Key Man Insurance
- 1 What is key man insurance?
- 1.1 Can any business buy key man insurance?
- 1.2 Who should purchase key man insurance?
- 1.3 Whose life is insured with key man insurance?
- 1.4 Why is key man life insurance especially important in a partnership?
- 1.5 What are the benefits of key man insurance?
- 1.6 What types of losses can be covered with a key man policy?
- 1.7 How large should the policy be for key man life insurance?
- 2 How to buy key man insurance
In every business, there are certain essential personnel whose knowledge and ability makes all the difference in terms of the organization’s success. The loss of one of these “key” men or women can have a huge financial impact on the company. A company could incur high costs to recruit a successor or to hire and train a replacement. The company could also experience financial loss resulting from a decreased ability to transact business until a suitable replacement can be found. To protect against this financial loss, smart companies purchase key man insurance.
What is key man insurance?
Key man insurance is a life insurance policy purchased by a company to protect against the death or incapacitation of a valuable and essential employee. The corporation owns the life insurance policy and is the beneficiary of the policy. When the employee dies, the policy pays out to the business and not to the family of the deceased.
Can any business buy key man insurance?
Any business of any size has the opportunity to purchase key man insurance. Key man insurance is routinely used by small partnerships because the death of a business owner could mean that the co-owners need to have sufficient funds to buy that person’s share of the organization.
However, large companies may also incur significant expenses, especially when a company loses an iconic figure. When your business is reliant upon any person’s unique talent, abilities, or reputation and you have concerns you could experience any financial loss upon his death, buying key man insurance is a smart choice.
Who should purchase key man insurance?
Key man insurance is owned by a company. Co-owners, a partnership or a corporation can purchase the insurance policy. It is common for a corporation or partnership to own multiple different key man policies on all of their top personnel.
Whose life is insured with key man insurance?
A company may buy an insurance policy on anyone whose death could cause the business to incur a financial loss. This could include an executive, a principal shareholder, a salesperson who is extremely effective at closing deals, a senior scientist, IT staff, or even a spokesperson. The person who is considered the “key man” is the one whose life is insured.
Why is key man life insurance especially important in a partnership?
While key man insurance is important for virtually any business, it can be especially important in partnerships and in small-closely held companies. When a partnership is formed, the co-owners should have a written buy-sell agreement in place specifying what happens to each partners’ share of the company upon death or disability.
The remaining partners should have the opportunity to buy the deceased or disabled partner’s ownership share. Without such a contract, the partner could give away or will his share to anyone he wants- which could mean that the remaining partners end up working with someone who they do not like.
When a clause gives the remaining partners the opportunity to buy the ownership interest of the deceased, they need to have money available to do so. Key man insurance can give the partnership enough funds to buy out relatives of the deceased partner or to buy out the disabled partner.
What are the benefits of key man insurance?
There are numerous benefits of key man life insurance for a company. The premiums are relatively cheap as well, and you can deduct them as an expense on your taxes.
Key man life insurance gives business owners peace of mind that an insurer will cover their most important assets: people.
Upon severe injury or death of an important person in the company, the life insurance money a business receives can be used for the following:
Securing Funding with Key Man Life Insurance
Key man life insurance can benefit your company even if you never have to make a claim.
Businesses who are searching for funding through investments and loans will be in a much better negotiating position if they have key man life insurance on their most important staff.
Investors and lenders want to be sure that their money is safe. The death or permanent disablement of a company leader can spell chaos, especially if there is no key man insurance policy in place.
The company can also use a key man life insurance policy as collateral for a loan. If an insured employee dies, the lender can recover the remaining balance through the insurance policy. The lender will be considered the primary beneficiary, whereas the company will be considered a secondary beneficiary. Therefore, if there are any benefits remaining after the lender has recovered their loan, the company will receive the remaining cash benefit.
Lastly, if the loan has been paid off before the unforeseen death/illness/injury of an insured employee, the lender will no longer be the primary beneficiary. In this case, the company will receive the full cash benefit.
Establishing Control of the Company
If one of the primary shareholders of a company dies, the shares often transfer to their spouse or child. They might have no knowledge or interest in running the business with the other partners, and decide to sell.
If you don’t have enough funds to buy back your partner’s shares, you could end up working with or being controlled by an unpredictable third party.
This element is part of the reason why investors like to know you have a plan in place in case the worst happens.
A key man policy will give you the funds to repurchase your company’s shares from your partner’s family. You won’t have to worry about negotiating against an outside party who might pay more.
Finding a Replacement
You’ll eventually have to replace the partner or employee you lost, and this can be extremely costly.
You’ll likely have to pay a recruiting firm to search for you. Once you negotiate salary and hire the right person, you still need to teach them how the business runs and allow them time to get settled.
The whole process can cost hundreds of thousands of dollars. When you combine this with the loss of revenue you experience when an executive dies, the price is enough to stop a growing business in its tracks.
Paying the Company’s Debts
As we briefly covered above, you can use a key man insurance plan as collateral on your loans. If a primary figure in the company dies, the policy will cover the loans and give you some additional money to keep your company stable.
You can also receive monthly payouts on one of these key man policies.
Doing so will supplement the bulk of the income you might lose while you’re searching for a replacement and trying to keep customers happy.
Keeping Employees Happy
Losing a leading figure in your company means instability. Your employees will notice this and might start looking for other jobs, so they don’t fall victim to potential layoffs.
Key man policies will give you enough funds to retain many of your crucial employees. You can instill confidence in them, in regards to their job security and the security of your business.
Clients are even warier when a leader of the company dies. There’s a substantial chance they’ll take their business elsewhere.
If one of your partners has personal relationships with a string of clients, it will take a while to earn their trust again. Key man insurance gives you enough funds to give your remaining clients gifts and other incentives to stick with you.
What types of losses can be covered with a key man policy?
When you buy a key man policy, you receive a lump sum death benefit upon the death or disability of the covered individual. You can use this money to offset any financial damage the death causes your organization. Money from the insurance payout can replace funds not earned due to lost profitability. The money can be used to recruit and train a replacement, to hire temporary help, to move forward with expansion efforts, or to do anything else the company believes is important to regaining momentum after the death of a key player.
How large should the policy be for key man life insurance?
The death benefit to be paid out upon the death of a “key man” should be sufficiently large enough to cover losses that occur as a result of the death. The specific amount of coverage that is required is going to vary based upon the value of the person being insured and the size of the company. Death benefits available for the purchase of a key man policy can range between $500,000 in coverage and $10 million in coverage.
How to buy key man insurance
If your organization wants to protect itself financially from the potential losses associated with the death of important executives, you should begin to shop for key man policies.
First, make a list of the different people at your organization whose lives you need to ensure. Determine what each individual’s death could cost your business in terms of lost revenue and new expenditures. Then, Purchase a policy for everyone you consider irreplaceable. That way, if the worst happens, your business will be able to stay afloat.
In many ways, shopping for key man insurance is very similar to regular life insurance.
Make sure the plan covers the significant injuries or deaths that could impact your business – the same way you would if you were buying life insurance for your family.
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