Key Person Life Insurance Policies, Facts, Quotes

Introduction to Key Person Life Insurance

Key person life insurance is something that every company should consider. Within a small company, there is usually at least one key person who is critical to the success of the business. Key person life insurance needs may be limited to the business’ founders or partners, or defined more broadly to include other employees responsible for running a critical aspect of the business, such as the senior marketing or sales manager, chief engineer or software developer in the case of a technology company.

The death of any of these key people would likely cause serious impact on the business’ bottom line. Therefore, many small firms choose to purchase Key Person life insurance policies on these very important employees. As the policy owner, the company is the beneficiary and receives the proceeds when the insured key employee dies. The payout can help the company by providing:

Key person life insurance provides cash to weather the loss and continue operations until a new employee can be hired and trained to carry out the functions of the deceased.

Key person life insurance can provide the funding to buy out the key person’s heirs, if ownership rights of the business are involved.

In some cases, a small business seeking a loan from a bank or trying to raise capital from outside investors may be required by the lender or investor to carry life insurance for its partners. The bank may even require that the small business provide a collateral assignment agreement that gives the bank first rights to the key person life insurance policy proceeds to cover outstanding loans due in the event of one of the owner’s deaths.

Types of Key Person Life Insurance Policies

Like individual life insurance policies, Key Person life insurance policies may be purchased as term life insurance or permanent life insurance policies.

Term life insurance covers the insured for a term of one or more years. It pays a death benefit only if the insured dies within that term. Term products, used as key person life insurance, generally offers the best value for your premium dollar. However, it does not build up cash value. It may not be renewable at the end of the term or may cost considerably more to continue.

Permanent life insurance, which goes by several names, such as whole life, universal life and variable life, typically includes both a death benefit and cash value. Because of the cash value element, premiums tend to be higher than for term life insurance.

Tips & Considerations Concerning Key Person Life Insurance

A number of factors can affect key person life insurance premiums. These include:

The age of the insured and his/her overall health. Life insurance companies typically ask about the insured’s medical history, request access to medical records and even obtain blood and urine samples for testing.
Pre-existing and/or chronic health problems, such as diabetes, heart disease or cancer. These conditions may prevent a person from getting life insurance or can place him/her in a high-risk pool and therefore subject to higher premiums.
Poor health habits, such as smoking and excessive drinking. These habits can trigger higher premiums. Be aware that insurance companies may look back and consider these behaviors for the past five years.
Engaging in dangerous hobbies, such as skydiving, skiing or rock climbing.
The insured’s driving record, in terms of accidents, DWI/DUI citations, claims and tickets. The better his/her driving record, the better rates he/she will receive for life insurance.
The insured’s geographic area. Life insurance companies have access to regional data that documents mortality rates and life expectancy, and they use that data to calculate the term life rates they offer.

In purchasing Key Person life insurance, consider the following:

Consult with your accountant and financial advisers to determine which individuals in your company are critical to its financial success and what monetary contribution each key person makes to the company annually to decide what size policy to purchase. Think more broadly than just the founder or partners; consider other employees that add significantly to the company’s bottom line, as they may need key person life insurance as well.

One way to determine the amount of a key person life insurance coverage is to utilize a multiple of that individual’s annual salary, for example, two to five times his or her current salary. However, the actual amount of coverage some companies choose may be significantly higher; for example, to cover the buy-out of the deceased’s share of the business. Other considerations in determining the amount of coverage:

How much would it cost to replace the key person, both in terms of salary and training costs?
How much does the key person contribute to the company’s bottom line annually?
How many years would it take to get a replacement performing at the same level as the key person?
What level of premiums can the company afford?

It’s typically advisable to buy Key Person life insurance when the company is formed. Going without this insurance leaves the company at risk, and it also opens the possibility that the key people could later develop health problems that would make insuring them more expensive.

As with all life insurance, shop around and compare rates for comparable coverage from a variety of insurers.

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