Small to medium size businesses are often dependent on one or two key individuals. The loss of one through either death or disability would place significant financial pressure on the company. The purpose of key person assurance is to cover this scenario.
Financial pressure will result from the loss of a key person by way of loss of income due to specific knowledge lost, additional costs incurred to recruit and train a replacement, and loss of goodwill as customers may be less inclined to deal with a new recruit.
Key man assurance can help to ease this. For example, John Doe brings in 60% of all sales for ABC Company. If John where to unexpectedly die or become disabled it would severely affect ABC Company’s cash flow. If however ABC Company had key person assurance on John’s life; they will receive a lump sum to supplement the lost profit that John would have generated. The funds can be used to stabilise the business until a suitable replacement is employed who is capable of being trained to have the same key skills. Key person assurance can bridge the gap and enable the business to operate efficiently through, and after, the ordeal.
Key person assurance can be used to:
▪ replace the revenue the key person would have generated
▪ pay the extra costs the business incurs in finding a suitable replacement.
In either case, the profitability of the business can be maintained, and the business stabilised, when key person proceeds are available.
Some other areas of business profitability that can be affected are:
▪ Sales/revenue – The loss of a key person directly responsible for sales can result in a fall in sales until a replacement is found and the replacement person starts to generate similar sales results.
▪ Recruiting costs – The costs incurred by a business to locate, attract and recruit a suitable replacement can be considerable and will lower business profit.
▪ Training costs – The replacement key person may require expensive specialist training.
▪ Destabilisation – A key person is an integral member of the business. The loss of a key person can also indirectly affect business revenue. Short-term internal reorganisation can cause remaining staff to take on extra duties. The extra pressure put on those people may prevent them from performing to their usual standard.