Permanent disability of one or more of their key contributors is not something most organizations imagine. But for firms that rely on a few key contributors, a disability event could have a catastrophic effect on the organization’s sustainability. Bob Birdsell explains why disability insurance is as important, and as accessible, as life insurance.
This article is reprinted with permission from the February 2015 issue of PSX: The Exchange for People Strategy, an eMagazine that brings you cutting edge views and perspectives on all things related to people strategy.
For most organizations, success is highly dependent on just a few of their key executives. When organizations think of key person insurance, life insurance is often used to protect shareholder value, however, that’s typically the point at which the management of human capital risk ends. Organizations often overlook the fact that there is a far greater likelihood that an executive will suffer a disability than death. In fact, there is a 25% greater risk of a disability than of death during the working career of an executive.
While it might save individuals and organizations some money to ignore the possibility of temporary or permanent disability of key contributors, the odds of winning that bet are not as favorable as they might appear. Here are some statistics from the Council of Disability Awareness (CDA):
- 90% of us underestimate our chances of becoming disabled.
- 85% of us express little or no concern that we might suffer a disability lasting three months or longer.
- 56% of us don’t realize that the chances of becoming disabled have risen over the past five years.
Even in light of these statistics, many still dismiss risk of disability as little more than a scare tactic promoted by insurance companies. The facts tell quite a different story based on the findings of the CDA:
A typical male, age 35, 5’10”, 170 pounds and a non-smoker who works in an office environment, with some outdoor activity, and who leads a healthy lifestyle has these risks: a 21% chance of becoming disabled for three months or longer during his working career, with a 38% chance that the disability would last five years or longer and with the average disability for someone like him lasting 82 months. If the same person used tobacco and weighed 210 pounds, the risk would increase to a 45% chance of becoming disabled for three months or longer.
A typical female, age 35, 5’4”, 125 pounds and non-smoker, who works mostly an office job, with some outdoor physical activity and who leads a healthy lifestyle has these risks: a 24% chance of becoming disabled for three months or longer during her working career, with a 38% chance that the disability would last five years or longer, and with the average disability for someone like her lasting 82 months. If the same person used tobacco and weighed 160 pounds, the risk would increase to a 41% chance of becoming disabled for three months or longer.
Based on the facts, it would seem appropriate for venture capital firms, hedge funds, and private equity firms (as well as other professional organizations) that rely heavily on a few key contributors to recognize the potential catastrophic effect that a disability event could have on their investment and organizational sustainability.
Some of the most prestigious firms in the business recognize the value of their key contributors as is evidenced by the following excerpts from their 10K’s:
Blackstone Group: “Our most important asset is our people, and our continued success is highly dependent upon the efforts of our senior managing directors and other professionals. Our future success and growth depends to a substantial degree on our ability to retain and motivate our senior managing directors and other key personnel and to strategically recruit, retain and motivate new talented personnel.”
KKR: We believe that our success depends to a significant extent upon the experience of our Manager’s executive officers, whose continued service is not guaranteed. The departure of any of the senior management and investment professionals of our Manager or the loss of our access to KKR’s senior management and investment professionals may adversely affect our ability to achieve our investment objectives.”
We all know that developing a technology, a brand, or that ‘secret sauce’ often requires a strong CEO. This person commonly becomes synonymous with the organization’s success; if the CEO were to suffer a disability it could quickly lead to disaster. The risk is enormous: should the CEO be taken out of the picture suddenly, investment capital could be at risk; valuation may decline; and the company’s viability may well be put into serious question. Managing risk is paramount to success in any business. As such, the first step should be to obtain adequate disability protection on the CEO and other key contributors to the company.
Here is a case study that illustrates the point:
The subject was a 48-year-old male, who was the founder and CEO of a startup nanotechnology company providing unique nanotechnology solutions to emerging global textile markets. He was an individual with a distinct track record and proven capabilities.
The valuation for the liquidity event was set in excess of $250 million. As the plan was set in motion, the CEO was involved in a cycling accident that left him with severe brain damage. Since his involvement was essential to an efficient sale, transition and the ongoing success of the business, the company suffered significant loss in value and the sale has been placed on hold.
Building investor confidence and enthusiasm are both critical elements to the success of a company. As a prudent move to help reduce risk, firms are best served by viewing the combination of key life and disability insurance programs. Until recently, the only types of disability programs available were the traditional plans which are designed to pay a monthly stream of income to the owner of the policy at the time of a disability. This type of coverage would offer little comfort to a firm who is facing the permanent disability of a key contributor. Many such organizations don’t need a stream of income; they need a substantial lump sum to offset the financial loss they will incur when their leader or other key contributor goes down!
It is now possible to secure millions of dollars of “Lump Sum” disability benefits which previously were not available. The cost often can be measured in basis points and in some instances as little as 30 or 40 basis points per million dollars of coverage. For a lump sum benefit of $25 million the cost could be as low as $75,000 annually. Consider the fact that most organizations would never fail to secure insurance on their real property, but they often overlook their most valuable property: their key human capital which may not be replaceable.
As it turned out, the existing insurance advisor to the firm had obtained $20 million of key person life insurance, a standard practice easily achievable in domestic insurance markets. However, lacking an understanding of how surplus lines markets such as Lloyd’s of London could be utilized, the advisor did not obtain $20 million of lump sum key person disability coverage.
The implication seems clear: where there are significant risks such as an equity transaction, the prudent solution is the best one. And even though we all believe such an event won’t happen to us – these things only happen to other people – there is no rational way to justify taking unnecessary chances. Failing to insure against disability risk could severely impair both existing assets and future success should a disability occur. This is why viewing key person disability protection, along with a well-constructed portfolio of key person life insurance, is the prudent decision and may even be seen as a fiduciary responsibility of the CFO.
Where the CEO or other key contributors are crucial to organizational sustainability and success, implementing a comprehensive insurance program is a straightforward and practical risk management tool that can avert a potential disaster.