What is Key Man Life Insurance and Do I Need It?
Business is great. Sales are up. Revenues are increasing. Costs are under control. Things are going well at your small business, all thanks to one important employee. You.
But what will happen to your business if something happens to you? In the case of many small companies around the world, the death of the owner/operator is the death of the company too. To avoid that fate, some companies purchase a key man life insurance policy. Here’s how it works and why it may be beneficial.
What is a Key Man Life Insurance Policy?
A key man life insurance policy is more or less what it sounds like. It is a life insurance policy on a key man, or woman, in a business organization. The policy works just like any other term life insurance policy in that the policy costs are based on the health and lifestyle of the insured party. Payments are made each month for the life of the policy. If that person dies, a payment is made to the policy beneficiary.
What is different from a typical life insurance policy is the policy beneficiary and who holds the policy. In a typical policy, someone takes out a policy and lists a relative, such as a spouse or child, as the beneficiary. In a key man policy, the business takes out the policy, makes, the payments, and collects the payment if the insured party dies.
When Is a Key Man Policy Helpful?
Many small businesses have an owner/operator that does everything for the business. In that case, if the owner passes away, there is rarely anyone with enough knowledge or the right skillset to keep the business going.
In that case, a key man life insurance policy is not very valuable. Instead, a regular life insurance policy with a payout to the spouse or children is the best option.
However, in a business with multiple employees, the loss of a key team manager, sales person, or leader may seriously harm the business, but not completely shut it down. In that case, a key man policy is perfect for the business.
In this situation, a company may lose revenue or profits from the loss of a key member of the organization. In some situations, that loss is enough to shut down the business. But if the loss is something that will only be temporary while the key person is replaced, a key man insurance policy may bridge the gap.
When a business is considering a key man insurance policy, it should try to reasonably assess the cost to the company if the key person were to unexpectedly pass away. The policy should be setup to cover those losses until the person can be replaced.
For example, if a company brings in $2,000,000 per year in revenue and half of that can be attributed to the key person, and it would take roughly a year to find and train a replacement, a $1,000,000 key man policy will help the business survive the gap until the business is back up and running as usual.
Life Insurance as Executive Compensation
There is another option for businesses to use life insurance as both a protection for the company and as a form of executive compensation.
This is not the same thing as a typical group life insurance available to employees of a large company. Instead, it is a specific insurance policy taken out on the individual and paid for by the company.
In these types of policies, the beneficiary may be solely picked by the executive, but in many cases the company splits the payout with the executive’s family.
One potential such arrangement is called a split-dollar arrangement. Just like it sounds, with this type of policy the company and employee share the premium, death benefit, and cash value of a permanent (investment style) life insurance policy. This lowers the monthly premium cost for the employee and can make it easier to obtain coverage. This is great for the business as well, as it can recoup some of the costs of that employer paid benefit.
In other situations, the company pays the complete policy payment as a bonus on top of their regular pay. The policy can be structured where all benefits go to the employee, but it can also be structured where the company will receive a portion of the payment back, like with a key person policy.
Be Thoughtful and Plan Ahead
The thing about life insurance is that few of us think we are going to die unexpectedly. While we don’t like to admit it, bad things happen. And by the time you might think you really do need life insurance, it is already too late.
Just like with a personal term life insurance policy, it is vital to plan ahead for future “what if” situations and cover your business and your family to survive your loss without any major financial hardship.
If you are a key person in a small business, you have more people counting on your for their living than just your family. With a key person term life insurance policy, you can protect everyone who relies on you in case a worst case scenario comes to life.
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