The untimely death of a business owner or someone else critical to the enterprise can be devastating, causing it to fail or requiring time and money to get the company back on its feet.
’Key-person’ life insurance can help soften the blow by providing an injection of capital that can be used to compensate for lost contracts and customers, keep up the staff payroll, pay off outstanding debt, cover the cost of recruitment and training as well as pay for overhead and incidentals.
“There can be a sudden, traumatic impact on the business,” says Simon Tanner, principal financial advisor with the Dynamic Planning Partners team at Investia Financial Services Inc. in Vancouver. “The money provides security, it provides flexibility and it provides operations.… You can be able to keep the doors open and keep things healthy during an uncertain time.”
Mr. Tanner says that beyond key-person life insurance, companies can consider other options for such disruptions, depending on the circumstances. Critical illness insurance can cover the cost of replacing indispensable people who are out of work for extended periods on medical or disability leave, while buy-sell agreements provide insurance when a partner in a business dies or becomes incapacitated for an extended period.
“It’s all part of a bigger conversation,” he says, starting with an awareness that certain people are assets to the business that will have to be replaced – and pose a detriment to the company – if they are absent. “It’s an important element of ‘what if?’ planning.”
Businesses should identify their key-person insurance needs and educate themselves through a broker or adviser about the best products to fit their situation, says Michael Aziz, co-president of Canada Protection Plan (CPP), which develops and markets life insurance products. He says that all small businesses, from the professional offices of doctors and lawyers to franchises, are vulnerable to being upended if the principal or someone critical in the operation suddenly dies.
Companies need to identify persons with “insurable interest,” without whom they would suffer a loss, and determine the type and amount of insurance that’s appropriate. For example, should it be term insurance that covers a specified period or permanent insurance that lasts for life? The amount of coverage might be dictated by the expected impact on the company’s cash flow of losing the key person, which should be determined in conversation with financial planners, accountants and lawyers.
The company pays the premiums and is the beneficiary of the policy, so it receives the insurance payoff.
While the benefits can be significant, Mr. Aziz says many company founders and owners don’t get around to getting key-person insurance. “The problem with entrepreneurs is they’re go go go,” he says, and many think “I’ll do it later, it’s really not a priority right now.’”
Al Roissl, a certified financial planner and managing director of Desjardins Financial Security Independent Network in Mississauga, Ont., says that key-person life insurance is something to think of at an earlier stage. That’s especially true because senior executives can be hard to insure due to health issues, although life insurance policies arranged through companies such as CPP that don’t require a medical examination are also a possibility.
There are some options that give key people in the company an incentive to stay healthy and remain on the job, which is especially useful given the cost and time involved in replacing them, Mr. Roissl says. For example, an executive health savings plan, also known as shared ownership critical illness insurance, compensates the company if the employee becomes ill or dies but pays out the accumulated premiums to that same employee if he or she remains healthy and stays on the job until a set age, which is an important retention tool. “It’s a double win,” he says.
Some companies come up with unique forms of contingency plans and funds so the firm can keep operating in the event of illness or death, Mr. Roissl says. However, he often sees companies that spend time and money working on agreements but then do not actually finance them or get around to arranging for the insurance required.
“They think that nothing is going to happen to them, but unfortunately stuff happens,” Mr. Roissl says, warning that those who are left behind can end up “forced into a corner,” with the company going into bankruptcy or sold at fire-sale prices.
“You can think a lot more clearly when you don’t have a huge financial burden to deal with,” he says, noting that many business owners are “one-person shows” but they feel especially loyal to their staff and don’t want the company to stop running if they’re suddenly incapacitated or pass away. “You’re trying to mitigate risk.”
Mr. Tanner says that many entrepreneurs focus on the success of their business rather than the potential pitfalls, especially as their enterprises grow in scale. Meanwhile, their own value is rising, which is precisely the time to take precautions. He knows of a company where one of three partners died and the business suffered a 40-per-cent revenue drop in the two years following his passing.
“There were some dark days when they were saying, ‘Is the business going to recover?’ It took them six years to come back,” Mr. Tanner recalls, while key-person life insurance would have made a big difference. “That injection of liquidity would have given them flexibility and less stress in that situation.”