Key Person Insurance
While not mandated by state law, many small businesses purchase key person coverage to provide continuity and financial protection if a partner or critical employee dies or becomes disabled.
Key person life or disability coverage, offered as separate policies, can help a company make up for lost sales, or cover the costs associated with finding and training a replacement for the deceased or disabled key person.
The idea of what constitutes a critical employee will depend from company to company. A key person may be an important sales executive, a partner in the business, or a manager who oversees daily operations. In short, it's someone a business could not survive without, or would have a difficult time replacing.
Key person insurance can also provide critical financial assistance if the death or disability of a partner or owner triggers payment covenants in the company's bank debt.
Some financial and operational benefits of key person insurance may include:
- Funds to maintain cash flow and payroll following the loss or disability of a critical team member
- Money to identify, recruit and train a replacement employee
- Protection of company assets from a need to finance cash flow or repay debt suddenly
- Protection of other equity owners. Key person insurance proceeds can be used, for instance, to purchase the departed or disabled employee's shares in order to provide financial protection to his or her family.
Premiums will be based on a variety of factors, including the key person's age, health and medical history, whether he or she smokes, and other underwriting considerations.
Unlike life or disability insurance purchased by the team member, key person coverage is purchased by the company, which is also the named beneficiary in the event of a loss. Depending on the company and its financial needs, key person insurance may be structured as long-term disability coverage, a life insurance policy, or a combination of the two.
Small business owners interested in key person coverage should consult with an experienced insurance professional, as well as a tax advisor, to arrange the most effective policy.