There are employees at every business who are essential to the company’s operations and financial success. Key person (also known as key employee or key man insurance) is a life insurance policy that financially supports a business even if an essential employee — like an owner, partner, CEO, or other major executive — passes away.
Key Takeaways
Start-ups, small businesses, and large corporations can all benefit from owning key person life insurance.
Businesses go through financial underwriting to qualify for key person life insurance.
Experts recommend purchasing five to 10 times the employee’s gross compensation in key person life insurance.
What is key person life insurance?
Key person insurance pays a death benefit o your business if a crucial employee dies. The business owns the policy, pays the premiums, and is the beneficiary of the payout. Businesses can’t take out a key person policy on an employee without their knowledge and consent (known as dead peasant insurance).
The payout can be used to:
Absorb losses in revenue after the death
Buy out the deceased’s share in the business
Cover outstanding business loans
Pay for recruiting and hiring a replacement
Provide severance if the business has to shut down
You can use term life insurance or permanent life insurance in a key person agreement. If you or your family will get some of the benefits of the policy, it’s known as a split-dollar life insurance agreement.
Key person insurance is also transferable if the business shuts down. Usually the insured person can either transfer their policy to their next employer or convert it into a private policy.
A key person policy protects your business and rarely benefits your loved ones. If you have key person insurance, you still need your own personal life insurance policy if you have dependents.
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Who needs key person insurance?
Businesses of all sizes can benefit from key person life insurance:
Large businesses and corporations Doctor’s offices, publicly traded companies, and big financial firms need key person life insurance policies. If a top executive’s name or client base helps keep the business afloat, their death can affect every employee.
Start-ups Early and late-stage startups often have founders or a small group of key employees whose expertise is hard to replace. Buying key life insurance for start-ups can be more complicated because they don’t have a long track record of success.
Small or private businesses Small businesses typically have owners or partners who would be hard to replace either because of their reputation with clients or their involvement in day-to-day operations.
Consider protecting any employee whose death would cause a significant financial or operational loss. For most businesses, that’s a CEO, CFO, owner, or partner.
“There's no excuse for most businesses, especially small businesses, not to have a life insurance policy such as key person insurance,” says Warren Robbins, senior sales associate at Policygenius. “Businesses often skip this step in risk evaluations for business planning, but if you don’t have life insurance for your top employees, you are not mitigating a potentially devastating risk.”
Summary
Businesses of any size can benefit from key person insurance. C-suite executives, owners, partners, and any other employee without whom the business would suffer financially are a fit for a key person policy.
How to buy key person insurance
The process for buying key person coverage is generally the same as buying individual life insurance. The big difference is that in addition to underwriting the insured employee, your business also goes through underwriting.
Financial underwriting for key person insurance
When buying key person coverage for an employee, insurers evaluate your startup’s overall financial situation and the business value of the key employee you’re insuring. They may ask for:
Annual sales figures
Estimated cost to replace key employee
Fair market value of the company
Gross compensation of key employee
Net profit of the business
Tax statements
This information, plus the health of the employee and amount of coverage you need, will impact how much the policy costs.
We recommend combining key person life insurance with a buy-sell agreement. If a key person (like a partner) dies, the payout from a key person policy gives the surviving executives enough cash to buy out the deceased partner’s shares.
→ Learn more about how to buy life insurance
How much key person coverage do businesses need?
Experts recommend key person coverage of between five to 10 times the employee’s gross compensation. Gross compensation includes:
Salary
Bonuses
Equity/stock
Business expenses
Transportation services
For example, a CEO might have a gross salary of $250,000. But if they also own $80,000 in restricted stock, earn $20,000 in annual bonuses, and have a $10,000 yearly stipend for meals, their gross compensation is $360,000. The business would need between $1.8 million and $3.6 million in key person life insurance for the CEO.
Summary
To get key person insurance, you need to share financials from your business and the employee needs to go through the standard underwriting process. Get coverage equal to five to 10 times the employee’s total compensation.
For key person life insurance, like individual life insurance, the advantages of having a policy outweigh the disadvantages. “When shopping for life insurance, many businesses, like many families, say, ‘we’ll do it later,’” says Robbins. “But life insurance is just as vital to a business as it is to a family.”
A Policygenius agent can help you choose the best policy to cover your key employees and protect your business.
Frequently asked questions
How does key person life insurance work?
Key person insurance insures the life of an employee whose death would have a major negative impact on a business or its finances.
Who is eligible for key person insurance?
Anyone who is critical to a company’s operations or financial success is eligible to be covered, including a CEO, CFO, partner, or owner.
Is key person insurance tax deductible?
Premiums for key person insurance aren’t tax deductible, but the death benefit is tax-free.
Why is key person insurance important?
Key person insurance ensures that if a critical employee passes away, your business can continue operating without major losses.
