Most businesses can attribute a large part of their success to just a few employees.
In fact, studies show that 71 % of small businesses rely on just one or two people to oversee day-to-day operations.
Bigger businesses also generally rely heavily on a few individuals - consider, for example, where Facebook (now Meta) would be today without Mark Zuckerberg or Sheryl Sandberg, or where Apple would be today without Steve Jobs or Steve Wozniak?
Many business people like using the 80/20 principle, and this principle can also be applied to the employees of a business: in general, 20 % of the employees will produce 80 % of the value.
With this in mind, most businesses run the risk of being hurt financially if one of these key people dies or becomes disabled and unable to work.
Key person insurance can help businesses protect themselves from this risk as well as provide other benefits, which we will learn more about in this article.
This article is written as general education, and should not be considered as personal financial advice. If you would like personal guidance with life insurance, you can schedule a time to talk with one of our experts.
What is Key Person Insurance?
A key person insurance policy (also known as a “key man insurance”, “key woman insurance”, or “business life insurance”) is a life insurance policy that a company purchases on one of their key employees.
Key employees are people who contribute significantly to the business, and can include business owners or partners, members of the executive leadership team, or top salespeople.
In a key person policy, the company is the beneficiary, and will pay the premiums and receive any payouts from the policy.
A key person policy can either be a term policy, which is valid only for a certain amount of years, or a permanent policy, which is valid for the entire life of the insured person.
Certain permanent key person policies have a cash value, which can grow tax-free and serve as loan collateral for the business.
Key person policies can also double as disability insurance, which means that they will pay the company money in case the insured person becomes disabied.
Use Cases for Key Person Insurance
Key person policies can provide many different types of benefits, arising either from the death benefit of the policy or from the cash value of the policy.
Death benefit use cases
The death benefit of the policy can replace income that otherwise would have been generated by the insured person, and buy the company time to recruit, hire, and train a replacement.
If the deceased person is a partner in the business, the death benefit could be used by the other partners to buy back the deceased person's interest in the business.
If the company can’t go on without the deceased person, the death benefit can be used to pay off debts, distribute money to investors, provide severance benefits to employees, and fund other costs associated with closing down the business.
For any person who personally guarantees a business loan or other credit facility, key person insurance is an essential part of ensuring that the business will be able to pay back the loan.
In fact, many Small Business Administration loans such as SBA 7(a) loans require you to purchase key person insurance when the loan amount is higher than $350,000 and not fully secured by other types of collateral.
Cash Value Use Cases
If the business chooses to get key person insurance through a cash value life insurance policy, a range of other benefits becomes available.
Cash value life insurance can serve as an alternative asset class on the balance sheet of the business, and provide benefits while the insured person is still alive.
Many cash value life insurance policies feature competitive growth rates with strong guarantees that provide strong alternatives to alternative money market vehicles.
Beyond the strong growth rates of cash value life insurance policies, they also feature attractive tax advantages.
Additionally, the cash value can serve as collateral for accessible loans with competitive interest rates, which the company can use to fund ongoing cash needs.
How Getting Key Person Insurance Works
When getting key person insurance, there are a few things to consider:
- The company must notify and get consent from the person they intend to insure
- The insured person must be in the highest-compensated third of employees
- The insured person must be an employee and can’t be an independent contractor
Beyond this, there are several considerations that go into choosing the optimal type and size of policy that will depend upon your special circumstances.
The insurance experts at White Swan have decades of experience in helping business owners find, apply, and maintain optimal key person insurance to protect their businesses.
If you want to learn more about key person insurance or get one for your business, you can schedule a free consultation with one of our experts by picking a time below.