What is Key Person Insurance and Why Your Company Might Need It
Key person insurance can help a company survive the death or disability of the business owner or core employees. Key person insurance, also called key man insurance, is life or disability insurance that a business carries on its core employees. If the key person dies or becomes disabled, the insurance policy pays the business to help replace them.
Key person insurance is valuable for companies with revenue that is dependent on one person’s expertise, performance, or personal network. But if you work in an industry where employees have more generalized skill sets, this business insurance coverage probably isn’t necessary.
What is the purpose of key person insurance?
The purpose of key person insurance is to help a small business maintain its financial footing after the death or disability of an owner or a core employee. Investors and lenders often require key person insurance on a business’s management team.
In addition to the owner, key people in your business might be those who:
- Have highly specialized technical knowledge or industry expertise.
- Have a reputation in your industry or community that is key to your business’s success.
- Are responsible for bringing in a significant amount of revenue that would take time to replace.
Key person insurance can also be used in situations where there’s no key member of your business. For example, in a small business partnership, partners can purchase key person insurance to buy out the shares of former partners.
For businesses, the proceeds from key person insurance can be put toward any of the following:
- Covering operating expenses until you find a replacement hire.
- Training the replacement hire.
- Offsetting lost income.
- Purchasing a former owner’s ownership interest in the business. (You should also have a buy-sell agreement if you plan to use key person insurance for this purpose.)
If you determine that it’s better to close the company, key person insurance proceeds can also be used to pay off debts, distribute money to investors, pay severance to employees and otherwise wind down the business.
In addition to the cash proceeds of the policy, buying a key person insurance policy can benefit your company in other ways. For example, you might be able to borrow against the policy’s cash value or withdraw cash from your policy, though this will reduce the amount of the death benefit.
Types of key person insurance
Key person insurance falls in the category of life and disability insurance. When you shop for key person insurance, you’ll be able to purchase the following types of insurance policies:
- Term life key person insurance
Term life insurance is the most popular and affordable option. You pay premiums on a term life policy every month or every year, and you’re covered if the insured passes away anytime during the term of the policy. Typically, you can purchase term life insurance for a period of up to 35 years, and you can renew when the policy expires.
- Whole life key person insurance
Whole life insurance, also called permanent life insurance, doesn’t have an expiration date. The policy remains in effect for as long as you pay the premiums. Whole life insurance is more expensive than term insurance, but your premiums go into a savings account. As a result, the policy gains cash value that you can borrow against or withdraw money from.
- Variable life key person insurance
Variable life insurance is similar to whole life insurance because the insurance stays in effect for as long as you pay premiums. The difference is that the premiums are placed in investment accounts rather than a savings account. Investments can lose value unpredictably with market highs and lows, so a variable policy can be risky.
- Disability key person insurance
You can add a disability insurance component to your key person insurance as well. The insurer will pay a benefit if the insured experiences a disability that prevents them from performing their job responsibilities.
Key person insurance is a great option for contractors, people with specialized skills in their company, and employees who are valued assets to the company. If you’d like to know more about key person insurance and if you should consider it for your company, give us a call today!
