Key person insurance, also called key man/woman insurance, is a type of life and disability insurance that a business takes out to protect itself in the event of the death or disability of an owner or employee whose role is critical to the success of the business. Less common than certain other types of business insurance, key person insurance is nonetheless an important type of protection for many businesses.
How Key Person Insurance Works
Unlike personal life and disability insurance, a key person policy is purchased by a business, which pays the premiums and is the beneficiary. A business may take out a policy on one or more critical individuals, who are typically founders, owners or other top executives. In the event that the covered individual suddenly dies or is no longer able to work because of a disabling illness or injury, the policy will provide a source of funds to buy out the interests of the disabled shareholder or the shareholder’s beneficiaries in the event of death. If the policy insures a key non-owner employee, the monies are often used to keep the business afloat while it locates and hires a replacement.
Who Needs Key Person Insurance
Key person insurance is particularly important for small businesses that have one or two key people whose knowledge, skills, client relationships or other contributions are so critical to the operation of the business that the individuals’ death or disability would have a devastating impact on the business and threaten its survival. Small businesses across a range of industries, from technology startups to professional service firms, often have one or two individuals that are hard to replace, whether due to their unique skills, reputation with clients or their role in day-to-day operations. Larger businesses have a greater infrastructure, with many experienced executives to absorb the impact of the loss of one individual.
In certain situations, key person insurance may be required if the business is pursuing financing, mergers and acquisitions, or an initial public offering.
What Key Person Insurance Covers
Key person insurance proceeds may be used to pay for a wide variety of costs, from offsetting day-to-day operations expenses to recruiting, hiring and training a replacement for the deceased or disabled insured.
In certain cases, the loss of the key person can impair a company’s reputation, operation or financial viability to such an extent that business closure is unavoidable. In cases where a business cannot continue following the loss of the key person, the monies paid can be used to pay off debts, distribute funds to investors, provide severance benefits to employees and close the business in an orderly fashion. This may stem the need to file for bankruptcy.
Key person insurance policies have exclusions. The most common exclusions are fraud and misrepresentation, as well as suicide.
Amount of Coverage
The amount of money paid is equal to the coverage taken. There is no set formula for determining this value and it is up to the business to decide what coverage it wants and/or can afford. Be advised that some of these policies may require that a written buyout agreement be in place and there could be limiting language affecting benefits based on the value of the insureds’ ownership interest.
What Impacts the Cost
A business can buy term or whole life insurance. Term life policies, which provide a guaranteed level of protection at a fixed premium for a specific time period, are considerably less expensive than whole life policies, and are the most popular form of key person insurance. Key person life insurance ordinarily provides payment of a single, lump sum benefit.
Key person long term disability buy-out insurance (know as “DBO”), can be payable monthly or in a lump sum, depending on the product purchased and the election made by the owner.
Policy costs are impacted by several factors, including the age, gender, lifestyle and health of the employee, the length of the term and the coverage amount.
If you have questions about key person insurance or if your business is involved in a dispute with your insurance company, do not hesitate to call us for assistance. We have the experience, expertise and tenacity to make sure insurance companies keep the promises they made to you and your business.
Contact us today for a free consultation.
Evan S. Schwartz
Founder of Schwartz, Conroy & Hack