What do Rita Hayworth’s legs and your trusted CFO John have in common? Both are valuable, irreplaceable business assets, worthy of insured protection. If John gets hit by a truck, both you and his widow may weep copiously at the funeral. But come Monday, it’s back to business, and with the sudden realization that he has passed on without passing on any of your company’s financial information, a very tangible sense of his loss will hit home.
Insuring against lost time, expertise, and sales until a replacement can be found and trained typically has been a consideration mostly for major corporate CEOs. Yet more often it is in the smaller firms that a handful of individuals hold irreplaceable knowledge or abilities.
To help companies determine the cost and value of such protection, the New Jersey Women Business Owners Association’s Business Center offers “Business Killers,” a free seminar taking place on Thursday, July 6, at 10 a.m. at the Gloucester County Business Center in Thorofare. Visit www.njawbo.org to register.
The seminar includes a video, skits detailing mistakes, and a panel discussion with speakers representing the banking, legal, accounting, and consulting industries. Gwen Faulkner, financial service professional with the MassMutual Financial Group, speaks to specific insurance strategies.
Growing up as an Army brat, Faulkner got used to a life of uncertainty. Her father, a flight engineer for C-141s, the Air Force’s huge workhorse planes, kept the family moving until they settled in at McGuire Air Force Base. After earning her bachelor’s degree in finance from Pennsylvania’s West Chester University in 2002, Faulkner became a trade processor for Vanguard Mutual Funds. “I witnessed traders who held knowledge that no one else in the company did and who could be counted on for substantial sales,” she says. Three years ago Faulkner joined MassMutual Insurance, and now works out of the firm’s Cherry Hill office.
Insuring key people has traditionally been seen as a compliment conferred by the directors and received as a status symbol by the executive. In smaller firms, such a policy, if employed at all, is generally taken out only on the owner. “But rank or past performance have nothing to do with key person insurance,” insists Faulkner. “It is a matter of determining the individuals whose sudden loss would effect the bottom line.” These may not necessarily be partners or upper management people.
Supposing a firm’s young sales manager provides excellent motivation and training for his sales force, and sales figures show that an amazing two-fifths of annual sales come from one aging senior salesman. Loss of the manager would entail a relatively short replacement time, with a small dip in revenue. But losing that senior salesman and all his clients might nearly sink the ship. Which of these two should be insured?
He’s worth what? Unlike a movie star’s body parts, a business person’s worth is fairly easy to calculate and less personal. The very first step before any insuring is to get an outside valuation of the company.
“This should be the real value of the firm,” says Faulkner, “not the under-valuing that we so often do for the IRS.”
Once the actual company’s value is determined, any individual’s percentage of that value becomes more apparent. In the case of a salesperson, it is easy to judge his annual revenue stream and figure the cost of, for example, a half-year’s replacement time. For a design engineer who is continually turning out new products, worth must be calculated in terms of the whole company’s profit picture.
Faulkner continually warns clients that insurance demands a constant reassessment of corporate value. Benefits for key person insurance depend not only on company growth, but also on the relative value of the insured individual.
Insurance as perk. Blending key person insurance in with the rest of the benefits package transforms a company safety net into a real hiring lure. For that trusted CFO to be worth anything to the firm, he must not only be alive, but also fit, alert, and able to sit at his desk and perform. This means that an increased health insurance benefit for that CFO is a wise investment.
Similarly, such additional insurances can be applied to that person’s pension plan at minimal cost.
“The whole trick to key person insurance is flexibility,” says Faulkner. “Every insurance company has standard formats, yet in each case the terms are something the company can design.” Blending in such additional coverages with the compensation package may tip the scales in your favor when top managerial talent is looking for a new home.
Buy-sell hedges. Business auction ledgers are rife with tales of partnerships reluctantly put on the block so the remaining partner can come up with the cash to satisfy the heirs’ inheritance. Whether the business has boomed or remained steady, partners’ fortunes tend to be fixed to their company’s growth. Thus, they seldom have enough capital to buy out the other partners’ shares.
A simple buy-out insurance plan on all the partners ensures that any surviving partner can pay off the heirs’ share without dissolving the business. Premiums here tend to be quite affordable. Yet before plunging into such an agreement, Faulkner suggests each partner get to know the heirs. Does each partner even have a will? Are the heirs interested in participating in the business, and is it worthwhile to bring them aboard now?
Ounce of prevention. There is a difference between responsibility and knowledge. It may be a fine thing for the CFO to take responsibility for every dollar in the company. It is absolutely foolhardy, however, for him to be the sole person who knows where every dollar is spent. The best insurance against sudden key person loss is to flatten the organization. By constantly sharing knowledge and preparing successors, the company is hedged against loss. This is also a good business practice because it tends to discourage fiefdoms and encourage morale, fresh ideas, and team play.
Insurance for life. South Brunswick CPA Gary Edelman was recently the recipient of another kind of key person protection. His major client was totally dependent on Edelman for his fiscal health. “He is one of those people who is an expert at making money, but has no idea how to handle it,” says Edelman, who spends long sedentary hours making his business run.
To ensure that Edelman would be around to handle his finances, the client gave him and his wife memberships to Golds Gym. “I can honestly say it was better for me than the car he gave me the year before,” says Edelman.
As a final caveat, Faulkner notes that while nearly all treasurers and CFOs are bonded, this does mean that they are insured. Bonding, in essence, protects the company’s safe. Insurance protects the individual, and his worth to the company. If a company is worth anything at all, it will probably outlive its current executives, so key person insurance is less a bet than an investment.
“After all, I’ve seen people insure their pets for $100,000,” says Faulkner. “Hopefully, your key people are worthy of being treated at least as well.”