KEY PERSON INSURANCE – COULD YOUR PRACTICE SURVIVE LOSING A CRUCIAL EMPLOYEE?
15 August 2019 | Featured
Flu season is in full swing – we hope that you’re coping well. But it does remind us that your practice also needs that ‘little shot in the arm’ to protect against a situation that can hit any day of the week.
It’s a fact that the success or failure of your practice is wholly dependent on your people – their professionalism, expertise and availability. As much as you aim to share skills, knowledge and information in your practice, you probably have some people who are key to your practice’s success. Their loss, for whatever reason, could turn into a fight for survival.
It might be one of the specialists (or you, as the boss), a highly skilled employee whose reputation is a boost to the practice, or the practice manager whose knowledge gained over many years is invaluable. Or perhaps your practice is heavily invested in technology and you have an in-house expert who doesn’t create revenue but is essential to the day to day smooth running of the systems.
Now, what would happen if you suddenly lost one of those key people?
And if you think it would never happen because they’re well remunerated, love their jobs and are settled, think again. Career mobility is definitely a possibility. They might decide to start a family and want to leave the workforce, or a partner may accept a transfer in another town. Or what if they suffered an incapacitation such as a major illness or injury, or even passed away?
In addition to the obvious issue of lost productivity and their contribution to the practice, you also have to spend precious time (and money) to recruit and train a replacement. And losing such a key person in your company could even affect your reputation and credit standing.
Could your practice survive until you find someone who can fill their shoes?
Key Person Insurance can help you get back on your feet
Key Person Insurance can give you the financial support you need while you’re getting back on your feet. It can offset both your costs (e.g. hiring temporary help or recruiting and training a replacement) and your losses (e.g. not being able to do as much until they finish their training).
It can also help with:
- practice succession planning
- protecting your company’s equity value
- agreed funding to purchase the equity from a spouse or partner
- funding re-payments of any capital loans or personal guarantees
- meeting requirements for bank business loans
- salary packaging benefits (depending on the person’s taxation affairs)
You can take out a policy (which is usually tax-deductible) on anyone you feel is a key person in your company.
How much should I insure them for?
You can set the policy amount to be anything from $500,000 to $10 million. Of course, the amount you specify will depend on the size of your practice and the person you’re insuring.
The amount can be calculated in a few ways, including:
- the ‘replacement cost method’, which is based on the cost to replace the key person
- the ‘contributions to earnings method’, which is based on the percentage of their earnings towards your practice’s revenue
- the ‘multiples of income method’, where their current salary is multiplied to determine their value.
Protecting your partners (and their partners) with a Buy/Sell agreement
What if the key person happens to be your partner in the practice? Yes, the Key Person Insurance may well cover the finances involved in buying your partner’s shares from their family. But do you really want to be negotiating a deal at such an emotionally trying time?
Having a Buy/Sell Agreement in place can save everyone from a lot of anguish. It’s a legally binding agreement that determines what will happen to each stakeholder’s shares if they suffer a major illness or injury, or pass away.
It has two parts:
- The Disposal Mechanism (also known as a Business Will), which states what happens if a partner leaves the practice due to death or disability. It usually contains a valuation method.
- The Funding Mechanism, which funds the Buy/Sell Agreement. This is where you would find the details of the Key Person Insurance policy taken out for each partner.
How do I arrange Key Person Insurance?
Your Kennas advisor is the person to guide you through the best approach to key person insurance for your circumstances and the size of your practice. We are also right across the tax implications and how to maximise your financial success while keeping your practice profitable over a personnel crisis.