the Agreements, Company valuation (or formula) and Company Financial Statements.
The insurance company needs the above information to accurately assess facts and financial risk of issuing the policy, in order to make the best insurance offer.
What if the key person leaves?
You can continue to pay the premiums. You can stop paying the premiums. You can sell the policy to a life settlement company if the insured approves the transfer. The life settlement company will pay you a fraction of the death benefit upfront. It takes over the policy and continues to pay the premiums, and collects the death benefit when the insured dies. It may also exercise conversion options and convert a term policy into a whole life or universal life policy. You can also transfer ownership of the policy to the insured, and let them decide what to do with the policy.
Rewarding and retaining key employees. Life insurance can be used to fund key executive compensation strategies, executive bonus plans, supplemental executive retirement plans and deferred compensation