Kathleen Williams didn't think twice about key-man insurance when she cofounded Business Investigations, in Plano, Tex., nearly six years ago. "I didn't have the money to think about it," she recalls.

But a couple of years later, when her company was growing "at a monstrous rate" and she approached bankers for a line of credit, they provided her with a list of key employees she needed to insure. In complying with their requirements, she says, "I started thinking about how to use key-man insurance to protect our own needs. Now it's not just a question of being able to check off the right box on a loan application. I wouldn't do business without it."

To prepare for her annual board of directors meeting, she conducts her own informal analysis of the value to the company of each of her 100-plus employees. "There are some people my bankers don't require me to insure who are invaluable to our growth and profitability. So we buy key-man insurance on them as well," she says. In all, the company carries policies on 6 key employees, including Williams. In deciding whom to cover, Williams considers two financial issues:

1. Replacement cost. "This may or may not be close to a person's actual salary," Williams says. "To come up with a realistic number, contemplate a worst-case scenario where you had to find and pay someone else who could actually fulfill all this person's functions within the company."

2. Possible revenue losses. "You can't look just at the salary you're paying a person. She may earn $50,000, but if something happened to her, the company might lose sales of $300,000," she says. So even though the bank doesn't require it, she buys insurance on her executive vice-president of marketing and sales: "She's a competitive advantage for us. I don't care if the bank knows it or not.

"In a growing company, every person's value and contribution is constantly changing," says Williams, who evaluates the payout levels of each key-man policy annually. "With some people, you need to increase the insurance levels as sales grow, whereas with others, as their departments grow and they share corporate responsibilities, you may want to reduce coverage levels." Since policies change frequently, consider using annually purchased term life policies for key-man coverage. Rates vary according to a person's age and health but are generally quite affordable.

A corporate valuation can help quantify how much key-man insurance you'd need to buy out an executive's stock at today's market value. But when purchasing coverage Williams prefers to rely on her own instincts about each person's worth to her company: "If you know your executives, you can make a pretty good guess about how their loss would affect the business financially -- either in jobs you couldn't perform or sales you wouldn't make." -- Jill Andresky Fraser

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