Key Person Insurance is a great way for a business to insure against the loss of a key employee. Typically, when a business owner is just starting out, they are thinking of immediate survival and not yet working on protecting the business in the event of the premature death of a key owner or employee.
Key Person Insurance is life insurance on a “key person in the business”. In a small business, the key person is usually the owner, however a key person can also be a sales person who brings in the majority of the business, a machine operator, or an artisan who is needed to turn out work that will make the business prosper. Anyone whose absence would place the business in jeopardy or whose loss would damage the revenue stream of the business is a key person.
How it Works
When a company identifies a key person to their operation, the company can purchase a life insurance policy on the key person, pay the premiums, and be the beneficiary of the policy. Oftentimes the death of the key person in the company can mean the death of the company. The Key Person Insurance policy helps the company survive the loss of the key person.
It provides cash flow while the business is either sold or provides money until the key person can be replaced and the business can then continue to grow or make up for the loss of the key person. The company can use the proceeds to pay expenses until the key person can be replaced. If the key person cannot be replaced, the company can use the funds to pay-off creditors, pay severance to employees, distribute money to investors, and, if necessary, close the business down in an orderly manner.
Who Should be Insured?
In any business, the business owners can easily identify who is integral to the operation. Typically, in a small business the owner is the key person without which the business may not survive.
The founder may have landed all of the customers, may manage all of the employees, and may be the “expert” on the services or products being offered. In short, without the founder, there may be no business.
Key Person insurance will allow for an orderly transition if the owner is unable to continue the operation due to untimely death or disability. “Accelerated Benefit Riders” for terminal, critical, and chronic illness may, in certain circumstances, help provide a transition if the key person can no longer continue in the business.
In other situations it is a key salesperson or someone who is integral to the manufacturing process that may be a key person whose loss could be devastating to the company. That person needs to be insured so the company can withstand their loss.
How Much Insurance is Enough?
How much is enough? Create a spreadsheet of what would happen if the key employee would no longer be available.
Use your spreadsheet to determine how much money your business would need to survive until it could replace the key person, regain lost momentum, and make the business viable again. The reason we call it Key Person Insurance is that it can take years to regain momentum and make the business profitable again.
Key Person Insurance (or Key Man Insurance, as it has long been referred to), compensates a business like a personal life insurance policy compensates a family for the loss of a loved one or breadwinner. Many businesses have key intellectual property that needs protection. This insurance can also do double duty for debt protection, revenue protection or even Buy-Sell protection.
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*This blog is strictly the opinion of Michael A. Malleo and not those of
ASH Brokerage Corp., nor any of our affiliates.
Malleo Financial Services LLC cannot and will not give any specific tax or legal advice.
Please consult your tax professional or legal professional for such advice.