How to Protect Your Business with Key Person Life Insurance | Best Types & Tips

 

If you own or run a business, you know how important it is to have the right people on your team. Some people are so vital to your business success that losing them would be a major setback or even a disaster. These are your key persons, such as partners, top executives, or specialized employees.

But what if one of these key persons dies unexpectedly? How would your business cope with the loss of their skills, knowledge, experience, or relationships? How would you pay off their debts, find and train their replacement, or maintain your cash flow and profitability?

That’s where key person life insurance comes in. Key person life insurance is a type of life insurance that covers the life of a key person in your business. It’s also known as key man insurance, key woman insurance, or business life insurance. It’s a risk management strategy that can help you protect your business from the financial impact of losing a key person.

In this article, we will explain how to protect your business with key person life insurance and what are the steps and tips that can help you.

Key Person Life Insurance: How It Works

Key person life insurance is a life insurance policy that you buy on the life of a key person in your business. You are the policy owner and you pay the premiums. You are also the beneficiary and you receive the death benefit if the key person dies during the policy term.

The death benefit is usually equal to the estimated financial loss that your business would suffer from losing the key person. You can use the death benefit for any purpose, such as paying off debts, finding and training a replacement, maintaining cash flow, etc.

Key person life insurance can help you protect your business from the financial consequences of losing a key person. It can help you:

• Pay off any debts or obligations that the key person may have left behind, such as loans, taxes, leases, etc.
• Find and train a suitable replacement for the key person, which may take time and money
• Maintain your cash flow and profitability, which may be affected by the loss of revenue or productivity that the key person generated
• Preserve your business reputation and relationships, which may be damaged by the loss of trust or confidence that the key person had with your customers, suppliers, investors, etc.
• Avoid bankruptcy or liquidation, which may be the worst-case scenario if you can’t recover from the loss of the key person

For example, suppose you have a software company and your chief technology officer (CTO) is a key person in your business. He is responsible for developing and managing your products and services. He also has a lot of contacts and influence in the industry. You buy a key person life insurance policy on his life for $1 million and pay $100 per month in premiums.

If he dies unexpectedly, you will receive $1 million from the policy. You can use this money to pay off his debts, hire and train a new CTO, cover any revenue losses or delays in product development, and maintain your reputation and relationships in the market.

Key Person Life Insurance: Who Needs It and How Much

Not every business needs key person life insurance. And not every person in your business is a key person. To determine whether you need key person life insurance and how much coverage you need, you need to consider some criteria and factors.

The main criterion for needing key person life insurance is whether losing a certain person would cause significant financial harm to your business. This may depend on:

• The size and type of your business: Small businesses may be more vulnerable to losing a key person than large businesses because they have fewer resources and less diversification. Some types of businesses may also rely more on certain individuals than others because of their nature or industry.
• The role and contribution of the person: Some people may have more impact on your business than others because of their skills, knowledge, experience, or relationships. They may be responsible for generating revenue, managing operations, creating innovation, or leading teams.
• The financial impact of their loss: Some people may cause more financial loss to your business than others because of their value, potential, or liability. They may have outstanding debts, future obligations, or unrealized profits.

To estimate how much coverage you need for each key person, you need to consider some factors, such as:

• The cost of replacing them: This includes the expenses of finding, hiring, and training a suitable replacement for the key person, which may vary depending on their qualifications, availability, and demand.
• The loss of revenue or productivity: This includes the income or output that the key person generated or contributed to your business, which may depend on their performance, sales, or projects.
• The value of their assets or equity: This includes the value of any assets or equity that the key person owned or controlled in your business, such as shares, options, or intellectual property.
• The amount of their debts or obligations: This includes the amount of any debts or obligations that the key person may have left behind in your business, such as loans, taxes, leases, or contracts.

To calculate how much coverage you need for each key person, you can use some methods, such as:

• A formula: This is a mathematical equation that uses some variables and factors to determine the coverage amount. For example, you can use the following formula: Coverage amount = (Replacement cost + Revenue loss + Asset value - Debt amount) x 2. The factor of 2 is used to account for inflation and interest.
• A rule of thumb: This is a general guideline that uses a percentage or a multiple to determine the coverage amount. For example, you can use the following rule of thumb: Coverage amount = Annual income x 5 to 10. The range of 5 to 10 is used to account for different levels of impact and risk.
• A professional assessment: This is an evaluation by an expert or a consultant who can analyze your business and your key persons and provide a customized recommendation for the coverage amount.

