Does Your Company Need Key Person Insurance?
Key person insurance is just what it sounds like: life insurance on the key people in a business. In a small business, this is usually the owner, the founders or perhaps a key employee or two. These are the people who are crucial to a business — the ones whose absence would sink the company. You need key person insurance on all those people.
Here's how key person insurance works: A company purchases a life insurance policy on the key employee, pays the premiums and is the beneficiary of the policy. If that person unexpectedly dies, the company receives the insurance payoff. The reason this coverage is important is because the death of a key person in a small company often causes the immediate death of that company. The purpose of key person insurance is to help the company survive the blow of losing the person who makes the business work.
The company can use the insurance proceeds for expenses until it can find a replacement person or, if necessary, pay off debts, distribute money to investors, or pay severance to employees and close the business down in an orderly manner. In a tragic situation, key person insurance gives the company some options other than immediate bankruptcy.
Don't confuse key person insurance with personal life insurance: If the company is just you and doesn't have any employees or other people who depend on it, then key person insurance isn't necessary. If you have a spouse or children who depend on your income, then personal life insurance is all you need.
How do you determine who needs key person insurance? Look at your business and think about who is irreplaceable in the short term. In many small businesses, it is the founder who holds the company together — he or she may keep the books, manage the employees and handle key customers. If that person is gone, the business pretty much stops.
How much key person insurance do you need? That depends on your business, but in general, you should get as much as you can afford. Shop around and get rates from several different agents; most life insurance agents will sell you a key person policy. Be sure to ask for term insurance — many agents will push whole life and variable life, which have much higher premiums and commissions, but are unnecessary for a key person policy. Ask for quotes on $100,000, $250,000, $500,000, $750,000 and $1 million, and compare the costs of each.
Think of how much money your business would need to survive until it could replace the key person, come up to speed and get the business back on its feet. Buy a policy that fits your budget and will address your short-term cash needs in case of tragedy.