Dennis Carlson
Executive Benefits & Total Rewards Advisor
We've explored two components of our three R's of executive benefits framework: “restore” and “reward.” In this installment, we turn to the final R: “risk.”
When organizations think about executive benefits, they typically focus on what they can provide to their key employees. Benefits that focus on risk change this view, addressing what the organization needs to protect itself from the potential loss of those same individuals.
Understanding business risk exposure
Every organization faces business continuity risks associated with the unexpected departure, death, or situations where key individuals become sick or injured and unable to work. These risks include:
- Gaps in knowledge and expertise: Critical information and skills that may not be documented
- Disruption of relationships: Client, vendor, and partner connections tied to individuals
- Leadership void: Disruption in strategic direction and decision-making
- Delays in projects: Challenges to continuity for ongoing initiatives
- Financial consequences: Direct and indirect costs of unexpected transitions
The more successful your organization becomes, the more essential certain key individuals often are to that success, and the greater the potential impact of their loss.
Did you know that about 90% of long-term disability claims come from illnesses rather than injuries? The average claim lasts 34.6 months, nearly three years, during which your organization might be without a key contributor.1
Key person risk management strategies
Effective risk management involves both financial protection and organizational planning:
Key person life and income protection insurance provides financial protection when a critical team member passes away, becomes severely ill, or is injured and unable to work. These policies:
- Are owned by the organization
- Pay benefits directly to the organization
- Provide liquidity to cover transition costs
- Can fund the recruitment of replacement talent
- Offset potential revenue loss during the transition
Unlike the insurance programs discussed in the previous articles in this “three Rs” series, these policies protect the organization rather than the individual, though they insure the same key people.
Buy-sell funding
For organizations with multiple owners, buy-sell agreements establish what happens to an owner's interest when they exit the organization. Insurance funding for these agreements:
- Offer immediate liquidity for ownership transitions
- Allow remaining owners to maintain control
- Ensure fair value for departing owners or their families
- Prevent forced liquidation or fire sales
- Set clear valuation methods
Properly structured buy-sell funding integrates with both the legal agreement and the overall executive benefits strategy.
Business continuation planning
Beyond financial protection, comprehensive risk strategies include planning for operational continuity:
- Succession planning: Identifying and developing future leaders
- Knowledge management: Documenting critical processes and information
- Cross-training programs: Developing redundant capabilities
- Temporary leadership protocols: Establishing clear interim authority
- Client relationship management: Expanding client relationships beyond individuals
These operational strategies complement financial protection, creating a comprehensive approach to risk management.
Implementing effective risk solutions
1. Risk assessment
The first step in addressing risk is conducting a thorough assessment to identify your organization's specific vulnerabilities:
- Which individuals have irreplaceable knowledge or relationships?
- What would be the financial impact of their unexpected loss?
- How quickly could the organization recover from their departure?
- What key projects or initiatives would be affected?
This assessment forms the foundation for all subsequent risk planning.
2. Key person valuation
Determining appropriate protection levels involves assessing the financial impact of losing key individuals. Valuation methods include:
- Replacement cost approach: The cost to recruit and train a replacement
- Contribution to earnings method: The individual's direct impact on revenue
- Multiple of compensation: A formula based on current pay
- Present value of future contribution: Discounted value of future impact
The appropriate method depends on your organization's structure and the individual's specific role.
3. Solution design
Effective risk solutions combine multiple protection elements:
- Insurance structures: The right types and amounts of coverage
- Legal documentation: Buy-sell agreements and business continuation plans
- Funding mechanisms: Strategies for premium payments and cash flow
- Tax planning: Making the most of the tax treatment of premiums and benefits
Each element should fit with your overall risk management strategy.
4. Integration with other benefits
Risk solutions work best when coordinated with your restore and reward programs. This collaboration:
- Prevents gaps or overlaps in coverage
- Ensures consistent treatment of key individuals
- Takes advantage of medical underwriting efficiencies
- Streamlines administration
- Maximizes your investment in executive benefits
The business case for risk protection
Organizations sometimes hesitate to invest in risk protection, viewing it as a backup that may never be needed. However, the business case is strong:
- Cost comparison: The premium investment is usually a small fraction of the potential financial impact.
- Competitive consideration: Organizations without protection risk losing key talent to better-prepared competitors.
- Stakeholder confidence: Clients, investors, and lenders increasingly expect continuity protection.
- Peace of mind: Operational focus improves when existential risks are addressed.
When properly structured, risk protection often pays for itself through reduced uncertainty and improved organizational resilience.
Common implementation challenges
Organizations that implement risk protection typically encounter several challenges:
1. Valuation complexity
Determining the precise financial impact of losing a key individual can be difficult. Best practices include:
- Using multiple valuation methods
- Consulting with valuation specialists
- Setting conservative protection thresholds
- Revisiting valuations regularly
2. Medical underwriting
Insurance-based risk solutions require medical underwriting for key individuals. To manage this process:
- Start with preliminary assessments.
- Coordinate with other executive benefit underwriting.
- Consider guaranteed issue options when available.
- Use multi-carrier strategies when appropriate.
3. Budget constraints
Like all executive benefits, risk protection requires a financial investment. Organizations with budget limitations can:
- Phase in protection over several years.
- Prioritize the most critical exposures.
- Explore premium financing options.
- Use hybrid self-insurance and transfer strategies.
Building a comprehensive three Rs strategy
With this exploration of risk, we've completed our journey through the three Rs of executive benefits. The most effective executive benefits programs address all three dimensions:
- Restore: Ensuring key employees receive benefits that match their compensation
- Reward: Providing additional benefits that attract and retain essential talent
- Risk: Protecting the organization from the financial impact of losing key individuals
By thoughtfully addressing each dimension, organizations can create executive benefits programs that benefit both their key employees and their strategic goals.
Next steps
To assess your organization's risk protection needs:
- Identify which roles and individuals are critical to the organization.
- Quantify the potential financial impact of their unexpected loss.
- Review existing protection mechanisms, including insurance and operational strategies.
- Evaluate how your current approach fits with your Restore and Reward programs.
- Consider working with specialized advisors to create integrated solutions.
By taking these steps, you can ensure your executive benefits strategy addresses not only what you provide to your key employees but also how you protect your organization from their potential loss.
