What is key person insurance?
In a small business, one or two people often keep the business running. It may be the owner, founder or a critical employee whose expertise, relationships or leadership drive the company’s success. This person is typically so crucial to a business’s function that if they were to (poof!) disappear one day, the business could fall apart.
The loss of a key person could lead to a sudden drop in revenue. There can also be costs associated with hiring and training a replacement. The disruption in daily operations might also damage client relationships or delay important projects. A business might struggle to stay afloat without this individual’s contributions.
Key person insurance coverage, sometimes called key man insurance, can help cushion a business from financial losses in the event of this important person’s death. Think of it this way – key person insurance is essentially a life insurance policy, but the beneficiary is your business.
What is the purpose of key person insurance?
Key person insurance helps to ensure your business doesn’t go under without you. If you’re the owner, you’re probably the one who keeps everything together. It’s quite likely that you’re the top salesperson, and only you know the details for filing your income tax return as well as the password for the router.
Without you, the rest of your employees might struggle to continue your business. With the death benefits from a key person insurance policy, your business could:
- Pay for a temporary worker to do some of your tasks.
- Cover lost income that results from your absence.
- Stop work while someone else learns your job.
- Pay off a business loan.
- Fund a buyout.
- Tie up business ends and close smoothly.
For many small businesses, this coverage is not just a precaution — it’s a critical component of their risk management strategy. It can help ensure the business can survive and thrive in the face of unexpected challenges.
Key person insurance vs. life insurance: What’s the difference?
Key person and life insurance both provide financial protection in the event of a person’s death, but they serve different purposes.
Key person life insurance
- This is purchased by a business to protect against the financial impact of losing a key employee or owner.
- The business pays the insurance premiums and is the beneficiary of the policy.
- The payout helps cover business-related expenses, such as lost revenue, debt or costs associated with finding a replacement.
Life insurance
- This is typically bought by an individual to provide financial support to their family members or dependents after their death.
- The individual pays the premiums, and their chosen beneficiaries receive the payout.
- The funds are usually used for personal expenses like mortgage payments, living expenses or education costs.
So, it’s a similar concept, but key person insurance protects the business, while life insurance is designed to protect an individual’s family.
Is key man insurance right for your business?
Evaluate the potential impact of losing a critical team member. A business operator should ask:
- How much will it cost to replace the employee? Whether that means recruiting and hiring from outside or training from within, consider the cost and time it’ll take to find a suitable replacement.
- How much revenue do they bring in? How much business will you be losing while you find a replacement? Will clients leave without the key employee around? Will project timelines suffer?
- Does this person have unique skill sets that are tough to replace? Certain industries, like tech startups or construction businesses with specialized expertise, may find this insurance crucial due to the unique skills of key individuals.
If you feel your business would stop without a particular employee, it might be worth looking into key man life insurance.
Or, If you’re the key person in your business and you want your business to outlive you, key person business insurance can ensure your team has the resources to carry on.
What happens if the insured person quits the business?
Three common possibilities exist for a business if an insured key person leaves their job:
- The company surrenders the policy. The business accepts the loss of the money spent on premiums and surrenders the policy. The insurance company will terminate the coverage and send a check for the policy’s cash surrender value.
- The company can sell the policy. Sometimes, business owners can sell the key person policy to the key person’s new employer.
The company can arrange a life settlement. The business sells the policy to a third party.
