Understanding Key Person Insurance

Group of business partners shaking hands

Regardless of the type of business you own or operate, it’s important to seek out financial protection for your company in the form of insurance. While liability insurance is an absolute must for any company, have you stopped to consider what might happen if a key stakeholder, owner or high-ranking executive died? Key person life insurance (also known as “key man insurance” or “key employee insurance”) is a type of life insurance and disability insurance policy that reduces the impact of devastating loss on your company or team.

What is key person insurance?

Key person insurance policies provide a death benefit to a business if crucial employees die or become disabled. Crucial employees may be classified as an owner or co-owner, partner, CEO or other executive. 

Personal life insurance provides benefits to family members or other loved ones after a death. Key person insurance pays a death benefit to the business, which can help ensure it remains functional and employees are taken care of in the aftermath of a loss.

Common purchasers of a key person life insurance policy include:

  • Independent small businesses, such as local stores, whose owners’ reputations are key to success
  • Software or tech companies with high performing salespeople or executives
  • Organizations where one employee brings specialized industry knowledge and expertise to the table

How does key person insurance work?

A business takes out a key person insurance policy on an individual at the company. Because the business is the policyholder as well as the beneficiary, they receive the death benefit or disability benefit after the death/disability of the individual in question. 

Businesses can’t take out key man insurance on an employee without their permission. Both parties need to be aware of and in agreement over the purchase of the insurance, even if the employee and their family won’t see the proceeds of the policy.

When should a business buy key person insurance?

If the loss of the business owner or employee would result in immediate harm to your company or firm’s operations, purchasing key person insurance can help safeguard your company. Often, key person insurance—either as a life insurance policy or a disability insurance policy—covers:

  • Operating expenses while finding a replacement
  • Income loss due to the absence of the insured employee
  • Training for new associates or replacement executives
  • Buying out ownership stake of former partners and/or investors

Companies that sell key person insurance can choose to deny claims or investigate them for fraud for the first two or three years of the policy, which is known as the contestability period.

If you’re a business owner who only wants to provide for your family in the event of your death, you’ll want to purchase a personal life insurance policy instead of a key person insurance policy.

What types of key person insurance are available?

Like personal life insurance, companies have several options when purchasing key person life insurance. Depending on their needs, they may choose term life insurance, whole life or variable life insurance to cover their important employees.

Term Life Key Person Insurance

Term life insurance is a popular option for key person policies because it’s affordable. You pay premiums on term life insurance each month or year. Most term life policies include the option to pay for up to a 35-year term, with an option to renew at the end of the term. You are usually covered if the insured passes away any time during the term.

  • Organ donation preferences
  • Burial or cremation
  • Final wishes related to cremated remains
  • Cemetery placement (if required)
  • Other services to be rendered, such as clergy, organist, music, etc.
  • Type of casket to be used, if applicable

Whole Life Key Person Insurance

Whole life insurance policies are a permanent life insurance option. Unlike term life insurance, whole life insurance policies don’t have expiration dates. When you purchase a whole life insurance policy, it covers the insured person until they die or until you stop paying the insurance premiums. Whole life policies are more expensive than term insurance but they have the added benefit of putting your premiums into a savings account. Because the policy gains cash value, you can borrow against the value or withdraw money from the account.

Variable Life Key Person Insurance

Variable life insurance is similar to whole life insurance in that it doesn’t expire and stays in effect as long as you pay premiums. The difference is how the premiums are used. Instead of a savings account, they get placed in an investment account. Investments can be unpredictable, so this type of policy carries some level of risk due to market volatility.

Who is the policyholder for key person insurance?

A business or organization that takes out a key employee life insurance is the policyholder. This means they pay the premiums and are the primary beneficiary of the policy’s death benefit.

What influences the cost of key person insurance?

Key person insurance costs can vary depending on what you need. One policy won’t cover all key people at your company; you’ll need individual policies for each key employee. In addition, the same rules for personal life insurance apply to key man policies: insurance companies will factor the age, medical history, health, lifestyle and hobbies of the prospective insured person into the premiums. But those aren’t the only details at play. Business concerns are also important, and can include:

  • The occupation and industry of the insured
  • The total compensation package of the insured
  • The amount of coverage you’re looking to buy for your business needs

Key person policies only cover the death or disability of the individual. If that person leaves the company voluntarily, you’ll need to cancel the policy. You may also transfer the key man policy over to the former employee and they can start paying the premiums as a personal life insurance policy.

How much key person insurance coverage should I buy?

It might feel challenging to assign a monetary value to an employee’s life as you think about the level of key person insurance to buy. Purchase as much as you can afford, but be mindful of existing insurance needs, like general liability insurance or property coverage. Some ways to determine the level of coverage include:

  • Consider the cost to replace the employee. How long would it take to source, hire and train their replacement? Don’t forget about lost business income brought on by their absence.
  • Multiply the insured’s compensation by the number of years your business will take to recover from their loss. For example, a junior sales executive might take two to three years to build a similar book of business.
  • Multiply how much they contribute to the revenue or profits of the company by the number of years it might take to replace them.

Key person insurance coverage can be purchased in increments of $100,000, $250,000, $500,000, $750,000— all the way up to $1 million. Beyond that amount, coverage can be purchased in increments of $1 million.

SelectQuote Can Help Answer Your Questions About Key Person Insurance and Other Life Insurance Products

Even if you’ve purchased personal life insurance before, you might have questions about how key person insurance works and how to determine the best value for your business’s budget, especially when you have other costs to consider, including commercial insurance. SelectQuote can help answer these questions. We can help you save money and time when buying life insurance. Compare quotes from several trusted insurance companies at one time and help protect your business in the event of the death or disability of a key member of your team.

We do the shopping. You do the saving.