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. Key person insurance is one way you can limit the damage and risk from this tragic situation.
Key person insurance is a type of life insurance policy taken out on an essential individual in your business. If the covered person dies or becomes disabled while covered under this policy, your business gets a payout that helps you protect your operations, find another person to fill that critical role, or gives you the resources to work around that loss. This type of insurance is sometimes referred to as business life insurance and key executive insurance. You can leverage key person insurance as part of your company’s succession and business continuity planning.
A key-person varies from business to business. In many cases, you would take this life insurance policy out on business owners, executives, founders, and other leaders. If your business can’t function without massive changes if you lose that person, they would fall under the key person criteria.
Your company purchases and owns this life insurance policy, not the key person. Your business would pay the premiums for the key person insurance policy.
Your company is the beneficiary of the key person insurance. If death or disability occurs, you will receive a payout based on the terms you set up with the insurance company. The funds can cover many types of business expenses, including recruiting a replacement, restructuring the business, paying for operational costs, servicing debts, and others.
The size of your key person life insurance policy is dependent on your type of business, your revenue, your liabilities, the role of the key person, and many other factors. Try to account for all the costs that could reasonably be associated with the loss of an important employee.
You may need a temporary cashflow while you put new procedures and staff in place or enough to pay off the company’s creditors before closing. If the employee is directly responsible for bringing in a certain level of revenue into the company, the policy may need to cover that loss until you onboard someone else.
Another consideration to keep in mind is how much of a financial impact you expected that individual to have over the long-term with the company, especially if you expected them to spend many years there. The insurance company you chose may have minimums and maximums on this type of policy, so confirm those numbers while you make your decision.
You need to balance your chosen coverage with the premium cost. The larger the policy, the higher this premium payment will be. However, that’s not the only factor influencing this cost. Your key person’s age and health also play a role. Your company’s industry and how large it is can also change the policy expenses.
The first step of taking out a key person insurance policy is to prove that you have an insurable interest in regards to the selected individual. Make sure that you can show estimates of the financial impact of losing that employee.
While the key person neither owns nor benefits from this policy, they must consent to it before your business purchases it.
You select how long the policy covers this person–either with a specified term or permanently. The typical life insurance term ranges from 5 to 20 years, but this period can be customized based on your requirements. You only receive benefits if that person dies or becomes disabled in this term.
If you chose permanent life insurance, your key person is covered for their entire life. This policy is much more expensive than a term policy, but you don’t have to worry about it running out when you need it the most.
Upon the key person’s death or permanent disability, the insurance company pays the benefit to your business. In the event of disability, you will need to be past the initial waiting period, if there is one for that policy.
You may receive the payment as a lump sum or spread across several months, which is called a benefit period. Your business can cover more than one key person. Some insurance companies offer a group key person policy that covers the first individual to die in that group. You save money on your premiums, but you would need to take out a new key person insurance policy for the others in that group.
Small businesses and startups frequently have a handful of people who fulfill many duties. You can find owners, founders, and executives wearing multiple hats. The business needs a plan in place to react in case those key employees can no longer contribute.
Companies whose reputations are strongly linked to an individual, such as a local service company or a sole proprietorship, may not be able to survive losing that person. The key person insurance would cover severance for employees and contractors working with that individual, or it could allow them to split off and form a new company.
Key person insurance is also useful for partnerships. If one of the partners dies, then the others would have the resources available to buy those shares and avoid a major shakeup in the organization.
Businesses that are heavily leveraged with debt and reliant on specific people to keep the cash flow coming in, may find this policy useful. You can protect your company’s credit rating and maintain good relationships with your creditors when the death benefits can cover those payments.
Some investors, financial institutions, and venture capitalists require life insurance policies in place as part of their qualification process. Without a key person policy, you may not be able to access those financing channels.
Key person insurance policies are highly customized for your business, as an out-of-the-box solution wouldn’t be able to cover complex scenarios. When you’re shopping for key person insurance, get quotes from multiple providers so you can compare your options.
You not only want to see what the costs are at different providers but also how much different coverage levels would require in premiums. A key person may only result in a $100,000 loss or they could have a multi-million-dollar impact on your company.
Policies that cover disability, as well as death, are more complex, and you want to pay close attention to the exact situations they cover. You don’t want to deal with a tragic situation that results in the permanent disability of the key person, and then find out that the losses aren’t covered due to a misunderstanding at the policy creation.
Look into how hard it is to file a claim, the paperwork required to prove the death or disability of the key person, and what other business owners think about the companies. You can’t spend months waiting for a benefit payout when the survival of your business is on the line. Compare life insurance policies that work for your needs.