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 is a type of coverage that companies like these acquire in case of the loss of a vital income generator.

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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How Does Key Person Insurance Work?

In the event of the loss of a key person, a decent insurance policy will offer any/all of the following services:

  • Offsetting lost income. From lost sales to loss of expertise, a key person policy should be able to compensate for a variety of financial losses caused by the death or incapacitation of a business’ key person.
  • Funding replacement hires. Many key person insurance policies will finance the recruiting and training of a replacement employee (temporary or permanent).
  • Protecting partners or shareholders. If the key person owned a portion of the business, a key person policy should give other partners or shareholders the opportunity to purchase their equity share.
  • Paying loan guarantees. A key person insurance policy should pay out an amount equal to the value of any loan guarantees.

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.