Most business owners have life insurance to protect their families and home in the event of their death. Key person insurance offers similar protections but instead of providing coverage for an individual, a policy protects a business. When a business owner or significant employee passes away, key person insurance provides the business with a death benefit.
Key person insurance goes by several names, such as “key man insurance,” “key woman insurance” and “business life insurance.” After acquiring a key person insurance policy, the company pays premiums to the insurance company. If a key person within an organization dies, the death benefit can be used to cover operational costs and recruit a replacement for the position. Without the financial protection that key person insurance provides to a business, the loss of a key person could result in the demise of a company.
Who Should Acquire Key Person Insurance?
Key person insurance is often purchased by corporations to protect top executives. For small businesses, a key person may be the founder or owner of the business. If the business is very small, the owner may be the only person capable of running the business.
However, this type of insurance is more commonly acquired by businesses with more than one owner. Partnerships often rely on this type of insurance to provide financial protection in the event of premature death. Any business that has key people who are irreplaceable or whose contributions to the business are critical, should consider acquiring key person insurance.
Business Reputation Linked to Key Employee’s Name
There are certain circumstances in which a business should acquire this type of insurance, such as when the reputation of the company is directly linked to the key employee’s name.
Some business owners or employees are so crucial to a company that they become a well-known figure for that particular business. If that person passes away, it can have a noticeable effect on operations and can even have a negative impact on the business’s reputation.
Top employees often become brand ambassadors and when they are no longer with a company, customers may notice the lack of positive representation. Key person insurance can provide businesses with the funds needed to find a qualified replacement for the lost employee.
Businesses with Key Partners
Business owners involved in a partnership rely on each other to maintain smooth operations. When one business owner becomes unable to work or passes away, the bulk of the workload falls onto the remaining owner’s shoulders. In addition, the remaining business owner must determine how the business will continue running without the key partner.
Key person insurance can be invaluable when the death of a key partner threatens a company financially. Business owners involved in a partnership have the option to buy out the other’s shares and continue business as normal.
Financial Institutions Who Require Collateral
Businesses experiencing financial challenges may seek out a loan to help cover common operating expenses or major purchases. However, small businesses or newly established businesses may have trouble acquiring a loan without collateral. These insurance policies can be used as a form of collateral for a business loan.
Policy loans from key person insurance policies can be highly beneficial to business owners in need of quick funds. Unlike traditional bank financing, the approval process is often swift and generally, no assets are required to be put as collateral for the loan.
Small Businesses Involved in Partnerships
Businesses that have two or more owners should consider acquiring key person insurance. The payout from a key person insurance policy is usually paid out directly to the business so that it can be used to cover various financial losses that may incur due to the death or complete disability of a key person.
Key person insurance is also necessary even if the remaining business owner plans to close the business after the loss or disability of a partner. The funds from the insurance payout can then be used to pay off investors, provide severance pay to employees, and take care of other closing costs.
Who Actually Owns the Policy
Key person policies are generally owned by the business with claim proceeds being paid directly to the company. However, this is not the only way that a key person insurance policy can be owned. In certain cases, the business and the key employee may agree to split the cost of the premium payments, death benefit value, and cash surrender.
The key employee must agree to the company’s purchase of the policy. In addition, the insurance company may require that the board of directors of the business provide a resolution stating the policy’s purpose.
How Much Coverage Do I Need?
How much coverage is needed will ultimately depend on the business, the number of key people being covered, the value of the business, and similar considerations. When deciding how much to budget for key person insurance, the business should consider how much they can realistically afford and opt for the most amount of coverage possible within the budget.
These insurance policies can range in coverage limits from $100,000 to over $1 million. No two policies are exactly alike; it is important to compare options and acquire several quotes to determine which policy best meets the needs of the business and its key persons.
Reach Out to the Professional Succession Planning Consultants
The consequences of losing an important contributor to a business can be emotionally and financially devastating. Key person insurance ensures that a business is able to gain financial protection from the fallout, allowing for a speedier recovery. With the funds from a key person insurance payout, a business is better equipped to take the necessary steps to move forward, such as hiring and training replacements. A policy can even be used to hire a temporary substitute.
In the event that the key person leaves the company during an active coverage term, the business is generally able to cancel the policy without risk. For more information about acquiring a key person insurance policy, speak with the expert succession planning consultants at Business Benefits Group.