Key Person Insurance: Definition, Cost, Types, and How It Works

A key person insurance policy is a life insurance policy purchased by a company on the life of an owner, a top executive, or another individual deemed critical to the business. The company is the policy's beneficiary and pays the premiums. This is also referred to as "key man (or "keyman") insurance," "key woman insurance," and "business life insurance."

Understanding Key Person Insurance

Key person insurance provides a financial cushion if the sudden loss of a specific individual has a significant negative impact on the company's operations. The death benefit effectively buys the company time to find a new employee or implement other strategies to save (or close) the business.

The key person in a small business is usually the owner, the founders, or a key employee or two. The main criterion is whether the person's absence would cause the company significant financial harm. If this is the case, key person insurance is definitely something to think about.

The Process of Key Person Insurance

A company purchases a life insurance policy on a specific employee(s), pays the premiums, and is the beneficiary of the policy for key person insurance. In the event of the person's death, the company receives the death benefit from the policy.

That money can be used to cover the costs of finding, hiring, and training a replacement for the deceased employee. If the company does not believe it can continue operations, it can use the funds to pay off debts, distribute funds to investors, provide severance benefits to employees, and shut down the business in a timely manner. Key person insurance provides the company with options other than bankruptcy.

To determine whether a company requires this level of protection, executives must consider who is irreplaceable in the short term. In many small businesses, the owner does the majority of the work, such as keeping the books, managing employees, dealing with key customers, and so on. Without this person, the company may come to a halt.

Categories of Loss Covered by Key Person Insurance

A company's key person insurance can protect it against a variety of risks. It may, for example, provide:

1. Profit protection insurance, for example, offsets lost income from lost sales or losses resulting from the delay or cancellation of any business project involving a key person.
2. Insurance designed to protect the interests of shareholders or partnerships. Typically, this allows the surviving shareholders or partners to purchase the deceased person's financial interests.
3. Anyone involved in guaranteeing business loans or banking facilities should have insurance. The amount of insurance coverage is set up to equal the amount of the guarantee.

Cost of Key Person Insurance

The amount of insurance required by a company is determined by the size and nature of the business, as well as the role of the key person. It's worth getting quotes on policies worth $100,000, $250,000, $500,000, $750,000, and $1 million and comparing the costs.

The cost will also be determined by whether the company purchases a term or permanent life policy. Term life insurance is almost always significantly less expensive.

Furthermore, as with most other types of life insurance, the cost of the coverage will vary depending on the insured person's age and overall health.

For a $500,000, 20-year term policy on a healthy 50-year-old male, one major insurer would currently charge $107 per month. Increasing the coverage to $1 million would result in a monthly cost of $190.