Key Person Insurance: What You Need to Know

Key person insurance is a type of life insurance that businesses purchase for an individual who is essential to the company. These policies can protect your business against the loss of key personnel.

Let’s go over key person insurance, its benefits, who qualifies as a key person, and what businesses need key person insurance coverage.

Understanding Key Person Insurance

Key person insurance aims to protect business interests in case a key person related to the business passes away or becomes disabled. It is also known as key man insurance, key woman insurance, and business life insurance.

With key person insurance, the insured company will receive a lump sum that can help maintain business continuity even if it loses a critical member. The life insurance payout can be used for expenses such as operation costs, compensation for lost income, and hiring and training a replacement.

Key personnel

The key person could be the company owner, founder, executive, engineer, or other individuals critical to the business' success.

When a key person in a company dies, sales decrease around 60%. Companies that fail to recover normal business operations after the loss of a key person can end up with great reputational and financial risks.

Types of events covered

Depending on your chosen policy and key person insurance type, your business may receive coverage for:

• Death of the key person
• Disability of the key person
• Operation expenses until the business can hire a replacement

How does key person insurance differ from other types of business insurance

Businesses often need liability insurance, property insurance, and business interruption insurance. These policies protect companies from liability claims, damaged property, legal feels, and lost income during a disruption period (such as when the supply chain has been interrupted).

Key person insurance focuses on protecting a company from the financial and reputational risks in case a key individual within the business dies or becomes disabled. Other types of business insurance mainly protect the company from third-party claims and lawsuits.

Identifying Key Personnel

How to identify key personnel in the company

To identify key personnel, a company can look at different metrics and factors. Here are some ways to determine if an individual should be covered by key person insurance.

Performance metrics: Looking at key performance indicators and metrics can help your company determine who should be covered by key person insurance.

Leadership and succession: Leaders of the company play important roles, impacting major business decisions. Also look at the company’s succession planning and consider obtaining coverage for successors.

Responsibilities: Evaluate the importance of an individual’s role and responsibilities. A key person often holds heavy responsibilities within the company. If this individual becomes unable to perform their duties or manage employees, business operations may be thrown into disorder.

Client relationships: If an employee plays a crucial role in client relationships, losing them may result in losing important clients. If clients rely significantly on a single worker, it is a good indicator that this worker is a key person in your company.

Skills and expertise: If someone has a unique or specialized skill that is integral to the continuance of business operations, they may be considered key personnel. Without this person, it can be challenging to find a replacement hire or someone to train new employees.

Impact on operations: If a key person is abruptly unable to work due to death or disability, their importance within the company could lead to a serious disruption of operations.

Example of key person roles

There can be numerous key persons who should be insured by key person insurance. Key personnel can be any owner, founder, or employee who is essential to the success of your business. This may mean that:

• Your company reputation is closely linked to one person’s name
• The brand is related to the owner or an employee
• One salesperson is responsible for a significant portion of sales
• The company hinges on an individual’s ideas or inventions for success

Commonly chosen key individuals include:

• Founders and co-founders
• CEOs and other C-level executives
• Top salespeople
• Product and project managers
• Top engineers
• Creative directors and lead designers

Benefits of Key Person Insurance

Financial protection for the business

A key person can be responsible for most of the sales, ideas, or progress within a company. If a key person abruptly passes away or becomes disabled, this could cost a business thousands, if not millions, of dollars. Obtaining key person coverage improves the financial stability of a business. In case of a covered death or disability, the business can file a key person insurance claim and receive a sizable payout. A death benefit or disability benefit can help a company stay afloat as they look for a replacement hire or otherwise maintain business operations.

Ensuring business continuity and stability

Without a key person actively working as a part of your company, business operations and stability could be disrupted for an indeterminate period of time. Typically, this means a business would have to seek out a replacement hire, which may be challenging due to the unique qualifications and role of the key person.

Mitigating risks associated with the loss of key personnel

Many risks are associated with the death or disability of key personnel. If key personnel die or become disabled, this can result in lost sales income, project delays, project cancelations, as well as public relations concerns. A company may end up in debt, need to pause its operations, and/or need to quickly find a replacement hire.

The loss of key personnel due to disability or death is often incredibly unexpected, which means that there may not be adequate measures set in place for the crisis. Having key person insurance ensures that the company will at least receive a substantial lump sum to help it through difficult times.

