Life Insurance Needs of a Business

Life insurance is used in business applications to insure key employees, fund buy-sell agreements, and in various compensation arrangements, such as in death-benefit only plans, Section 162 plans, split-dollar arrangements, and in qualified pension and nonqualified deferred compensation plans. The insurance need in most of these cases depends on circumstances peculiar to each case, and is beyond the scope of the current discussion. However, the insurance need in most key employee situations is amenable to a systematic and generic type of analysis, which is presented in the following paragraphs.

Key Employee Insurance

In most businesses, especially in smaller firms, one or a few key employees are responsible for a significant portion of the firm’s earning capacity. The premature death or disability, or an untimely resignation, of these employees can have a severe impact on the firm’s profitability, and may even cause the firm to fail. Noncompete clauses in employment/severance agreements, cross-training among key employees, and a management philosophy and practice of mentoring subordinates, along with attractive and properly-designed compensation packages, can help to prevent or minimize the risk of early resignation. Life and disability insurance on key employees is the logical choice to help the firm weather the financial loss of a premature death or serious disability. But the critical question remains —how do you determine the insurable value of the key employee to the firm?

A commonly held maxim of management is that no one is irreplaceable. That is generally true, but it does not mean that replacement is costless and that full value can always be recouped. In any event, the loss of a key employee will generally cause business and management disruptions and will entail a period of adjustment before a new replacement is up to speed and the company can adapt to the new arrangements. A properly designed insurance plan can provide the funds necessary to finance the transition period. Since most companies, and especially smaller firms, do not have unlimited cash resources for insurance premiums, it is critical to have enough, but not too much insurance.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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