Most business owners know the value of their inventory, the raw materials used to create their product or what it would cost to replace the vehicles used to move their product. They may not know the value of their most important employees.
Employers already know how important employees are to the success of their business but may not know how much certain employee’s contributions are worth. Those with certain creative talents or the sales person who doggedly pursues every sale or the manager that ensures each employee is working to the best of their ability may not be part of the executive team but might be a key employee. The loss of that employee might have a significant impact on the business and your business income.
The loss of certain employees can financially impact a business in different ways:
*A key salesperson might directly and immediately impact profits.
*An employee with unique talents that are difficult to replace will cost time and resources to locate and train a replacement.
*An employee that maintains crucial contacts with suppliers or customers might impact the future of business with the loss of those contacts.
To insure against the loss of a Key Person, a business must determine the financial impact that loss would have on the business. There are three common methods used to determine the value of a key person:
Multiple of Compensation — The simplest method involves annual compensation multiplied by a selected factor determined in part by the difficulty the business will have in replacing the employee. Typically, this is 5 to 7 times the currently salary including benefits. Generally, insurers will accept up to 10 times the current earnings. The specifics of the position might justify a higher or lower multiple. This method does not work well if the key employee is an owner who taking a small salary that does not reflect their value to the business.
Contribution to Profits — This method is calculated based on the percentage of the company's profits are attributable to the key person. This percentage is then applied to the company’s annual profits and then multiplied by the number of years needed to find and train a comparable replacement.
Replacement Cost — The third method totals the direct, out-of-pocket expenses involved in finding, hiring, and training a replacement, as well as the estimated lost revenue to the business.
Type of Policy
There are several life and disability insurance options that a business can consider to properly insure their Key Person Insurance needs.
Term Life Insurance covers a person for a preselect time frame, usually 10, 15 20 or 30 years. This is usually the least expensive option and the premium is guaranteed to remain unchanged through the term of the policy. Since the coverage has a specified end date and gains no cash value. The length of the term is usually based on the time until the employee’s retirement.
Permanent Life Insurance is a policy that can remain in force as long as the owner of the policy continues to pay the premium. There are a variety of types of permanent policies and they can provide the added benefit of accumulating cash value in addition to the death benefit.
Return of Premium Life Insurance is an option that can be included in a term policy that will allow the refund of the premiums if the insured person survives beyond the term of the policy. This policy is more expensive than a term policy but can provide a business a low risk way of protecting a life.
Key Person Disability Insurance will provide a business with a monthly income or lump sum in the event that the Key Person suffers a long term or permanent disability. The risk of an employee experiencing a disability is actually much greater than the risk of loss by death. The loss to the business due to a disability would likely be the same as if that employee had died. Key Person Disability Income Insurance protects the business by paying anywhere from 40% to 70% of that employee’s earned income. If the disabled employee is a partner or sole proprietor, a disability policy can help to cover overhead expenses such as rent, salaries and other expenses that continue when that owner is disabled.
Most businesses do not have the funds on hand to weather the loss of a key employee. Key Person Insurance can provide the financial support necessary to allow a business to survive the unexpected loss of that person. Zeiler Insurance Services can assist you in evaluating the risk and sourcing the right product to fit your needs.
For estimates on what Term Life policy would cost – follow this link, or reach out to me, I’m available for any questions.