What is Key Person Insurance?
Key person insurance (also known as Key man insurance) put simply, is life insurance on a key person within a business. In a small business this is typically the business owner, or perhaps a key employee or two. These are the people who are critical to a business — the ones whose absence could potentially sink the company. For example if something happened to the top sales person, the loss of revenue could cause major financial implications for the business.
So how does Key Person Insurance work?
Here’s how key person insurance works: A company purchases a life insurance policy on its key employee(s), pays the premiums and is the beneficiary of the policy. If that person unexpectedly dies, the company receives the insurance payoff. The reason this coverage is important is because the death of a key person in a small company can cause the immediate death of that company. The purpose of key person insurance is to help the company survive the blow of losing the person who makes the business work.
The company can use the insurance proceeds for expenses until it can find a replacement person, or, if necessary, pay off debts, distribute money to investors, pay severance to employees and close the business down in an orderly manner. In a tragic situation, key person insurance gives the company some options other than immediate bankruptcy.
If the company is a sole proprietorship and employs just you and no other employees or has no other people who depend on it, then key person insurance isn’t as necessary. You’ll notice we didn’t mention your family – don’t confuse key person insurance with personal life insurance. If you have a spouse and/or children who depend on your income, then you should have personal life insurance for that purpose.
Who typically needs this insurance?
Look at your business and think about who is irreplaceable in the short term. Within small businesses certain key staff hold so much experience and knowledge of processes and systems, that if anything was to happen to them, it’s not just a matter of replacing them – a new person could take years to fill their boots.
In many small businesses, it’s the owner who holds the company together – they may keep the books, manage the employees, handle the key customers and so on. If that person is gone, the business pretty much stops.
How much key person insurance do you need?
That depends on your business, we recommend you seek independent financial advice from an adviser who is experienced in business protection.
This article should be taken as information only and should not be taken as advice.