Insurance Decisions for the Life of Your Business
When it comes to life insurance, small business owners must consider both the team and the individual. Group life and key person insurance are designed to help employers protect their most valuable assets — people.
Many small business owners offer group life insurance to employees either as a benefit paid for by the employer, or as a voluntary offering whereby the employee pays for the premiums.
For policies paid by the employer, the benefit often is equivalent to a full year’s salary, an amount not necessarily sufficient for most people. For this reason, employer-paid policies often are viewed as “supplemental” to coverage an employee is assumed to already possess. Employees interested in greater coverage amounts, i.e., double or triple annual salary, can purchase additional coverage through an individual plan.
There are two basic types of group life insurance: term and permanent, or “cash value” life insurance.
- Term life insurance pays a death benefit if the policyholder passes away within a specified time period. Term insurance is typically less expensive than permanent life insurance, especially in the early years. Most group life insurance coverage paid by employers is sold on a term life basis. Group policies are typically guaranteed issue, meaning no medical examination is required for eligibility. An employee with a serious medical condition may still be a part of the group, as long as he or she is an active employee. Employees out on disability leave are not eligible for group life insurance until they return to work unless the leave began after the policy was issued.
- Permanent life insurance differs from term in several ways. There are four types of permanent life insurance — whole, universal, variable and variable universal. As the name implies, permanent life insurance remains in effect as long as the premium is paid. These policies also typically feature a cash value that increases over time, and allows the insured to borrow against that value. Before issuing a policy, permanent life insurers likely will require a medical exam to determine level of insurability based on health.
To determine the group rate you will be charged to insure your small business, insurance companies weigh a variety of factors including:
- Number of employees within the group
- Average age of employees
- Female to male employee ratio as women tend to live longer than men
- Prevalence of smokers
- Geography, specifically mortality and life expectancy rates where your business is located
Insurers also take into account special business-related factors that make one type of business more physically “risky” than another, i.e., marketing firm vs. roofing company.
Group Life Insurance Tips and Considerations
- Shop around. Group life insurance rates and packages differ from one insurance company to another.
To save money and simplify paperwork, consider purchasing all group insurance packages, i.e., health, disability, etc., from the same provider.
- As your business grows, review your group plans regularly. Your company’s group life insurance needs and premiums may change as your company adds employees, products or capabilities.
- If you plan to offer voluntary group life insurance, be sure the policy allows the employee to keep the plan should they change jobs. Look for additional flexibility in the policy such as a waiver of premiums when a worker is on disability leave.
Key Person Life Insurance
In a small business, a few key people often are critical to the organization’s success. These individuals may be limited to the business’ founders or partners, or unique subject matter experts such as the senior marketing or sales manager, or in the case of a technology company, the chief engineer or software developer.
The death of any of these key people would likely have a serious negative impact on the business’ bottom line. That’s why businesses may choose to purchase Key Person life insurance. Should a designated key person die, as the policy owner, the small business becomes the beneficiary and receives proceeds from the policy.
The key person insurance benefit payout can provide to the business:
- Cash to weather the loss and continue operations until a new employee is hired and trained to carry out the functions of the deceased;
- Funds to buy out the key person’s heirs, if ownership rights are involved.
In some cases, for a small business to secure a loan or investor capital, the company may be required to carry life insurance on its principals. A bank may even request a collateral assignment agreement giving the financial institution first rights to policy proceeds to cover outstanding debt in the event of a principal’s deaths.
Key Person life insurance can be purchased as part of a company’s group term life or permanent life policies.
Because the coverage is for a specific individual, several personal factors can affect key person life insurance premiums including:
Age and overall health including general medical history, pre-existing and/or chronic health conditions such as diabetes, heart disease, cancer, etc.;
- Poor health habits such as smoking and excessive drinking within the past five years;
Dangerous hobbies such as skydiving, skiing or rock climbing; and
- Driving record, specifically number of accidents, DWI/DUI citations, auto insurance claims and traffic tickets.
Key Person Life Insurance Tips and Considerations
- If possible, investigate Key Person life insurance when the company is formed. Doing so early helps mitigate the degree of business risk and the likelihood a serious health issue later in life will make insurance more expensive.
- To determine what size policy to purchase, consult your accountant or financial adviser to determine which individuals in your company are critical to financial success, and the annual monetary contribution each key person makes. Think beyond company founders or partners to include others who add significantly to the company’s bottom line.
- Align coverage amounts with the projected financial impact the key person’s death would create. Common approaches include coverage as a multiple of pay, i.e., five times’ annual current salary, or coverage in the amount needed to train a replacement or to buy-out of the deceased’s share of the business from his or her heirs. Don’t forget to account for downtime to find a new hire and get him or her up to speed.
- Of course all purchase decisions should take into account what the company can consistently afford to pay.
As with all insurance, shop around and compare rates for comparable coverage from a variety of insurers.