5 Reasons Your Business Needs Key Person Insurance
Key person insurance. It is a term many business owners are unfamiliar with, but also should know more about. This is a special type of life insurance that protects your business from negative impact when a key member of your team dies or is faced with a disability that keeps them from working.
Your essential team members help keep your business afloat, and without them, your company might not survive. Here we explain more about key person insurance and offer five compelling reasons every business needs it.
What is Key Person Insurance?
In the world of insurance, key person insurance falls under the category of corporate-owned life insurance (COLI). COLI allows a corporation to be named as the beneficiary of a life insurance policy. The company pays the premiums and in the case of death collects the proceeds.
While this might seem odd, it ensures the company doesn’t suffer financially from the loss of key employees. It is not a way to profit from the loss of life, but instead to cover the potential losses related to not having that person’s expertise available. There are three basic types of key person insurance:
- Term Policy: This coverage applies for a specified term, which can range from five to 20 years. The policy expires based on the expiration date, or when the key person dies.
- Permanent Policy: In this case, the policy ends when the insured person dies. It also carries a cash value making it a company asset that can be used before the individual dies towards business expansion, purchasing inventory, etc. Because of these additional benefits, permanent policies are more costly than a standard term policy.
- First to Die Policy: If you have more than one key person, a first to die policy is a form of group life insurance. The policy ends when the first person named on the policy dies.
You can discuss your options with your insurance broker to find the best policy for your needs.
Who needs Key Person Insurance?
If your company has a team of individuals necessary to keep your company profitable, operational, and successful, you need key person insurance for those individuals.
Whether it is your top salesperson, your CEO, or an industry influencer, when key personnel are suddenly removed from business operations, your company is put at risk of lost revenues. Your key person insurance protects against those losses, allowing you to regain your footing, and find a suitable replacement.
You need key person insurance if:
- Your company revenue is dependent on the skillset or input of key individuals
- Certain individuals’ reputations are at the heart of your success (i.e. thought leaders)
- Your business debt obligations can’t be met with the loss of certain individuals
- You are a partnership where buying out partners’ shares in the case of death or disability could shut down the business
- The insurance is required as part of the conditions of a loan or to attract venture capitalists
These are the most common reasons a company invests in key person life insurance.
Who is Considered a Key Person?
Your business can only purchase life insurance on individuals whose loss will directly impact your success. In other words, you must prove you would experience substantial financial loss if the individual were to die or suffer a disability.
However, although the person named as a key person or their own beneficiaries do not receive payment in the case of death or disability, the company requires written consent from the person named to purchase the insurance policy.
5 Reasons You Need Key Person Life Insurance
Here are five reasons you need key person life insurance:
1. It offers financial stability
There are many people who might be a major contributor to your success. It could be the person who has become the face of your company, helping drive sales through their authority, influence and expertise. It could be your CEO, or your top salesperson.
If your company depends on any individuals whose loss could mean you are unable to operate or generate a sustainable income, you need to plan for the possibility of their sudden loss. Key person life insurance provides the financial stability you need to regain your balance, come up with a replacement plan, and be back on your feet without experiencing financial loss.
2. It instils investor confidence
Venture capitalists and investors want to see the highest ROI. Your insurance shows them you have a contingency plan should key personnel or management be lost. In most cases having the proper insurance to protect yourself and your investors against unnecessary loss is required at some point when seeking capital through investors or loans.
3. You remain operational
The shock of sudden loss can interfere with operations. Your management will scramble to find their footing, which can make meeting the needs of your customers, staff, and debt obligations become difficult.
Your insurance provides cash flow to keep you operational so you can seek help, find a suitable replacement, or come up with a new plan. You’ll maintain your customers, avoid losing more key team members who jump ship and continue to meet debt obligations to avoid insolvency.
4. Maintain cash reserves
In the case of a lost business partner where you need to buy back shares, you can quickly drain your cash reserves. This puts you at risk for bankruptcy. With key person life insurance, you have the cash available to buy those shares and cover other related expenses, so you maintain stability and control.
5. Possible asset building
Permanent policies can be treated as assets. If you choose a permanent policy, you can use the policy as an asset to help you access capital to grow your business. As well, in most cases the benefits received should someone die is usually tax-deductible. You can discuss these options with your insurance provider, as well as your corporate tax lawyer or accountant to decide if a permanent policy makes sense for your business.
Calculating How Much Coverage You Need
Calculating how much key person insurance you need is based on how much you stand to lose as a result of the death or disability of the individual. This can be difficult, depending on the person’s role.
For example, if it is a key salesperson, their revenue is easier to calculate than someone who has become the face of the company. Other costs to consider would include replacing the person, time spent coming up with a new plan, etc. Your insurance provider can assist with calculations, and contribute information based on standard insurance risks such as the nature of their role and your business, age, health, and sex.