Key man life insurance is an insurance policy a business buys on a key partner’s, executive’s, or employee’s life. The company pays the premiums and is the beneficiary of the life insurance policy. A death benefit would be paid out to the company if the insured partner or employee dies.
More specifically, key man life insurance is a type of death or disability policy which businesses purchase for irreplaceable employees. Key person coverage is a form of business insurance because there are some employees whose loss would irreparably damage a business’s ability to function and others who would be difficult and expensive to replace.
The payout to the business could be used to pay off corporate debt, defray the cost of hiring and training a new employee/executive/owner and to cover any potential business losses, or even buy out the deceased’s ownership in the company.
The premiums are based on the employee’s current age, health, medical history, and salary, as well as the term period and amount of coverage.
What Type of Businesses Need Key Man Insurance
Partnerships should consider insurance since, if one partner dies, the other partner may have to buy the other’s share of the business from the deceased’s family. However, any business with an employee whose contribution to the company is incredibly crucial should strongly consider key man insurance.
Who Qualifies as a Key Person?
According to KeyPersonInsurance.com:
Key employees are those people who are critical to the success and profitability of the business.
Rank or title should not be used to determine who is a valuable asset to the company. A key person can be anyone in the company whose skills or expertise are necessary to the daily operation. Whether the person is a company executive, a salesman or skilled worker (i.e. a famous head chef, spokesperson, mascot, etc.), if the business would have difficulty replacing the person and functioning without him/her, that person is a key employee.
Key man insurance offers the option of life or disability insurance, which pays out a death benefit to the business if the employee dies or is disabled.
Types of Key Man Insurance
There are various types of key man life insurance coverage that may be used. These, too, may differ, depending on the strategy that a company is trying to accomplish. As with individual life insurance strategies, businesses may be able to choose from either term or permanent coverage.
Term Life Insurance
Many companies choose term life insurance as their preferred policy choice because the premiums are cheap compared to permanent types of coverage. It is important to note that key man life insurance premiums are not tax deductible, but the death benefit may not be taxed upon death, depending on specific circumstances.
Term life policies are available from 1 to 30 years and once the policy is purchased, the premium remains fixed for the policy’s entirety.
Whole and Universal Life Insurance
Some businesses may choose to pay the higher premiums of whole or universal life insurance for key man policies. The one advantage of these permanent policies is that they build cash value as the premium is paid. If the key person leaves the business through retirement or to take another job, the business can recoup some of the premiums from the policy through the cash value.
Businesses can retain key man insurance even after the insured employee leaves the company. However, when you get life insurance quotes online, you will quickly realize that permanent life insurance can cost 5 to 10 times more than term life.
Survivorship Life Insurance
Partnerships may elect to purchase a special type of key man policy called survivorship life insurance. With survivorship policies, two people may be insured under one policy and the policy pays the surviving partner. Survivorship policies are usually more affordable than purchasing two separate term life policies and work well for partnerships where the heirs of the deceased partner may make a claim on the business and need to be bought out.
What is the Best Type of Key Man Life Insurance to Use?
While there are several different types of life insurance that can be used with a key man life insurance strategy, the one that is used by a certain business or company will be primarily dependent upon the situation and needs of that particular entity. It will also be determined based on the age, health, and gender of the person who is being insured.
This is because, just as with any other type of life insurance purchase, the policy purchase – as well as the premium cost – will be dependent on the amount of the policy’s death benefit, as well as the type of life insurance that is being purchased.
Additional Benefits of Using Key Man Life Insurance
In addition to the life insurance protection that it can offer, key man coverage can also provide other benefits. For instance, the businesses that decide to purchase permanent life insurance can build up a nice amount of cash value. This cash can be considered as a business asset for the company.
The money that is inside of the life insurance policy can then be used by the company for a variety of different needs, such as buying needed equipment, paying for advertising, or any other need.
Key man life insurance can also be viewed by the company’s customers as additional security for maintaining their business. The same goes for investors in the company.
For example, there are many people who may do business with a particular company solely because of a particular salesperson or representative. If that person were to suddenly be gone due to an unexpected death, the life insurance policy could provide the company with added financial “cushion” if the customer opts to take his or her business elsewhere.
Likewise, there may also be various investors that purchase stock or shares in a company based upon that company’s key executives or its management team. If, however, a certain member of that team were suddenly lost, it is likely that the company could lose money – and in turn, investors may pull their funds.
Having a key man life insurance policy in place can help a business to ensure that it will have money in place should the unexpected occur.
These types of life insurance plans can also provide additional benefit – and that is for the family and other personal survivors of the key person. Oftentimes, the spouse, children, and / or other dependents of a business executive or owner may be depending on the income from a business. If, however, the business person dies suddenly, that income may quickly disappear.
