Every business depends on key individuals whose expertise and relationships drive the company forward. If the sudden loss of one of these people would cause a significant disruption, it’s time to consider Keyman Insurance. Also known as Key Person Insurance, this policy protects businesses from the financial impact of losing a key employee, such as a founder, executive, or top salesperson.
In this article, we’ll dive into how keyman insurance works, who needs it, and why it’s essential for safeguarding your company’s future.
What Is Keyman Insurance?
Not to be confused with buy-sell agreements, keyman Insurance, also called Key Person Life Insurance, is a type of life insurance policy taken out by a business on a key employee. The insured person could be the business owner, an executive, or any individual whose loss would result in a significant financial loss to the company.
The business pays the insurance premiums, and the company is the beneficiary of the death benefit. If the insured key person dies or becomes disabled, the insurance payout provides the business with financial protection, allowing time to adjust, find a replacement, or cover any business needs.
Why Keyman Insurance Is Essential:
- Financial Protection: It ensures the business can cover losses due to the key person’s absence.
- Business Continuity: The funds can help keep the company running during a time of transition.
- Credit and Loans: Lenders and investors often require keyman insurance before extending a business loan or investment.
Who Needs Keyman Insurance?
Any company that relies heavily on one or more individuals for its success should consider keyman insurance. This is particularly important for small businesses and start-ups, where losing a founder or other key employee can be catastrophic.
Here’s who benefits most from keyman insurance:
- Business Owners: If you’re the driving force behind your business, your company needs protection in case of your unexpected death or disability.
- Top Salesperson: A top salesperson who generates a significant portion of revenue is crucial to business growth. Losing them could hurt the company’s bottom line.
- Specialized Skill Sets: Employees with unique skill sets that are difficult to replace, such as lead engineers or scientists, should be insured to prevent major disruptions.
Example:
A tech start-up insures its co-founder, who is responsible for product development. If the co-founder were to pass away, the business would receive a tax-free insurance payout that could be used to hire a replacement and keep operations running.
How Keyman Insurance Works
Obtaining Keyman Insurance is straightforward and similar to purchasing a traditional life insurance policy. Here’s how it works:
- Identify Key Employees: The first step is identifying which employees are vital to the business. This could be the CEO, a co-founder, or someone with specialized knowledge.
- Choose the Type of Policy: Businesses can opt for term life insurance, whole life insurance, or indexed universal life insurance, depending on their needs and budget.
- Apply for the Policy: The business applies for the policy, and the key employee typically undergoes a medical exam as part of the underwriting process.
- Pay the Premiums: The business is responsible for paying the premiums to the life insurance company.
- Receive the Death Benefit: If the insured person passes away, the business receives the death benefit to cover financial losses, recruit new talent, or sustain operations.
Example:
A manufacturing firm takes out a $2 million keyman insurance policy on its lead engineer. If the engineer dies unexpectedly, the life insurance company will pay the business the death benefit, which the firm can use to cover production delays and recruitment costs.
Types of Keyman Insurance Policies
There are different types of keyman insurance policies to choose from, depending on your business needs and budget:
- Term Life Insurance: This is the most common and affordable option. The policy provides coverage for a specified period, such as 10 or 20 years, and only pays a death benefit if the insured person dies during that term.
- Permanent Life Insurance: These include whole life insurance and universal life insurance, which provide lifelong coverage and build cash value over time. While more expensive, these policies offer additional benefits such as disability coverage.
- Disability Insurance: In addition to life insurance, some businesses also purchase disability insurance as part of their keyman policy. This provides payouts if the key person is unable to work due to illness or injury.
Example:
A healthcare company purchases both a term life policy and disability insurance on its CFO. If the CFO is injured and unable to perform their duties, the business can claim the disability payout to fund their replacement.
How Much Does Keyman Insurance Cost?
The cost of key person insurance depends on several factors, including the amount of coverage, the insured person’s age and health, and the type of policy chosen. Permanent life insurance policies tend to be more expensive due to the cash value component, while term insurance is more affordable but only offers short-term protection.
Here are some key cost considerations:
- Age and Health: As with any life insurance policy, younger and healthier individuals qualify for lower premiums.
- Amount of Coverage: The more coverage the business requires, the higher the premiums.
- Industry: Some industries, such as construction or healthcare, may be deemed higher risk, resulting in higher insurance premiums.
Tax Considerations for Keyman Insurance
The premiums paid for keyman insurance are generally not tax deductible. However, the death benefit received by the business is typically tax-free, which can be a major advantage when it comes to covering significant losses.
Additionally, keyman insurance can be used in a buy-sell agreement, helping remaining business partners buy out the shares of a deceased owner without triggering immediate tax consequences.
Example:
A law firm purchases key person life insurance on its managing partner. Upon the partner’s death, the tax-free proceeds are used to buy out the partner’s share of the business, ensuring smooth business succession.
Protecting Your Business with Keyman Insurance
For any business, protecting its most important assets—including key employees—should be a priority. Keyman Insurance provides financial protection in the event of a key employee’s death or disability, helping the company navigate difficult times without severe financial loss.
Whether you’re a business owner of a small business or a large corporation, keyman insurance is an essential part of any business insurance plan. Speak with a financial professional or life insurance company to explore your options and get life insurance quotes that fit your business.