Key person insurance

Key person insurance is a life insurance policy on an owner or other critical member of a business. The business is the beneficiary and pays the premiums.

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Andrew HurstSenior Editor & Licensed Insurance ExpertAndrew Hurst is a former senior editor at Policygenius who has spent his entire career writing about life, disability, home, auto, and health insurance. His work has been featured in The New York Times, The Wall Street Journal, the Washington Post, Forbes, USA Today, NPR, Mic, Insurance Business Magazine, and Property Casualty 360.

Edited by

Antonio Ruiz-CamachoAntonio Ruiz-CamachoAssociate Content DirectorAntonio is a former associate content director who helped lead our life insurance and annuities editorial team at Policygenius. Previously, he was a senior director of content at Bankrate and CreditCards.com, as well as a principal writer covering personal finance at CNET.
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Reviewed by

Maria FilindrasMaria FilindrasFinancial AdvisorMaria Filindras is a financial advisor, a licensed Life & Health insurance agent in California, and a member of the Financial Review Council at Policygenius.

Updated|3 min read

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There are employees at every business who are essential to the company’s operations and financial success. Key person insurance (also known as key employee or key man insurance) is a life insurance policy that financially supports a business if an essential employee — like an owner, partner, CEO, or other major executive — passes away.

Life insurance terms you should know
  • Beneficiaries: The people you name on your life insurance policy to receive the lump sum of money — also known as the death benefit — when you die.

  • Cash value: The portion of a permanent life insurance policy’s monetary value that grows tax-deferred over the life of the policy.

  • Death benefit: The amount of money the life insurance company will pay your beneficiaries when you die.

  • Face amount: The dollar amount, or death benefit, your beneficiaries receive if you die while your life insurance policy is active.

  • Insured: The person who is covered by the insurance policy.

  • Policy: The legal document that includes the terms and conditions of your life insurance contract.

  • Policyholder: The person who owns an insurance policy. Usually, this is the same person as the insured.

  • Permanent life insurance: A type of life insurance that lasts for the rest of your life and usually includes a cash value account.

  • Premium: The amount you pay your insurance company to keep your coverage active. Premiums are typically paid monthly or annually.

  • Riders: Add-ons to a life insurance policy that provide more robust coverage, sometimes for an extra cost.

  • Term life insurance: A life insurance policy that lasts for a set number of years before it expires. If you die before the term is up, your beneficiaries receive a death benefit.

  • Underwriting: The process where an insurance company evaluates the risk of insuring you and determines your final rate.

What is key person life insurance?

Key person insurance pays a death benefit to your business if a crucial employee dies. The business owns the policy, pays the premiums, and is the beneficiary of the payout. Businesses can’t take out a key person policy on an employee without their knowledge and consent (known as dead peasant insurance). 

The payout can be used to:

  • Absorb losses in revenue after the death

  • Buy out the deceased’s share in the business

  • Cover outstanding business loans 

  • Pay for recruiting and hiring a replacement 

  • Provide severance if the business has to shut down

You can use term life insurance or permanent life insurance in a key person agreement. If you or your family will get some of the benefits of the policy, it’s known as a split-dollar life insurance agreement.

Key person insurance is also transferable if the business shuts down. Usually the insured person can either transfer their policy to their next employer or convert it into a private policy.

A key person policy protects your business and rarely benefits your loved ones. If you have key person insurance, you still need your own personal life insurance policy if you have dependents.

Who needs key person insurance?

Businesses of all sizes can benefit from key person life insurance. Consider protecting any employee whose death would cause a significant financial or operational loss. For most businesses, that’s a CEO, CFO, owner, or partner.

“There’s no excuse for most businesses, especially small businesses, not to have a life insurance policy such as key person insurance,” says Warren Robbins, senior sales associate at Policygenius. “Businesses often skip this step in risk evaluations for business planning, but if you don’t have life insurance for your top employees, you are not mitigating a potentially devastating risk.”

How to buy key person insurance

The process for buying key person coverage is generally the same as buying individual life insurance. The big difference is that in addition to underwriting the insured employee, your business also goes through underwriting.

Learn more about the life insurance underwriting process

Financial underwriting for key person insurance

When buying key person coverage for an employee, insurers evaluate your startup’s overall financial situation and the business value of the key employee you’re insuring. They may ask for:

  • Annual sales figures

  • Estimated cost to replace key employee

  • Fair market value of the company

  • Gross compensation of key employee

  • Net profit of the business

  • Tax statements

This information, plus the health of the employee and amount of coverage you need, will impact how much the policy costs.

We recommend combining key person life insurance with a buy-sell agreement. If a key person (like a partner) dies, the payout from a key person policy gives the surviving executives enough cash to buy out the deceased partner’s shares.

Learn more about how to buy life insurance

How much key person coverage do businesses need?

Experts recommend key person coverage of between five to 10 times the employee’s gross compensation. Gross compensation includes: 

  • Salary

  • Bonuses

  • Equity/stock

  • Business expenses

  • Transportation services

For example, a CEO might have a gross salary of $250,000. But if they also own $80,000 in restricted stock, earn $20,000 in annual bonuses, and have a $10,000 yearly stipend for meals, their gross compensation is $360,000. The business would need between $1.8 million and $3.6 million in key person life insurance for the CEO.

For key person life insurance, like individual life insurance, the advantages of having a policy outweigh the disadvantages. “When shopping for life insurance, many businesses, like many families, say, ‘we’ll do it later,’” says Robbins. “But life insurance is just as vital to a business as it is to a family.”

A Policygenius agent can help you choose the best policy to cover your key employees and protect your business.

Author

Andrew Hurst is a former senior editor at Policygenius who has spent his entire career writing about life, disability, home, auto, and health insurance. His work has been featured in The New York Times, The Wall Street Journal, the Washington Post, Forbes, USA Today, NPR, Mic, Insurance Business Magazine, and Property Casualty 360.

Editor

Antonio is a former associate content director who helped lead our life insurance and annuities editorial team at Policygenius. Previously, he was a senior director of content at Bankrate and CreditCards.com, as well as a principal writer covering personal finance at CNET.

Expert reviewer

Maria Filindras is a financial advisor, a licensed Life & Health insurance agent in California, and a member of the Financial Review Council at Policygenius.

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