What Is Key Person Insurance?

What Is Key Person Insurance?

Most companies have one or two primary individuals whose work accounts for a significant portion of overall profits, or whose contributions are otherwise indispensable to the business.

Key person insurance, also known as key person life insurance, provides critical financial protection for businesses in the event they lose a vital team member or that team member suffers an illness or injury. This article will outline the important information to know about this business life insurance policy, who needs it, and how much coverage may cost your business.

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What Is Key Person Insurance?

Key person insurance is a crucial risk management tool for startups, protecting the company against the loss of its most valuable assets: its key employee(s). This type of policy provides financial compensation to the business if a designated “key person” — typically a founder, top executive, or indispensable team member — dies or becomes unable to work due to disability.

The payout can help cover costs associated with finding and training a replacement, mitigating potential revenue loss, or even keeping the company afloat during a challenging transition period. For startup founders, securing key person insurance can be vital to safeguarding their vision and the company’s future against unforeseen circumstances.

Who Needs Key Person Insurance?

Key person insurance is worth looking into for any company operating with more than one member, but it’s especially important for small businesses that rely heavily on one particular person. If the key person in a small business is to pass away or become incapacitated, the company may not survive without an insurance policy in place.

Key person coverage allows businesses to hire temporary or permanent replacements for deceased/incapacitated individuals, as well as recoup lost income that they would have accounted for.

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What Does Key Person Insurance Cover?

In the event of the loss of a key person, key employee life insurance policies likely will cover some or all of the following circumstances:

  • Financial Losses: The policy can compensate for lost revenue or profits directly attributed to the key person’s absence.
  • Recruitment and Training Costs: It helps cover expenses associated with finding and training a suitable replacement.
  • Debt Repayment: Companies can use the “death benefit” of this life insurance policy to pay off outstanding business loans or debts the key person may have guaranteed.
  • Shareholder Protection: In partnerships or closely held corporations, the payout can fund buy-sell agreements that allow surviving owners to purchase the deceased’s shares.
  • Business Continuity: The insurance proceeds can provide working capital to keep the business operational during the transition period.
  • Client Retention: Companies can allocate payout funds to maintain client relationships that might be at risk due to the key person’s departure.

It’s important to note that while the term “key person insurance” often refers to life insurance, some policies also offer disability coverage. This additional protection ensures the business receives benefits if the key person becomes unable to work due to a severe illness or injury.

How Much Coverage Do I Need?

The amount of coverage you should seek out in a key person policy depends on the size and scale of the business itself, as well as the value of the key person’s contributions. Most insurance providers offer key person coverage at five levels: $100k, $250k, $500k, $750k, and $1 million.

It’s important to acquire a large enough policy to address your company’s potential financial needs, but not to exceed the limit of what the business can afford. For example, a $100k policy with a 10-year term typically runs around $100 per year, whereas a $1 million policy with a 20-year term carries annual premiums of around $1000.

In other words, make sure you understand your company’s budgetary constraints before investing in a key person insurance policy.

Wrapping Up

Whether their value comes from generating sales or creating a vital piece of intellectual property, losing a key person is never easy.

That said, having a key person insurance policy in place can significantly minimize the damage felt by your business in the event of a tragedy. If you can identify one or more key persons in your company, we encourage you to consider investing in key person coverage today.

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