Key Person Insurance is life insurance your financial services firm purchases on the lives of key employees.
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As a financial services firm, are you prepared for the unexpected death of a key employee? It could be your investment management firm’s CEO, the founding partner in your accounting firm, or the financial advisor who brings in the most clients. Especially in a smaller financial services company, losing one key person could dramatically impact the business. If that key person holds great responsibility in your company or drives a vast amount of revenue, how will his or her absence impact your bottom line? That’s where Key Person Insurance comes in.
What is Key Person Insurance for financial services?
Key Person Insurance is life insurance purchased by a business on the lives of employees critical to the business. The company pays the premiums and is the beneficiary of the policy. If the key employee dies unexpectedly, the insurance company will pay out a benefit to the company.
Key Person Insurance helps the company survive losing a person who is a vital part of the business. For small financial firms, key people are typically the owners, founders, or other high-level employees.
- Your investment management firm has purchased Key Person Insurance for all the partners of your company but not for the employees below them in the hierarchy, including vice presidents and associates.
Key Person Insurance should not be confused with personal life insurance, which pays out benefits to beneficiaries (usually close family members) if an employee dies. Key Person Insurance provides benefits to the company after a key employee dies.
What does Key Person Insurance provide for financial services firms?
Key Person Insurance provides important funding for businesses that have suffered the loss of a key employee. The unfortunate loss of a crucial employee can bring about financial turmoil and organizational chaos, potentially putting the viability of your company at risk. Key Person Insurance benefits play a pivotal role in bringing stability to your organization, with funds that can be used for:
Replacing the key employee. The costs of hiring temporary help, recruiting to find a replacement, and training a new hire can all be covered by Key Employee Insurance.
- Example: The CEO of your insurance brokerage dies in a boating accident. You hire an executive search firm specializing in the insurance industry to find a replacement.
Losses related to the absence of the key person. The key person may have cultivated important client relationships that can’t be replaced or had critical knowledge of complex, ongoing projects. Their death may lead to lost sales and profits or hinder the completion of important projects.
- Example: Your financial advising firm has twenty financial advisors, but your star player has actually brought in 25% of your company’s clients. When he dies suddenly in a car accident, your firm’s annual revenues falls dramatically without his talent for acquiring customers.
Shareholder buyouts. For companies with shareholders who all work in the business, Key Person Insurance can also help buy out the stake of a deceased shareholder or partner. Most companies would not have the ordinary cash flows or cash reserves to repurchase partner shares.
- Example: Your financial planning firm has 3 equal partners and earns $1.5 million per year in profits. Businesses in this industry are valued at 5x the profits. If one of the partners dies unexpectedly, his shares would cost ($1.5 x 5) / 3 = $2.5 million. Your firm purchases enough Key Person Insurance to cover a buyout.
Loan guarantees. Company owners and partners are often required to guarantee loans made to their business with personal assets. If an owner/partner dies unexpectedly, Key Person Insurance can help pay off the business loans without burdening the deceased owner/partner’s estate. Banks may also look to see if your company has Key Person Insurance when making their lending decisions.
- Example: A partner of your accounting firm has guaranteed a $1,000,000 loan to your business with his personal assets. When he dies unexpectedly from a heart condition before the loan is repaid, his home and investments are not used to pay off the loan because the company has Key Person Insurance.
Orderly liquidation. Paying severance to employees, settling company debts, returning money to investors, and shutting down the business in an orderly manner may be necessary if your business cannot continue after the unexpected death of a key person. With Key Person Insurance, funds can be used to manage a wind down of your company, helping to avoid immediate bankruptcy.
- Example: The managing director of a mid-sized insurance brokerage runs the company in a command-and-control fashion. He holds an enormous amount of institutional knowledge that has not been passed onto other executives or employees. Unfortunately, when he unexpectedly dies of a heart attack, the company fails without his leadership. Key Person Insurance helps pay the costs associated with shutting down the business.
What financial services firms need Key Person Insurance?
Would your company be in dire straits if an owner, partner, manager, or key employee died suddenly? A key person is usually someone who would be difficult or impossible to replace. He or she might have specialized knowledge or important relationships with clients that would be difficult to replicate with a new hire. If this is the case with your business, you may be a good candidate for Key Person Insurance.