To help you calculate and compare your key person life insurance needs and costs, you can use some tools, such as:

• Online calculators: These are online tools that can help you estimate your coverage needs and costs based on some inputs and assumptions. For example, you can use this online calculator from Corporate Finance Institute.
• Comparison websites: These are online platforms that can help you compare quotes and offers from different insurance companies and products. For example, you can use this comparison website from Quotacy.
• Agents or brokers: These are professionals who can help you find and apply for the best policy for your needs and goals from a variety of companies and products. For example, you can contact an agent or a broker from Policygenius.

Key Person Life Insurance: Types and Options

The type and option of key person life insurance policy you choose can affect your coverage amount and how it works. There are different types and options of key person life insurance policies, such as:

• Term life insurance: This is a type of life insurance that provides coverage for a specified period of time, such as 10, 20, or 30 years. If the key person dies during the term, the policy pays the death benefit. If the key person survives the term, the policy expires and no benefit is paid. Term life insurance is usually cheaper and simpler than other types of life insurance, but it only provides coverage for a limited time.
• Permanent life insurance: This is a type of life insurance that provides coverage for the entire life of the key person, as long as the premiums are paid. It also has a cash value component that accumulates over time and can be accessed through loans or withdrawals. There are different types of permanent life insurance, such as whole life insurance, universal life insurance, variable life insurance, etc. Permanent life insurance is usually more expensive and complex than term life insurance, but it provides coverage for the entire life of the key person and has a cash value component.
• Disability insurance: This is an option that can be added to a key person life insurance policy to provide coverage in case the key person becomes disabled and unable to work. It pays a monthly benefit that can be used to cover the loss of income or productivity that the key person would have generated for the business. Disability insurance can be short-term or long-term, depending on the duration of the disability.

The type and option of key person life insurance policy you choose can affect your coverage amount and how it works in different ways. Some of the factors to consider are:

• Duration: Term life insurance can help you cover temporary needs, such as paying off a loan or completing a project that involves the key person. Permanent life insurance can help you cover permanent needs, such as leaving a legacy or funding a buy-sell agreement that involves the key person.
• Cost: Term life insurance can help you get more coverage for less money, especially if the key person is young and healthy. Permanent life insurance can help you lock in a lower premium rate for life, especially if you expect the key person’s health or lifestyle to change in the future.
• Flexibility: Term life insurance can help you adjust your coverage amount as your needs change, such as increasing or decreasing your coverage or converting to a permanent policy. Permanent life insurance can help you access your cash value for any purpose, such as supplementing your cash flow or paying for emergencies.

To choose the right type and option of key person life insurance policy for your coverage amount and how it works, you need to weigh the pros and cons of each type and option and decide which one suits your needs and goals. You can also use online tools or contact agents or brokers to help you compare different types and options of key person life insurance policies and find the best one for you.

Key Person Life Insurance: Tips and Best Practices

Buying and using key person life insurance effectively and efficiently can be challenging, but not impossible. You just need to follow some tips and best practices to avoid common pitfalls and mistakes and make smart decisions. Some of the tips are:

• Shop around for the best rates and terms: You don’t want to pay more than you need to for your key person life insurance policy or settle for a policy that does not meet your needs and goals. You should compare quotes and offers from different insurance companies and products and find the best value for your money.
• Review your policy regularly: You don’t want to keep a policy that is outdated or irrelevant to your current situation. You should review your policy at least once a year or whenever there is a significant change in your business or your key person’s status. You should update your coverage amount, beneficiary, premium, or policy type as needed.
• Communicate and document your policy: You don’t want to cause confusion or conflict among your stakeholders or beneficiaries regarding your key person life insurance policy. You should communicate and document your policy clearly and transparently with your key person, your business partners, your employees, your accountant, your lawyer, etc. You should also keep a copy of your policy in a safe and accessible place.

Conclusion

Losing a key person can be devastating for your business. That’s why you need key person life insurance to protect your business from the financial impact of losing a key person.

Key person life insurance is a type of life insurance that covers the life of a key person in your business. It can help you pay off debts, find and train a replacement, maintain cash flow, preserve reputation, and avoid bankruptcy.

To protect your business with key person life insurance, you need to consider who needs it and how much, what type and option to choose, and how to buy and use it effectively.

You can also use online tools, comparison websites, agents, brokers, or financial planners to help you with this process.

Remember, the right key person life insurance policy for you is the one that meets your needs, goals, budget, and preferences. So don’t delay and get started today!