Small Business
Cover key employees
March 1, 2001: 7:23 a.m. ET

Losing an important employee can do irreparable harm
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NEW YORK (CNNfn) - It's not something that most business owners want to think about, but the death or disability of a key employee is something they should definitely plan for.

Every business has employees whose loss could result in financial damage. In some cases, the loss of an employee with highly specialized knowledge, or a key executive in a small business living on the margin, could create chaos from which a company will never recover.

  Most companies have somebody who is so instrumental to the business that losing them means the company may never be the same.  
  Loretta Worters, spokeswoman
Insurance Information Institute
Consider getting key-employee insurance to cover those people whose death or disability could create a serious blow to the bottom line.

"Most companies have somebody who is so instrumental to the business that losing them means the company may never be the same," said Loretta Worters, a spokeswoman for the Insurance Information Institute in New York.

Key-employee insurance functions much like a life insurance policy. When a principal employee passes away or can no longer work because of a disability, the insurance will make sure the remaining partner or partners have the financial means to keep the company afloat until they find a replacement.

Not every employee in a company can be considered a key employee, however. In order to secure a policy, the owners have to be able to prove to the insurer that the business will suffer financial losses if this person is to suddenly pass away.

Who is a key employee?

Examples of key employees, said Worters, are employees who develop products for the business, such as scientists or software developers. The work those types of employees perform is so specialized that not just any person can step into their position after they are gone. By virtue of their long-term relationship with a company, the founders of a business are also usually considered key employees.


An exceptional salesperson, too, can be considered a key employee, especially if the company stands to lose much of its revenue if that person dies, said Worters.

Individual business owners however, will have to work with an insurance agent and financial planner to determine who meets the criteria of a key employee. The needs of the company, in terms of how much insurance to purchase for key employees, will also vary from business to business.

The cost of such insurance, as with any insurance, will vary according to the size of the policy. But, as certified financial planner Carmen Petote points out, the cost is worth it in those cases in which the person's demise will force the company's closure.

Insurance is important, but get an agreement too

Petote, who works out of Allegiance Financial Advisors in Pittsburgh, added it is extremely important, in addition to key-employee insurance, that business owners sign a buy/sell agreement. In many cases, the key-employee insurance is a vehicle that will fund the agreement when one or another partner dies.

Take, for example, a company that is started by two equal partners. One is the face of the company and performs functions like sales and manages the relationships with the company's clients. The other takes care of the back-office functions like accounting and inventory.

If one or the other dies, his or her heirs will probably inherit the deceased partner's shares in the company. By signing a buy/sell agreement early on in the partnership, the heirs will have to abide by the terms of the agreement. It may be written in, for example, that they must sell the shares in the company to the remaining partner.

The remaining partner will have funds available, through key-employee insurance, to buy out the heirs.

This type of agreement will, explained Petote, prevent a situation where the heirs may decide to sell their shares in the business to another person.

"People often wait for an event to occur such as...where one partner dies, to consider a buy/sell agreement," said Petote. "If you do work out the terms in the beginning of a business relationship, you can avoid a lot of trouble if one person dies." graphic