Protect Your Business With Key Person Insurance

Key person insurance is simply life insurance on a key person in a business. In a small business, this is usually the owner, the founders or perhaps a key employee or two. These are the people who are crucial to a business.

Here’s how key person insurance works…

A company purchases a life insurance policy on its key persons or employees, pays the premiums and is the beneficiary of the policy. If that person unexpectedly dies, the company receives the insurance payoff. The purpose of key person insurance is to help the company survive the blow of losing the people who make the business work.

The company can then use the insurance proceeds for expenses until it can find a replacement person, or, if necessary, pay off debts, distribute money to investors, pay severance to employees and close the business down in an orderly manner if needed. In a tragic situation, key person insurance gives the company some options other than immediate dissolution or bankruptcy.

If the company is a sole proprietorship and employs just you and no other employees or has no other people who depend on it, then key person insurance isn’t as necessary. You’ll notice we didn’t mention your family—don’t confuse key person insurance with personal life insurance. If you have a spouse and/or children who depend on your income, then you should have personal life insurance for that purpose.

How do you determine who needs this insurance?

Look at your business and think about who is irreplaceable in the short term. In many small businesses, it’s the owner who holds the company together—he/she may have core competencies like, artistic talents, keeping the books, managing the employees, handling key customers and so on. Without that key person’s functionality, the business pretty much stops.

How much key person insurance do you need?

That depends on your business, but in general, you should get as much as you can afford. Insurance carriers will want to see that all key people, or owners of the company will be insured. It’s a red flag to them if any key persons or owners aren’t being insured, unless they are uninsurable. Shop around and get rates from several different agents; most life insurance agents will sell you a key person policy. Be sure to ask for term insurance—many agents will push whole or variable life, which have much higher premiums and commissions but are unnecessary for a key man policy.

Ask for quotes on $100,000, $250,000, $500,000, $750,000 and $1 million, and compare the costs of each. Then think of how much money your business would need to survive until it could replace the key person, come up to speed and get the business back on its feet. Buy a policy that fits into your budget and will address your short-term cash needs in case of tragedy.