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What is Key Person Insurance?

What is Key Person Insurance?

| February 01, 2021
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If you are a business owner, you need to be aware of key person insurance to help protect your business if you or another key person were to pass away or become disabled.

In most small businesses, the owner or a key individual is the basis of the company's existence and the loss of that person would be detrimental to the organization. 

What is key person insurance?

Key person insurance is basically a life insurance policy on the business owner or a key person in the company. However, unlike your personal insurance policy, the business pays the premiums and is the beneficiary of the policy. 

The goal of the policy is to keep the business viable following the loss of the key person or if that isn't possible, paying debts for the business. 

In many cases for closely held businesses, the death of a business owner can leave the company without leadership and funds to run its operations. 

The death benefit from this insurance policy can be a needed source of cash that the business can use to hire a replacement or shutter the business by paying severance to employees and outstanding debt. 

Some banks even require key person insurance when issuing debt if your organization is reliant on a key person. 

How much do you need?

Determining a coverage amount can be difficult. How do you measure the employee or owner's worth to the company, financially?

Here are three things to consider when determining the amount of insurance you need:

  • Salary- If you don't accept a below market salary, like most business owners, you could use this as a benchmark times a factor that represents how difficult the key person will be to replace.
  • Replacement Cost- Similar to the salary option, looking at all the costs that will be involved in finding, hiring and training a qualified candidate could be an option. 
  • Profit Contribution- What is this key person's contribution to profits due to key relationships with suppliers or customers? This can be difficult to monetize, but when you consider what percentage of the profits this individual is responsible for, it can guide you to a decision on the amount of coverage needed.

A big thing to keep in mind is not just the out of pocket costs but also the opportunity costs the loss of this person creates for the business. 

Still unsure if key person insurance is right for your organization or how much coverage to get? Speaking to a financial advisor can help. 

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