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Key person insurance is life insurance taken out by a company on an employee, with the company as the beneficiary in case of death. It’s important for businesses to insure crucial employees, and lenders may require it. The money can be used to buy back stock, cover expenses, or find a replacement. Disability insurance is also an option. Coverage can range from $25,000 to over $1 million, and policies should be reevaluated regularly.
Key person insurance is a special type of life insurance policy taken out by a company on one of its employees, in which the company is the beneficiary in the event of that employee’s untimely death. This type of insurance is a relatively new phenomenon, but it has attracted much praise and is encouraged by many strategy consultants. Life insurance is basically a system whereby a fixed amount of money is paid to a beneficiary in the event that the covered person dies. Most life insurance companies offer some type of key person coverage, as it has become increasingly necessary in the modern business world.
Exactly who a business wants to cover with key person insurance depends on the nature of the business and its employees. In many partnerships, founders are crucial to the success of the business, and so insuring the loss of one or more partners is a smart business move. For some companies, the entire management team may be considered difficult to replace, so insurance can be purchased for each team member. Some companies may also have lower-level employees who have formed personal connections with major distributors or customers, the loss of which could conceivably cost the loss of those customers.
Many lenders require a business to take out insurance for key people they deem important before lending money to a business. In this case, it’s usually still up to the company to pay the premiums on the coverage, but the lender is listed as the beneficiary, so that if the crucial person dies, the bank can collect some, if not all, of the capital they have originally invested. Many businesses choose to take out additional insurance on top of what the lenders require, classifying themselves as beneficiaries for the amount in excess of the lenders’ requirements.
The money from this coverage can go to pay for many different things. One of its most common uses is to buy back stock in a company from the deceased’s estate. Especially in the event of the death of a founding partner or majority shareholder, this can be crucial in helping the company maintain control over its destiny. Payments can also be used to pay a headhunting firm to find a suitable replacement for the lost employee, to cover expenses while the business adjusts for the loss, or to cover lost cash flow from customers who walk away with the loss of a key employee.
In addition to purchasing life insurance, many businesses also purchase disability insurance as part of key person insurance. This will help cover temporary productivity losses during the rehabilitation of a crucial employee. Coverage can range from as little as $25,000 US Dollars (USD) to well over $1 million USD, depending on any number of factors involved. Especially in cases where the insurance will be used to buy back shares, the policy will need to be reevaluated frequently to ensure that the payment is sufficient to cover all expenses in the event of the key person’s death.
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