What is Key Person Insurance?

Key person insurance is a particular type of life insurance policy taken out by a company on one of their employees, in which the company is the beneficiary in the case of that employee's untimely demise. This type of insurance is a relatively new phenomenon, but has attracted much praise and is encouraged by many strategic advisors. Life insurance is basically a system by which a fixed amount of money is paid to a beneficiary in the event that the person being covered dies. Most life insurance companies offer a type of coverage for key persons, as it has become more and more necessary in the modern business world.

Whom exactly a company wants to cover with key person insurance depends on the nature of the business and its employees. In many partnerships, the founders are crucial to the success of the business, and so insuring against the loss of one or more partners is a smart business move. For some businesses, the entire management team might be considered difficult to replace, so insurance could be purchased for each member of the team. Some businesses may also have lower-level employees who have built up personal connections with major distributors or clients, whose loss could conceivably cost the loss of those clients.

Many lenders require a business to take out key person insurance on people they consider important before loaning money to a business. In this case, it is still usually up to the business to pay the premiums on the coverage, but the lender is listed as the beneficiary, so that if the crucial person dies, the bank can collect some portion, if not all, of the capital they originally invested. Many businesses choose to take out additional insurance beyond what the lenders require, listing themselves as the beneficiary for the amount in excess of the lenders' requirements.

The monies from this coverage may go to pay for many different things. One of its most common uses is to buy back shares in a company from the estate of the deceased. Particularly in the case of the death of a founding partner or majority holder, this can be crucial to helping the business retain control over its own destiny. Payments may also be used to pay a headhunting firm to find a suitable replacement for the lost employee, to cover expenses while the business adjusts to the loss, or to cover lost cash flow from clients who leave with the loss of a key employee.

In addition to purchasing life insurance, many businesses also buy disability insurance as part of their key person insurance. This will help cover temporary losses in productivity while a crucial employee is rehabilitating. Coverage can range from as low as $25,000 US Dollars (USD) to well over $1 million USD, depending on any number of factors involved. Particularly in cases where the insurance is going to be used to buy back stock, the policy will need to be reappraised frequently to ensure that the payment will be sufficient to cover all expenses in the event of the key person's death.