07/ 18/ 2005
by Steve Strauss
Q: An associate told me that he recently bought “key man” insurance for one of his top employees. I don’t know what that is. Could you enlighten me?
A: To answer your question, I went to Byron Udell, founder and CEO of AccuQuote.
When I asked Udell about key person insurance, he gave me this scenario: “Say that a business has an employee who is critical to its profitability—someone who is firmly entrenched and important; someone who is integral and critical to the business,” Udell said. “It might be a top salesperson or a manager who is vital. Then ask yourself—what would happen if that employee were to pass away?”
Think about it. If you have a vital or key employee who creates significant revenue for your business—revenue that would take time to replace—what would it mean to your business to lose that person? Would their loss trigger a financial crisis in your small business?
That’s the purpose of key person insurance. It’s sort of like life insurance for your business. If you do lose a key employee, the policy will pay you for lost profits, and in doing so, buy you some time to replace the person and get things back on track.
Key person insurance can have another purpose as well: It can serve as an incentive to retain vital employees. How? Since you can divvy up benefits under the key person policy any way you want, you can legally offer part of any proceeds to the employee’s family. Therefore, you can incorporate the insurance into your employee benefits package.
So how much should you buy? Udell said that the typical policy payout runs between $250,000 and $1 million. He mentioned two ways to determine the proper amount to buy. The first rule of thumb is to buy eight to 10 times the key employee’s salary. The second and most preferable method is to look at the economic value of your key employee and ask yourself, “How much money would I lose if something happened to this person?” The answer determines how much key person insurance you need.
You’re probably thinking that while this sounds good, buying this much insurance probably costs too much. Think again. According to Udell, rates for key person insurance are “dirt cheap right now.” In fact, they’re 60 percent less than they were 10 years ago. Back then, insuring a 40-year-old employee with an average 20-year-term, key person policy would cost you about $995. Today, that same policy runs you less than $400 a year.
When I asked Udell if he had any insider tips for someone buying key person insurance for the first time, he mentioned two things. First, make sure that you buy the right amount, which your broker can help you determine. Secondly, “Don't overpay,” Udell said. Look for a broker who works with multiple carriers and who will shop your policy around. That means you’ll get the best deal.
Most employers describe their employees as their most important business asset; with key person insurance rates so low, it would be shortsighted not to insure yours.
