Life is full of surprises—twists and turns, ups, and downs. As a small business owner, you have to pray for the best and prepare for the worst.
Although no one likes to dwell upon death, as an employer, it’s your responsibility to consider what would happen to your business and its employees if you or a key employee of the company suddenly passed away.
Would it be able to continue on in your absence? Or would it collapse?
If you fear the latter, you should consider protecting your business and purchasing key man insurance, a special type of life insurance that covers business losses caused by the death of an irreplaceable member of the company. But how does key man insurance work, and what does the insurance carrier cover? We’ll answer all your questions below.
What is key man insurance?
Key man insurance is a specialty life insurance policy that a company purchases on an important team member’s life (not exactly the person who has all of the keys, but they’re probably pretty important too). The business pays the policy premiums and acts as the beneficiary. Should that insured person die or experience a long-term disability, the business would then be compensated with an insurance payout by the insurer.
Almost every business has a couple of irreplaceable members, cornerstone players that everything else is built upon. But, take away those key people, and the business can come tumbling down like a house of cards.
For instance, a key person could be the owner, the founders, business partners, or invaluable employees.
So, if you’re trying to determine who that person might be in your own organization, ask yourself the following:
- Does the person have a specialized or rare skill set, expertise, or knowledge that would make them difficult or expensive to replace?
- Do they have a unique talent or knowledge skill set that is an invaluable part of the business and its revenue?
- Are they responsible for a large percentage of the business’ profits or cash flow?
This could be a famous chef, a starring actor, a world-famous plastic surgeon, or an adept software developer. Put simply, they’re an indispensable part of the business, and their absence would hinder the company’s ability to continue operating normally.
This is why it’s wise to put key man insurance on those specific players.
How does key man insurance work?
Key man insurance works like a standard life insurance policy, except it’s not the individual paying the life insurance premiums and designating a beneficiary; rather, it’s the business.
Policies vary, but the most common ones are:
If the key employee(s) designated by the company dies, the company would receive a death benefit. This would give the company breathing room to take any of the following actions:
- Create a business succession plan
- Employ new strategies for a business continuity plan
- Pay off debts
- Distribute money to investors
- Pay employee severances if the business needs to close down
Fundamentally, it acts as a safeguard that allows you to avoid immediately going into bankruptcy because you lost an all-star.
So, for instance, imagine a small but specialized tech company has a one-of-a-kind research scientist that is the head of the R&D team. For two decades, she’s the driving force behind all of their product development and the various patents the company has registered.
If she were to die, the gap on the team that’s now left vacant is too big to fill, which could significantly hinder the business’s ability to go on as usual. The leaders of the company would then have to scramble to find a suitable replacement (if one even existed). And, if they did, they’d likely be in high demand and hard to get.
A key man insurance policy taken out on this head researcher would give this business a monetary cushion and the breathing room needed to perform the search or make new arrangements.
In this case, it could be the difference between the company persevering or going bankrupt.
What does key man insurance cover?
Key employee insurance covers several categories of loss. They include:Cash-value life insurance to protect profits – If death or long-term disability caused financial loss from the delay or cancellation of a business project that the key man was involved in, it could be covered.
Losses due to inability to work – If the key man doesn’t die but is unable to work for an extended period because of an illness or injury, the business could be compensated.
Guaranteed business loans – If this key man is involved in guaranteeing a business loan, the insurance coverage would be the same as the value of the guarantee.
Protecting shareholders or partner’s interests – This allows shareholders or partners to purchase the departed key member’s existing stake in the company.
How much does key man insurance cost?
There are several factors that go into a key man insurance policy’s premiums, including the underwriting risk and the type of policy selected. Some are as low as a few hundred dollars per month, while others can be in the thousands of dollars. This price range is based on the following factors:
- The key man’s age, gender, and health
- The industry
- The company size
- The company structure
- The amount of coverage
- The term of the policy
- The type of policy
Typically, policies go on a 10-, 15-, and 20-year term, but they also offer year-to-year renewable terms.
Key man insurance: protecting your business’s MVP
Key man insurance is a specialized type of insurance policy that may be required for some small businesses and unnecessary for others. That said, there are other types of business insurance policies that are vital for your company to operate safely. Specifically, every small business should have at least general liability insurance and, in some cases, also professional liability insurance.
Now that you know what key man insurance is, perhaps you have someone in the company that you need a life policy for. We hope this guide helped answer all the questions you had regarding this specific, but extremely important insurance policy.
Our editorial content is intended for informational purposes only and is not written by a licensed insurance agent. Terms and conditions for rate and coverage may vary by class of business and state.