It’s a difficult, but important question to ask. What would happen to your business if a key person (owner, founder, or essential employee) passes away? Companies of all sizes and in all industries meet all sorts of challenges when they lose someone they heavily depend on.
What could you lose if you lost a key person at your company?
- Specific knowledge and a valuable skillset
- Follow through on strategic initiatives
- Consumer and creditor confidence
- Valuable customers
If losing a partner or key employee would jeopardize your ability to continue successful administration and operation of your business, you might consider key person (sometimes known as “key man”) life insurance to protect your company.
Key person life insurance (one of the four types of business life insurance) can help your company by providing a monetary payout to see you through the loss.
With key person life insurance for your business, you can:
- Help make up for lost sales or earnings.
- Cover costs of finding and/or training a new employee to assume the key person’s role and responsibilities.
- Pay down debt.
- Ensure continuation of strategic initiatives.
- Assure customers and creditors your business remains viable even without that key employee.
Businesses of all sizes – from very small companies to large Fortune 500 corporations – routinely use key person life insurance. It’s available as both term life policies (which have more affordable, lower-priced premiums) and permanent life policies such as whole life and universal life (which have higher premiums with cash value in addition to a payout).
What can you expect when applying for key person life insurance?
- You’ll be asked if all key persons in your company will have policies on them for comparable amounts. If not, prepare to explain why.
- You’ll need to explain why the employee is “key.” What knowledge, skills, and abilities do they have that – if lost – would cause your business to suffer financially.
- You’ll need to provide some general information about your business including things like: fair market value, assets, liabilities, net profit, etc.
- You’ll need to provide financial documentation such as: tax returns, balance sheets, P&L reports, etc.
Life insurance companies’ application requirements vary, so you might be asked for other information as well.
Your business would own and control the key person life insurance policy. Your company, not the employee, would pay the premium (it’s a tax-deductible expense). If the key person dies, your business would be the beneficiary and receive the death benefit to help keep your business running.
Death benefits paid to a business or organization could be considered taxable earnings to the company. To avoid this, you’ll typically need the key person’s written approval to be covered by the policy. Other documents may be needed as well. So play it safe and consult with a tax attorney prior to purchasing a new policy.
How much key person life insurance does your business need?
There’s no magic formula to calculate it, but carefully consider how much money your company would need to survive while you search for someone to replace the key person. Then look for a policy to fit your budget and meet your business’s short-term needs in the event a heartbreaking disaster strikes.
Term policies are most flexible and cost effective as you can purchase them to cover the number of years you anticipate the key person will remain active in your business. Shorter term policies have lower premiums; if you expect a key person will retire in 10 years, you can apply for a 10-year term policy. Talk with a trusted insurance advisor when choosing a policy.
Think twice before thinking you don’t need key person life insurance for your business.
Dealing with the unexpected is part of life. It’s also a part of business.
There’s no joy in thinking about losing a friend/business partner, but with key person life insurance you can avoid the pain of a financial tragedy on top of the emotional distress.