A key man life insurance policy can, therefore, help with replacing this lost income for the individual’s survivors. It can also help the loved ones with paying for the person’s debts and final expenses, such as the cost of a funeral, memorial service, and other related costs.
Death benefits on key person insurance can currently be taxed unless:
A) the employee was notified in writing about the policy before it was issued;
B) the employee gave the employer written consent to being insured under the policy; or
C) the employee was notified in writing that the employer is the beneficiary of the policy.
If these steps are not taken prior to the insurance policy being issued, the death benefit is taxable.
Lenders, Banks, and Investors
When small businesses are highly dependent on one or two key players, it may be difficult to find investors or get business loans unless the lender, bank or investor is guaranteed to be paid back in the event of the death or disability of a key person. Banks and investors may refuse to extend a loan if the key person is not insured. In some cases, the lender may even buy a key man policy on an executive in order to cover the cost of the loan if the key player dies or becomes disabled.
Stock Buy Outs
Larger companies often offer top executives stock or stock options as part of their compensation package. If an executive with a large amount of stock should die, ownership would pass to his/her heirs and the company board of directors might have less control over the direction of the company.
Key man insurance provides the funds for the company to buy back the stock from the employee’s estate.
Disability Insurance On Key Employees
Similar to key person life insurance, key man disability insurance covers the business’s expenses if the key person is not dead, but unable to work. Life insurance only pays benefits on the death of the insured person, but disability of a key player can be equally devastating to a business.
Key Person Insurance Strategies
There are many different key man life insurance strategies that may be used. These will depend primarily on the type of company that is purchasing the policy (or policies), the number of key people that are being insured, and the specific goals that the company is trying to accomplish.
For instance, the death benefit on a key man life insurance policy will often be set up in the amount of what the company may lose when the individual passes away.
In other words, if a top sales person were to pass away, the company may purchase life insurance on him or her of lost revenue for six months (or the amount of time that the company may need to locate a suitable replacement for the individual). An additional amount of coverage may also be added to the policy to cover the cost of hiring and for training a replacement.
In some cases, key man life insurance coverage may also include a policy provision where the insured individual may be changed – without the need to cancel the policy. This may be possible when or if there is a change in personnel at an organization.
There are other types of business life insurance planning that can also be important to a company. For example, buy / sell agreements are contracts that are set up between two or more owners of a company. In this case, each of the individuals will purchase a life insurance policy on each of the others.
Should one of these individuals pass away, then the proceeds from his or her life insurance policy will pay out funds to the remaining individuals. These funds can then be used for these individuals to purchase the deceased’s portion of the company and / or to keep the business afloat.
Funds from a buy / sell agreement may also be paid out to the business person’s family or other loved ones. In this case, the proceeds could be used just like the funds from a personal life insurance policy would be, such as paying off debt, replacing ongoing income, and / or paying for final expenses such as funeral costs.
When business owners or executives opt to go with a buy / sell agreement, it is important to keep in mind that the policies that they use should ideally be permanent in nature rather than term. This way, the policies will not expire after a certain period. With permanent life insurance, provided that the premium continues to be paid, the coverage will typically last throughout the insured’s lifetime.
Using permanent life insurance will also help to ensure that the insured will not need to re-qualify for coverage and that they remain protected – regardless of their increasing age over time, and regardless of whether they contract an adverse health condition.
As an added bonus, the life insurance policies that are used in a buy / sell agreement for business purposes may even include the option for increasing the death benefit in the future. Doing this can help to provide additional benefit if the value of the business increases over time.
This can help to ensure that the business person’s family is properly compensated if they were relying on income from the business. It can also help to provide the other business owners / partners with a more realistic amount of funds for purchasing the deceased’s person’s portion of the company if or when they should pass away at a future time.
How Much Key Man Insurance Is Necessary?
The purchase of key man life insurance should be a consideration for any business looking to protect itself.
The amount of coverage to buy can be determined by the amount of revenue or profit generated by the key person, a multiple of the employee’s compensation as a valuation of their worth, or the direct cost of recruiting, interviewing, hiring and training a replacement. Planning for future business growth includes buying enough protection to cover future contributions the employee may make, too.
How to Find the Best Premium Quotes on Key Person Life Insurance Coverage
When seeking the best premium quotes on key man life insurance coverage, it is often wise to work with a company or an agency that has access to more than just one single life insurance carrier. That is because in doing so, you will be able to more directly compare the plans – and the premiums – that are available to you.
If you are ready to move forward with a key man life insurance strategy, we can help. We work with many different life insurance carriers, and we can assist you in choosing the plan and the strategy that works the best for you particular company. When you are ready to begin the process, just simply complete the form on this page to get your first set of quotes.
We understand that the purchase of key person life insurance can entail a number of different variables, and there are several different ways in which these plans can be set up. With that in mind, you will want to be working with an expert in the life insurance industry. The good news is, we can walk you through all that you need to know so that you are comfortable with the plan that you have chosen.