Although most small businesses say that every employee is important, companies that rely on one or two people for the bulk of their revenue often turn to "key person" insurance to provide financial protection against the disability or death of those critical employees.
The idea of how a company defines a key person will vary from firm to firm, but in basic terms, the concept applies to someone who would be difficult or expensive to replace, or whose sudden loss from a company could threaten its ability to continue. Typical examples may include a partner, a sales executive, or someone who coordinates the company's daily operations.
Unlike life or disability insurance purchased by an employee, key person coverage is purchased by, and is designed to protect, the company and its financial interests.
Depending on the company and its financial needs, key person coverage may be structured as long-term disability coverage, a life insurance policy, or a combination of the two.
Key person insurance can help a company make up for lost sales, pay ongoing expenses, cover the costs associated with finding a replacement or buying out the interest of a surviving spouse.
Key person insurance can also provide funds if the death or disability of a partner or owner triggers payment covenants in the company's bank debt (and, accordingly, the coverage may be required by a lender as part of a loan agreement).
Some financial and operational benefits of key person insurance may include:
- Funds to maintain cash flow and payroll following the loss or disability of a critical team member
- Money to recruit and train a replacement employee
- Protection of company assets from a need to finance cash flow or repay debt suddenly
- Protection of other equity owners
Premiums will be based on a variety of factors, including the key person's age, health and medical history, whether he or she smokes, and other underwriting considerations.
Small business owners interested in key person coverage should consult with an experienced insurance professional, as well as a tax advisor, to arrange the most effective policy.