How successful do you think Barcelona FC would have been without the contribution of a certain Lionel Messi? Or perhaps The Beatles without John Lennon? Or maybe Apple without Steve Jobs?
The truth is that these diverse organisations/groupings would not have generated anywhere near the levels of success and plaudits without their star performers – their indisputable game-changers.
Now think about how your own business would likely perform should your critical, star employee(s) become debilitated – or worse still, pass away? How badly would the company be impacted should their supreme expertise within the business suddenly cease to exist? Indeed, their skills might be so exceptionally rare that, in their absence, the very survival of your business is now under serious threat.
Keyman Insurance to the Rescue…
According to the research, top performers are three or even four times as valuable to their respective businesses compared with an average employee. Keyman insurance (also known as “key person insurance” and “key employee insurance”) represents a crucial way for companies to protect against the losses that are likely to arise following the death or incapacitation of those critical performers.
It could be the brilliant CEO, the visionary Founder, or the outstandingly-performing Executive such as the leading Sales/Marketing Manager. The policy can also cover employees with specialist expertise that is extremely difficult to replace, such as the company’s ‘IT wizard’.
By failing to plan for the potential loss of these hugely talented people, you could end up losing greater sums of earnings than you might imagine – lost sales, lost customers, lost contracts, a severely shrunken knowledge base and skills base within the company, and ultimately, substantial losses in earnings and profits.
Keyman insurance is thus a life insurance policy that is taken out on those essential assets. The policy provides financial protection in the event of having lost someone who had proven themselves utterly indispensable for the previous success of the business.
It is also worth noting that the key person himself/herself neither pays the insurance premium nor personally receives any portion of the payout from the policy. Rather, the policy is set up on the life of the employee, with the business paying the insurance premium and receiving the payout from the insurer when appropriately triggered.
Nonetheless, keyman insurance can be an ideal way to indicate to your most important employees that they are highly valued assets – and how significant their loss will be to the business.
Keyman Has Key Benefits!
It’s fair to say that all companies value the safeguarding of business continuity highly among their long-term priorities. By providing the appropriate sum to help businesses endure the loss of their top-performing personnel, Keyman insurance can prove vital for facilitating business continuity through difficult times.
The policy also tends to offer considerable flexibility – typically there are no restrictions on how this death benefit is spent. The funds can be used for any expense, including daily operational costs, and the costs of recruiting a new hire.
Of course, replacing that star performer is always going to be a distinct challenge, but keyman insurance can cover many of the costs associated with bedding in a new employee, including the training expenses, as well as costs associated with advertising the role and interviewing job applicants.
Should the key employee own a stake in the company, moreover, the policy’s payout can be used to acquire this stake. This is more common among business partnerships, when the payout can fund the buyout of a partner’s shareholding to retain control over the business.
In this context, small businesses – especially partnerships – often find it useful to additionally acquire a Buy-Sell Agreement. These legally-binding contracts determine how businesses continue to operate in the event of one partner either leaving the business, retiring, becoming disabled, or passing away, typically by using the funds from the life insurance policy to acquire this partner’s equity in the business.
So, while key person insurance protects the business against losses from the loss of contribution of valuable employees, buy-sell agreements protect the remaining partners when one of the partners leaves, retires, becomes incapacitated or dies, and are frequently updated to reflect changes in the business’ earnings and balance sheet.
There are two main types of buy-sell agreements:
- Cross-Purchase Agreements – where all partners in a business purchase key person life insurance policies on each other, such that should one partner pass away, the other(s) can ensure business continuity and/or buy out the deceased partner’s family.
- Entity Purchases / Stock Redemption Agreements – where the business owner uses life insurance proceeds to purchase an owner’s shares should they pass away.
Furthermore, a Wait-And-See Agreement combines many of the desirable features from each of the above two types of buy-sell agreements, such as neither the explicit naming of specific partners nor the entity. When triggered, however, the agreement then opts for one or the other, typically depending on what’s preferable for the prosperity of the business.
Keyman insurance funds can also be used to manage the company’s outstanding debts. This explains why businesses often take out this policy when also applying for financing such as a bank loan – say, to pay for office space or equipment – as the policy’s payout can eventually be used to pay off this debt. This can be pivotal in limiting the overall impact on the business and preventing its closure.
But if the hit taken to the business is just too much to continue operations, the funds can help ease the pain of the closure of the company via employee severance packages, repaying creditors and paying investors.
Offshore Insurance Trust Enhances Asset Protection
Having keyman insurance in place for all key employees helps in enhancing the business’s value in the long run, especially with regards to the owner’s succession planning and/or the sale of the business.
As a type of life insurance policy, moreover, keyman insurance is often best structured through offshore ownership, ideally in a trust, which is typically set up to transfer assets from one party (the Settlor) to another (the Trustee) in an overseas jurisdiction for the benefit of one or more individuals (the Beneficiaries).
In the case of a life insurance trust, the Settlor transfers the ownership of their life insurance policy to a trust, while the Trustee manages its benefits. When the Keyman dies and the policy is triggered, the death benefit is paid to the trust, and the Trustee distributes the payout as per the terms of the trust document
As such, this trust structure can offer distinct advantages for the keyman life insurance policy (and also business insurance options that offer pivotal risk management from the likely losses incurred to a business from the employee’s unfortunate death or disability) in a number of important ways:
- Favourable tax benefits – not only are the most popular offshore trust locations such as Labuan found in tax havens and thus have lower tax rates on trust income, they offer distinctly favourable tax treatments, such as reduced or zero capital gains, inheritance, or wealth taxes. As such, this can prove the optimal solution for estate planning.
What’s more, offshore jurisdictions have lower tax rates on trust income, providing a more efficient environment for asset growth. In the case of Labuan, a mere 3% percent tax is imposed on the audited net profits of trusts, while the distribution to beneficiaries of a trust is exempt from taxation.
- Additional layers of protection for your assets – offshore trusts typically adopt legal frameworks that protect assets against such threats as asset seizures, predatory litigation, and confiscation by a government. This protection can also indirectly aid in tax planning.
- Confidentiality – trusts offer an additional layer of asset protection when anonymity is crucially important to your business.
As a Business Owner, Do I Need Keyman Insurance?
If you consider your staff to be your most important asset then the answer to this question should be a clear YES. Keyman insurance thus makes particular sense for smaller businesses as they tend to more intently rely on employee performance to deliver during this crucial phase of growth, although this life insurance is hugely popular among businesses of all sizes.
In terms of the specific amount of cover, formulas that are commonly adopted include:
– Basing the amount on the key employee’s earnings – for example, 10 times for the employee’s death, or 5 times for a disability.
– Basing the amount on their contribution to profits – for example, 2 times the gross profit amount that’s directly attributable to the key employee.
By all means, your company should be aiming for the very highest echelons of success. But if you don’t prepare for the worst when your own business version of Messi / Lennon / Jobs disappears – your company should be sufficiently funded to be able to cope with this loss.
