How much Key person insurance do you need?
What’s the impact on the sudden, unexpected loss on the Company’s ability to survive?
Sudden drop in profits and revenues
The loss of a top salesperson affects revenues and profits. Will there be layoffs, excess inventory? Will major clients defect to competitors? What will it take to find, hire & train a replacement? How long will this take. Include employment agency fees.
The loss of a top engineer or scientist can affect the Company’s Future Intellectual Property, and perhaps the defense of existing Intellectual Property.
The loss of a founder or key executive affects the strategic direction of the Company, making lenders and investors nervous.
What does it take to service debt and continue operating until a replacement is found, hired & trained?
Consider the Replacement Costs and the Contributions to Earnings
The impact of a sudden lost of a key person and the impact on current and future revenues, earnings, ongoing competiveness and the Company’s ability to continue to service debt service. If the key person is contributing half the profits, how will you service debt?
What would it take to remain competitive in your industry?
Loss of a key engineer or scientist could negatively impact the future competitiveness and intellectual property of the Company. What would it take to replace such a person? Salary, stock options, moving & training costs, employment agency fee?
The loss of a top sales person on revenues & profits could impact the whole enterprise, result in layoffs, lost business to competitors and lost shareholder value. How fast can you find and replace the lost talent and at what costs? How long will you have to service debt before a replacement is found and is up to speed?
Multiple of Salary
Underwriters typically allow 5 to 7 times salary, bonus and percentage share of profits if the key person is an owner. For example, using a 5 multiple, a key person earning $200,000 would allow a $1,000,000 policy. Each case has its merits. A higher or lower multiple may be justified. Some Key people are more valuable to the Company and harder to replace.
In addition to income of the key person, the underwriter will want to know why the key person is valuable enough to the business enterprise to be considered a key person. They will consider the role the person plays in the business, their experience and special skill or knowledge they possess.
If indemnifying a business loan, the underwriter will want to know the history of the business, the reason for the loan, loan terms, loan collateral and financial statements of the business.
If the key person insurance is funding a Buy-Sell Agreements, the underwriter will need to know ownership percentages, copies of the Agreements, Company valuation (or formula) and Company Financial Statements.
The insurance company needs the above information to accurately assess facts and financial risk of issuing the policy, in order to make the best insurance offer.
Bruce E Cox CPA
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