For smaller financial firms, Key Person Insurance may be of particular importance. For partnerships and companies with multiple shareholders who work in the business, Key Person Insurance can be an important tool to allow the remaining partners to buy out the shares of the deceased partner. The remaining shareholders may not want the deceased partner’s heirs to own a stake in the business that the deceased partner no longer contributes to, and, at the same time, the heirs may not want to be involved in the business and may be looking to cash out of their shares. Key Person Insurance could provide the funding for the company to buy out the deceased partner’s shares.
For financial firms with debts that are personally guaranteed by a founder, owner, or partner, Key Person Insurance can help pay off the debt. Companies may face difficulty repaying debts after losing the business generated by a key person, and Key Person Insurance can step in and cover some or all of the debt.
For financial firms that are sole proprietorships without employees, Key Person Insurance is usually not needed because the business ends with the death of the sole proprietor.
How much Key Person Insurance should a financial services firm buy?
Key Person Insurance pays a fixed sum to the business after the death of a key person. This amount is specified in the insurance policy and varies based on your business’s coverage needs.
How do you estimate how much Key Person Insurance your firm needs? Think about the purpose of the insurance. To continue business operations, for example, will your business need to hire temporary help, recruit a replacement employee, or recoup the fall in profits after the key person’s death?
- Your investment management firm buys $1,000,000 of Key Person Insurance to cover the CEO. You estimate that it would cost $200,000 to pay for an interim CEO, another $100,000 to hire an executive search firm to find a new chief executive, and you would lose $700,000 in profits without some of the key personal relationships with high net worth clients cultivated by the current CEO.
If your company has purchased Key Person Insurance to fulfill a Buy/Sell Agreement, the insurance should be enough to buy out the deceased partner under the terms of the agreement.
If your company is purchasing Key Person Insurance to guarantee business loans that were personally guaranteed by the key person, you need enough to fully pay off the loan if a key person dies.
What type of Key Person Insurance should financial services firms purchase?
Term life insurance policies are the most appropriate for Key Person Insurance, rather than whole life or universal life policies.
Key Person Insurance should only protect against the risk of the “key person” dying. Other types of life insurance come with much higher fees than term life insurance because they are both a risk management product and an investment product. These types of policies would be unnecessary for Key Person Insurance.
For your Key Person Insurance, you’ll choose the fixed term (usually in years) and benefit amount (in dollars). Depending on how long you think the key person will remain crucial to your business, you may choose different terms. Think about whether the key person will always be critical. As your business grows, sometimes you’ll be hiring additional employees that make the key person’s responsibilities less irreplaceable.
- You are the owner of a fledgling stock brokerage firm. You hire one seasoned stock broker with a reputation as one of the best in the industry to lead a team of fresh graduates. You purchase Key Person Insurance for the star broker for a term of five years. At that point, you plan to raise more equity funding for the firm and hire additional brokers with stellar experience.
If you are using Key Person Insurance for loan guarantees, match the term of the insurance to the term of the debt. If you think you will have enough cash flow in the future to pay off the debt even in the absence of the key person, choose a term that lasts until your business has that cash flow.
How much does Key Person Insurance for financial services firms cost?
While premiums may vary from insurer to insurer, pricing for Key Person Insurance is generally determined by the following factors:
- Age and gender of key person
- Health of key person (medical exam and medical information must be submitted)
- Amount of coverage
- Type of policy (term, whole, or universal)
- Type of company
- Company industry
Key Person Disability Insurance
Some companies also purchase key person disability insurance, which pays out benefits if a key employee becomes disabled and unable to work. A key employee who becomes disabled may also affect company sales, profits, and major projects. Key person disability insurance offers some financial protection in these cases.
As a financial services firm, you need to be prepared for the financial losses that could occur if an owner, partner, or other key employee suddenly dies. Are there people in your firm that hold a vast amount of critical knowledge no one else can claim? Are there key employees who have cultivated relationships with important clients that contribute significantly to your revenue? Key Person Insurance will cover many of the expenses associated with losing key people in your organization, including hiring temporary help, recruitment costs, and lost profits. Protecting your company from the death of a key employee could be vital to keeping your business solvent.