Some employees are crucial to the ongoing success of your business. If a key person suffers a serious illness or dies, your business could suffer financially. You can protect your company’s bottom line, ownership, and general day-to-day management by taking out a key man insurance policy.
What is key man insurance?
Also known as key person or key employee insurance, key man life insurance is a policy that protects profits and management in case a key executive or partner dies. The company is the beneficiary of the policy, and the payout is designed to buy time to find a replacement or figure out a way to save or sell the company.
The major benefits of key man insurance
Key man insurance can pay for and offer protection against:
Lost revenue. If a talented salesperson passes away or a big project has to be cancelled, the lost revenue can be offset.
Recruiting. Pays for training a replacement to handle the essential tasks the key person was responsible for.
Funding future growth. The sum paid can be used to find new opportunities, secure loans and provide for business expansion.
Retaining clients. If an employee has cultivated successful relationships, then key man insurance can help pay for gifts or services to maintain a connection with your customers.
Outstanding debts. The insurance payout can settle any business loans or debts held by the key man to maintain your business’ credit rating.
Ownership transitions. The insurance payout can fund the acquisition of shares from the deceased’s beneficiaries and otherwise pay for the costs of transferring ownership.
Key man insurance vs. traditional life insurance
Key man insurance is a type of life insurance coverage — but the main differences are who owns, pays for and benefits from the policy.
Here’s a breakdown of the main features of both policies.
Key man insurance
Personal life insurance
Who is the insured?
Business partner or executive
John Doe
Who owns the policy?
The business
John Doe
Who is the beneficiary?
The business
John Doe’s family and financial dependents as laid out in the policy
Who pays the premiums?
The business
John Doe
How much does key man insurance cost?
The cost of key man insurance varies between insurers, and tends to cost the same as a personal insurance policy. Providers consider the following when determining how much you’ll pay:
Type of policy. The choice between term and permanent insurance can mean the difference of thousands of dollars.
Death benefit.The higher your payout, the more you’ll pay in your premium.
Lifestyle and health risks. The age, health history, lifestyle and driving history are among some of the factors that life insurance underwriters consider when determining your premium.
Size of the company. Generally the larger the company, the higher the premium.
Industry. Industries that are considered risky, with large machinery or factories could pay more than a low-risk office space.
The amount of coverage you get should be enough to cover your key person’s stake in the company. For example, if you own a business valued at $100,000, and your partner owns 50%, her policy should be at least $50,000.
Find a key person life insurance policy today
Can key man insurance protect business partnerships?
Key man insurance helps solve several difficult financial situations that can emerge following the loss of a critical individual. Taking out a policy means deciding who your business simply couldn’t do without and getting them insured.
In some cases, two executives might personally take out key man policies on each other, or the entire board of a company might insure each other in the business’ name. The proceeds of the policy can then be paid directly to the business or to an individual.
How business partnerships take advantage of key man insurance
Succession planning. The shares held by the key person are usually transferred to their family or other beneficiaries if they pass away. Key man insurance can provide the funds needed to buy them back and smoothly transfer ownership. If there are buy/sell agreements in place where stakeholders have entered into a contract on what to do with their shares upon death, then the key man insurance payout can facilitate these plans.
Business debts. What if the key man puts his or her name on business loans before passing away, or personally guaranteed loans made to the company? Key man insurance can be used to pay off the debts of a business partner in order to maintain the company’s reputation and credit rating.
Case study: Surviving a key loss
Richard and Brad’s financial services company had been in operation for just over a year. Richard handled most of the numbers and behind-the-scenes work, while Brad maintained client relationships and focused on sales. With the help of their insurance broker they found a good key man policy and each took one out on the other, nominating the company as the beneficiary.
In a tragic accident, Brad was involved in a fatal car crash. He died instantly, and Brad’s wife inherited his half of the company. It was now Richard’s job to reacquire company ownership.
Using the lump sum paid from key man insurance, he made Brad’s wife a solid offer, which she accepted. Now that he was a full owner in the business, Richard was able to pay off debts and use the rest of the funds to recruit and train a replacement.
What would have happened if there was no key man insurance?
Without key man insurance, there would have been some implications:
Brad’s wife would have had the stock in the company. Stock that she might have wanted to sell.
Richard may want to buy stock back. However, Richard may not have had the cash to pay for Brad’s portion of the company.
Lose-lose situation. Without the adequate funds to buy out Brad’s wife’s ownership, Richard may have low-balled her. Alternatively, Brad’s wife could have sold to another buyer and offset the course of the company.
When does key man insurance pay out?
In the context of business partnerships, key man insurance can pay out if a business partner:
Passes away
Develops a serious medical condition
Is disabled due to an injury or illness
Is key man insurance tax-deductible?
No, the insurance premiums are not tax deductible. The only situation in which premiums would be deductible is if the business does not benefit from the insurance policy — meaning the death benefit is paid to the key person’s family, and not to the business.
Can startups purchase key man insurance?
If you’re seeking funding from venture capitalists, chances are one of the requirements will be to purchase key man insurance. However, as a startup, you might run into challenges when buying coverage. Life insurance companies will need you to justify your policy in terms of your company’s growth, financial standing and future revenue. Some insurers won’t offer key man insurance to startups, while others are much more open to covering companies that are still establishing themselves.
Your best bet is to compare quotes from a bunch of insurers to ensure you’re getting the best possible policy and premium for your startup’s needs.
Are there alternatives to key man insurance?
There is no direct alternative to key man insurance, but there are other options which might be preferable for your business in the event of the loss of a key person:
Take out a loan. This is another way to access funds at a crucial time and because it’s done after the loss of your key person, you can accurately judge how much you’ll need. However, lenders may be hesitant to offer money to a company that’s just lost a key person — or they may offer poor rates.
Cover the loss with company profits. If you’ve accumulated a reserve for emergencies, you can recover from the situation with the current year profits. Naturally this is only an option if your business is sufficiently profitable, but it might not be best for the bottom line.
Sell off assets. This can help you raise money fast, but you generally won’t get your money’s worth. Businesses generally don’t hold unnecessary assets, so you’ll likely be selling off useful equipment.
Bottom line
Key man insurance could keep your company operating during a difficult time, and it’s worth looking in to if your business relies heavily on a partner or executive to stay afloat and maintain cash flow. If key man coverage makes sense for your company, compare life insurance policies now.
Richard Laycock is Finder’s NYC-based senior content marketing manager & insights editor, spending the last decade data diving, writing and editing articles about all things personal finance. His musings can be found across the web including on NASDAQ, MoneyMag, Yahoo Finance and Travel Weekly. Richard studied Media at Macquarie University, including a semester abroad at The Missouri School of Journalism (MIZZOU). See full bio
Katia Iervasi is a lead writer and spokesperson at NerdWallet and a former editor at Finder, specializing in insurance. Her writing and analysis on life, disability and health insurance has been featured in The Washington Post, Forbes, Yahoo, Entrepreneur, Best Company and FT Advisor. She holds a BA in communication from Australia's Griffith University. See full bio
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