Key Person Insurance: How It Works

Author: C. Curley Date: August 02, 2012

Key Person InsuranceIn the event of the death of a key colleague, key person insurance can help keep your business afloat. Here’s what to consider.

No one wants to consider the death of a colleague. But if such a tragedy could lead to your company’s demise, then key person insurance is a worthwhile precaution. It is life insurance on specific people in a business and is beneficial when a company’s survival relies heavily on the role of one or two people.

Some small business owners don’t understand that they need key person insurance, in addition to life and disability insurance, because it’s designed to protect the business, says Rich Davis, a commercial insurance agent in Portland, Ore. If your company employs more than one person, review the basics below to determine whether it makes sense for you:

Who is insured?

Typically, key person insurance covers the owner, the founders or one or two key employees. Jeff Kear, owner of Planning Pod in Denver, Colo., says his company purchases it to cover its primary shareholders. He recommends talking to an agent with small business experience to determine what package is right for you.

RELATED: How to Price and Choose Key Person Insurance

How does it work?

Your business would pay annual premiums and be the beneficiary under the policy. If a key person unexpectedly dies, the company would receive the insurance payoff.

When reviewing packages, get quotes on different amounts—say, $100,000 versus $500,000. Your decision should take into account what your budget allows versus how much money the company would need to survive while bringing a new person up to speed. Davis advises asking for term insurance, which is valid only for a stated period of time and typically has lower premiums.

How is the money used?

As to how benefits get paid out, variations abound, says John Graves, Managing Principal of The Renaissance Group in Ventura, Calif. The money can pay off debts, distribute money to investors or cover day-to-day expenses.

You could also split the premium and death benefit between the firm and the spouse of the key person, says Graves. “This ensures that she or he receives replacement for [the person’s] economic value to the family,” he explains.

Key questions:

Every company is different, so when weighing your options, Davis recommends asking these types of questions:

•    What would happen in the event of an unexpected loss of any key people?
•    How much income or revenue could you lose in the time it would take to replace them?
•    Would appropriate candidates be available to replace them? Would you have to fly them in from other locations?

RELATED: Key Person Insurance Offers through NFIB

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