When Key Man Insurance Becomes Worth the Cost

A puzzle piece with a blue silhouette on it that stands out amongst the others. Representative of key man insurance.

The tragic loss of a key employee due to an incapacitating illness or accident can have a devastating impact on your startup or small business. One of the best ways to ensure your company is protected against this kind of tragic loss is through a Key Man insurance policy. Stabilizing the company financially during tough times can make all the difference in how quickly your business recovers. 

What is Key Man Insurance?

A key man policy is a simple insurance policy on people who are crucial to a business. Key Man insurance helps fill a financial void in case of a critical person’s death or incapacitation. With this type of policy, the company is the owner, as well as the beneficiary.

A Key Man Insurance Policy is often referred to as Key Person Insurance or a Key Life Policy. The key person does not have to die for the policy to take effect. In the event a key person becomes incapacitated or unable to perform their duties, a Key Person Disability Insurance Policy will reimburse the company for costs related to their partial or total absence, whether the person is temporarily or permanently unable to contribute to the organization.

5 Reasons Why Businesses Need Key Person Insurance

Whether you plan to hire and train a replacement, or plan to shut down, the proceeds from a Key Man policy can help cover outstanding debts, the cost of hiring a temp to fill the position, closing costs, severance packages, and investor payoffs. And, if you plan to continue operations, the monies can also be used to offset any loss of profits while your company is recovering. Some important reasons to have this policy in place:

  1. Recent studies show (PDF) that losing a key person is one of the top contributing factors to small business bankruptcies;
  2. Outside shareholders, venture capitalists, private equity firms, and banks may contractually require this type of coverage;
  3. Key Man Insurance Policies can be used as a guarantee on business loans;
  4. Key Man Insurance Policy premiums are deductible as business expenses;
  5. If all legal requirements are met before the issuance of a policy, the payout will be tax-exempt.

Types of Key Man Policies

Life insurance policies and disability insurance policies are the two principal types of Key Man insurance.

Key Man life insurance policies are either term or permanent policies. “Term” policies are in effect for a specific period, from 1-20 years, and coverage expires upon the demise of the key person or when the term ends, whichever occurs first. Term policies are typically less expensive than permanent policies.

Exclusions in Key Man Insurance Policies

Fraud, suicide, and misrepresentation are the most common Key Man policy exclusions. Claims can be denied if any of those conditions are uncovered or occur.

A clause in the policy known as the “contestability period” is typically in effect during the first two years of the policy. Any claims made within that period will be investigated by the insurance company to determine if there were any deliberate omissions or fraudulent statements made during the application process. It should be noted that Key Man policies typically do not cover suicide during the contestability period.

When Key People Leave the Company

If the Key Man policy is in effect when a key employee leaves, there are two options:

  1. The company can cancel the policy, or
  2. Transfer it to a different key employee, who then assumes payment of premiums. They will also need to change the beneficiary.

How Much Key Man Insurance Should You Have?

Your business insurance agent can set you up with a Key Man policy that has the right amount of coverage for your type of business. Ask for a range of quotes – incremental increases in coverage typically have a small impact on the premium. Compare costs on $100k to $1 million in coverage and choose a policy that fits into your budget and covers your short-term financial needs.

Key person policy premiums range from $100 to several thousand dollars monthly depending on numerous factors:

  • the amount of coverage
  • the health history of each key person
  • the type and term of the policy
  • the types of policies chosen
  • the underwriting risk

How can We Help?

By law, a business must inform the critical employee of its intent to buy a Key Man policy, obtain their consent in writing, and give them the details of the policy. The employee must also consent (in writing) to the employer having the choice of keeping the plan in effect even after they are no longer with the organization.

Contact the Law Office of Elliott J. Brown for your free consultation and assistance in Corporate Law matters, including consents for key man insurance and shareholder agreements.

Contact an insurance agent today to help you figure out how much Key Man insurance your company needs–and buy it!