Insurance has become part of our lives, whether for business or personal level. With the right policy, you can be able to protect your loved ones, yourself, and your business. This is likely to give you total peace of mind when you know that you are ready for any situation that may arise.
Key person insurance is the life insurance for the key person in a business. The owner of a small business, the founders, and maybe two employees can be the key person. The key persons are essential in the business; their absence may lead to poor performance or collapse of the business. So, it is important to consider key person insurance on these special people.
How it Works
A company or business purchases the policy on the key people only; it pays the premiums and is the main beneficiary of the policy. If the key person dies unexpectedly, the business or company gets the payoff.
In a small business, the coverage is important because when the key person dies, the company may die immediately. The insurance policy will help the business to survive the tragedy of losing the key person of the business.
The business can use the proceeds to cater for expenses until another key person is found or pay the debts, pay severance and close the company, or distribute money to the investors. The insurance policy provides the company more options than being bankrupt in a tragic situation.
If a business is a sole proprietor and has few other employees or another person who depends on it, then this insurance policy is not important. The key person policy should not be confused with personal life insurance. If you have a family that depends on you, personal life insurance is ideal.
How Much Insurance Do You Need?
How much key person insurance needed depends on the company, but generally, it is ideal to get as much as want. Shop around the insurance companies and get different rates from various agents, most companies sell the key person insurance. Request for term insurance, most companies may push for variable or whole life policy which have high commissions and premiums but are not essential. You can request for a range of quotes and compare the costs. Consider how much the business will require for surviving until it can replace the key person and get the business on feet.
Purchase a policy that is within your budget and which will address the cash needs in the short-term in case of a tragedy.
There are different ways to determine the amount of key person insurance that a company needs. The amount should be affordable. The key things to consider are the multiple incomes, the cost of replacement, and the business income. These have been highlighted below:
- Multiple of income or salary: The multiple of salary should be factored in, it is an easy method of evaluation but may fail to take much if something to the business or key person. You can take the key person salary and multiply it five or ten.
- The cost of replacement: Consider what will cost the company to get another key person or employee. Some of the aspects to consider include training, the time taken to get the replacement, and also bringing the new person up to speed. Before a replacement is found, the company will lose revenue. Therefore, the revenue factor should be considered.
- The business income: This is the amount of income that the key person contributes to the company. Determine the percentage and multiply by the time it will take the company to replace the key person. It may take one to three years.
To find the amount that the insurance needs, the company should be able to estimate the losses it will incur when the key executive becomes disabled or dies. The cost of replacement is also considered. The insurance professionals will help you to evaluate the amount of insurance you will need. The type of policy and the limits you choose will determine the cost of coverage. The policies are designed to satisfy the needs of small and large companies.
Identifying the Key Persons
The key person insurance policy focuses on the survival or continuity of the business, difficult or impossible replacement, and financing a bank loan.
The insurance policy should be used on any employee in the organization whose death can threaten the survival of the company. The key person insurance offers the creditors the peace of mind that if the key person dies the company will still survive.
The policy can be used on any employee whose demise can make it difficult for the company to get a replacement for the company.
The key person insurance is required on any business owner who wants to take a bank loan. The policy will help to finance the loan.
Examples of Key Persons
The business owner, if the demise of the owner will affect the long or short-term viability of the company.
The top salesperson, especially if the person is the best in the company sales and contributes a large percent of the business income, then the person is considered as a key person in the company.
A software engineer or scientist who made the business’ important property company can be considered as the key person.
The General Underwriting Requirements
The underwriter will allow amounts ranging from 5-10 times earned income.
The bonus can be included.
Some companies request the bonus to be paid on a regular basis as part of the company plan.
An appropriate percentage of the company income can be added to the key person’s income if they have an ownership interest in the enterprise.
The employee should sign the employer-owned life insurance acknowledgment and consent forms before the coverage.
The insurance company should inquire about the business to determine the amount of the policy sought.
The underwriters of the insurance may want to know the key person’s income, role in the business, business type, skills, and experience.
Categories Covered by the Key Person Insurance
The losses related to the time when the key employee is not able to work, but has not yet died.
The insurance protects the business profits. For example, it can be used to offset income lost through lost sales, losses from cancellation or delay of any project where the key person is involved.
