Key-personnel insurance creates cash flow, reassures creditors
July 13, 2012
Key-person insurance —often referred to as “key-man” insurance — involves the use of life insurance to create immediate working capital for a business to meet urgent cash needs and find a replacement in the event of the death of a business owner or key executive.
Business owners and key managers spend considerable time and effort acquiring the knowledge, experience, relationships, and skills that make them valuable to the business. The death of a key person can have a severe financial impact on the business.
Lenders may suspend or limit credit or even call loans; creditors may press for immediate payment; debtors may delay making payments; and employees and customers may lose confidence. The spinoff of this is that competitors may seize the opportunity to take advantage of the situation. Life insurance provides the business with funds to meet these potential urgent cash needs.
So what should the business owner consider when determining the amount of insurance needed? The answer lies in three key areas: cash flow required, possible changes to credit, and replacement cost.
Understanding cash flow needs requires knowing how business operations will be disrupted. Predicting how loss of a key staff member will impact sales, production, and customer service and for how long will go a long way in easing the transition.
Will the loss of your key person affect your company’s ability to secure credit? Will the terms of existing loans change? Will suppliers change credit arrangements? Will an existing bank loan have to be repaid on the death of a key person? These questions need answers and require a deep understanding of the terms of all loans.
Finding an immediate replacement with the same skills and qualifications can be difficult in small businesses. These questions must be answered:
Determining the right amount of insurance is not an exact science. However, most experienced life insurance brokers have analysis tools available to them to use as a starting point.
The most important step in the whole process is recognizing that life insurance is the most economical and tax-effective way to push cash into a company. It is also the most common solution in the business market today.