The Business Need for Key Person coverage
Consider for a moment the following statement attributed to the United States Court of Appeals:
“… what corporate purpose could be considered more essential than key man insurance? The business that insures its buildings, machinery and automobiles from every possible hazard can hardly be expected to excercise less care in protecting itself against the loss of two of its most vital assets – managerial skills and experience …”
It is clear that key persons may be found in all types of business, large and small, incorporated and unincorporated, capital oriented and personal service oriented, new and old. However, the need for key person insurance is not the same for all businesses that have key persons.
The need for key person insurance to indemnify the business for loss of a key person will generally be minimal when the business:
- spreads its management responsibility amongst a number of individuals;
- has a well thought out management training program;
- has sufficient liquid surplus to meet emergencies;
- can borrow money in its own name without the personal guarantee of any of its owners.
It would be a most unique business indeed that could substantiate the existence of all of these features at any given random point in time – yet death and disablement are both unexpected and random.
Even if the first two points are met, it would seem an anomaly if sufficient liquid surplus was maintained at all times since this would mean that available capital reserves were being held dormant – certainly not an indication of a successful and well run business.
Likewise, why create a necessity for borrowing money at an unexpected and possibly inopportune time in the future, underwritten by personal guarantees of the owners, if the necessary indemnity can be obtained at a yearly expense of generally not more than 0.5% to 5% of the face amount of a key person insurance policy. No business owner could or would possibly admit that a lesser return would be generated from their management of business cash reserves which would therefore be freed for investment and/or business purposes.
Find following some realisations I have had and now hold to be true:
- Profits are made by people – not machines;
- A business that insures its plant, stock and equipment can hardly refuse the logic of insuring its people;
- The difference between operating at a profit and operating at a loss is almost universally influenced by the skill and capacity of a handful of people within the business;
- The secret is to identify the need and discover where indemnity is needed. It may be needed to offset loss of future profits, to minimise the loss of momentum or to provide liquidity when a key person departs as well as a host of other real requirements;
- Cash provided through an insurance policy is the only effective answer to the problems which arise on the loss of a key person;
- If a business insures a key person and such insurance subsequently proves unnecessary, this is a minor cost. On the other hand if the business does not insure its key person and that key person dies or is disabled the financial cost may well be as horrific as the emotional burden which would also be experienced.
This is a subject that is worthy of consideration and regular review by all who are in business. We would be pleased to assist with any queries you may have as a result of the post.