Disability Overhead Expense & Key Person Coverage for Small Businesses

Small businesses are particularly vulnerable to the impacts of unexpected events, such as the disability of a business owner or the loss of a key employee. Disability Overhead Expense (BOE) insurance and Key Person Coverage are critical strategies for mitigating these risks. This article explores the nuances of these insurance options, their coverage details, and their importance in ensuring the financial stability and continuity of small businesses.

Disability Overhead Expense Insurance

What is Disability Overhead Expense Insurance? 

Disability Overhead Expense (BOE) insurance is designed to protect business owners from the financial burdens associated with their inability to work due to a disability. BOE insurance reimburses the business for fixed overhead expenses, ensuring that the business can continue to operate during the owner's period of disability​​.

Coverage Details

BOE insurance typically covers a range of essential business expenses, including:

• Rent or Mortgage Payments: Ensures that the business premises are retained during the owner’s disability.

• Utilities: Covers the cost of electricity, water, and other utilities necessary for business operations.

• Employee Salaries (Non-Owner): Ensures that the salaries of non-owner employees are paid, maintaining staff retention and morale.

• Leased Equipment Payments: Covers payments for leased equipment crucial for business operations.

• Business Insurance Premiums: Includes premiums for other business-related insurance policies.

• Office Supplies and Professional Dues: Ensures the business remains stocked with necessary supplies and retains memberships in professional organizations.

• Legal and Accounting Fees: Covers the costs of essential legal and accounting services.

• Principal Payments on Business Loans: Helps manage debt obligations during the owner's disability​​​​.

Options for BOE Insurance

When selecting a BOE insurance policy, business owners can choose from various options to tailor the coverage to their needs:

• Automatic Benefit Increases: This rider adjusts the benefit amount over time to account for inflation and rising overhead costs.

• Partial Disability Benefits: Provides partial payments if the owner can return to work in a limited capacity.

• Temporary Replacement Coverage: Covers the salary of someone brought in temporarily to perform the owner's duties.

• Tax Benefits: BOE insurance premiums are generally tax-deductible, while the benefit payments are taxable but used to pay tax-deductible overhead expenses​.

Importance of BOE Insurance

For small business owners, the financial impact of a disability can be severe. BOE insurance is crucial as it helps cover fixed expenses, preventing the business from facing financial ruin. It allows the business to continue operating, giving the owner time to recover without the added stress of financial instability. According to the Social Security Administration, a 20-year-old has a one in four chance of becoming disabled before retirement age.

In addition to BOE insurance, business owners should also consider individual disability income insurance. While BOE insurance covers business expenses, disability income insurance provides personal income replacement, ensuring the owner can cover their personal living expenses during a period of disability.

Key Person Coverage

What is Key Person Insurance?

Key Person Insurance, also known as Key Employee Insurance, is designed to protect businesses from the financial impact of losing a vital employee due to death or disability. This type of insurance provides the business with funds to cover the costs associated with the loss of a key individual, including recruiting and training a replacement, as well as mitigating lost revenue​​​​.

Identifying Key Employees

A key employee is someone whose skills, knowledge, and business connections are critical to the company's success. These individuals often include top-performing salespeople, senior managers, or specialists whose contributions are directly tied to the company’s profitability. Identifying these employees involves assessing who significantly impacts the revenue, reputation, and operational efficiency of the business.

Coverage Details

Key Person Insurance typically covers:

• Recruiting and Training Costs: Provides funds to find and train a suitable replacement for the key employee.

• Lost Profits: Compensates the business for the revenue lost due to the absence of the key employee.

• Project Disruption: Covers costs related to the disruption of ongoing projects or loss of clientele.

Additionally, some policies offer a replacement benefit, which reimburses the company for a percentage of the replacement costs for a specified period after the key person’s disability occurs. These policies can also be converted to individual coverage if the business no longer needs the insurance​​​​​​.

Options for Key Person Insurance

When selecting a Key Person Insurance policy, businesses can choose from various options to tailor the coverage to their needs:

• Replacement Benefit Rider: Reimburses the company for a percentage of the costs associated with finding and training a replacement.

• Convertible Policies: Allows the policy to be converted to individual coverage if the business no longer requires it, providing flexibility for both the business and the key employee.

• Term vs. Permanent Coverage: Businesses can choose between term life insurance, which covers a specific period, and permanent life insurance, which provides lifelong coverage with an accumulating cash value.

Importance of Key Person Insurance

The sudden loss of a key employee can have devastating effects on a small business. The IRS and courts recognize that the loss of a key individual can significantly impact a business’s earning power and stability, particularly in closely held corporations. Without key person insurance, small businesses risk facing severe financial difficulties, including potential closure. Despite its importance, many small businesses lack this critical coverage, underscoring the need for greater awareness and adoption​​​​.

How Much Coverage Should You Purchase?

The “right” amount of coverage for both BOE and Key Person Insurance depends on various factors:

• For BOE Insurance: Calculate the total fixed monthly expenses (rent, utilities, employee salaries, etc.). Determine the length of time you would need coverage, typically between one to two years.
• For Key Person Insurance: Assess the key employee’s contribution to the business’s revenue and profits. Consider the costs of recruiting, hiring, and training a replacement, as well as the potential loss of business during the transition period.

A useful approach is to use calculators provided by insurance companies or consult with a financial professional who can help you determine the appropriate coverage amount based on your specific business needs and financial situation​.

Conclusion

For small business owners, preparing for unexpected events is crucial. Disability Overhead Expense Insurance and Key Person Coverage are essential components of a comprehensive risk management strategy. These insurance options provide financial support during critical times, ensuring that the business can continue to operate smoothly despite the temporary or permanent loss of key individuals. By investing in these insurance policies, business owners can protect their enterprise, employees, and their own financial well-being.

To learn more about how disability overhead expense insurance and key person coverage can benefit your small business, consult with a financial professional. These experts can help you assess your specific needs and guide you in choosing the right policies to secure your business's future.

- Article posted on 5/22/24 -

Disclaimer

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The information in this article has been sourced from Advisys and Massmutual.com.

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