Every business should evaluate whether it needs key man insurance, a type of insurance policy that covers the business’ most valuable employee. Key man insurance is also known as key person insurance or key executive insurance and can help offset the costs of replacing the key person in the event of death, disability or other trauma.
Who is the Key Man?
The key man named on the insurance policy could be a business partner, a sales person, the company’s founder, a majority stockholder, or another employee who has key skills or knowledge. The key man is a person who contributes significantly to generating profits for the business. Their expertise or skills are extremely valuable and costly to replace.
If you are trying to think of the key person in your business, think about whose loss would significantly impede business progress in terms of stability and profitability. If you lost this person the business would struggle and might eventually close. You would have a difficult and costly time trying to replace your key person.
What Does Key Man Life Insurance Cover?
Key man life insurance has a specific amount listed on the insurance policy. The insurance policy will compensate the cost of replacing a lost key employee including recruiting and training a new employee. Some insurance policies allow the company to buy out the key man’s stock or interest in the company. The benefit can also be used to offset profit losses and lost sales during the time it takes to replace the key man.
Although the key man is named on the insurance, key person life insurance does not benefit the employee directly. Instead, the company who purchases the insurance receives the benefits of the policy. Key man insurance is not intended to compensate the employee or his family in the event of death or disability – that’s what personal life insurance and disability insurance coverage are for.
Key man insurance won’t cover every employee loss event. For example, retirement is not typically covered since that is a usual and expected part of the employee life cycle. The business should have enough time to plan for the key man’s retirement. Certain types of dismissals and resignations are also uncovered.
Does Your Business Need Key Man Insurance?
Having key man insurance can make your company lookmore attractive to investors and lenders. The presence of the insurance policy shows your company has a contingency plan in place to keep the business running even if something happens to one of your most valuable assets. Not having key man insurance won’t necessarily stop investors from contributing to your company, nor will it keep lenders from giving you a loan, but it can improve your chances of getting funding.
Before insuring your key man, the insurance company will go through a set of tests to ensure the employee is critical to the company. The insurance company will only
cover the employee for the time that he or she is needed for the operation of the company. The insurance company will also consider the age and health status of the employee in determining the insurance premiums.
Key man life insurance may not be necessary for all businesses. As you consider whether to purchase this insurance for your business, think about these things:
- Will it take a long time to replace your key employees?
- Can your business continue to operate if you lose certain employees?
- Who will inherit your majority stakeholder’s shares?
- Does that person know and care about the business?
- Do your lenders require this insurance before giving your business any financing or credit?
You may be able to offset the cost of key man insurance by deducting insurance premiums as a business expense. Your accountant can give you more information.