One afternoon early in January, I received a stunning text message …
Peter Donnelly (name changed), the key employee of my client Dale Bingham’s company (name changed), had been killed in a freak accident. My client was just touching down at the airport, and was then on his way to be with Pete’s widow. Pete was like a son to him, and this was not going to be easy for anyone.
I felt a deep sense of loss and sadness. Peter was a terrific guy … full of spunk and someone who had lived life to its fullest … and he was going to be truly missed by everyone. Not only was his loss a major blow to his family and friends, but what was going to happen to the business, customers and other employees now that he was gone? Would the company be able to continue?
Pete had been with the company for over 20 years. More important than his day-to-day activities, Pete was responsible for most of the long term relationships that had been developed with their loyal customers. When Dale bought the company in June of 2002, Pete made the transition to the ‘new owner’ almost seamless with the customers, vendors and the other employees following his lead. He was the key man in the business.
The seriousness of the situation turned gradually to a profound sense of relief and thankfulness. Barely three months before, we had put a key person life insurance contract into effect on Peter’s life, with the beneficiary being the business. We couldn’t guarantee Pete’s life … but we could guarantee that his loss of life would not cost the business its life, too. I was relieved and thankful that Dale had been willing to consider the wisdom of insuring Pete, and then take action to obtain the coverage even though Pete’s lifestyle and habits made his insurance premium quite a bit greater than expected.
That decision very likely saved the business. At a minimum, it gave them tax-free working capital to insure several years of profits, and the extra money with which to hire (or steal!) a replacement for Pete.
Key person insurance, also commonly called key man life insurance and key man disability insurance, is an important form of business insurance. According to wikipedia.org, the free on line encyclopedia, “There is no legal definition for “key person insurance”. In general, it can be described as an insurance policy taken out by a business to compensate that business for financial losses that would arise from the death or extended incapacity of the member of the business specified on the policy. The policy’s term does not extend beyond the period of the key person’s usefulness to the business. The aim is to compensate the business for losses and facilitate business continuity. Key person insurance does not indemnify the actual losses incurred but compensates with a fixed monetary sum as specified on the insurance policy.
An employer may take out a key person insurance policy on the life or health of any employee whose knowledge, work, or overall contribution is considered uniquely valuable to the company. The employer does this to offset the costs (such as hiring temporary help or recruiting a successor) and losses (such as a decreased ability to transact business until successors are trained) which the employer is likely to suffer in the event of the loss of a key person.”
As defined above, key person insurance refers to both life insurance and disability insurance. And, both are equally important to businesses. As was the case with Peter, unexpected death does happen. An even greater and more common risk is long term disability. Securing both key man life and key man disability on all key employees is the best option for minimizing risk.
Not all key employees are easily insured. Pete had led a very active lifestyle. Although he was only in his early 40’s he was a smoker and he thrived on adventure. He lived hard and fast. Dale did pay more for the premium on Peter’s life insurance than most would have cost. But a special note, even when life insurance proves too costly or worse, unavailable, accidental insurance may be a good solution.
It is important to mention the ever changing tax laws. Since August 17, 2006 the Pension Protection Act of 2006, which includes the COLI Best Practices Act, requires all employers to report annually all business-owned key person life insurance policies to the IRS. If proper record keeping and reporting is not maintained, and the Notice and Consent requirements as well as the Exceptions and Record Keeping and Reporting requirements are not met, the tax burden for the business can be significant. Unfortunately many CPA’s are unaware of Form 8925 that must be filed annually.
The loss of Peter Donnelly will have a big impact on Dale Bingham’s business for many a long time to come. But with the good fortune of a key person life insurance contract in place, the company has been able to maintain stability during the initial adjustment period. Although most of the 120 company employees will tell you they’ve been deeply affected by Pete’s loss in January, the business is now back to an almost normal rhythm, and the future feels secure.
Dale hasn’t been able to fill Pete’s shoes yet with just one person, but the customers and vendors have all stayed with the company thanks to the key person insurance which created a business-as-usual confidence even with Pete gone. Key person life and disability insurance can save your company from being dramatically impacted when “life happens”…..Having a stream of income after an untimely accident can:
- Buy you time
- Insulate your profits
- Insure continuity
Contact R. J. Kelly (858) 569 – 0633
Written by R. J. Kelly – August 2012