Key-person insurance is…keyMay 31, 2022
If a business is going to take just one action to guard against potential future disaster, that action should probably be taking out insurance policies against the loss of its key personnel. These policies, fittingly known as key-person insurance, come in three main types: key-person life insurance, key-person disability insurance, and business-continuation insurance (also known as business-interruption insurance).
All three work the same way. The company purchases and maintains the insurance policies, and if a person vital to the company dies (or becomes critically ill or disabled, depending on the type of insurance purchased), the insurer issues a tax-free insurance benefit. This benefit not only gives the company the cash infusion it needs to continue the business, but also bolsters lender confidence and buys it time to recruit and train a replacement.
That’s important, because when a person vital to the company dies, becomes critically ill, or is permanently disabled, the business can go into a tailspin that can lead to reputational loss, operational trouble, internal conflict, or even dissolution. In fact, experts estimate that a business has, on average, 4-6 months after the loss of a key person before the business starts to decline.[i] Beyond the sudden loss of leadership and a potentially steep drop in profit, loss of a key person can give lenders the jitters, prompting them to call in their loans. Additionally, capital-gains taxes and other costs associated with this kind of loss can cripple a business financially, especially if it’s a small family-owned business.
While many may think of losing key members of their team only in abstract and unlikely terms such as “getting hit by a bus,” there are much more common scenarios that can and do lead to key-person loss. These include swift-moving cancers, heart attacks, COVID-19, and Alzheimer’s disease. In the United States, 1 in 4 people will be disabled between the start of their careers and retirement,[ii] while in Canada, 14% of the population over 15 years old has or experiences disability, with 43 being the average age at which the disability starts to cause difficulty[iii]. Meanwhile, the age of CEOs has risen steadily in recent years, with more than 50 CEOs in the Standard & Poor’s 500 Index companies over 65, 19 of them over 70, and three (including Warren Buffet) over the age of 80.[iv] As one Financial Post article puts it, it is folly to look at the advanced age of many company leaders and think that “death won’t apply to them.”[v]
So who exactly qualifies as a “key person”? That’s up to the business to decide. The most obvious candidates are the owner, CEO, and selected other C-suite personnel, but insurance policies needn’t—and often shouldn’t—stop there. Key people include all those whose talents, knowledge, or reputation are important to the running and financial well-being of the business. For instance, head chefs, designers, or others on the creative side could deal a crippling blow to the company by being unexpectedly unable to work. The same is true of anyone in the company who has special knowledge or connections that the business relies on. The main question to ask is, “Would the company suffer significant financial, operational, and/or reputational harm if this person suddenly couldn’t work?”
The cost of policies varies according to the amount of the benefit, the age and health of the insured person, and the type of insurance (term or permanent). For those on the fence about purchasing key-person insurance, it’s worth remembering the truism that people are any company’s biggest asset—which means that losing them unexpectedly is one of its biggest risks. Paying the relatively small cost of an insurance policy to protect against this contingency is the first and most sensible step toward business security.
[i] “Family Business Contingency Planning: ‘What Happens If…’.” Family Business Experts.
[ii] Social Security Administration. The Faces and Faces of Disability. https://www.ssa.gov/disabilityfacts/facts.html
[iii] Statistics Canada. “A profile of persons with disabilities among Canadians aged 15 years or older, 2012.” https://www150.statcan.gc.ca/n1/pub/89-654-x/89-654-x2015001-eng.htm#a1
[iv] Green, Jeff. “Dying on the job: CEOs’ ages forces investors to reckon with succession.” Financial Post online, Jan 2018. https://financialpost.com/executive/ceos-age-forces-investors-to-reckon-with-succession-correct
[v] Green, “Dying on the job.”