What is Key Person Life Insurance?
Key person life insurance is a type of insurance that businesses purchase in order to cover essential people on their staff. It’s also called key man insurance, key woman insurance, or key employee insurance.
Who buys key person insurance
Every business has people who are critical to its success. That could be a business owner, a top strategist, a high-ranking executive, or someone else. Ultimately, what makes a person eligible for key person insurance isn’t their title or level in the business organization structure. Instead, it’s their employment with the company and the company’s decision that they play such an integral role that replacing them would create a financial challenge.
In other words, any company can buy key person life insurance on any person on staff. But not all companies insure all employees. The main driver here is in the title of the insurance product: the key nature of that employee’s contribution.
A business might buy a key person policy on anyone whose absence would negatively impact the business in a serious way. That could be:
An owner
A founder
An executive
Someone with a significant number of shares in the business
A sales or account professional who brings in a large portion of the company’s revenue
An employee with highly specialized expertise
The company doesn’t just decide who to insure. They also have to pick a policy type. They have the option to buy term life insurance, with the death benefit and premiums fixed for a set number of years (e.g., 10 years, 20 years), or a permanent policy, which lasts the insured’s individual’s lifetime. Term insurance is generally significantly more affordable than permanent coverage.
How key person insurance works
The business buys the insurance policy and is responsible for paying the premiums to keep the coverage in force. They’re also the one to claim the death benefit if the insured individual dies while the policy is in effect.
At that point, they can use the money however is necessary. That could be recruiting a replacement with the necessary specialized skills or replacing lost income because sales dipped without that person.
Key person insurance can also protect the distribution of ownership or shares. Some companies buy it in order to purchase the shares or partnership interest of the now-deceased person, keeping ownership stake in the hands that they want.
Finally, some companies purchase key person insurance to secure financing. If the company takes out a business loan and knows that repaying that money hinges largely on one person, they might buy a policy on that individual with the death benefit equal to the loan amount. Then, should the worst happen and that person pass away, the company can use the death benefit to repay the outstanding amount.