Finance

What Is the Purpose of Key Person Insurance?

As the owner of your own business, you understand that your most important asset is your team. Without your top employees and key business associates, your business could suffer some major setbacks.

Thankfully, there is a certain kind of business insurance, known as key person insurance, that can help. What is the purpose of key person insurance? And what does it even do?

Key person insurance can help your business operate when a core employee suffers from a disability or death. With the insurance payouts, you will be able to find a replacement or replace the lost income. 

In this article, we will go over what key person insurance is, what its purpose is, and what it covers. So if you would like to learn more about key person life insurance then keep on reading!

What Is the Purpose of Key Person Insurance?

The point of key person insurance is to assist small businesses after the owner or primary employee becomes disabled or dies. Usually, you would buy a disability or life insurance policy and the family members would be listed as the beneficiaries. 

Key person life insurance is different. Here, the business is both the beneficiary and owner of the policy. The insured is the person who is central to the operation of the business. Any company where growth and revenue rely on just a few people should consider getting key man insurance

Even if you run a business where there is no key member, key person insurance can still be extremely useful. For example, if you are in a partnership, the partners can buy this kind of insurance in order to buy out the shares of former partners.

Lenders and investors will usually require key person insurance for a company’s management team. It costs a lot of money to find and train an executive’s replacement. And it is even worse when the executive becomes incapacitated unexpectedly.

With key person insurance, you have more breathing room in these situations. This way, you won’t be forced to go into bankruptcy or close down the business. 

Of course, it is important to remember that the beneficiary and owner of this kind of policy is the business itself. You will need a separate, life insurance policy to protect your family members if you die or become disabled.  

What Does Key Person Insurance Cover?

Key person insurance lets a business purchase disability and life insurance on the core team members. The company is the beneficiary of this policy.

If the person who is insured dies or becomes disabled, then the company gets money to recover from the loss. The benefits from this kind of insurance can be put to a variety of items.

These include offsetting lost income, training the replacement person, covering business expenses until a replacement is found.

This insurance policy can also be used to buy a former owner’s ownership stake in the company. If you plan to use the insurance policy for this purpose then you should also have a buy-sell agreement in place. 

After the key employee becomes incapacitated, the insurance benefits can also be used to pay severance to workers, distribute money to investors, and pay off debts. This is assuming that you decide it is better to go with these options than shutting down the company.

Insurance benefits aren’t taxed as long as you get consent from the key person before you buy the policy and let the IRS know. The uses for key person insurance benefits are fairly broad. However, they aren’t unlimited.

During the first few years of the policy, known as the contestability stage, the insurance provider can deny claims that arise from suicide. They can also investigate claims more closely for fraud. 

Another benefit of this policy is that you may be able to borrow cash against the value of the policy. You might even have the chance to withdraw cash. 

How Much Key Person Insurance Coverage Should You Get?

When it comes to getting key person insurance coverage, you first need to think about how much of the policy you actually need. It can be difficult to place a monetary value on a person. But this is the case with a variety of insurance policies out there. 

Usually, it is in your best interest to take out as much key person insurance coverage as the company can afford. Of course, you also need to consider the other insurance policies that your company is already taking out. You are more than likely already paying for commercial property insurance and general liability insurance. 

And all of this can really strain your budget. 

It is important to make sure that you don’t pay for too much coverage or too little coverage. You need to think about your cost to replace employees and that person’s contribution to the earnings of the company.

The Importance of Knowing About Key Person Insurance 

Hopefully, after reading the above article, you now understand what is the purpose of key person insurance. As we can see, key person insurance coverage can help to save a small business after they lose a key worker. If you run a small business, you should definitely speak with your partners and discuss the possibility of getting this kind of insurance coverage.

Are you interested in reading other useful and educational business articles? If so then check out the rest of our site for more today!