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Key Person Coverage: Protecting Your Practice
By Chad Carlson

What's the problem? The technical knowledge and specialized skills of key team members are more vitally essential to the long-term success of a practice than ever before. The key to profitability, efficiency, and growth often lies in the hands of a single individual or a handful of key team members. When a practice loses a key physician or staff member, it can suffer financial loss from a number of factors including: disruption of management, reduction in earnings, impairment of credit, or even the loss of patients to other practices.

Who's at risk? Although the risk of losses applies to very large medical organizations, it is particularly pronounced for smaller, privately operated medical clinics or professional practices. Such practices are much more likely to be dependent on key people for profit generation and long-term stability.

Life insurance as a solution. Life insurance can provide a cost effective means of providing immediate liquidity to help recover from the death of a key staff person or physician, protecting the economic welfare of the practice. Policy death benefit proceeds are available to assist in finding and training a replacement, covering lost profits and protecting the credit of the clinic. In addition, permanent life insurance can provide a funding vehicle for a deferred compensation arrangement, or tax-advantaged access to a policy account value in times of need.

Using a life insurance policy has advantages over the two other common methods of financing replacement of a key team member: establishing an accumulation fund and borrowing the assets. While effectively reserving for a potential loss, dollars kept in a savings account do not accumulate that quickly. If you borrow, each dollar must be repaid with interest, making this an expensive option. With a life insurance policy, the premiums are relatively small compared to the lump sum, which would have to be raised quickly, out of earnings or by borrowing.

How else can I use the policy proceeds? As mentioned earlier, t here is no limit to how your practice can use the death benefit proceeds from the policy after the death of a key employee. Options include replacing lost profits due to reduced productivity, recruiting and retaining a replacement, helping the practice pay off debts, or continuing the deceased's income for his/her family.

Here's how it works. The practice purchases a life insurance policy on a key physician or staff person's life and is the policy owner and beneficiary, as well as the premium payer. While the premiums are typically not tax-deductible, the death benefit proceeds are generally received tax-free. And, if a permanent life insurance policy is used, the policy's cash value may be treated as a corporate asset.

Determining the appropriate amount of coverage and the best provider is easier than you might think. Consulting with an experienced insurance advisor in cooperation with your CPA and attorney is the best place to start in designing a plan that is best for your practice. And if you have key person coverage in place, remember that it's important to review your coverage regularly. We'll look at the benefits of regular policy reviews in a future column.

Chad Carlson is a Financial Advisor with Delta Trust Investments, Inc. For more information, contact Chad at (501) 975-4010 or by email at ccarlson@delta-trust.com. Delta Trust does not offer tax or legal advice and recommends that you consult your tax or legal advisor.