Q&A: Difficult transitions

What does key man insurance offer the private equity industry? 

As you know, the private equity industry usually has long lockup periods (i.e. five years to invest and five years to harvest).  And investors follow talented individuals or groups of individuals. So if those individual(s) perish prematurely, their investment could be at risk or not obtain the anticipated returns.  Key-man insurance can create immediate liquidity and ease the mind of investors and the firm’s employees – it could also unwind long term positions. Depending on how the key-man contract is structured at the private equity firm, it could create a more flexible environment that just might attract investors to a particular firm or individual.

There is another element to this theory.  The key-man coverage could be used for estate planning purposes that could help the “key” employees liquidate their position and help solve the estate tax burden that could occur.  It could also secure the position of the surviving employees.  

How much does it cost? 

David Parker

In comparison to other policies investors are asking funds to purchase, key man insurance is relatively inexpensive. A 50 year-old private equity manager in good health can buy a 10-year, $10 million term policy with a guaranteed premium for approximately $11,300 a year, and $20 million in coverage for about $22,600. Its low cost may be contributing to the rise in demand.

This may not seem expensive at all when you consider what you’re purchasing:  the comfort of knowing that in the event of a keyman’s death the firm has ample liquidity to unwind the portfolio and thus avoid any kind of fire sale. Or maybe the firm decides to continue operations going forward – this money gives them an opportunity to perhaps go out and get more key players if that’s necessary.

Does the cost increase depending on a dealmaker’s seniority or stature within the firm?

It is strictly based on an individual’s demographics, so things like someone’s health, age, gender, smoking status, lifestyle, etc.  

How popular is key man insurance in the industry? 

I would estimate insurance companies wrote 10 percent more key man policies in 2011, compared to 2008. It has become one more item on the institutional investors’ check list. 

Investors aren’t trying to insure against the loss of the manager so much as they are seeking to protect their investment by promoting an orderly transition or dissolution of the fund. They worry about the time it takes to unwind illiquid investments, while other demands on the funds’ cash continue, such as paying rent and vendors. Cash from key man insurance can go a long way towards alleviating those concerns.

And more private equity employees are realising this aspect of risk and they’re looking for more security. They know that if a key man insurance policy is in place to provide liquidity for the firm, they are going to be in a better position as they seek new opportunities.