How Key Person Insurance Can Protect Your Business

Key person insurance can help your business avoid financial burdens if a critical employee, like a CEO or founder, passes away or becomes disabled. The death benefit from this type of insurance can help you recover from lost income, repay debts, find a replacement for the position or even close your business.

Keep reading to learn about key person insurance, who it's meant for, its benefits and what factors affect your premiums.

On This Page

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  What Is Key Person Insurance?

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  How Does Key Person Insurance Work?

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  Types of Key Person Insurance

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  What Are the Benefits of Key Person Insurance?

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  How Much Does Key Person Insurance Cost?

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  How To Get Key Person Insurance for Your Business

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  FAQs

What Is Key Person Insurance?

Key person insurance is a form of life insurance offered to companies to cover an employee critical to your business. It aims to help protect the company from financial hardships in the event of the covered person’s death or disability, depending on the policy. For example, if your key person dies and their clients decide to take their business elsewhere, the death benefit from the policy can help offset that income loss.

Who Does Key Person Insurance Cover?

Generally, a key person insurance policy should cover someone whose sudden loss to the company would result in major financial harm, usually because of their unique experience and expertise and business relationships. Below are a few roles that key person insurance could be used to cover:

• High-ranking executives, like a CEO or COO
• Head sales personnel
• Product development leads
• Key engineers
• Specialized employees

How Does Key Person Insurance Work?

Once a business has determined a key person, it can take a life insurance policy out on the individual, provided they have both consented to the policy. Key term policies can either be term or permanent life, with term life insurance policies typically lasting between 10 and 30 years.[1] Alternatively, permanent life insurance policies can be whole life or universal life policies and last for as long as the insured key individual lives (as long as the business pays the insurance premium).

In the event of the covered employee’s death or disability leaving them unable to work, benefits are typically paid out to the company. These funds are often used to cover the costs of getting a suitable replacement or, if the figure is irreplaceable and key to the company’s success, closing the company. Some of these situations could include:

• Covering lost income until a replacement is found
• Training costs for the replacement
• Paying off debts or returning investments
• Paying severances 
• Expenses for closing the business

The benefit amount paid out by your insurance company will vary by policy. Additionally, the business would receive no benefits if the company cancels the plan or fails to pay its premiums. Whole life policies may also be able to borrow against or cash out a portion or all of the cash value fund, although there may be fees.^[2] Keep in mind that withdrawals or failing to repay the loan can reduce the death benefit, which can be insufficient for the beneficiary’s needs.

Types of Key Person Insurance

Depending on the type of policy you buy, the benefit from a key person insurance policy can be paid out either when the key person dies or suffers a disability that prevents them from working.

Life Insurance

Key person life insurance works similarly to other life insurance policies, with the primary difference typically being who owns the policy.

For key person insurance, the business usually holds the policy, pays the premium and receives the policy's death benefit (whereas in a personal life insurance policy, the insured pays the premium, but the death benefit goes to their spouse, child or some other designated beneficiary).

However, the business and insured individual (key person) may agree to split payments and benefits.[3]

Disability Insurance for Key Employees

Some policies may allow you to add a disability insurance rider to your policy, which provides a benefit if the key person receives a disability that prevents them from working. The benefits are typically between 40% and 70% of the covered individual’s income.[3]

What Are the Benefits of Key Person Insurance?

Considering the potential risks a business might face if a key employee passes, key person insurance can offer several benefits to a business. Some of these benefits can include:

• Protecting profits: Losing a key employee, such as a founder or CEO, may leave the company struggling to achieve its goals, which could affect profits. Key person insurance can help offset these costs until a replacement is found.
• Pay off debts: Even if an immediate successor is determined, key person insurance benefits can help those who inherit a company from being straddled with debts. This can benefit someone who wants to reduce the burdens during this transition period.
• Buying out the company: Company partners may be able to use the insurance benefit to purchase the company from someone who inherited it, like a surviving family member.
• Get a loan: Sometimes banks or creditors may require collateral when giving a loan to protect their investment, with a key person insurance policy filling this role.
• Peace of mind: Death or disability can come at any time, and knowing that your company is safeguarded from the financial consequences of losing a key employee can bring peace of mind. This can help you and your business focus on improvements and operations instead of being anxious.

How Much Does Key Person Insurance Cost?

The cost of a key person insurance policy will vary between companies and individuals covered, but factors can affect the price. Considering the key person’s income, the company's annual revenue and how much the employee contributed to that revenue can help you determine how much coverage you’ll need and how much it will cost.

The industry can also factor into the cost of this type of insurance. For example, nearly 20% of all workplace deaths in 2022 were in the construction industry. If your key person is on the ground and directing operations, it will likely cost more to insure them than a key person who operates exclusively in a relatively safe office.^[4]

Personal factors about the key person will also come into play, such as their gender, age and health. Generally, the higher risk an individual has, the higher your premiums may be. Men and older individuals typically face lower life expectancies, giving them a higher risk of a death benefits claim that could result in higher rates.^[5][6]

How To Get Key Person Insurance for Your Business

After determining if you have a key individual you’d like to insure, you’ll want to find the best options for maximizing your benefits while reducing premium costs. Get quotes from three to five insurance companies to discover available offers. Keep in mind you’ll likely need to provide information on your business and details on the key employee to each insurance company one at a time, which can make the process frustrating and tedious.

You can speed up this process by using an insurance marketplace like SmartFinancial. After answering a brief questionnaire, we can connect you with a licensed insurance agent to help you find the best policy that meets your business needs. Click here to get a free commercial insurance quote today!