The unexpected loss of a colleague will likely cause you emotional pain, but that doesn’t mean it should cause financial pain as well. If a key employee were to leave your company, pass away or become disabled, how would it affect your business? It’s likely that the loss of his or her knowledge, client relationships and skills would have a lasting effect on company operations. While this may seem devastating on multiple levels, there are ways to protect against the financial loss of a key employee.
Some strategies to protect against the loss of a key employee include:
Do you employ at least one individual who is essential to your company’s success? In addition to you, chances are a partner or someone with unique expertise is crucial to your company’s success. If this person were to leave due to voluntary termination, retirement, death or disability, your business may be at risk. Depending on the size of your company, all employees might be key employees. And as your company grows, it can be difficult to identify key employees, especially if you don’t work with them closely.
If you aren’t able to immediately pinpoint those essential to keeping your business running smoothly, consider the following attributes:
Especially for those with whom you have a close working relationship, it may be difficult to imagine them leaving. However, losing a trusted employee can be highly unpredictable, and having a strategy is essential. Your vulnerability to losing a key employee depends largely on how your business is structured and how the employee operates within the business. For example, someone who works mainly solo on tasks that he or she sets the procedures for (that is, without documentation) creates a larger risk. In contrast, is a top sales producer who works closely with other team members and maintains a record of all his clients’ a contact information is not as big of a risk.
It’s important to assess the role key employees play within the company as well as how the company would be affected if they were to leave. Only after you’ve assessed the risks can you begin to address them.
Thorough documentation can help you more fully understand the role of key employees in your business and make the transition to a new employee much easier. If your business is new or you have not yet started documentation, consider the following list as a starting point.
If you already have good documentation, ensure that everything is up to date and set up an annual review process. Since these documents will need to change along with your company, they require regular review to be of value.
Having regular, one-on-one meetings with key employees is a best practice for many business owners. Some choose to hold these meetings simply to check in on large projects or update employees on company movement in the past week. However, it can also be important to include topics such as job satisfaction and engagement in these discussions, which allow you to gain a more accurate picture of how an employee is feeling. These conversations may also serve as a warning if you sense that an employee may be at risk of leaving. In addition, this gives employees the chance to raise questions and perhaps improve their company experience, leading to higher overall retention. Many employees don’t feel comfortable approaching their bosses with job concerns, so it helps if you are the one to initiate the conversation.
Depending on the nature of your company and the amount of overlap among departments, cross-training may be a more natural solution than in other companies. Identifying these areas of overlap and the employees that may be able to work within them is a valuable first step in cross-training. By training employees in multiple areas, you can help expand employee skillsets as well as protect yourself against key employee loss. Even during shortened periods of illness or vacation, if another employee is able to step up and fulfill the role of the absent employee, it creates much less of an interruption in workflow. It may improve employee satisfaction as well, as it gives employees more responsibility as well as diversifies their workload. Although cross-training may include higher training costs in the beginning, it will also increase each employee’s value within the company and can lead to higher employee retention.
Some situations simply can’t be anticipated for—losing a key employee to death or disability is emotionally shocking and disruptive to your business as well. Most business owners are careful to provide coverage for physical assets, such as office space and equipment, but some don’t realize that similar coverage exists to protect human capital. Key person disability income and life insurance can help to offset financial loss should you lose a key employee to death or disability.
Consider key person insurance if losing an employee would:
With key person life insurance, the company purchases a life insurance policy for the key employee, in which the company is the beneficiary and owner. It pays the premiums, and the company will receive the insurance payoff in the event of the employee’s death. While premiums are not tax-deductible, benefits may be received income tax-free1 and offer a flexible cash flow for the company. These can be put toward finding, hiring and training a replacement employee, compensation for lost business during the transition and/or financing timely business transactions. This type of policy can also be used to buy out the key employee’s shares or interest in the company.
Since premiums are based on age, health history and amount of coverage, a company should estimate the value of its key employees. By considering projects that could be lost, their annual salary, sales they generate and costs associated with replacing them, a company can determine the appropriate amount of coverage for each key employee.
Key person disability income insurance covers almost the same risks as key person life insurance, but is usually a short-term contract, providing benefits from 6-24 months, until the key employee recovers or a capable replacement can be found and trained. This type of policy is paid out in a fixed stream of income that the company may use in the way it determines is best to offset any potential costs or losses from the disability of a key employee.
If you already have a key person insurance policy, you should reevaluate the benefits of your policy as the role of this employee changes within the company. Perhaps the person’s role has expanded, and the cost to replace the position may have risen. Or, perhaps a new employee has risen within the ranks and requires key employee coverage as well. These types of changes in coverage may be more difficult to spot than with other types of insurance. If you move office buildings or upgrade equipment, you will likely be reminded to change your insurance. However, changes in human capital can be more subtle, so it helps to reevaluate each employee’s status within the company on a regular basis.
A key person insurance policy is fairly easy to implement and does not require IRS approval—only an annual report to the IRS2. This type of insurance can help provide customers, creditors, lenders and stockholders with assurance of business continuity preparedness and that coverage in place. Even if you never use the benefits from this policy, it can provide peace of mind. However, it also costs you in premiums and, depending on the coverage you choose, may not entirely compensate for the loss of the employee, depending on his or her role within the company. Insurance should be used in conjunction with other risk management strategies to help establish the most appropriate transition.
1 For employer-owned contracts issued after August 17, 2006, the Pension Protection Act generally provides that death proceeds will be subject to income tax; however, where specific employee notice and consent requirements are met and certain exceptions apply, death proceeds can be received income tax-free. The exceptions apply only where the employee receives notice of, and consents to, the following in writing prior to policy issue.
2 The employer must also provide notice to the IRS annually, using IRS Form 8925.
This article was written by Advicent Solutions, an entity unrelated to Prudential. ©2020 Advicent Solutions. All rights reserved.
White Rose Wealth Management
Peter Kelly
White Rose Wealth Management is not an affiliate of Prudential Financial. Pete Kelly sells insurance products of Prudential Financial's affiliated insurance companies in addition to products of non-affiliated insurance companies. White Rose Wealth Management and its representatives do not render tax or legal advice. Please consult with your own advisors regarding your particular situation.
Peter Kelly offers financial planning, Aaron Trinh offers investment advisory services through Pruco Securities, LLC(Pruco), under the marketing name Prudential Financial Planning Services (PFPS), pursuant to separate client agreement. offering insurance and securities products and services as a registered representative of Pruco and an agent of issuing insurance companies. 1-800-778-2255.
White Rose Wealth Management, LLC is not affiliated with The Prudential Insurance Company of America and its affiliates, including Pruco. Other products and services may be offered through a non-Pruco entity. Peter Kelly, Aaron Trinh, nor White Rose Wealth Management, LLC do not render tax or legal advice. You should consult with your own advisors regarding your particular situation.
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