Keyman
insurance is meant to help a business recover from the loss of its valuable
assets or access to key customer demographics, that is, the persons who manage
it or possess the knowledge. Every
business has a few valuable employees who contribute significantly to the
running and growth of the company. They
factor into the valuation of the business by investors and creditors.
Keyman
insurance can be defined as an insurance policy where the proposer as well as
the premium payer is the employer, the life to be insured is a key employee,
and the benefit, in the event of a claim, goes to the employer. The object of keyman insurance is to cover
the life of a keyman in case of untimely death, or any form of incapacity, or
loss incurred by actions by the keyman.
It is meant to mitigate the monetary impact of these events.
The Gap Between Recognising the Risk and Insuring against It
A
survey of small businesses found that 71% considered themselves highly
dependent on one or two key people for their success. Only 22% of those same businesses had taken out
keyman insurance. Nearly three-quarters
of small businesses know exactly how exposed they are, and fewer than a quarter
have done anything about it. That is not
an oversight. That is a company betting
its survival on nobody important ever getting sick, dying, or leaving.
Shawn
Wang, chief financial officer of Baidu.com, died on 27th December
2008. In the two trading days following
his death, Baidu’s share price fell 4.7%.
A single executive’s death moved the market value of one of China’s
largest technology companies within 48 hours.
Steven Paul Jobs resigned as chief executive officer of Apple on 24th
August 2011, and passed away on 5th October 2011. Apple’s share price fell 6% the day after his
death. Neither company collapsed. Both, however, demonstrated in real time exactly
what academic researchers studying key person insurance have found repeatedly:
the sudden loss of a critical individual produces an immediate, measurable
market shock, distinct from any longer-term operational disruption that
follows.
A
public company the size of Apple or Baidu absorbs a share price shock and
continues operating the next morning. A
small business built around one founder, or one dominant salesperson, does not
have that cushion. Some small businesses
lose up to 50% of their revenue when a single key person is lost, a proportion
no public company of comparable scale would ever come close to experiencing
from one departure. Loss of sales
damages cash flow directly. Lenders grow
nervous. A bank that extended credit
partly on the strength of one person’s relationships and expertise has every
reason to reconsider that facility the moment that person is gone, and banks
reconsidering credit facilities rarely do so slowly.
What the Payout is For
The
death benefit under a keyman policy goes directly to the business, not
restricted to any specific use. It can
cover lost revenue while a replacement is found, fund the recruitment and
training of that replacement, settle outstanding debts a nervous lender no
longer wishes to extend, or buy out a deceased partner’s share of the business
entirely. Liquidity is easiest to
arrange before a loss occurs. After a
key person’s death, replacement talent, lender confidence, and strategic
flexibility all become considerably more expensive to secure, precisely when
the business has the least capacity to absorb that cost.
A
business that has correctly identified its key person risk and still declines
to insure against it has not made a considered decision. It has made a bet, using the entire
enterprise as the stake, on an outcome markets have already proven, twice, in
full public view, does not favour the house.
Terence Nunis | Executive Chairman, Equinox Zenith | Author, The 1%
Playbook: The Billionaire Cheat Code
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