What is key man life insurance?

Do you need key person insurance? A company or small business will buy key person life insurance if the business would suffer financially after an essential employee’s death. Employees considered key to a company are usually business owners or C-suite executives with intimate knowledge of corporate plans and processes.

This type of life insurance is often referred to as key man insurance or corporate-owned life insurance (COLI) since it’s owned by the business entity rather than the insured employee.

Since the company buys the policy, it’s responsible for paying the monthly life insurance rates. However, how much life insurance costs for a key person still depends on the age, gender, and medical history of the insured.

Keep reading to learn more about key person life insurance, when you need it, and how to determine the best policy limits based on the future needs of your business.

What is key person insurance?

A key person policy is a type of life insurance used by a company or small business to protect itself from losses and bankruptcy after the death of an essential employee. 

If the insured employee should die, the benefits from their key person policy would cover any costs associated with either training and rehiring a replacement or closing the business responsibly.

For example, business owners can use death benefits to cover severance packages for other employees should the company close after a key person’s death.

An essential employee is anyone whose death would negatively affect the business’s overall success. Key employee life insurance can cover a business owner or partner, a high-level executive, an engineer with specialized talents, or a salesperson responsible for much of the business’s revenue. 

Read more: Life Insurance for Business Owners

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When does your business need key person insurance?

If you have a business loan, your lender likely requires some sort of key man insurance policy on yourself, your business partner, or another core employee. Your investors may also require insurance for key employees to protect their losses in the event of the death or permanent disability of these employees. 

Key person life insurance will also protect you if you don’t have employees. For example, business partners can use the benefits to buy the other’s shares should one die or become disabled and unable to work. This type of policy is often referred to as partner insurance. Learn more about when you might need to buy life insurance for someone else.

How does key person insurance work?

Business owners and company leaders can take out key employee life insurance at any time. The insured employee has no say in the type of policy bought or policy limits, but the company must notify and receive written permission from the employee to take out the policy.

Like traditional life insurance policies, key person policies contain three parts.

• The policy owner is the entity that owns the policy and pays the annual life insurance rates.
• The insured is who the policy covers and on whose death the benefit is received. Annual rates are directly linked to the insured’s medical history and lifestyle.
• The policy beneficiary is the entity that receives the benefits after the insured’s covered death.

The main difference between key person life insurance and traditional policies is that key person policy owners are also the policy beneficiaries. 

This means that the company buys the policy, pays the annual premiums, and receives financial compensation to cover business costs directly related to the key employee’s death or disability. 

Types of Life Insurance You Can Use as Key Person Insurance

Life insurance for key employees can be a term or permanent policy, depending on the needs of the business.

• Term life insurance. Covers the insured for a set number of years at much lower monthly rates than whole or permanent life insurance.
• Permanent life insurance. Covers the insured for their entire life and provides a cash-value savings account.

There are pros and cons to each type of life insurance, so consider the following before you buy key person insurance.

Term vs Whole Life Insurance: Key Differences

As you can see, permanent policies provide lifelong coverage, which may not be necessary because business needs often change. That’s why term life insurance is popularly used as key man coverage. Term policies typically last between 10 and 20 years, although some life insurance companies offer coverage as long as 40 years or as short as five. Compare term vs. whole life insurance to learn more.

Read more: What is key man life insurance?

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How much does key person insurance cost?

The cost of key person insurance depends on many different variables, including:

• The type of life insurance policy
• The policy limits
• The age, gender, and health of the insured employee

Whole life insurance rates are more expensive than term life, and your business loan may also require a specific amount of coverage. Higher limits lead to higher monthly rates, so it’s best to get life insurance quotes for different policies to compare the costs of each. 

Start comparing monthly life insurance quotes here with this table showing term life and whole life rates for a $100,000 policy.

Term vs. Whole Life Insurance Monthly Rates by Age & Gender

Monthly insurance costs will increase with higher policy limits, so compare quotes for $250,000, $500,000, and $1 million policies with our comparison tool below to get the best rates.

Key Person Life Insurance and Taxes

Is life insurance taxable? While death benefits are not taxed, key person life insurance payments are not tax-deductible. This means that the company pays the policy’s annual premiums with after-tax income, which might influence how much your business is willing to pay per month for key person coverage.

If your company wants to deduct life insurance payments, consider offering group life insurance to your employees. This type of life insurance covers funeral costs and family benefits for insured employees. In addition, the company covers a portion of the annual group premiums so employees can pay lower rates.

How to Buy Key Person Insurance

Deciding to buy key person life insurance can save your business from bankruptcy after the death of a business partner or essential employee. If you have a business loan or investors, you might be required to carry key person or key man insurance on yourself or other core employees.

Core employees typically include owners, C-suite executives, engineers, and salespeople who know the inner workings of the business or are responsible for a considerable amount of revenue. 

However, the trick to saving money on life insurance for employees comes from knowing what limits you need and which type of policy to buy. Companies can choose to buy term or whole life insurance to cover a key employee, but policy limits will vary depending on the following:

• The multiple of compensation dictates how much it costs to employ this key person per year.
• The percentage of profits indicates how much revenue the key employee brings to the company each year.
• The cost to rehire is the total cost of finding, training, and rehiring a suitable replacement for the key employee, including the loss of revenue while the position is unfilled.

If you’re not sure how much key person life insurance your business needs, use our life insurance calculator to get an idea of how much coverage to buy. You can also enter your ZIP code below to compare life insurance costs from companies in your area.

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Case Studies: Key Person Insurance in Action

Case Study 1: Protecting Business Continuity

A successful software development company experienced a tragic loss when their chief technology officer (CTO) unexpectedly passed away. The CTO was not only a key employee but also one of the co-founders of the company. His knowledge and expertise were integral to the business’s operations and growth.

Fortunately, the company had a key person insurance policy in place for the CTO. The policy provided a substantial death benefit, which allowed the company to hire a qualified replacement and cover the costs of training and onboarding. Without this financial support, the company would have faced significant challenges in maintaining its operations and meeting client demands.

Case Study 2: Safeguarding Business Ownership

A manufacturing company with multiple business partners faced a critical situation when one of the partners suddenly passed away. The deceased partner held a significant ownership stake in the company, and his absence could have jeopardized the stability and future of the business.

Fortunately, the company had implemented a key person insurance policy on each partner’s life. Upon the partner’s death, the policy’s proceeds were used to buy out his shares from his estate.

This ensured a smooth transition of ownership and prevented any potential conflicts or disputes among the remaining partners. The key person insurance played a vital role in preserving the company’s financial security and continuity.

Case Study 3: Mitigating Investor Risks

A tech startup secured substantial investments from venture capitalists to fuel its growth and development. The investors recognized the importance of the company’s talented and visionary CEO in driving its success. To protect their investments, the venture capitalists required the company to obtain key person insurance on the CEO’s life.

Tragically, the CEO was involved in a fatal accident. The key person insurance policy provided a significant payout to the company, compensating for the loss of the CEO’s leadership and expertise.

The funds were used to hire interim management and facilitate a smooth transition until a permanent replacement could be found. The key person insurance mitigated the financial risks faced by the investors and ensured the company’s continued operations.

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