What Is Key Person Life Insurance? And Why Does Your Business Need It?

The smaller the company, the bigger certain challenges can feel—if you own a small business, you’ve probably experienced this firsthand. While a large corporation can take the hit of, say, a delayed product shipment, such an issue would be a nightmare for a small business staying afloat. Imagine, then, how big of a blow losing a member of your team can be.

While losing a key member of the business, such as a CEO or founder, is difficult for any size company, many large corporations would be able to recover from the death. But such a death would likely mean the corresponding death of a small business.

That’s why key person life insurance exists.

What IS Key Person Life Insurance?

Key person life insurance functions as a way of ensuring that a small business stays afloat after the death of a leading figure in the company. It involves the business taking out a life insurance policy on a (surprise) key person involved with that business, such as the owner, founder, or an important employee. The business pays the premiums for the policy and is the beneficiary of the policy; simply put, the business pays monthly so that if the key person dies, the business will get enough money to stay afloat while it hires and/or trains a replacement.

In some situations, when a business would be completely dead without the key person, the money from the life insurance does not go toward keeping the business afloat but rather toward closing the business down in an orderly manner. The money allows the business to pay off any outstanding debts, provide severance pay to its remaining employees, and pay investors.

In such a situation without key person life insurance, the company would be forced to declare bankruptcy immediately.

For small businesses consisting of a single employee (the owner, founder, and only worker), key person life insurance is unnecessary. If the owner of a single-person business is worried about their family in such a situation, they would be better served taking out a personal life insurance policy. Key person life insurance is only for helping the remainder of the business in the event of a critical employee’s death.

What To Look For In A Key Person Life Insurance Policy

When shopping for key person life insurance, be sure to visit multiple insurance carriers, as different carriers have different ratios of premium to payout. In addition, some carriers will have fixed payout plans (usually $100,000, $250,000, $500,000, and $1 million), while others will pay based upon the key person’s salary or value to the business.

It is recommended to look for a payout amount based upon the key person’s perceived value to the business, as well as the key person’s age and general health. The longer the key person would be with the business naturally, the more the business stands to lose if that person dies unexpectedly, so the higher the life insurance policy payout will be.

A Note About Term Life Insurance

Another option when investing in key person life insurance is to get term life insurance. Term life insurance applies for a set amount of time (as opposed to whole key person life insurance, which applies until the key person is no longer with the company). Going with a term life insurance plan is helpful if you predict that your business will grow rapidly in the next few years, as the policy may not be necessary after a certain point.

The bigger your business becomes, the more replaceable your key person may be and the larger a hit your company will be able to absorb without needing a payout to stay afloat.

Losing anyone within a company is never easy, but it’s a possibility every business owner needs to think about. Key person life insurance is a very important resource for your small business. Having such a policy is essential for guaranteeing your business’ survival (or orderly dissolution) in the event of an unexpected tragedy.