Insurance: Hindsight Advice on Key-Man Coverage
In January 1994 Francis Chao died, and PRP, the research-and-development company he had founded 10 years earlier in Watertown, Mass., nearly died with him.
It was a crisis of nearly insurmountable proportions. PRP's main product -- infusible platelet membranes to be used in the treatment of cancer patients undergoing chemotherapy -- was still not ready for Food and Drug Administration clinical trials at the time of Chao's death. PRP was running low on working capital, but since it didn't have an obvious management successor in place, its investors were unwilling to contribute additional funds.
Fortunately, PRP had a $2.5-million key-man insurance policy on its 56-year-old CEO. "That policy was the only reason PRP survived its founder's death," says senior vice-president Richard D. Whiting. "We needed money to carry us through to the point where we'd have some FDA clinical-trial results and new management in place."
Whiting, who works jointly for PRP and for one of its largest investors, Dynamics Technology, offers some advice for other companies weighing the pros and cons of key-man insurance:
· The thinner the top-management ranks, the more you need the protection. "In a case like PRP's," says Whiting, "where Dr. Chao was the main person responsible for running the company, directing research, and attracting investors, you need more insurance than in a case where there are more people near the top."
· You'll need more coverage than you imagine, so buy as much as your company can afford. In retrospect, Whiting believes that a more accurate assessment of PRP's key-man needs would have been $5 million to $10 million. (One reason: If Chao's widow had wanted the company to purchase his 50% stock stake, that would have eaten up the insurance proceeds, leaving nothing for working capital.)
"Unfortunately, there's no science involved in making the assessment. You just come up with an estimated range and then buy as much coverage as your company can afford," Whiting says. PRP's annual policy fee was $7,800 in its last year.
· Keep reevaluating your coverage level. "In a growth situation, the value of your key man keeps changing, so it makes sense to recheck your coverage levels yearly," Whiting advises. If you broaden management ranks, you may be able to reduce coverage. "But in a case like PRP's, where our capital needs kept getting greater the closer we got to clinical trials, we really needed to be increasing Dr. Chao's coverage."
Although a bigger policy might have been desirable, Chao's policy did achieve the goal of keeping his company alive. With new management and scientific leadership in place, PRP was able to raise $2 million more from investors, which carried it through some successful FDA trials. For now, says Whiting, "we're in great shape."