Key Person Insurance
Coverage for the Loss or Disability to a Key Employee
As its name suggests, key person insurance protects a business against the death or disability of a key executive or employee. The coverage may consist of a life policy, a disability policy, or both. Key person insurance may also be called key executive, key man, or key employee coverage.
When It's Needed
Key person coverage can be important when a company depends on one or two individuals to succeed. For example, Dave and Dan Divine own Divine Designs, a renowned architectural firm. The two men are brothers and each has special skills. Dave is a talented architect and Dan is a marketing whiz. The company's success depends on the talents of both men. If either Dave or Dan dies or becomes disabled, the business might not survive. To protect itself, the company purchases key person coverage on both men.
You should consider purchasing key person coverage if your business has any of the following characteristics:
- Your business is highly dependent on one or more individuals who have special skills and would be difficult to replace
- The death or disability of a key individual could cause your business to lose significant income
- Your business has debt that would be difficult to pay off if a key individual died or became disabled
- Your business plans to seek financing. Most financiers and banks will require you to have key person coverage before they extend financing to your company.
- Your company plans to merge or go public. You will need this coverage for top executives and board members.
A business purchases key person life insurance to protect itself against the death of an important individual. If the key person dies, the company receives the proceeds of the policy. The company can use the money to hire and train a replacement, to pay off debts, or for some other purpose.
Key person life insurance can be written for a specific period of time (such as twenty years) under a term policy. It can also be written under a universal or whole life policy.
Some companies have more than one key person. An example is Divine Designs, described above. The company is dependent on both Dan and Dave for its survival. One option the firm could consider is a life policy that includes a "first to die" provision. The policy would pay benefits to the company if either Dan or Dave died. The policy would no longer apply to the remaining founder. The policy payment would be used to replace the efforts of the first founder (hiring personnel, covering loss of sales etc.).
Insurance purchased in this manner would cost less than two individual life policies.
Key person disability insurance protects a company against the risk that a key employee will become disabled to the extent that he or she is unable to work. Benefits may be payable on a monthly basis or as a lump sum. Benefits are paid after a specified waiting period. This period might be 30 or 60 days for monthly payments and 12 or 18 months for a lump sum payment.
There is no "standard" key person disability policy. Rather, each policy is typically designed to meet the needs of the company buying the coverage.
Amount of Insurance Needed
Determining the amount of life or disability insurance to purchase on a key person isn't easy. You will need to estimate the economic loss (lost revenue or profit) your firm will suffer when a key person dies or becomes disabled. You will also need to consider the cost of recruiting, hiring and training a replacement employee. An insurance agent or broker can help you calculate the amount of insurance you need.
The premiums you pay for key person coverage are generally not deductible for tax purposes. However, the death or disability benefits your company receives are generally tax-free. Consult your tax professional to determine how the purchase of key person insurance will affect your firm's taxes.
Article edited by Marianne Bonner