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Publications : Bar Bulletin

Editor: W. Patrick Tandy

March, 2004

 

Key Employee Life Insurance:
Key to Your Business Continuation Strategy

By Todd E. Binder


Suppose you received a phone call at your firm one afternoon – a key partner or associate has passed away unexpectedly. This loss would hit hard both personally and professionally. Not only have you lost a friend and colleague but a person of critical importance to your firm as well. So many emotions and thoughts course through your mind. First your heart goes out to the family and loved ones. Then you stop and think of your management team and your firm. Do you have a plan of attack for this situation? Have you outlined your business continuation strategy and how you will replace a key employee?

Many times these questions are asked too late. Employers are often caught off guard, and a tragic event can have a devastating impact on the vitality of a business. The passing of a key employee can be an enormous loss to your firm. There may be the loss of know-how, the loss of a cultivated skill set and – possibly the most important loss – that of business relationships that have developed over many years. All too often, the loss of a key employee also has a serious financial impact on a business.

Key Employee Life Insurance

What many business owners fail to realize is that this situation can be easily avoided by implementing plans for dealing with the loss of a key employee. Although no one can totally prepare for or prevent the sudden and unexpected loss of a vital employee, a key employee life insurance policy can help. It can provide funds to a business in the event of the loss of a valued employee. The life insurance proceeds can help sustain the company and allow for its continuation during this time. The proceeds can provide funds to recruit, hire and train a qualified replacement. It also can assist the business in paying off loans and help secure the relationships it has with its customers, clients and lenders.

The Value of a Key Employee

It is important to establish the value of a key employee. The valuation may be based on an estimate of the probable loss of income that might result from the employee’s death or an estimate of the additional expense of hiring and training a replacement. Generally, there are three different approaches used to determine the amount of key person insurance that is necessary: a multiple of the key employee’s compensation, an amount equal to their contribution to profits and the cost of replacement of the key person.

Business owners should consult with their financial advisor to help determine who should be covered under a key person policy and to help determine the appropriate amount of life insurance coverage that should be purchased on these individuals. The financial advisor can assist in determining which valuation method is most appropriate for the company’s situation.

In most cases when the firm or business owns a key employee life insurance policy, it pays the premiums, which are typically not tax deductible, and the death proceeds are received by the company income tax-free. These funds can have a substantial impact on the financial health of a business and help assure its continuation.

[The information in this article is not intended to be interpreted as specific tax or legal advice. Consult your own personal legal or tax counsel for specific tax or legal advice.]

Todd Binder, MBA, is an associate with Franklin Morris, exclusive coordinating broker for the Bar Associations Insurance Agency, Inc.

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Publications : Bar Bulletin: March, 2004

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