If your business depends directly on a vital employee or two and would not be able to function without them, you should consider key person insurance. If a person was deemed essential to the functionality of the business, then it would be wise for the company to utilize key person insurance. In a key person insurance contact, the company takes out a life insurance policy on one or multiple employee(s). The company then pays the premium for the life insurance contract on the life of the employee and the company is also the beneficiary of the life insurance policy. The amount of the death benefit for the policy would be used to keep the business functioning without said employee in the worst-case scenario.
When to Use Key Person Insurance?
If the business depends on a main executive or founder who was responsible for main projects, clients, or source of income, then key person insurance allows the business to cushion their financial losses and avoid bankruptcy. When considering key person insurance, it is important to consider how much monetary loss the company would see in the absence of the person’s business. The insurance policy will allow the company to either pay off any outstanding loans, such as an SBA loan, severance to employees, and close down the business in an orderly manner, or maintain their level of income until they are able to find a replacement. Meaning that in most cases, the business should purchase as much insurance as they can afford on any key person.
What is the Right Amount?
When considering key person insurance, there are two main factors. The amount of death benefit and the type of life insurance to put in place can make for complex decisions when placing key person insurance. In regards to the amount of death benefit, the amount should be enough to keep the business running smoothly in the wake of the passing of the employee. Additionally, other factors that you should take into consideration are the key person’s compensation, how much would it cost to replace the key person, and how much has the key person contributed to my business. When deciding what type of life insurance to pick there are two main kinds. Term life insurance will cover the key person for a temporary period of time and is the most cost-effective. Permanent life insurance, like guaranteed universal life insurance, will cost more for the same coverage as a term policy but there is also a cash value aspect that can, in some cases, be counted as an asset for the business.
Who is a Key Person?
When determining who in the business needs to be insured, it will depend completely on the structure of the business. In a larger operation with many employees and only a few key executives or co-founders, only those would be necessary to insure. In a sole proprietorship with no employees, for example, key person insurance would not be necessary because you are the only employee. Key person insurance works differently from personal life insurance, they are two completely separate policies. However, if you have dependents, you should also have personal life insurance for that reason. All businesses are unique in their financial needs and this is why if you are ever in the need of key person insurance you should consult one of our financial advisors to help you determine the best plan for your budget and cost needs in the case of a tragedy.