You may not think life insurance and business insurance are related, but they are. Most small business owners (SBOs) carry a general commercial policy to protect against routine business risks – fire, employee theft, business interruption coverage, business liability and other protections against risk.
Having a life insurance policy can protect the company against the sudden passing of a business owner or key employee. Why is life insurance on SBOs (and top level management) so important? It can keep your business operational while the company adjusts to a new manager, or even a new owner.
Life insurance takes care of families when the breadwinner passes on, but a life insurance policy on a business owner or top level manager (key man insurance) can get your company through difficult times, at times when no one is thinking clearly, products still need to be shipped, projects completed, and services delivered.
Here are some typical questions asked by SBOs concerning life insurance, who should be covered, and what type of life insurance is best for the business.
How does life insurance protect your small business?
A life insurance policy on an SBO helps in a couple of ways to keep the business moving forward, even if the owner is no longer involved in day-to-day operations.
It enables other owners to execute a buy-sell agreement that ensures that, if a co-owner dies, the remaining owners have the capital required to buy the business. A buy-sell agreement details terms of ownership if owners leave, pass on, retire, or opt to sell their ownership stake. If the remaining business owners lack financial resources, that business can sink like a stone.
It’s important to routinely assess the value of the business and increase or decrease the amount of life insurance coverage each owner carries.
The founder and business owner may be the company’s most valuable asset – one that needs to be replaced quickly with an equally competent replacement. A life insurance policy on SBOs delivers flexibility and options to the remaining owners, the business itself, and of course, the employees who rely on that weekly paycheck.
What’s term insurance and how is it different from permanent insurance?
Term insurance is paid by the insurer upon the death of the insured. It’s low-cost insurance, it doesn’t build in value over time, and if you cancel your term insurance, you won’t receive benefits.
On the other hand, with term insurance you can set the dollar amount of coverage and how much and when the actual term payments will be made. Take out a $100,000 term life policy for 10 years and determine how much your beneficiary business receives each month to keep the business running.
Term insurance is recommended when your business needs cash until the building mortgage is paid off, or to find a replacement for the deceased.
Permanent insurance provides lifelong protection, with the full dollar amount of coverage paid in full upon the death of the insured business owner as long as monthly premiums are up to date. Permanent insurance also has an element of an investment because savings build and you, or your business, can borrow against the policy’s cash value.
Permanent insurance includes whole life insurance, universal life, variable life insurance, and variable universal life coverage. Unlike term coverage, permanent has no term, so if you buy this class of insurance early in the development of your business your premiums should stay low – an advantage your company will enjoy as the beneficiary of your permanent life insurance.
Who should be covered by term or permanent insurance?
There is no easy answer here, because each owner and insured key person delivers different benefits and skills that contribute to the successful operation of the business.
When determining which employees to insure, and for how much, ask questions. What are the tangible and intangible benefits and value an employee brings to the workplace? The more indispensable the employee, the more coverage may be required.
Another question? How much could the company lose if it can’t find a replacement for the deceased? If the “secret formula” is stored in the SBO’s head, and the owner passes on, the company may have to shut down. Recognize the value each employee brings to work each day. Assign the dollar amount it would take to replace that critical employee and add more coverage to these essential employees – at least enough to replace the SBO.
What are the costs of recruiting, training, and keeping in place a key employee to replace the deceased SBO?
How will clients, customers, vendors, sub-contractors and others feel when a key employee passes away? If too many clients lose faith in the business, you may no longer have a business. Prepare with ample insurance to help protect your company and its assets – from machinery to patents to office furniture.
How can I start creating an insurance portfolio?
Talk to your CPA and your insurance agent to determine just how much insurance each key employee should have to help protect the smooth operation of the company. It would also be wise to discuss this with your business banker if your company, like most small businesses, has outstanding business loans and mortgages. You should have enough insurance to make sure these loans can be paid off.
Discuss other business needs to develop a strategy to keep the business growing, even after the death of the company’s beloved founder. At this stage, the business is valuable to employees and other stakeholders. Your team of trusted professionals, including your banker, can help you navigate the difficult waters when there’s a death in the business.
The information provided is presented for general informational purposes only and does not constitute tax, legal or business advice.