Does Your Business Need Key Man Insurance?

Replacing a key employee usually involves a significant investment of time and money. Should you take out insurance in case that key person dies or becomes disabled? This type of insurance policy is known as key man insurance, or sometimes key person insurance. This type of coverage can help you maintain your business through difficult personal and financial times that can result from the loss of an essential employee. Here’s what you need to know about key man insurance.

Who is a key employee?

“This person could be your top salesperson or deal-maker, whose knowledge and skills are so important that without them, the business would be greatly affected,” says Steve Repak, a Charlotte, North Carolina–based certified financial planner and author of the book 6 Week Money Challenge: For Your Personal Finances.

Keep in mind that not just any employee can be considered a key person. “The insurance company is going to want to know how that person is essential to the business, and will ask for financials and a job description to prove it,” says chartered life underwriter Tony Steuer, founder of the website The Insurance Literacy Institute. You will also need the key employee’s consent to take out the coverage.

In some cases, a business owner or partner should be insured as a key person. “Oftentimes, owners are the key people because a lot of the business is dependent on them or their connections,” Steuer says.

How does a key man policy protect your business?

There are two main types of key man insurance: life insurance and disability income insurance. The business is usually the owner and the beneficiary.

The insurance payout from a key man policy can help cover the cost of hiring and training a new employee and make up for any lost revenue during a transition period. If you plan to sell the business, it can help cover expenses until the business receives a fair offer.

What length of coverage should you buy?

To protect your business in the event of a key employee’s death, you’ll typically want to purchase a term life insurance policy for this key person. This type of policy provides coverage for a specified number of years (for instance, five, 10, or 20 years) and is usually affordable, as long as the person covered is in good health at the time of purchase.

When figuring out how many years of term coverage to purchase, consider how long that key person will be essential to your business. “Are they a family friend who’s never going to leave the business, or are they somebody who may move on if they don’t become CEO in 10 years?” says Steuer. “You may also want to think about what type of salary or compensation might be needed to hire somebody with comparable skills, and then factor in the cost to hire a search firm.”

Key man disability income insurance is typically sold as short-term disability insurance that pays out benefits for about six to 24 months if the employee gets sick or injured. It usually costs more than key person life insurance, but with good reason: the risk of losing an employee to disability is greater than losing them to death, Steuer explains, so the odds of an insurance company paying a claim are higher.

Can a key man policy benefit an employee?

Yes, you can create a key man policy to be used as an employee benefit.

Key man insurance that is funded with whole life insurance can be an excellent employee benefit, while still providing your business the protection that would otherwise be secured through a term policy for the company. To create a key man insurance policy that can protect your business AND benefit your employee, you may want to consider purchasing a whole life insurance policy on the employee. You would still own and be the beneficiary of the policy, meaning your business will have the protection it needs. But, unlike term life insurance, whole life builds a cash value over time. Once your key employee retires or leaves your business amicably, you can provide them with the cash value that the policy may have built over the years.

If you are concerned about retaining key employees, an executive bonus plan that is funded by life insurance may help incentivize your employees to stay with your business.

Is key man insurance right for your business?

Every business is different, and there are a number of variables to consider when determining whether key man insurance is the right choice.

To determine if a key man insurance policy is right for you, consider this:

• What would be the financial implications to your business if you or a key employee died suddenly?
• Could your business continue operating if a life-altering injury caused you or a key employee to be unable to work?
• If either of these things occurred, would your business continue to function as it does today without the key person in place?
• Does your business rely heavily on the intellectual capital of a few people?

If your business couldn’t safely overcome these scenarios, or if you’re unsure, consider consulting an agent who can help you assess your needs.