The insurance is designated to protect the partnership or shareholders’ interests. It allows the partnership or shareholders’ interests to be bought by the existing partners or shareholders.
Insurance for the person guaranteeing the company finances or loans. The value of the coverage should be equal to the value of the guarantee.
The Value of the Key Person Insurance
As explained above, most businesses have one or more key persons who are important for the success of the company. The person can be the owner of the business, a partner, stockholder, or expertise. The demise of that person can lead to failure or collapse of the company.
The key person insurance will protect the solvency of the company after losing a key person. Insuring the business from any tragedy loss is important for the business itself, investors, and lenders
The insurance companies need the board of directors to give a resolution that affirms the aim of the business insurance policy. The business should notify the key person in advance and agree about the purchase of the policy.
The company will pay the premiums, and it is the main beneficiary. Most businesses buy the policy as a permanent insurance policy. However, there is term insurance which is relatively cheap and can be purchased to cover the key employees until they retire. Upon retirement, the policy can be transferred to a different key person.
The benefits of the key person insurance person are used to purchase the interest or shares of the person in the company. The proceeds from insurance can be used to get a replacement.
The premiums are based on various factors like the physical condition, age, history health of the person, and the coverage.
Before buying the key person insurance, the business owner or board of directors should determine the value of the person to be insured and if a separate policy like credit insurance is essential.
The business should have a continuation plan to outline how the business will survive in case of a tragedy. This will help to determine the type of policy to purchase. Most insurance companies request for a business continuation plan before the offer the key person insurance.
Does Your Company Need Key Person Life Insurance?
Examine the company and determine if the key employees are irreplaceable or their contributions are so vital that the company may not survive without them. Large companies may have more skilled executives who can replace the key persons in the company. The small businesses depend on one or a few people. This is the main reason why key person insurance is essential for small companies.
The amount of insurance that you will purchase depends on your needs and the premiums that you can afford. The more the face amount, the higher the premiums. Term insurance policies are the best to purchase; they have low premiums when compared to a variable or whole life policies. You can consult an insurance professional to find out the most suitable policy for your company.
It is also called a key man, key executive or key employee coverage. The insurance protects the company against the demise or disability of a key person. The policy can include life insurance, disability coverage or both.
Types of Key Person Insurance Policies
- Term Policy: The term policy is relatively cheap when compared to a permanent policy. The policy applies for a specified period; it can be one year or more than 20 years. The policy coverage ends when the stipulated term ends or the key person dies. If the key person dies, the company will collect the proceeds. The money can be used to get a replacement, pay off debts, or other purposes.
- Permanent Policy: The policy applies for the whole life of the insured person. The policy serves as an asset which can be used as collateral and it pays the death benefit. This policy can be transferred to another key person. For example, if the insured person retires. An organization can have more than one executive or key person. Such organizations can purchase a policy that has ‘first to die’ policy. The insurer will pay death benefits to the organization if any of the executives die. The policy will then cover those executives who remain.
- Disability Insurance: The policy covers a firm against the risk that an executive member can be disabled to the extent of not working. The benefits are remitted monthly or in a lump sum after waiting for a given period. The period can be one or two months for monthly and one to one and half years for a lump sum. This policy has no standard policy.
When you take key life insurance, ensure that you read and understand the exclusions carefully. This part contains the items that the policy cannot cover. The most common exclusions are suicide, misrepresentation, intentionally dishonest, and fraud. A claim may be rejected if there is intentional dishonesty. During the contestability time, the policy does not cover suicide. There is a contractual clause called the contestability period, during the first two years when the policy is purchased. If there is a claim within this period, the insurance company will investigate the matter to find out if there is any omission, deception, or fraudulent on the insurance exam and original application.
Consider the nature of your company and think of the person or employee that cannot be replaced in a short time. In most companies, the owner puts the company together, may manage the employees, keep the books, handle customers, and more. If the person dies, the business will also die.
The premiums paid are not deductible for tax. However, the benefits that a company receives are tax-free. You can talk to a tax professional to know how the key person policy will affect the company’s taxes.
The good news for you is you’ve reached the business insurance experts. Here at CFAinsure, we specialize in providing insurance to business owners and entrepreneurs. If you’re looking for a key person quote, get in touch with us today!