Every team member in a company is important. But some employees are simply essential, especially founders, C-suite executives, anybody with specialized knowledge or experience integral to the smooth running of the company, or someone who brings in a good portion of the revenue.
Losing these folks would be hugely damaging to the company in the short-term and could also impact the long-term outlook for the business. And they aren’t easily replaceable.
This is especially so with SMEs, lower middle market companies, and startups where things are often held together by the vision of those who started the business and are still hands-on every day.
In insurance terms, one of these folks is known as a “Key Person.” And there is a specific type of insurance to help companies bounce back if this person dies.
It’s not something that is pleasant to think about – especially if you’re the Key Person. But these are essential conversations to have, and there are specific actions you should take to make sure the company is protected in case the unthinkable happens.
Key Person life insurance is a specialized type of life insurance policy that pays a business upon the death of the insured (the key person).
The payout is supposed to give the company time to keep things running until they can find a replacement. (If the person is not dead but rather disabled and unable to work, that can be covered in one of these policies as well, as long as a disability rider is in place.)
A key point here is that the business owns and pays for the policy – making it a company-owned life insurance policy. However, the employee does have to consent to having this policy written and having the company as the beneficiary. This consent – in writing – is required by insurers.
Who Needs Key Person Life Insurance
The long and the short of it is that pretty much any company needs Key Person life insurance. Like many things, it’s something you probably won’t need… but if there is an incident and you don’t have coverage, it creates immense difficulties.
But it’s especially important in the M&A world and has become a go-to coverage for PE firms, hedge funds, and VCs. It has to do with the way these types of organizations are organized.
As Lynne Rosenberg, President of our affiliate Innovative Solutions, put it in our recent conversation:
“All of them rely on an individual’s ability to make deals happen.”
Sounds like a key person, doesn’t it?
Lynne explains that there are immediate economic consequences if a person like this dies or becomes disabled. Says Lynne, who says this coverage is like “leveraging life”:
“Do we want to put the company in that position? No. Life insurance is a tax-free cash infusion into a business to buy time, so that the business has the ability to make choices, have flexibility, and protect its economic viability and interests.”
This coverage is so important for these types of companies because they are very much people-centered. Investors are putting their money in a person. And when that person is gone, there is a lot of uncertainty and create unwelcome publicity.
Lynne explains that being able to announce that there is a succession plan in place at the same time as you announce the loss of the Key Person goes a long way towards calming things.
The advantages of Key Person life insurance are clear. But, says Lynne, very few essential folks at VCs, PE firms, or hedge funds actually carry this coverage. It’s a step that many attorneys and other M&A advisors miss. And that can prove disastrous when insurance like this would make things so much easier.
Take this scenario that Lynne laid out:
Say you and I are partners in a PE firm, and we have a Buy-Sell Agreement in place. The funding is in place. But then one of us dies, and we are each a 50% shareholder. Who gets that stock and how will they pay for it?
“[This insurance] provides the funding – the cash – in a very tax-efficient manner to make that agreement actually happen.”
Lynne explains that when she sets out to write one of these policies, she first looks at the Buy-Sell Agreement. This document will lay out what is to happen in the case of the death of one of the partners and in what timeframe and in what amounts. Then she goes to the life insurance marketplace to find coverage for the individual or individuals in question so that the money is available to actualize what exactly is in the Buy-Sell Agreement.
The process takes from 30 to 60 days, and there are many carriers to choose from. This competition means more favorable terms and pricing.
Lynne does caution that many people mistakenly assume that they cannot get life insurance, even older folks with chronic illness. With so many carriers, some might reject the application, others will be fine with health issues.
She says there is flexibility with this insurance and often you can find the appropriate product that works in your case.
I would also add that trying to “do it yourself” with this coverage is a bad idea for two reasons.
- Going on your own limits the amount of coverage you can get.
- You could “poison” the well with insurance companies by submitting an application that Underwriters reject or makes them ask a lot of questions. Having a pro broker prepare applications that answer questions Underwriters might have… before they ask them… can go a long way to getting the right policy in a timely manner.
Your Next Steps
If you’re in a business partnership you need Key Person life insurance. Really, you need this coverage no matter how your company is set up… you no doubt have an essential person – or persons – whose loss would immediately impact the business.
These policies would give you breathing room to reorganize the business while keeping it running. And that’s something those in the C-suite, the rank and file, and investors can appreciate.
If you have any questions about this type of coverage, please reach out me and I’ll immediately connect you to Lynne Rosenberg, who specializes in key person life insurance.
You can contact me, Patrick Stroth, at pstroth@rubiconins.com for information on other M&A transactional liability insurance products.