Understanding Key Person Insurance and Its Role in Small Business

By: Updated: March 2, 2017

 

Key person insurance is life insurance for a key person in a business. In a small business, this usually includes the owner, the founders and perhaps a key employee or two. These are the people who are crucial to a business -- the ones whose absence would sink the company.

How Does Key Person Insurance Work?

Here's how key person insurance works: A company purchases a life insurance policy on its key employee(s), pays the premiums and is the beneficiary of the policy. If that person unexpectedly dies, the company receives the insurance payout. This coverage is important because the death of a key person in a small company can result in the immediate death of that company. The purpose of key person insurance is to help the company survive the blow of losing the person who makes the business work.

The company can use the insurance proceeds for expenses until it can find a replacement person, or, if necessary, pay off debts, distribute money to investors, pay severance to employees and close the business down in an orderly manner. In a tragic situation, key person insurance provides the company with options other than potential bankruptcy.

If the company is a sole proprietorship and employs just you and no other employees or has no other people who depend on it, then key person insurance isn't as necessary. But don't confuse key person insurance with personal life insurance. If you have a spouse and/or children who depend on your income, then you should have personal life insurance for that purpose.

Why Do Small Businesses Need Key Person Insurance?

Small businesses often have the most to lose when it comes to key staff members. If your small business loses its leader or another important person, there’s a chance that the company will close its doors for good. That's why it's crucial to take out key person insurance on these irreplaceable members of your business.

Key person insurance ensures that your company will be financially protected in the wake of a key person’s death, so you can do whatever it takes to recover and move forward. You will be better positioned to address situations like hiring or training a replacement. You can also make up for loss of profits or any debt that you may incur while your company recovers.

The life insurance death benefit is paid directly to your business so it can be used to cover the financial losses incurred by the death of a key person. Key person life insurance is necessary even if your business plans to shut its doors after the loss of a key person. The money can be used to take care of closing costs, debts, wages, and benefits and severances owed to employees.

Finding Key Person Insurance

To learn more about key person insurance and to obtain a detailed quotation specific to your circumstance and goals, contact a professional insurance advisor. These agents can help you to determine whether a key person insurance policy would be right for your business and they will work to find the best insurance policy for you. Working with a professional in understanding key person insurance is critical to protecting the future of your company.

Related Reading: How Much Life Insurance Does a Small Business Owner Need? 

Interested in learning more about Life Insurance and how it can protect the future of your business? Click below to download our free ebook, "A Beginner's Guide to Life Insurance".New Call-to-action

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