Key Man insurance is a life and/or disability policy taken out by the business as a beneficiary in the event of death or disability to a particular key employee. This type of policy is also called: key executive coverage, key person coverage and key employee coverage.
The policy works by paying the business in the event of the death or disability of a person who is so important to the business that their loss could destroy the business. The policy is a cheaper option than standard life or disability policies because the policy can be purchased with a “first to die” provision and cover multiple key employees.
A software company founded by three software engineers could take out a key policy on all three of the founders with a “first to die” provision. Upon the death or disability of one of these founders, the policy would pay benefits to the company. The policy would no longer apply to the two remaining founders. The policy payment would be used to replace the efforts of the first founder (hiring personnel, covering loss of sales, etcetera).
Insurance purchased in this manner would be much cheaper than three individual life policies and three individual disability policies.
Why Purchase Key Man Coverage?
You should consider “Key Man” coverage as a part of your business insurance program. Specifically, you should consider the coverage when any of the following apply to your business:
- Your business is a professional services business and key employees cannot be replaced expeditiously because of legal or ethical restraints. For example, a law firm or medical office cannot replace a twenty-year veteran with a new graduate.
- The business cannot continue in the event of a loss of particular people. Imagine “The Dog Whisperer” without Cesar Millan. The fact is that some businesses are simply not a business without a particular person in the operation.
- Business continuity is a concern. Look at your partner’s children, wife and other heirs. Do they know the business? Do they care? Are they in the same profession? Your partner’s share of the business will be inherited by someone and the business may need to buy out that person’s share or dissolve the business.
- Future growth or financing is possible.Most financiers and banks will require this coverage to be in place before extending any financing or credit to the company. If the company merges or goes public, this coverage will be required on top executives and board members.
- The key persons are between the ages of 30 and 55. Young key people are more likely to be disabled than die. Young key people are also the least likely to have adequately planned for their death. Thus, if your business has young key people consider this coverage because it is human nature for young people to ignore their mortality and the business may be hurt by the lack of planning.
The cost of this coverage can often be defrayed as a business expense on company taxes (see your tax professional). The cost is often cheaper because it is sold as a term product usually for fifteen to twenty years and often corresponding to the most productive work years of the employee or officer. Your company may not need this coverage, but even engaging in the analysis of whether this coverage is necessary is often helpful. Do the analysis and consider what you would if Employee X was not able to work tomorrow.