Definition

Key person insurance

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What is key person insurance?

The term "key person insurance" refers to a form of life insurance policy that a corporation buys on the lives of particular important people regarded as valuable assets or have shown to be critical to the firm, such as top executives or owners. "Business life insurance," "key woman insurance," and "key man insurance" are all terms used to describe this type of life insurance.

The firm is the policy's beneficiary, and it is the one that pays the premiums. The firm wants key person insurance because losing a key worker would almost certainly have significant financial ramifications.

Summary
  • Key person insurance refers to a life insurance policy a corporation purchases on the life of a critical individual or top executive.
  • For small companies, the key person may be the founder or owner.
  • When a key employee dies, key person insurance gives a financial lifeline for the firm.

Frequently Asked Questions (FAQs)

Explain the term ‘key person insurance’?

The term "key person insurance" refers to life insurance on a firm's most important employee. This is usually the founders, the owner, or a key employee or two in a small business. These are the workers who are critical to a company's success. The death of a key worker puts the organisation in jeopardy; therefore, key person insurance provides a financial cushion in a crisis.

What is key person insurance?

 

Moreover, the death benefit effectively buys time for the firm to recruit a new human being or to execute other methods to protect the firm from going out of business. Hence, key person insurance is essential for businesses.

Replacing a significant asset such as a key employee is difficult; it requires money and time and may cost precious business clients during the changeover. Therefore, the death benefit is a key aspect of key person life insurance, and it helps maintain the firm's operational continuity for creditors, customers, and employees.

Having a key person policy for top employees also reaffirms their significance to the firm and improve the relationship.

In the following situations, key person insurance may be helpful to the firm:

  • If the firm's economic sustainability and status are inextricably tied to the key personnel's distinctive expertise, position, or name, the key personnel's death could spell the firm's end.
  • If the demise of a key worker such as a top salesperson may put the company's financial position in jeopardy immediately.
  • Suppose creditors or financial institutions seek collateral for a corporate loan. In that case, they could choose to place a lien on a key person policy, which is sometimes known as a collateral assignment.
  • In the case of a partnership, each partner may desire to purchase the other's shares if one of them dies prematurely.
  • Earnings protection insurance includes repaying lost revenue from missed sales or losses incurred due to the delay or termination of any business project in which a key individual was engaged.

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How does key person insurance work?

Many insurances are available today, and key person insurance is crucial to safeguard the organisation. A firm obtains a life insurance policy for one or more of its key employees, pays the premiums, and is the policy's beneficiary. If a key worker suddenly dies, the firm receives the insurance payout.

A key person's death in a small business may result in the corporation's imminent death; therefore, key person insurance coverage seemed critical at the time to help businesses endure the jolt.

The importance of key person insurance is well-known. The firm will be able to use the insurance payments to cover costs until a replacement is found. Aside from that, paying severance to staff, allocating cash to investors and paying back loans, and ultimately shutting down the business on time can be beneficial. In the worst-case scenario, key person insurance offers healthy alternatives other than bankruptcy.

In some cases, however, key person insurance is not needed. For example, if your firm is a sole proprietorship and you are the only worker or no other personnel who rely on you, key person insurance isn't required.

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What level of key person insurance do you require?

There's no precise method to determine how much coverage is necessary to insure a key person, but the best way to start is to think about how much it will cost to take someone to replace the key personnel in that position.

Furthermore, it is critical to analyse the proportion of the key person's contribution to the firm's bottom line and the present wage, which is usually multiplied by a ratio of five to seven to get at a figure for determining how much coverage is required. You may have to choose between permanent and term insurance coverage for this purpose, depending on what is best for the firm. 

A term policy gives a death benefit to a corporation if a key person dies while the policy is active. Premiums are fixed for the first 10, 20, or 30 years, based on the policy. The permanent insurance policy similarly offers a death benefit if the key person dies. In contrast, the policy exists, but the policy also includes a cash value fund that the firm can use.

Furthermore, as with most other types of life insurance, the cost of the coverage will vary based on the nature and size of the organisation and the covered individual's age and health. It's worth getting quotations for policies worth $100,000, $250,000, $500,000, $750,000, and $1 million and comparing the prices.