Key Person Insurance

Key person insurance is simply life insurance on the key personin a business. In a small business, this is usually the owner, thefounders or perhaps a key employee or two. These are the people whoare crucial to a business–the ones whose absence would sink thecompany. You definitely need to consider key person insurance onthose people.

Here’s how key person insurance works: A company purchases alife insurance policy on its key employee(s), pays the premiums andis the beneficiary of the policy. If that person unexpectedly dies,the company receives the insurance payoff. The reason this coverageis important is because the death of a key person in a smallcompany can cause the immediate death of that company. The purposeof key person insurance is to help the company survive the blow oflosing the person who makes the business work.

The company can use the insurance proceeds for expenses until itcan find a replacement person, or, if necessary, pay off debts,distribute money to investors, pay severance to employees and closethe business down in an orderly manner. In a tragic situation, keyperson insurance gives the company some options other thanimmediate bankruptcy.

If the company is a sole proprietorship and employs just you andno other employees or has no other people who depend on it, thenkey person insurance isn’t as necessary. You’ll notice we didn’tmention your family–don’t confuse key person insurance withpersonal life insurance. If you have a spouse and/or children whodepend on your income, then you should have personal life insurancefor that purpose.

How do you determine who needs this insurance? Look at yourbusiness and think about who is irreplaceable in the short term. Inmany small businesses, it’s the owner who holds the companytogether–he may keep the books, manage the employees, handle thekey customers and so on. If that person is gone, the businesspretty much stops.

How much key person insurance do you need? That depends on yourbusiness, but in general, you should get as much as you can afford.Shop around and get rates from several different agents; most lifeinsurance agents will sell you a key person policy. Be sure to askfor term insurance–many agents will push whole or variable life,which have much higher premiums and commissions but are unnecessaryfor a key man policy. Ask for quotes on $100,000, $250,000,$500,000, $750,000 and $1 million, and compare the costs of each.Then think of how much money your business would need to surviveuntil it could replace the key person, come up to speed and get thebusiness back on its feet. Buy a policy that fits into your budgetand will address your short-term cash needs in case of tragedy.