Does Your Business Need “Key Person” Coverage?
Replacing an essential employee usually involves a significant investment of time and money. Should you take out insurance in case that key person dies or becomes disabled? Here’s what you need to know.
Who is a key employee? “This person could be your top salesperson or deal-maker, whose knowledge and skills are so important that without them, the business would be greatly affected,” says Steve Repak, a Charlotte, North Carolina–based certified financial planner and author of the book 6 Week Money Challenge: For Your Personal Finances.
Keep in mind that not just any employee can be considered a key person. “The insurance company is going to want to know how that person is essential to the business, and will ask for financials and a job description to prove it,” says chartered life underwriter Tony Steuer, founder of the website The Insurance Literacy Institute. You will also need the key employee’s consent to take out the coverage.
In some cases, a business owner or partner can be insured as a key person. “Oftentimes, owners are the key people because a lot of the business is dependent on them or their connections,” Steuer says.
How does a key person policy protect your business? Key person insurance can be purchased as a life insurance policy or as disability income insurance. The business is usually the owner and the beneficiary.
The insurance payout from a key person policy can help cover the cost of hiring and training a new employee and make up for any lost revenue during a transition period. If you plan to sell the business, it can help cover expenses until the business receives a fair offer.
What length of coverage should you buy? For death coverage, you’ll typically want to purchase a term life insurance policy for the key person. This type of policy provides coverage for a specified number of years (for instance, five, 10, or 20 years) and is usually very affordable, as long as the person covered is in good health at the time of purchase.
When figuring out how many years of term coverage to purchase, consider how long that key person will be essential to your business. “Are they a family friend who’s never going to leave the business, or are they somebody who may move on if they don’t become CEO in 10 years?” says Steuer. “You may also want to think about what type of salary or compensation might be needed to hire somebody with comparable skills, and then factor in the cost to hire a search firm.”
Key person disability income insurance is typically sold as a short-term contract that pays out benefits for about six to 24 months if the employee gets sick or injured. It usually costs more than key person life insurance, but with good reason: the risk of losing an employee to disability is greater than losing them to death, Steuer explains, so the odds of an insurance company paying a claim are higher.
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