Author: Dick Hartzen
It may surprise a client to find that the company’s most valuable asset was not insured. This would be especially upsetting for an insured who felt that there was always needed coverage in effect. Property, liability and business income insurance were purchased to eliminate serious losses. What went wrong? Why wasn’t this possible major loss brought to their attention and why wasn’t it insured against?
A piece of equipment that is required to generate a product should be insured for replacement value. If this piece breaks down, loss to the item and loss of business income may be minimized with proper coverage. Salaries, rent, insurance premiums, equipment contracts and the usual business expenses continue despite a loss of income. An often overlooked item is that this valuable piece of machinery may be a key employee.
The firm may have a very important and integral employee that plays a large part in the company’s success or failure. He/she may even be the reason for their success. This employee may receive a larger salary or bonus to assure his/her retention. The thought of this employee leaving and working for a competitor may be a constant fear.
This employee may be a sales person, manager, account developer, construction worker, secretary, product engineer, business partner or other essential person. Expansion plans may be based upon the continuing services of this key employee. Without his/her skills, needed income may drop substantially. A serious problem may occur if the key employee quits, dies or becomes disabled. These problems must be analyzed along with several possible solutions.
Death
Death of a key employee may result in:
loss of income for the business,
additional income required to find a replacement (including some failures),
loss of clients that fear for the company’s future,
loss of current employees that worry about the company remaining viable,
concerned creditors modifying current practices,
immediate decline in the value of the business.
A well planned life insurance policy could solve most of these problems. The effect of the loss of income could be eliminated. Concerns from clients, employees and creditors would be minimized. Even the value of the business may not suffer greatly.
A policy on the key employee (his/her approval required) would be purchased by the employer. The premiums are not tax deductible despite the fact that it is being used to protect the business in planning and insuring against losses. The premiums not being tax deductible permit the proceeds to be received income tax free. As the proceeds are being used, they are usually paid out for business deductible expenses.
The business should be shown as the owner and beneficiary of the policy. If the insured is left as the owner, he/she may change the beneficiary at a future date and leave the employer without this needed protection. Another method of protecting the employer can be accomplished by naming the employer as an irrevocable beneficiary.
Retention
An amount of insurance purchased over the needed figures could be used as an incentive for an employee to remain. Example: $200,000 is needed to protect the business. A policy for $300,000 is purchased. The key employee is told that upon his/her death a benefit of $100,000 will be paid the employee’s beneficiary.
A deferred compensation incentive may exist if a cash value policy is purchased. The employee may be offered a certain amount of cash upon completion of some time in the future if still active with the firm. Example: If attaining 20 years of service, a $50,000 (the cash value of the policy) bonus will be earned and paid.
The promise of a death benefit or a living bonus may be "golden handcuffs" used in retaining key employees. The term "key person" should accurately be referred to as "key employee"! Many of the key employees are women.
Disability
The same problem may exist should the employee become disabled. Expenses and concern increase as income decreases. The odds on an employee suffering a disability are far greater than that of death! The financial harm caused by the employee’s disability can usually be insured against with a minimal of problems.
Age Number of Number of Disability
Disabilities Deaths vs. Death
per 1000 Lives* per 1000 Lives* Ratio
--- --------------- --------------- ----------
27 5.17 1.46 3.54 to 1
32 5.36 1.64 3.27 to 1
37 7.45 2.14 3.48 to 1
42 10.22 3.22 3.17 to 1
47 13.93 4.68 2.98 to 1
52 17.52 6.82 2.57 to 1
57 23.02 10.23 2.25 to 1
* Source: 1985 Commissioner’s Individual Disability Table B, 1980 CSO
There is a 30% chance that a person will suffer a 90 day or more disability prior to age 65.
A disability income policy written on the employee would provide the funds to alleviate most of the problems. Once more, the employee must agree to the coverage. The company would pay for the premiums (non-tax deductible) and be the owner and beneficiary. The benefits would be received income tax free and usually be used for business tax deductible expenses.
If the person is an owner or a key employee, IRS allows a Business Overhead Expense Policy (IRC-REV. Rule 55-264-1CB11) to deduct the premiums as a business expense. The income would be taxable if received, but once more used for tax deductible expenses. There is usually a two year limit on the paid benefits.
The following items may be included in the amount of coverage:
rent,
interest payments of some business debts, utilities, employee’s salaries and payroll taxes, postage an stationery, equipment maintenance, office equipment fees, property taxes, workers compensation, group health, insurance, accounting fees, professional memberships and subscriptions.
Another serious concern may arise if the disabled person is a key employee. To guarantee that they will return after recovery may require a continuation of their salary during the disability. A salary continuation disability income policy may help the employee decide to return. His/her decision may change if income is not paid during this out of work period.
Copyright 2009 by Richard I Hartzen. Used with permission.
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