What is 'Key Person Insurance'

A life insurance policy that a company purchases on a key executive's life. The company is the beneficiary of the plan and pays the insurance policy premiums. This type of life insurance is also known as "key man insurance," "key woman insurance" or "business life insurance."

BREAKING DOWN 'Key Person Insurance'

Key person insurance is needed if the sudden loss of a key executive would have a large negative effect on the company's operations. The payout provided from the death of the executive essentially buys the company time to find a new person or to implement other strategies to save the business.

In a small business, the key person is usually the owner, the founders or perhaps a key employee or two. The main qualifying point would be if the person's absence would sink the company. If this is the case, key person insurance is definitely worth consideration.

How Key Person Insurance Works

For key person insurance policies, a company purchases a life insurance policy on its key employee(s), pays the premiums and is the beneficiary of the policy. In the event of death, the company receives the insurance payoff. These funds can be used for expenses until it can find a replacement person, pay off debts, distribute money to investors, pay severance to employees and close the business down in an orderly manner. In a tragic situation, key person insurance gives the company some options other than immediate bankruptcy.

To determine if a business needs this kind of coverage, company executives must consider who is irreplaceable in the short term. In many small businesses, it's the owner who does most things – keeping books, managing employees and handling key customers, etc. Without this person, the business would come to a stop.

How much insurance is needed depends on the business, but in general, a business should buy whatever they can afford. Companies should ask for quotes on $100,000, $250,000, $500,000, $750,000 and $1 million policies, and compare the costs of each.

Categories of Loss Covered by Key Person Insurance

  1. Losses related to an extended period when a key person is unable to work, but has not died.
  2. Insurance to protect profits...for example, offsetting lost income from lost sales, losses resulting from the delay or cancellation of any business project in which a key person was involved.
  3. Insurance designed to protect shareholders or partnership interests. Typically, this insurance enables shareholder or partnership interests to be purchased by existing shareholders or partners.
  4. Insurance for anyone involved in guaranteeing business loans or banking facilities. The value of insurance coverage is arranged to equal the value of the guarantee.
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