Key Man Life Insurance
Whether it's running day-to-day operations or providing the creative spark that drives a business, many small businesses or partnerships depend upon the hard work and effort of just one or two individuals. The untimely death of just one of these people can result in the demise of a business, unless there are sufficient funds readily available to tide the business over until a replacement can be found.
The purpose of key person life insurance is to protect a business from financial ruin if a key owner, executive, or employee unexpectedly passes away.
Key People Needn't Be Just Owners or Partners
Besides the owners or partners, some businesses depend upon their management team for their ongoing success. Without their expertise, the company may suffer financially. In that case, the contributions of each team member should also be insured.
Even lower-level employees may be candidates for key person insurance, especially those who are highly skilled, have specific expertise, or those who have developed personal contacts with customers or suppliers that generate a substantial share of the business's revenues.
Paying for Key Person Insurance
In most instances, key person insurance is bought by the business. The key employee is named as the insured on a life insurance policy, and the business pays the insurance premiums. The person named as the insured on the policy must agree to be insured and the business is named as the beneficiary.
Other Uses for Key Person Life Insurance
Many lenders or investors may be wary of loaning money to or investing in a small business, particularly when one or two individuals are the heart of the operation. As part of a loan or investment agreement, there may be a stipulation that key person life insurance is purchased.
Depending upon the terms of the agreement, either the lender or the business buys the policy and pays the premiums. However, in such an instance, the ender or investor is the beneficiary. This ensures that if the key passes away, the lender or investor is paid back.
When the lender or investor is the beneficiary, the business is not protected if the key person passes away. To protect the business' interest, the owners of the business should take out an additional key person life insurance policy and name the business as the beneficiary.
How Much Key Person Life Insurance Is Needed?
Purchasing key person life insurance should always be undertaken as part of an overall business plan. The first step is to measure the business's total revenue. The next step is to determine how much of that revenue is contributed by the individual to be insured. Next, estimate how much the business, and that individual's contribution, is expected to grow in the future. Be sure to purchase sufficient life insurance coverage--having to purchase additional insurance at a later date may raise the cost of insurance coverage.
Key Person Insurance: Term Life Insurance or Permanent Life Insurance?
Either term life insurance or permanent life insurance can be used for key person life insurance. Term life insurance provides pure insurance with no cash buildup, so it is usually the most affordable type of life insurance policy. When selecting a term policy, the term length should be long enough to cover the individual until retirement. Otherwise, the policy may expire while the key person is still an active member of the business, and a new policy would need to be put in place.
Permanent life insurance has cash value and may be an asset for the business, which may be borrowed against if the business needs a ready source of cash. Of course, if the business borrows against the policy, the death benefit may be reduced by the amount of any outstanding loans.
The Cost Factor
The difference in cost between term life and permanent life insurance should be weighed against their respective benefits. Of course, as with any type of life insurance, the age and health status of the insured individual affects the cost of the policy and may be a determining factor in which type of insurance is selected.
Whether term or whole life insurance is chosen, be sure to get enough coverage to protect a business from financial calamity if a key person should suddenly pass away.