What Is Key Person Insurance?
Key person insurance, also known as Key Man Insurance or Keyman Insurance and key employee insurance, is a business protection insurance especially designed for small business owners. As a business owner you can buy this type of insurance on a key person like a financial partner or an important employee and receive the insurance benefit when the key person dies or gets disabled.
The purpose of key person insurance is to protect small business-owners so that the death of a key person does not cause setbacks or bring an end to their business.
Say, for example, you run a restaurant and the head cook falls ill or has an accident that confines him to bed for a couple of months. Or, he dies by a mishap or of some ailment. This could put your business in trouble for some time, until the right person is found out. If your business goes off for a couple of months, you are to incur a considerable loss. If you don’t have enough liquid money, you may even have to put your hand in the capital which may, hypothetically speaking, bring an end to the business. The smaller the capital and the newer the business, the more vulnerable your situation could be. All you could wish is you did not have loans on your business.
A key person insurance protects your business in such situations.
What Is the Purpose of Key Person Insurance?
Generally, you buy life insurance so that your family does not face financial crisis if you pass on unprepared. You make those who depend financially on you the beneficiaries to the policy. Should you really die insured, an agreed upon amount of money (known as coverage or death benefit) goes to the beneficiaries and helps them carry on life. This is how traditional insurance protects the insured’s family.
But, a key person insurance policy does not benefit the insured’s family unless you choose the employee to enjoy ownership in the policy. Otherwise speaking, the key person on whom the insurance is bought is not the insured. The owner of the business is the insured in this type of a policy. So, when the key person dies, the benefit goes to the owner of the business. The reason is, the purpose of the insurance is to protect the business owner’s interest, not the insured’s family.
Thus, a key person insurance makes a businessowner the simultaneous policyholder and beneficiary of the insurance.
Of course, you, the business owner pays the premiums for the insurance.
Who Is a Key Person?
The owner of a business may buy key person insurance on anyone whose loss of service he thinks will affect the business in terms of:
As a result, anyone, from a partner on the executive level to an operator at the production level can be insured for a key man insurance policy.
There is no ideal as to who the key person for a business should be. It depends on the nature of the business than anything else. Any individual whose absence could put a business into trouble may be a key person.
Generally, the types of people who you can consider for key person insurance are:
A Financial Partner
Partners play an important role in a business, especially when a partner is a financier for a business. Sometimes death of such a partner creates situations that imperil the business. The family members of the deceased may not be willing to continue the business which might lead you to think of selling it. The death benefit received from the key person insurance may be useful then for you to buy and keep the business running.
Besides, an influential partner may be a source of clients and customers for a business. His death may affect the business in a negative way. Key person insurance may be considered for compensation for such situations.
One good strategy for the partners is to buy key man insurance mutually on each other.
A Service Provider
Like we said, the service of some people is imperative for a business. A skilled restaurant chef or baker is such a person. Their skill adds credit to businesses. Loss of service of such people can hardly be made good for easily. Finding the right replacement sometimes takes time. As a businessman you can consider key man insurance on them.
When you run some production business, you usually depend on the skill of few people. A mechanical engineer or operations manager is such a person. Losing their service affects the business for some time. A key person insurance policy on such people can be a good purchase.
A Decision Maker
Key person insurance does not always have to relate to active employees only. An executive or board of member who plays a crucial intellectual role in the business can also be a key man. If death of such a person is to have negative impacts on the business, you may consider buying key person insurance on him.
How Does Key Person Insurance Work?
Whether you would love to buy term insurance or whole insurance for key person insurance depends on you. But for employees, who may leave the job at their sweet will, buying an expensive permanent insurance does not make much sense. This is why term insurance is the best choice for key man insurance.
You can buy it to work for a specific term of period like 10, 15 or 20 years or as an annual renewable term insurance policy. If you choose a term, the insurance remains valid for those years. On the other hand, if you choose the latter method, you have to keep renewing it every year.
No matter what term you choose, death or disability of the insured benefits you so long as the policy is active.
How to Buy Key Person Insurance?
Choose the Right Key Man
When you buy keyman insurance, you simultaneously become the policyholder and the beneficiary of the policy. The chances of getting more insurance might allure you to buy insurance on more people. But remember that you are going to have to pay for the policy from out of your pocket. So, minimizing the number to the truly key person is important.
If there is a partner whose death might affect your business in a negative way, you can very logically get him insured. Similarly, as we have already learned,anyone who role-plays an operator can be considered for key man insurance.
Decide Right Coverage
Coverage is the amount of money you buy the life insurance policy for. Making an estimate of how much your financial loss might be by the death of the key man is important. For example, the death of a partner also translates into loss of some customers or clients as a direct consequence. Also, there is a recovery time that should be taken into account. Right projection is much needed when you decide the coverage.
Choose the Right Carrier
Choosing the right carrier is very important when you decide to buy key person insurance. Make sure the carrier you choose bears the following criteria:
1) The carrier is trusted with good reviews, ratings and customer satisfaction rates.
2) They have their service in your state.
3) You have the highest coverage from them.
4) The rate is competitive.
What Are the Benefits of Key Man Insurance
Key person insurance will benefit you in the following situations:
1) It will compensate for the loss that the disability or death of the key man leaves for you.
2) When you need loans and there is need for collateral.
3) If the policy is permanent type. you can use the withdraw the cash value to use as you deem best.
3) It will help the business continue if death of one partner creates issues for the business.
4) If the surviving partner wants to buy the business, he can use the insurance money to come to a settlement.
How Much to Buy for Key Person Insurance
No matter you buy life insurance for your family members or the key person of your business, choosing how much life insurance you need is very important. Generally speaking, you can buy as much as ten times the yearly earnings of the key man you are buying insurance on.
While calculating coverage for an employee, it is important to take into account:
- The expenses that you had to make to train the employee so that the you can train the new employee.
- Besides salaries, consider all the perks like bonuses, incentives and increments that you provide him.
- The probable economic loss that the key person’s death will cause through loss of customers and clients.
- The expenses that you will require to make during searching the new key person.
Is Key Man Insurance Taxable?
Whether key person insurance is taxable or not depends on the ownership of the policy. If you choose to buy a policy that entitles ownership to the key man, the benefit will be taxable. But if the ownership belongs to the business (you), it will be non-taxable. When the key man has ownership, he will benefit from the policy as well as have the right to carry the insurance to his new workplace or where he wants to. So, deciding how you want the insurance ownership to work is very important.