Key Employee Indemnification Insurance Policies, Explained

Companies around the world insure their assets with business insurance. This is designed to protect from financial losses arising from property and equipment damage or destruction, such as in the case of certain natural disasters. Protecting key employees, however, is a commonly-overlooked area for many firms. Most people know that successful businesses are made up of more than just buildings and equipment, and the employees are a major contributor to the success or failure of a given business operation. In fact, it can be argued that employees are among a company’s most valuable assets.

To fill the gap, protecting both the company’s physical assets and its most valuable employees, key employee indemnification insurance policies are a great solution. In this two-part article series, we will investigate what may happen to a company if critical personnel should die, and the solution for protecting against financial losses associated with that death.

When Key Employees are Lost

Businesses are comprised of far more than physical assets like buildings, equipment, product inventory, and vehicles. Employees form the core of any business operation. As some of the most valuable assets a company can have, certain employees with extensive experience or unique talents tend to stand out. These are called “key employees”, and such employees can account for much of the success a business enjoys. Key employees include managers, department leaders, and directors, but are not limited to these categories. Such employees may be:

  • Department heads
  • IT specialists
  • Sales directors
  • Company directors
  • Employees with years of experience, but no leadership role
  • Forward-facing employees, such as customer service specialists or client care managers

What happens when key employees were to die unexpectedly? First, profits may suffer. Businesses may also have to face significant expenses in recruiting and training suitable replacements for the lost employee(s). There both tangible and intangible losses a company may experience, including:

  • Disruption of Management/Leadership – if the key employee was responsible for much/all of managerial efforts, his or her loss can create confusion and inefficiency among the remaining employees.
  • Loss/Reduction of Earnings – many companies can attribute their successes to a few select people; those people that are responsible for the bulk of sales and receipts. When one or more of these key players are lost unexpectedly, earnings may decline as a result.
  • Credit Problems – some companies, especially small operations with only a few critical employees, may experience credit problems when creditors react to their loss.
  • Erosion of Confidence – when a key employee is lost, other employees may react negatively. So too may suppliers, vendors, and customers, each who has depended on strong relationships with the key personnel.
  • Replacement Costs – some of the significant expenses in the loss of a key employee are recruiting, hiring, and training a suitable replacement.

When a valued employee central to the operation is lost, it is clear that companies may face significant hurdles, both financially as well as in relationships with other employees or business partners. It is also clear that a logical move would be for a company to protect itself against these losses. How can companies protect themselves and their financial interests?

Key Employee Indemnification Insurance

A potential solution for protecting against the tangible financial losses of an unexpected death of critical employees is that of life insurance, specifically key employee indemnification insurance. In simple terms, this is an insurance policy purchased by a business to compensate that business for financial losses that would arise from the death or long-term disability of important company employees. This type of insurance is sometimes referred to as key man or key person insurance.

A key employee indemnification policy is typically a life insurance policy purchased on any employee who is considered a critical part of the business operation. Proceeds from such a policy can be used for a number of purposes, including:

  • Costs associated with recruiting, hiring, and training replacement personnel.
  • Replacement of lost profits.
  • Indemnifying the business for the permanent loss of an employee’s experience, skills, and business relationships.
  • Funding financial reserves for the company during the adjustment period associated with the loss of a key employee.
  • Paying of benefits to the lost employee’s surviving family members.
  • Funding the purchase of a deceased shareholder’s or employee’s ownership in the business.

There are many advantages in having these policies on critical employees. When a key employee dies unexpectedly or becomes permanently disabled and can no longer fulfill his or her duties, insurance proceeds work to maintain business continuity and to offset any potential financial hurdles the company may experience.

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We’ve learned what key employee indemnification insurance is and how it can protect a company from financial loss when a critical employee dies or becomes permanently disabled. We’ve also talked about how the proceeds may be used for a wide range of purposes. In our next article in this two-part series, we will go over the components of key employee indemnification policies and how they work, including tax implications. Finally, we will provide a summary of the benefits these financial protection solutions provide to companies that rely on their most valued employees.

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