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Key Man Loss

KEY EMPLOYEE INSURANCE

A study conducted in 1990 by Dun & Bradstreet indicated 47% of all business failures are attributable to a lack of management and finances. The death of a key employee can cause serious problems for the business. To help protect against this loss, the business can acquire a life insurance policy on the life of the key man or key woman.

The business entity owns the policy and pays the premiums. The premiums are not deductible and the death proceeds are received income tax free*. Proper amounts of key employee insurance are core considerations in any risk management program.

The life insurance proceeds received by the company can be used for a variety of purposes, including:

1. Recruit and train a new employee to replace the deceased. Determine the costs of replacing a key executive. What are the up front recruiting and incentive costs associated with bringing on a new key employee? Additionally, the training costs are expensive in both financial and time measurements.

2. Help replace lost profits that would have been earned had the key employee not died. What percentage of profits is attributable to the key employee.

3. Provide funds to continue the employee's salary to his or her family for a period of time, or to purchase the business interest owned by the decedent.

4. Pay a tax-deductible employee death benefit to the deceased's family or estate. Generally up to $5,000 can be received income tax free by the deceased employee's estate or beneficiaries.

5. Strengthen the company's working capital and balance sheet, which may help reassure other employees, creditors and investors about the continuity of the business.

Many guidelines can be used to determine the dollar value of a key employee. A multiple of the person's compensation, estimating profits lost, or the replacement method are examples. Sound planning should examine all the methods to determine the appropriate amount of insurance coverage to insure the key employee.

*Companies subject to the corporate alternative minimum tax provisions may be subject to minimum tax on policy earnings and death benefits in excess of the company's investment in the policy.