What Is Key Person Insurance and Does Your Business Need It?
Written by
Insurance doesn’t have to be boring. That’s why we hired Sara East to be our BA insurance writer. Maggie specializes in making mundane subjects hella-entertaining.
Reviewed by
Paul Martin is the Director of Education and Development for Myron Steves, one of the largest, most respected insurance wholesalers in the southern U.S.
Sometimes your business has an employee whose knowledge and contribution are essential to keeping your business alive. In fact, they're so important that you know that losing them would cause you significant financial loss. So you may be wondering if it's possible to take out insurance on a person? The good news is that we know so that you don't have to.
Independent insurance agents know everything there is to know about all different kinds of insurance, including key person insurance, which is what you need to protect your business from the loss of that special employee. These agents know how to keep your business running in the unfortunate event that your star employee passes away or cannot work for an extended period. But first, let's look deeper into key person insurance.
What Is Key Person Insurance?
Key person insurance is life insurance on a particular person because their contribution to your company is so valuable that their death or inability to work for a long period would cause your business to experience financial loss.
This insurance policy can be taken out on any employee, but its most commonly done in partnerships where each partner is contributing to the wealth and prosperity of a company. Often, if one partner were to pass away it would negatively impact the business financially, so key person insurance provides the financial means for the company to move forward.
Who Does Key Person Insurance Protect?
This insurance protects whoever is purchasing the insurance on the key person. In a group of partners, if one person were to die or be unable to work for an extended period, key person insurance protects the remaining partners. It enables them to have the finances to replace the lost partner, pay out a spouse who may have been the next in line to be a partner, and financially stay afloat after losing that person's participation in the company.
Another example would be a boxing federation that takes key person insurance out on the announcer for the federation because he's a major contributing factor to the brand. If the announcer were to pass away, the boxing federation would get paid the life insurance amount from the policy.
How Does Key Person Insurance Protect a Company?
There are a variety of scenarios where key person insurance can protect a company. Here are a few:
- If the founder of a company passes away, their death could mean the end of the business, so the payout from key person insurance can keep the company open.
- If a sales business's top salesperson becomes disabled and unable to work, key person insurance can replace their sales amounts until a new sales associate can be hired.
- If partners in a business want to be able to buy out each other's shares if one of them dies.
- If a financial institution needs collateral for a business loan and wants to put a lien on a key person policy.
The funds received from a key person insurance policy payout can be used for a number of expenses, including paying off debts, finding a replacement employee, giving money to investors, paying severance, and any other financial necessities that delay or remove the chances of the company going bankrupt or out of business.
Does Key Person Insurance Protect the Family of the Deceased?
No, it does not. Key person insurance is only designed to protect the business or company where the person is employed. The funds received from a key person policy payout can help a company buy out a beneficiary family member from a company, but the family of the deceased can only be protected through their own life insurance policies.
What If There Are Multiple Key People in a Business?
You can purchase key person insurance on as many people as you feel you need to in a company. Since it is an individual life insurance policy, as long as you can prove that the person is of insurable interest, then you can purchase a key person insurance policy on them. You can even buy life insurance on a group of people, but it may have more restrictions than individual policies.
Save on Business Insurance
Our independent agents shop around to find you the best coverage.
Who Owns a Key Person Insurance Policy?
Typically, an organization owns a key person insurance policy. This means they are the ones responsible for paying the premiums and they're the beneficiary. Sometimes businesses and the key employee will agree to split the premium payments and payout amount.
For any company that is looking to purchase key person insurance on an employee, the employee must agree to the company's purchase of the policy.
Why Do Some Businesses Need Key Person Insurance?
According to a survey of small businesses by the National Association of Insurance Commissioners, 71% of the firms surveyed said they were very dependent on one or two key people for their success. However, only 22% of respondents had key person life insurance in place.
If a key employee were to fall ill and be unable to continue working or pass away, it could be damaging to a company to the point of having to file for bankruptcy or go out of business. Imagine that your company has three founding partners and all three are in a horrific accident and pass away, how would the company be impacted financially? Now, imagine that your advertising executive is the sole project manager on a multimillion dollar contract and halfway through the project they're hospitalized for six months and unable to work. Without their skills and management, the project can't be completed, costing your company the millions of dollars in profit the client was going to provide. Where will the replacement money come from?
These scenarios and more are just a few reasons why a business should consider key person insurance.
Here’s How an Independent Insurance Agent Would Help
Independent agents understand that protecting your business also means protecting the people that help keep you in business. Key person insurance isn't for every business. But for those who think they may need it, independent insurance agents search through multiple carriers to find providers who specialize in key person insurance, deliver quotes from a number of different sources, and help you walk through them all to find the best blend of coverage and cost.