20 July 2016© Peter Lye
After 3 decades, Key Man Insurance is still too 747 heavy for lift off in big way.
It might be a sterling example of lost in translation. Though the label is semantically correct, the impression created seems to suggest some grandiose plan not meant for commoner.
This is far from reality as it was created mainly with the smaller business in mind instead MNCs and larger corporates.
Insurance is intangible in itself. Compound this complexity that Key Man Insurance hardly exists as ready to sell product but as a wrapper for a bespoke basket of insurance products, it is easy to understand why only the brave will attempt to venture.
It might be a sterling example of lost in translation. Though the label is semantically correct, the impression created seems to suggest some grandiose plan not meant for commoner.
This is far from reality as it was created mainly with the smaller business in mind instead MNCs and larger corporates.
Insurance is intangible in itself. Compound this complexity that Key Man Insurance hardly exists as ready to sell product but as a wrapper for a bespoke basket of insurance products, it is easy to understand why only the brave will attempt to venture.
Unlike liability class of insurance which provides a like for like recourse like repair, replacement or hold legally harmless, Key Man Insurance normally provides a pre-agreed compensation in cash. Some quarters voice that this money does not buy everything necessary to recompensate a key man insurance, it sure can buy many things.
Key Man are essentially owners, business partners or
employees for which their continued ability to contribute to the business if curtailed by illness, accidents or death can result in major business impact. The value contribution can be
special skills, relationships with customers or source of finance.
The risk coverage can range from basic death due to accident only,
to term for death due to whatever cause or even critical illness. Critical illness can affect work ability and this is an important consideration though it is relatively more costly risk to cover. Many have asked about risk of jumping ship to competitor or
leaving for whatever reason and the answer is normally no as there is a certain level of control over the outcome rather than a random event. This infringes one of the basic principle of insurance that the outcome is not controllable or largely not controllable.
Table:Key Man Issue Impact on SMB vs MNCs
SMB
|
MNCs or Large
Corporate
|
|
Funding
|
Owner.
Bank Facilities (OD/Trade) with Personal Guarantees
by shareholders.
|
Corporate Capital Market.
Bank Facilities with Corporate Guarantees.
|
Skills Duplication
|
Rarely or limited
|
Widespread
|
Process Documentation
|
Limited even for those with ISO 900X
|
Robust
|
Economy of Scale
|
Limited
|
Larger
|
Ownership/Management
|
More Integrated
|
Segregated
|
Too Big to Fail
|
None
|
In Some Case
|
Quick Access to Sudden Cash / Resource
|
Limited
|
Extensive in Most Case Especially in MNCs.
|
It is clearly evident from the table above why SMB should
be looking at Key Man Insurance rather than MNCs as they have sufficient buffer
in most case.
Key Man Insurance Cash Pay-out is normally arranged in one
of the following fashions when an insured event which is normally a Key Man
like issue arises.
Firstly, for business that are funded by owner and Bank Facilities with Personal Guarantors, the Pay-out is useful in case the of loans or trade facilities by banks. A wise sage once opined that wise Bankers only try to loan you money when you least need it.
Firstly, for business that are funded by owner and Bank Facilities with Personal Guarantors, the Pay-out is useful in case the of loans or trade facilities by banks. A wise sage once opined that wise Bankers only try to loan you money when you least need it.
In the case of a sudden skill shortfall due to key person
meeting the insured event, the cash pay-out is useful to secure additional
resource to re-compensate part of the resource or to keep the business a float
due to sudden drop in business.
As ownership and management is more often than
not integrated in SMB, a buy-out agreement using the insurance cash pay-out as a base load can
ensure a more congenial management of the company without the sudden intrusion of
a new management member to replace the key man. This can be structured along the lines of a Texas
Shoot Out Clause to ensure fairer value of transaction for both buyer and
seller.
Most SMB owners have poured in blood and sweat to take
their business to where it is and it would be a waste to see it die with them.
In addition, it is also part of being a responsible to your business partners
and employees.
Imagine chef/owner Peter of your favourite neighbourhood burger diner paralysed by a
sudden stroke and passed away. What will happen to his business, partners,
employees and most of all his family members. Little imagination is needed to
picture the catastrophe.
The special marinate that makes the burger unique was formulated by Peter and though many staff and partners
have seen it done daily, the exact recipe was never documented. Customers
started to complain that the burger tasted different.
The business started by Peter as a small street corner food cart
many years ago. When it tasted success, Peter
roped in 2 additional business partners who were in the restaurant business to
provide restaurant expertise to expand it into a full service diner. The
additional capital needed to acquire shop space, kitchen and dining area were
provided by the 2 new partners and bank over draft and trade facilities secured
by joint personal guarantee by Peter and his partners.
The Bank not only stop all credit
facilities but recalled all loans. The business almost grind to a halt as most
working capital is via Bank facilities. Bankers are logical business that take
such actions because firstly, they now have 2 instead of 3 personal guarantors.
Secondly, business risk has also increased with poorer business outlook.
The final straw came when the Bank lodged a
charge on Peter’s estate on account of the personal guarantee locking all the
emergency funds the immediate family needs.
If the same were to happen to a branch
manager of MacDonald, business would continue almost normally save for a minor
discontinuity during the initial period it takes to transfer and localise
another branch manager. Bankers, suppliers and customers would hardly blink
about it.
This is why
Key Man Insurance is for SMB.
lkypeter@gmail.com Safe Harbor. Please note that information contained in these pages are of a personal nature and does not necessarily reflect that of any companies, organizations or individuals. In addition, some of these opinions are of a forward looking nature. Lastly the facts and opinions contained in these pages might not have been verified for correctness, so please use with caution. Happy Reading. Peter Lye (c) Peter Lye 2014