What is Key Person Insurance?
What happens to your business if a key employee dies or becomes permanently disabled? Key person insurance is a type of life insurance policy taken out on an essential individual in your business and is one way you can limit the damage and risk from this tragic situation.
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According to the Horton Group, an estimated 86% of U.S. businesses are made up of 20 people or less.
This figure is even more interesting when you consider the statistics in relation to death before age 65. The probability of the death of at least one in three business owners before age 65 is surprisingly high at 53%.
What happens to your business if a key employee dies or becomes permanently disabled? Would you be able to get back to normal quickly, or are you looking at massive disruptions and revenue loss? The smaller your business, the more likely it is that losing a vital individual can impact the long-term viability of your organization.
This article will discuss what a key person life insurance policy is, how much it costs, how you can benefit from it, and whether your business needs it.
What Is Key Person Life Insurance?
Key person insurance is also referred to as “key man insurance” or “business life insurance.” It's a type of life insurance that covers a business owner or a high-ranking executive, such as a CEO, to make up for their absence if they die.
Organizations that purchase key person insurance do so to provide protection for their companies.
The covered person is usually very important to the company's operations and revenue generation.
In the event that this person dies or is injured, this insurance would make sure that the company gets a payout.
Most businesses, however, prefer buying term life insurance as they would want to cover a specified period of time only.
What Is Term Life Insurance?
Term life insurance policies are contracts between policyholders and insurance companies that financially cover people in the event of their death.
Policyholders pay the insurance company a monthly premium and when the policyholder dies, the insurance company pays out a death benefit.
Term life insurance plans, however, only offer coverage for a fixed period. The word “term” simply means a length of time.
How Does Key Person Life Insurance Work?
When a company buys a key person insurance policy to cover an important individual or key employee’s life, the company is the exclusive beneficiary of that policy.
The company would receive the death benefit of the insured person and the insurance premiums are paid by the company, assuming that the insured individual agrees to the policy.
The death benefit received by the company can help the business move forward.
This can include hiring and training a new business leader to take the place of the deceased key person, or paying business loan payments with the death benefit.
If the company wants to close, the death benefit can help with paying the employees their severance packages.
What Is a Severance Package?
A severance package is pay and benefits that employees may be entitled to receive when they involuntarily have to leave their employment at a company.
What Is the Cost of Key Person Life Insurance?
How much insurance a company needs will depend on the size and nature of the business and the key person's role. The pricing criteria for key person life insurance are very similar to that of ordinary life insurance.
Some factors that play a role in cost are:
Type of coverage
Amount of coverage
Age of the covered person
Health condition of the covered person
In general, young and healthy individuals are less expensive to insure than older people or individuals with a history of health issues.
What Is a Permanent Life Insurance Policy?
Permanent or whole life coverage is a life insurance policy that does not expire and stays in place for your entire life.
These life insurance contracts will only end if the policyholder stops paying their premiums or terminates their policy.
The cost of the coverage will vary according to the insured person's age and overall health, just like most other types of life insurance.
For example, an insurer could currently charge $107 a month for a $500,000, 20-year term policy on a healthy 50-year-old male executive.
If a company needs more coverage and raises it to $1 million, it would bring the monthly cost to $190.
When it comes to tax, key person insurance is not deductible. The IRS does not see life insurance premiums as a necessary ordinary business expense. That's why premiums must be paid out-of-pocket.
It's worth asking professionals, such as PolicyScout consultants, for policy quotes on everything from $100,000 to $1 million and comparing the costs of each.
Permanent vs. Term Key Person Life Insurance
The cost of a key person life insurance policy will also depend on whether the company buys a term life policy or a permanent life policy. Typically, term life is the cheaper option.
The table below shows a comparison between the two for a $500,000 policy for someone under the age of 45.
| Features | Term Policy | Permanent Policy |
|---|---|---|
| Duration | 1-30 years | Life |
| Cost | $25-35 /month | 5 to 15 times more than term |
| Guaranteed Death Benefit | Yes | Yes |
| Guaranteed Cash Value | No | Yes |
| Cash Value Growth | N/A | Earns interest at a predetermined fixed rate |
| Premiums | Can increase periodically or stay level for the policy duration | Stays the same |
What Does Key Person Life Insurance Cover?
Key person life insurance can protect a business from a wide range of things. For example, it might offer:
Insurance to protect profits—for example, a company can curb lost income due to the delay or cancellation of any business project involving a key person.
Insurance designed to protect shareholders or partnership interests. Usually, this allows the remaining shareholders or partners to buy the financial interests of the deceased key person.
Insurance for anyone who is involved in securing business loans or accounts.
Common Key People
Key people inside a business might include:
The founder: The person who started the business and got things off the ground in the first place.
Office Manager: This person is crucial in running the day-to-day operations of the business.
Technology guru: If your business exists online and relies on a website to drive sales to your business, losing the main developer of your business could mean losing the main source of income.
Top salesperson: If your business operates in the sales industry and there’s one person you rely on to bring the business through the door and make it stick, this person is key to the profits of the business.
Who Needs Key Person Life Insurance?
Not every company needs key person life insurance. Small companies tend to need key person insurance because multiple business functions are handled by a few key people.
For example, small business owners typically handle bookkeeping, hiring, sales, marketing, and other functions needed for the company.
There are three main types of businesses that can benefit from key person life insurance:
Larger Businesses or Corporations
Key person insurance is crucial for businesses like doctor’s offices, publicly traded companies, big financial firms, and medium-sized businesses.
Top executives can help keep a business going just through their name, reputation, or customer base. So, their death can affect everyone from the CEO at the top and downwards.
Start-Ups
Start-ups often have founders, CEOs, or a small group of key employees who are hard to replace.
However, it might be more difficult to get key person insurance for start-ups because the business doesn’t have a track record yet.
If you're unsure about whether you need key person insurance, speak with a licensed insurance agent to find out.
Small Private Businesses
People who own small family-owned businesses or private practice law firms are often hard to replace.
That's either because of how well they're known to clients or because they're very involved in the daily running of the business.
How Do I Choose Which Coverage to Buy?
Key person insurance could be a very valuable financial safety net that protects a business if an important person to the business dies. Before you purchase a key person insurance plan, consider these tips: 1) Weigh up the cost of the coverage and value that the person brings to the business.
2) Look at how many key employees you have at the business.
3) Determine whether the person or people you would like to insure can be replaced and what their death will imply for the company.
4) Look at your company’s contingency and legacy plans.
5) Get multiple quotes from different life insurance providers.
6) Work with an insurance broker or agent to determine your coverage needs and insurance options.
If you need any assistance with finding key employee or key person insurance, reach out to one of our agents today. We’ll happily help you find the best plans and can advise you on permanent life insurance, disability insurance, AD&D insurance, and other work-related cover.
Where Can I Learn More about Life Insurance?
Life insurance can be confusing, that’s why we’ve created our life insurance hub to help you. If you’re interested in finding out more about term, permanent, group, or final expense insurance, read our articles to learn more.
If you’re currently looking for a key person policy or are curious about which plans are best, get in touch with one of our professional consultants for personal and tailored advice. Send us an email at help@policyscout.com or give us a call at 1-888-912-2132.