I. The problem – What if a key employee or owner dies?

What happens when a person who contributes substantially to the financial well-being of a company dies prematurely? Will the business suffer an economic loss? What would it take to return the company to a thriving, profitable venture? These are questions business owners must consider when reviewing their contingency plans.

Example: a furniture-making enterprise has an employee who is very skilled at making dining room tables and chairs. If that employee were to die unexpectedly, the company could suffer severe economic loss due to not being able to fill orders for dining room tables and chairs, which is the main source of revenue for this organization.

Sole proprietorships, partnerships and corporations all need cash at the death of a key person to offset lost income and profits, pay off debt, and hire and train a replacement person.


II. The Solution – Key Person Life Insurance

What is it? It is insurance coverage on the life of a key man or woman – partner, co-owner, well-paid salesperson or employee with rare training or special talents – intended to restore the anticipated financial loss to the business which would result from the key person’s death. The business is the applicant, premium payer, owner and beneficiary of the life policy on the key person.

Example: the furniture-making enterprise above calculates that the dining room table/chair craftsman’s value to the company is $xxx,xxx. To help offset any economic loss that would result from the craftsman’s premature death, the business purchases a life insurance policy on the craftsman. At the unexpected death of the craftsman, the business is paid the life insurance proceeds, which can then be used to fund advertising and recruiting costs, training costs, debt reduction, restoration of profits, etc.

III. Who is the key person in an organization?

A key person is someone (employee or owner) whose death would cause an economic hardship for a company. He/she is the one with special training, sales prowess or leadership charisma who keeps the business competitive. He/she represents the backbone of the company. Consider answering these questions to determine the key people in your organizations…

•	Whose death would create a void that could not be filled from current personnel?
•	Whose death would upset the normal operations of the business?
•	Whose death would impair the firm’s credit standing?
•	Whose death would mean a loss of customers?
•	Whose leaving to go to a competitor would hurt the company most?

IV. What type of product should be selected – Term or Permanent?

Several factors must be considered when selecting one type of coverage over another. Permanent insurance will have a favorable impact on the balance sheet of the company and will last to the Key Person’s age of 95, 100, or longer. Term insurance may be attractive in that it offers low initial premiums. Ask yourself these three questions:

•	Do you plan for the key employee to be with the company ten years or more?
•	Do you plan to provide a supplemental retirement or incentive plan for your key employees in the future?
•	Do you have stable cash flow and earnings?

If you answered “yes” to these three questions, then consider permanent insurance. If you answered “no” or are unsure, consider term insurance.

V. How is a key person’s worth calculated?

There are three basic methods used to calculate a key person’s contribution to an organization.

A. Multiples of Salary Method

This is the simplest method available. There are just three steps involved…

1.	Determine the base compensation for the key person
2.	Add the dollar value of significant benefits like medical, life, and retirement plans
3.	Multiply the total of the above two figures by the number of years that may pass before a new employee could perform as well as the key person

B. Replacement Cost Method

This method considers factors other than just expenses incurred, including lost revenue, lost customers, and other intangibles. While there is no set rule on what should be included, here are some steps to use in calculating a key person’s replacement cost…

1.	Estimate how much profit will have to be replaced as a result of the key person’s death
2.	Add the annual cost to hire a replacement for the key person (advertising, travel, relocation, training, etc.) to the figure obtained in step 1
3.	From the total obtained in step 2, subtract the salary saved because the key person died
4.	Multiply the result obtained in step 3 by the number of years anticipated to return company profits to what they were prior to the key person dying

 C. Contribution to Profits Method

This is the most involved calculation method and measures the key person’s contribution to the company’s bottom line. Here is an example of how to use this method…

Source: 1980 Commissioners Standard Ordinary (CSO) Mortality Table