People management: sudden death can damage your firm.
Most people like to believe they are irreplaceable. In the long term, of course, that's rarely true. But in the short term, one of the biggest potential risks to a company's survival is the damage caused when a key person, perhaps a director, sales manager, or person with specialist skills, dies unexpectedly.
Such a loss can have a major financial impact on a company and its remaining employees. In the short term, overheads and salaries still need to be met and without income generated by the key man, there may be severe cash-flow problems. Expenses will be incurred in recruiting and training. Moreover, the loss of a key man may affect the ability to service or repay outstanding loans.
The practical solution for SMEs is to take out key-man insurance which covers the death, and/or disability of the key person insured. One way to calculate the amount of cover required is to take a multiple of the key man's remuneration package, accounting for fringe benefits. The multiple depends on how great the potential loss is felt to be, but up to 10 times total remuneration seems reasonable. A more scientific method is to calculate the individual's salary as a proportion of the wages bill as a whole.
This ratio is then applied to the firm's annual profit figure. The resulting sum is finally multiplied by the number of years which it will take to recover from, or replace, the loss of the key man.
As an example, take a company with net profits of £150,000 a year. The key computer researcher, who earns £40,000 (out of a total wage bill of £250,000) and would take three years to replace, requires £72,000 of cover.
The managing director of the same firm (earning £50,000 a year and taking six years to recover from his loss) would require £180,000 of cover.
Insurers offer a variety of cover options. The cheapest is term assurance which provides cover for a short specified period (for example, five years).
Extendible term assurance is as the name suggests. Whole life cover, which is most expensive, lasts for the lifetime of the key person, is more flexible and can be sold to the key person if no longer required by the company.
Death strategies, naturally enough, rarely appear on the Monday morning agenda. But bearing in mind the statistics, insurance looks an attractive option. Research from Johnstone Douglas, an independent adviser to SMEs, suggests that in a team of five people whose average age is 45, there is a 54% chance of one of them dying before retirement age. Will the Grim Reaper make a beeline for the most vital member of your team? No one can guess. But, as any racehorse trainer knows, it's generally the very slow gee-gees who remain in robust good health. As the Sod's law of racing will have it: only the fast die young.
Judith Oliver is a contributing editor for Management Today.