Insuring Key Employees
Have you ever wondered how your company would be affected if something happened to you? What would happen to your business if your production manager suddenly fell ill and couldn’t work for several weeks, months or ever again? What if the illness occurred during the peak growing season? How would that person’s absence impact the quality of your crops? More importantly, how would your bottom line be affected?
If the success of your growing operation is reliant on specific skills of certain key employees, you may want to consider investing in a key-person insurance policy.
What Is It?
Key-person insurance is an insurance policy a company can purchase on a specific employee; the company pays the premiums and is the policy’s beneficiary. Essentially, it is a life insurance policy for the business. Key-person insurance exists so business owners “…can protect not only their asset accumulation but also the equity they have in the business,” said Jim Carroll, vice president at Edwardsville, Ill.-based Hortica Insurance, which specializes in insurance for the horticulture industry.
Big growers may want to consider purchasing a key-person insurance policy on such individuals as the production manager, head grower, operations manager, top salesperson or certain top executives (including themselves) whose loss or prolonged absence from the business could negatively influence the overall financial health of the organization.
“You want to be sure that upon [the key person’s] death or disability there is not a loss in the business function,” Carroll said. “Should a death occur, the business can continue [to operate] because of the monies that are collected due to that death.”
Oftentimes, lending institutions will require a company to carry key-person insurance on specific individuals before they approve a loan. These lenders want to be sure the principal amount of the loan is covered if something were to happen to that individual. If the key person unexpectedly dies or is injured and cannot do the job, the company would be able to make a claim on the policy to help cover the loan.
The insurance policy helps ensure continuity and stability for the business. The proceeds from the claim can be used to cover lost sales and/or profits, pay for expenses toward replacement of that person, pay off debt or help provide a company bridge until that person is replaced.
If “…a key person goes out on disability, then that is considered ‘a living death’ because that nursery or greenhouse is not getting that person’s expertise; so monies that are paid to the business can help bring in expertise to fill those gaps,” Carroll explained.
How Does It Work?
A key-person insurance policy is not meant to replace or supplement an individual’s regular life insurance policy, benefits from which are paid to the person’s family. If the key person has dependents relying on that individual’s income, he or she should be sure to have a personal life insurance policy as well.
Key-person insurance policies can be customized to meet the very specific needs of a growing operation. Here are three commonly used models of key-person coverage:
Multiple compensation method. This method makes the assumption that the employee’s value is indicated by that individual’s total compensation package.
Contribution to profits method. What is the employee’s impact on the company’s net profit? By determining this figure, the company can calculate its anticipated profit loss due to the loss of that employee and multiply that figure by the amount of time it will take to replace the person and get the company back to “normal.”
Cost of replacement method. This payment method is determined by calculating the direct costs the company will incur to recruit, interview, hire and train a suitable replacement for the lost employee.
How Much Coverage Is Needed?
When you are determining the proper amount of coverage for your business, get different quotes for different levels of coverage. Be sure to figure out how much it might cost your company until the key person can be replaced. How long will it take that new person to learn the job and get your company operating smoothly?
Each key person insurance policy is different, so determining how much coverage to purchase is dependent on many different aspects. Insurance experts advise growers to have as much coverage as they can afford.
Before purchasing key-person Á insurance, be sure to discuss all policy specifics and its coverage with your insurance agent/broker. You should also consult with your attorney and financial/tax consultant before purchasing a policy to be sure all of your legal/financial bases are covered.
Carroll said the key person is subject to “your typical policy questions” such as age, personal health, family history, location and salary. These are just some of the factors that can influence the cost of a premium.
Carroll recommended that growers buy key-person policies on employees when they are younger because policies will cost less; premiums are less expensive for younger, healthier employees. “If there is an existing health problem [on older employees], premiums could be rated higher…or even declined,” Carroll stated.
Making Good Business Sense
Key-person insurance makes good business sense for growers. Establish an emergency back-up plan that includes key-person insurance in case something happens to your key personnel. By planning for a worst-case scenario and having a temporary backup plan, you can lessen the overall impact of losing a key staff member.
“I think it is extremely important for the principals in a horticulture business [to have key-person insurance], because they have the expertise. They are the ones that have the contacts that help make the business grow. That is especially important in the horticulture business,” Carroll said.
He said another business advantage to purchasing a key-person insurance policy is it “…is a business write-off. It is totally deductible as a business expense.”
You can also use a key-person insurance policy as a “benefit” for the key employee. If the employee dies, you can offer any of the proceeds to the employee’s family, thus making the policy a part of your employee-benefits package. Another option is to set up the insurance policy as a non-qualified deferred compensation where the employee is promised the cash value of the policy as it grows. This way the employee avoids paying taxes on that money until he withdraws it.
“The whole purpose of the key-person benefit is to protect the business and the assets of the person,” added Carroll.
Questions To Consider
If you are considering key-person insurance, ask yourself:
- If the company had to stop
doing business due to death or
serious injury of the key person,
how would this loss affect the
- Would the company be required
to sell its assets to settle the
estate in the event of a key
person’s untimely death?
- Does the company’s lender
require key-person insurance
before it will approve a loan?
- What types of additional
financial hardships would the
company face if something
happened to the key person?
Do you have the capital to
overcome these hardships?
Source: National Federation of Independent Business