Key person insurance is life insurance on a proprietor, partner, or a valued employee who is key to the successful operation of a business. Small and midsize businesses typically have one or a few key persons who are primarily responsible for generating revenue. Examples include the partners in a two-attorney law firm, the sole cosmetologist in a small beauty salon, or the owner-founder chef of an independent gourmet restaurant.
In the event of the sudden death of a key person, the business may fail or face serious financial difficulties. Proceeds from a key person insurance policy can help the business avoid bankruptcy in this situation. They can help cover expenses until a replacement can be found for the key person who passed away and get the enterprise back on track, or they can make it possible to pay off company debts, pay severance to employees, and close the company down properly.
How Does Key Person Insurance Work?
The business or company purchases a life insurance policy on the key person and pays the premiums. The business is the beneficiary of the policy. If the key person should die, the business would receive tax-free death benefits from the insurance company, which could be used to help keep the business running and to provide an alternative to losing the business to bankruptcy.
Who Is a Key Person in a Small to Midsize Business?
Many small to midsize businesses deliver a service to their customers or clients and may depend on a few key individuals to deliver the service that generates the revenues. They might be owners, partners, or key employees who have become indispensable to the continuing success of the business.
The ability to generate revenue is not the only factor to consider in evaluating a key person. The value to the business of a particular individual may lie in that person’s client list, technical skills, marketing results, or industry knowledge and experience. In a small or midsize business, it is not difficult to determine who the rainmakers are based on marketing successes and new and recurring revenues.
What Businesses Need Key Person Insurance?
Different companies need key person insurance for a variety of reasons, but it is most important for small to midsize businesses. The reason is that smaller businesses depend for their success on the knowledge and skills of a smaller number of individuals, and the death of a key person could mean the demise of the company or enterprise.
Businesses that should consider purchasing key person insurance include:
- Businesses that need to secure financing
- Companies in niche markets where potential replacements may be scarce
- Businesses in which the owner wants to ensure liquidity in case of death or disability
Key person insurance can be a valuable tool for planning business succession, as it provides liquidity to transition the ownership of the company. The cost can depend on several factors, including the amount of insurance you need and the type of policy – term, whole, or variable life insurance. Our seasoned insurance agency can help you determine how much key person insurance you need and the best type of policy for your company.