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Insuring for the Future for Small Businesses Part 3: How Can Insurance Help Me Plan for and Protect Against Personnel Turnover?

By August 20, 2014April 3rd, 2015Insurance, Startups

The people are the heart of any business. However, while businesses can live on in perpetuity, people move on to different opportunities, retire, or pass away. Insurance can help alleviate the impact these changes have on a business. The two most common forms of insurance are Key Person Insurance and Buyout Insurance. Although these insurance policies are oftentimes conflated, they provide distinct advantages to a business and careful consideration should be given to whether the policies are necessary.

Key Person Insurance
Key Person Insurance protects a company from financial hardship in the event that a key employee becomes disabled or dies. A key person is someone so critical to the business that without that person business essentially stops. In a small business, this person is typically the owner, because he or she keeps the books, manages the employees, and handles the key customers. In technology companies, key personnel may be those individuals with a unique skill set or a person with such an in-depth understanding or skill set that business would be substantially hindered without that person. Key Person Insurance can be either a disability policy or a life insurance policy or a combination. In any case, the business is the beneficiary of the policy.

Under a disability policy, the company can use policy proceeds to hire a temporary replacement. Generally, coverage is in the amount of the key person’s salary. It typically does not require a health assessment of the key person. Under a life insurance policy, the company purchases a life insurance policy on its key person. In the event of the key person’s death, the company receives the insurance payment, which it can use to soften the blow of the key person’s loss. Proceeds can be used for costs related to hiring a replacement, including recruitment and training, and to make up lost revenue. Proceeds may also be used to avoid bankruptcy and cover costs of winding down the business—paying off debts, distributing money to investors, and paying severance to employees.

Buyout Insurance
When there are multiple owners of a business, it is important to plan for the eventual death of one of the owners. This is important because the remaining owners may not wish to do business with whoever will inherit the deceased interest in the business. To avoid such an outcome, the survivors will need to be able to buyout the deceased’s successor. Buyout Insurance can provide just such a resource. In essence, the company purchases insurance policies for each owner. The proceeds of the insurance policy then finance the buyout of the successor’s share. This is typically carefully outlined in a buy-sell agreement, which states how the business value is to be determined, the circumstances under which a buyout would occur, and how the agreement would be funded with the proceeds.