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Business Planning

Protecting Your Business "Keys"

If you employ a key person who significantly contributes to the success of your business, have you considered the impact losing him or her could have on your operations? Key person life insurance can help protect your business from the financial consequences of a key employee's death. Consider the following hypothetical case study.

Peter Mason, a chemical engineer with a degree from MIT (Massachusetts Institute of Technology), works at Precision Plastix Inc., a plastics fabrication company in Detroit, MI. In his seven years with the company, he has developed several important compounds, in addition to an innovative new process for manufacturing automobile engine blocks. Because he has been so instrumental to Precision Plastix, and his work has propelled the company to the forefront of its industry, Peter is considered one of the company's most key employees.

Precision Plastix's owners, William Tate and Gordon Hayes, realized the importance of Peter to the lifeblood of the company and established a key employee life insurance policy. Such a policy can be of great benefit in the event of the loss of such a valuable employee.

How Does the Employer Benefit?

A company, such as Precision Plastix, may benefit from life insurance held by the company on key employees by the following:

  • Proceeds of the policy can provide Precision Plastix with funds to compensate for the loss that could result in the event of such a valuable employee's death. The company could then use the money: to recruit a new employee with credentials/capabilities similar to those of Peter Mason; to train the new employee; to promote additional sales; or to provide for new improvements that would eventually compensate for the loss sustained as a consequence of the death of such a key employee.
  • Life insurance on a key employee could provide Precision Plastix with an accumulation of funds to be used in emergencies. Payment of the annual premiums is an orderly accumulation of a fund with an increasing cash surrender value. The fund has a definite and guaranteed cash value, as the cash surrender value can be determined for any period of time.
  • By maintaining key employee insurance, Precision Plastix may actually strengthen its credit. The insurance may be used to supply supporting collateral for loans and may be considered good evidence that they will be able to meet future obligations even when the insured key employee is no longer part of the company.

How Does the Employee Benefit?

While life insurance on a key employee can aid in protecting Precision Plastix against the premature death of Peter Mason, there is no guarantee that such a key employee will remain with the company until retirement or death. Therefore, establishing a deferred compensation plan for that employee may act as an incentive for the desired employee to stay with the company.

Under this plan, Precision Plastix would enter into a contract with Peter to pay certain benefits upon his retirement. Precision Plastix may require him to promise not to compete (a noncompete agreement) against the company after his retirement. Such an agreement is a separate plan and isn't tied directly to the insurance contract. However, life insurance can be a particularly advantageous way to fund such an agreement.

A combination key employee deferred compensation plan may be adopted and funded with a single life insurance policy. That policy would function as indemnity to Precision Plastix in the event of Peter Mason's death and would also serve as a source of retirement income for Peter upon his retirement. Precision Plastix would merely take out a life insurance policy on Peter; he would not be a party to this insurance contract. Then, at the same time, Precision Plastix and Peter Mason would both enter into the deferred compensation plan.

Therefore, up until Peter's retirement date, Precision Plastix would have indemnity protection. At that date, the company can surrender the policy and use the proceeds to make the deferred compensation payments. This type of key employee insurance plan doesn't have to cover any specific number or class of employees, and may be particularly suited for companies that don't wish to establish qualified deferred compensation plans.

If you have employees that are vital to the smooth, successful operation of your company, you may consider taking the steps that Precision Plastix took and purchase life insurance as a tool of protection and incentive to key employees.

Copyright © 2003 Liberty Publishing, Inc. All rights reserved.


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