Understanding Key Man Life Insurance

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. Read on to learn more about this type of policy and who can benefit from it.

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What is Key Man (or Key Person) Life Insurance?

Key person insurance policies provide a death benefit to a business if crucial employees die or become disabled. The definition of a crucial employee may include an owner or co-owner, partner, CEO, or other executive. While personal life insurance offers protection to family members or other loved ones after a death, key person insurance can help a business owner protect their business through the death benefit, which provides funds that will help the business remain functional and take care of employees 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
Owners of family businesses who are looking to secure business continuity within the family

How Key Man Life Insurance Works

Before you purchase a key person insurance policy, it’s important to understand how it works. A business takes out a key person insurance policy on an individual at the company. Then, because the business is both the policyholder and the beneficiary, it will receive the death benefit or disability benefit after the death/disability of the key individual in question.

Keep in mind that businesses can’t take out key person insurance on an employee without their permission. Both parties need to be aware of and agree to the purchase of the insurance policy, even if the employee and their family won’t see the proceeds.

Who Counts as a “Key Person”?

The key person is typically an employee who has skills or knowledge that are particularly valuable to the business. This could include the owner or other executives, highly specialized or trained employees, or employees who individually bring in a significant amount of profit to the company.

How the Policy Pays Out After Death

The business or organization that takes out a key person life insurance policy is the policyholder. This means they pay the premiums and are the primary beneficiary of the policy’s death benefit. In the event of the key employee's death, the business receives the insurance benefit to help mitigate the financial impact of the loss.

Why Businesses Get Key Man Life Insurance

Key person insurance can help businesses stay financially protected in the event of a critical loss. Read on to explore some of the benefits of this type of coverage.

Protect the Business from Financial Loss

If a key person passes away or is unable to work due to illness or injury, the business could face significant disruptions, like lost revenue, delays in important projects, or a loss of valuable expertise. The death benefit or disability benefit can help cover these financial losses.

Keep Investors and Lenders Confident

In many cases, a business's success is tied to the contributions of one or more key individuals. The loss of such an individual can affect the company's market value or investors' confidence in it. The financial protection offered by key person insurance helps maintain business stability and can preserve the company’s value.

Ensure Business Continuity

With the insurance payout, the business can continue operating without the immediate financial pressure to replace the key person. This helps keep the business running smoothly while mitigating risks associated with sudden departures.

Factors that Affect Cost of Key Man 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

Types of Key Man Life Insurance Policies

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 typically one of the most affordable coverage types. You pay premiums on term life insurance each month or year. Most term life policies include the option to pay for up to a 30-year term, with an option to renew at the end of the term. You are usually covered if the insured passes away at any time during the term.

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.

How to Buy Key Man Insurance

Before a business secures key person life insurance, it should first identify the key employee whose absence could significantly impact the business. Then, the business can determine the appropriate coverage amount based on factors like salary, replacement costs, and potential lost revenue. Consulting with a broker or financial advisor can help ensure you select the right coverage for your company.

When to Buy Key Man Insurance

There’s no right or wrong time to buy key man insurance. However, it can be prudent to purchase a policy ahead of significant business changes, like acquisitions, mergers, or other business transitions.

Determining How Much Coverage Your Business Needs.

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 of replacing the employee. How long would it take to source, hire, and train their replacement? Don’t forget about lost business income caused 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, or $750,000 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 may have questions about how key person insurance works and whether or not this coverage is right for your small business. Luckily, SelectQuote can help answer these questions. Our licensed insurance agents can help save you time and potentially money by comparing quotes from several trusted insurance companies in just minutes.

Is key man life insurance only for big businesses?

No, key man life insurance is not exclusive to big businesses. While large corporations may rely on this type of coverage, small and medium-sized businesses also use key person insurance. It is designed to protect the business from financial loss in case of the death or disability of a key employee, regardless of the company’s size.

Are any medical exams required for key man insurance?

A medical exam is often required for key man insurance. Insurers typically want to assess the health of the key person to determine the risk of insuring them.

How long does it take for a key person policy to be approved?

The approval process for a key person policy can vary depending on the complexity of the case and the insurer. Typically, it can take anywhere from a few days to a few weeks. If medical exams are required, this may add time to the process.

Are there tax benefits?

Premiums paid for key man insurance are generally not tax-deductible as a business expense, but the death benefit payout to the business is typically received tax-free.

What happens if a key person leaves or retires?

If a key person leaves or retires, the policy may need to be adjusted or canceled. In some cases, the business may assign the policy to another key person or let the policy lapse. The specifics depend on the terms of the policy and the needs of the business.

What is key employee disability income insurance?

Key employee disability income insurance provides a business with financial protection if a key employee becomes disabled and is unable to work. This coverage can help the business maintain its financial stability while it finds a temporary or permanent replacement for the disabled employee.

What is a buy-sell agreement and is it different from key man insurance?

A buy-sell agreement is a legal contract that outlines how a business will handle the transfer of ownership if a partner or owner dies, retires, or becomes disabled. It typically involves life insurance to fund the buyout of the departing owner’s share. Key man insurance, on the other hand, is designed to protect the business from the financial loss caused by the death or disability of a key employee.