By Wes Caldwell
The “Key” to Buy/Sell Insurance
I am often contacted by clients inquiring about key man insurance. After asking a few questions to determine what they are trying to accomplish, it usually turns out that they are actually looking for buy/sell insurance. In fact, these types of insurance, for the most part, do not exist. The insurance is simply a funding mechanism for a financial obligation of the practice. The funding can come from one of several sources, such as cash flow, a sinking fund or an investment account. Due to the significant leverage provided, various types of life and disability insurance are usually employed. Key man differs from buy/sell in the type of financial obligation the practice faces due to specific events.
What is Buy/Sell?
Buy/Sell coverage funds the execution of a purchase agreement, in the event of the death or permanent disability of a partner. The purpose of the agreement is to facilitate a smooth ownership transition and exclude any outside interests from future business decisions. The agreement may stand alone or be included as part of the partnership agreement. The insurance creates the cash flow to satisfy the provisions of the agreement. Keep in mind that the agreement is the driver, so without it, the insurance makes no sense. Many agreements I see are funded with life insurance but rarely with disability insurance, even though most agreements contain a disability provision. An unfunded agreement, while better than none, could create a significant cash strain to the practice.
What is Key Man?
Key man coverage indemnifies the practice for the premature death or disability of a key employee or partner. The insurance provides cash flow for the practice to replace the resulting loss of revenue. It also provides the time and resources to find a replacement. If the loss of an individual, for any period of time, would significantly impact your practice revenue, then a key man arrangement should be considered.
It is prudent to consider the financial impact that the loss of a partner or key employee would have on the bottom line. Proper planning and funding will ensure the smooth continuation of the practice during an otherwise challenging time.