What is Key Man Life Insurance

Key man life insurance, also known as key executive or key employee insurance, insures an individual without whom a company may not be able to continue. Just as life insurance protects a family from financial catastrophe in the event of the death of the primary breadwinner, key man life insurance protects a business from financial disaster. Key man insurance can be purchased to cover the death of the founder or owner of the company, an executive, a scientist, a leading sales person, attorney or any other employee whose contributions to the company are so great that the future of the company would be in doubt if he or she were to die or become permanently disabled and unable to work.

A key man life insurance policy can insure employees and members of the board of directors at large and small companies. Large companies, especially those that have publicly traded stock or those that have issued bonds, almost always have key man insurance policies in place as part of a succession plan to cover any business interruption that would occur if a key player were to die. For example, a technology company whose chief executive officer serves as both the face of the company when promoting its products and is also instrumental in product development would no doubt purchase key man insurance. A small company with a sales person who accounted for a significant percentage of the company’s revenue would also benefit from a key man policy, as would a company with an engineer who had developed proprietary technology.

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Why Purchase Key Man Life Insurance?

Key man life insurance helps any company, especially a small company, withstand the loss of a key employee. As is the case with so many small businesses, the loss of a key player can mean that the company cannot continue operating. The primary purpose of key man life insurance is to make sure that the company can continue operating until either a replacement can be found or until the company can be restructured.

A company can use the death benefit of a key man policy in any number of ways. While the premiums are usually not tax-deductible, the death benefit that is payable to the company is usually not taxable. Therefore, the cash can be used to pay down debt, repay investors, provide severance payments to employees or to pay the costs associated with closing the business rather than simply shutting it down immediately. Key man life insurance provides a company with a number of options for either rebuilding or winding down in an orderly fashion.

Who Requires Key Man Life Insurance?

Banks, venture capitalists and other companies that provide operating capital to businesses almost always require a new business to have key man life insurance. Key man insurance, like any insurance product, transfers risk. In this case, the risk of the loss of a key member of the team is transferred to the insurance company rather than remaining with the bank or the investors. An established small business that enters into a multi-year contract with another company to provide goods or services may also be contractually obligated to purchase key man insurance. This protects both companies in the event of the death of a person both companies feel to be key to their mutual success.

The company that purchased the key man policy owns the policy. It pays the premiums, is named as the beneficiary and collects the death benefit. The most popular type of key man policy is a permanent life policy. With a permanent life policy, the insurance remains in effect as long as the premiums are paid. In addition to providing insurance coverage on the life of the key employee, a permanent life policy will build cash value for the company. This extra level of protection will provide additional cash when the policy matures upon the death of the insured. A term policy can also be purchased as a key man policy. It is less expensive than a permanent life policy and can in many instances be transferred to a replacement employee if the original employee retires or otherwise leaves the company.

What is the Cost of a Key Man Life Insurance Policy?

The amount of the premiums due on a key man insurance policy vary with the life insurance company underwriting the policy, but many factors are the same as those that determine the value of a traditional life insurance policy. The age, health, personal and family medical history of the insured will all be factors. In some states, it will be more expensive to insure a male key man as opposed to a woman. Other states require that life insurance companies charge the same for men and women. Of course the amount of the death benefit will also play a large part in determining the cost of the premiums.

In order to determine the amount of the death benefit of the policy, a company must first estimate the value of the contribution of the policy. In other words, a company must place a financial value on the contribution the employee makes. While this can be a daunting task, companies seeking a key man policy are often directed to consider what would be lost if the key man were no longer able to work on projects already in the works or those forecast in a long-term strategy document. For example, the value placed on a sales person might be the amount of sales that would be generated by that person and his or her team. The value placed on an engineer or scientist might be the amount of a patented product or one that could have an exclusive license.

Key man life insurance should be part of any company’s comprehensive insurance plan. Whether the goal of a key man policy is to wind-down operations in an orderly fashion or to continue serving customers or manufacturing products, a reputable business insurance agent will be able to help determine the proper value of the policy and the length of time it should be in force.

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