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
While small and medium-size companies are the most common purchasers of key man insurance, larger corporations also purchase policies to cover top executives. 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 Is A Key Man?
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.
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.
Types of Key Man Insurance
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.
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.
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.
As with any service or product, comparison shopping can save you a substantial amount of money. Business owners and executives should compare life insurance quotes from the best carriers in the U.S. to find the cheap rates and quality coverage.