Business Insurance

Protect Your Business with Life Insurance for Key Employees

Life insurance for key employees is an important type of business insurance. Also known as key man life or key person life, this insurance coverage can help a company survive in the event they unexpectedly lose a key employee to death.

Despite the role this insurance can play in the long-term sustainability of a business, there are a large number of organizations that do not have life insurance for key employees. 

A survey of small businesses by the National Association of Insurance Commissioners revealed the following:

71% of respondents indicated they were very dependent on one or two key people for their success.

Only 22% of respondents indicated they have a key person life insurance policy in place.

Businesses need to know what key person life insurance is and what it covers. It is also important to understand how to identify key employees and determine how much coverage you should have in place.

Understanding Life Insurance for Key Employees

Key person life insurance protects a business from losses that can be incurred after the unexpected passing of a key employee. Here are a few ways this type of coverage can help ensure continuity of the business for everyone (employees, customers, creditors, etc.):

  • The death benefit from a key life policy can be used to help keep a business afloat until a suitable replacement is found. This can include recovering lost income, the cost of hiring a temporary replacement, or recruiting, training, and developing a long-term successor.
  • Key person life policies can help affirm to employees their value to your business which can aid in retention of key employees.
  • Key person life policies are considered a business asset which will help improve your company’s credit worthiness when applying for a commercial loan.

In some cases, smaller businesses may decide to shut down entirely after the loss of a key employee. In this type of situation, the death benefits from a key life policy can be used to pay outstanding debts, distribute money to investors, pay severance to employees, and close the business. A key life policy gives a company options beyond immediate bankruptcy.

Identifying Key Employees

As you work to identify key employees, ask this question: “What impact would the business experience if we lost this employee to sudden death or disability?”

A key employee is one whose unexpected permanent departure from the business would result in substantial negative financial consequences for the business. Key employees can include the owner or founder of the organization; “the brains” of the business who develops ideas, strategy, or products; key income generators or drivers behind profitability; and high-performing sales people. They can also be employees who have a unique skill set, knowledge, or overall contribution that is considered crucial and uniquely valuable to the organization.

Determining the Value and Type of Insurance to Purchase

The amount of coverage you have on each employee should correlate with the financial burden that would be incurred if you lost that employee. Consider the employee’s responsibilities and their financial contribution to the company. How much would you lose if you lost this employee unexpectedly? How long would it take to find a suitable replacement, and would the replacement be able to make a similar financial contribution right away?

For help determining how much coverage to purchase, talk with your insurance advisor who can help you choose a policy that fits your budget and that will help your organization meet your short-term needs in the event of the untimely passing of a key employee.

As you work to identify key employees, ask this question: “What impact would the business experience if we lost this employee to sudden death or disability?”

In most cases, term life insurance will be the best option if the purpose is to compensate for losses that occur because of a key employee’s passing. There are policies that accumulate cash value that may be appropriate in certain situations. Talk with your insurance advisor to find out what is best for your situation.

Ownership of Key Person Life Policies

Premiums on key person life insurance policies are paid by the business; therefore, the business owns the policy. If the key employee who is covered by the policy dies, the death benefit is paid to the business.

There are alternative options where the company who owns the policy and the employee who is covered by the policy may split the premium payments, cash surrender, and death benefit value. In addition, as the owner of the policy, the business can offer some of the proceeds of the policy to the employee’s family as part of the employee’s benefit package.

Employees who are covered under a key life policy should be made aware of the policy and agree to the purchase of the insurance. In some cases, the insurer may require board of directors to provide a resolution stating the purpose of the policy before coverage will go into effect.

Key Employee Disability Income

The risk of a key employee becoming disabled (partial, total, permanent) is greater than the risk of the person passing away unexpectedly. Permanent total disability would leave your business at risk in much the same way as if the person had died. Key employee disability income insurance can pay the business (the policy owner) 40 to 70 percent of the disabled employee’s earned income. This type of policy can cover office expenses (salaries, rent, utilities, depreciation) that continue after the person is disabled (up to the policy limit). Another type of coverage to consider is “business overhead expense disability” for partners or sole proprietors.

The ultimate goal of life insurance and disability income policies for key employees is to facilitate business continuity and protect your business from losses that can arise from unexpected events. These types of insurance policies are a critical element in your risk management strategy.

Contact your Leavitt Group insurance advisor to learn more about this coverage. Review your business insurance, including key person life and disability policies, on an annual basis to ensure you have the right coverage in place for your situation. Your business needs can change over time, so an annual review is important to make sure your organization isn’t left exposed to uncovered risks.

References

http://www.iii.org/publications/insuring-your-business-small-business-owners-guide-to-insurance/specific-coverages/life-insurance-for-key-employees

http://www.insurancejournal.com/news/national/2015/08/31/380097.htm

http://www.nfib.com/content/resources/insurance/how-to-price-and-choose-key-person-insurance-24156/ 

https://www.entrepreneur.com/encyclopedia/key-person-insurance 

https://www.nationwide.com/key-person-life-insurance.jsp

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