Enhancing the company's creditworthiness and reputation

Other businesses, organizations, and creditors may require you to carry key person insurance. A company that cannot operate without a key person can take a reputational hit due to the disrupted business operations. With the payout from a key person life insurance policy, your business would be able to better handle the consequences of a key person passing away or becoming disabled.

Business partners and shareholders can feel more confident about relying on a key person if there is a solid key person life insurance policy to back them up.

In addition, if your business wants to obtain a business loan, having key person life insurance may be able to improve the likelihood of a business lender accepting your loan application.

Tax implications of key person insurance

The payout from key person insurance is tax-free if the key individual gives consent before the purchase of the policy and the form 8925 is filed with the IRS. However, the IRS does not usually allow key person insurance premiums to be tax deductible as a business expense.

Securing Key Person Insurance

1. Identify key personnel

When obtaining key person insurance for your company, the first step is to evaluate who qualifies as a key person within your company. Knowing who needs to be insured by key person coverage will affect the rest of your policy decisions. Depending on the size and risk tolerance of your company, you may have numerous key personnel who need to be insured.

2. Choosing the type of key person insurance

Key person insurance counts as life and disability insurance, and providers offer various policies within this category. Common key person insurance types include:

Term life key person insurance: Term life is the most popular type of life insurance because it is the most affordable. Your business agrees to pay the premium every month or year, and during this time coverage is active. If the insured key person passes away during this policy term, your business will be covered. Term life insurance can go up to a period of 35 years. If your policy expires, you can renew it.

Permanent life key person insurance: Also known as whole life key person insurance, this type of policy has no expiration date. As long as you pay a premium, your key person will be covered. The benefit of choosing a permanent life insurance policy is that the premiums enter a savings account, from which your business can borrow money. This cash value can be helpful in case your business encounters a financial hurdle that requires cash.

Variable life key person insurance: Provides similar coverage as a permanent life insurance policy. However, the premiums go into an investment account instead of a savings account. This involves variable value based on the current market conditions.

Disability key person insurance: Many companies choose to purchase an insurance rider that adds disability coverage to the policy in case the key person becomes disabled. The key person insurance provider would usually pay a benefit between 40% - 70% of the key person’s salary in case they experience a debilitating disability that interrupts their ability to carry out their job.

3. Deciding on the coverage limit

Most businesses opt for a coverage limit that is up to 10 times the salary of the key individual. This is generally between $250,000 and $1 million. A higher coverage limit will make the policy more expensive, but in the event of the insured’s death, your business will be better protected financially.

Businesses should regularly review their insurance policies and key personnel statuses. If your business’ needs or situation changes, it’s important to update the insurance policy so that it still provides suitable coverage and the best key persons are insured.

4. Comparing quotes

Business insurance premiums can easily accumulate over the years, becoming a substantial recurring expense. It is a good idea for businesses to compare quotes and insurance providers to ensure they are receiving a fair rate and suitable coverage. It is advisable to use an insurance brokerage or agency to obtain and compare business insurance quotes.

5. Assessing health and financial status

Before issuing key person insurance to a company, insurance providers often require the insured to undergo a health exam. A key individual’s medical conditions and health status can greatly affect the premium rate of your insurance policy. A healthier, younger individual usually means a lower premium. A key person with higher health risks will likely require you to pay higher premiums.

Other than the key person’s health, additional documentation will be necessary for business life insurance. The insurance provider may request financial statements and details about your key person’s responsibilities and roles.

6. Paying the premium

The business is responsible for paying the key person insurance premium. After your business insurance policy has been underwritten and approved, your business will need to pay the initial premium to activate coverage.

The premium for key person insurance is around $180 per month. The premium depends on numerous factors, such as the insured key person’s age, physical health, industry, and the business’ needs. While the premium for key person life insurance is around $180 a month, this amount can vary greatly depending on your business needs and designated key person.

Remember to keep paying the premiums on time to ensure the policy coverage is not interrupted.

Summary

All businesses that rely on one or more key individuals for their success should consider key person insurance. It helps businesses endure the worst case scenarios of the death or disability of key personnel. The life insurance payouts can go into the millions, providing essential financial protection during times of crisis and ensuring operational continuity.

Assess your business’ needs and employee roles to see whether you need key person insurance. Consult with an insurance broker or agent to explore your coverage options today.

---