Many business firms have been built by one person whose capabilities, knowledge, experience, and skills make him/her a valuable asset of the company and become critical to its overall success. However, the untimely death of that employee can result to a disastrous effect on a business.
Why Key Person Life Insurance is Important
A key employee insurance is vital to the survival of a company. A key employee, or key person or key man, insurance covers a business firm for the loss of earnings brought about by the death of a key person. As such, key man life insurance is not a specific type of life insurance policy; rather, it is an effective way for a business entity to use life insurance. Most lenders and investors generally require that a business have key person life insurance to protect their loans and investments in the company.
The business typically owns the key man life policy, pays the premiums, and is the beneficiary. Most businesses purchase key man life as a permanent life insurance policy; however, term life insurance may be less expensive and can be bought to cover the person until he or she retires.
What Key Man Life Insurance Provides
There are serious financial consequences when a person dies, which a key man life insurance can cover. Through key man life insurance, the business receives needed funds that can be used for financial obligations and employee replacement. Some key man life insurance plans offer a replacement benefit which will reimburse the company for some percentage of the replacement costs, up to certain limits, for the first 12 to 24 months after the person’s death.
Sometimes the key man insurance will be convertible to individual coverage if the business has no further need for the coverage, the insured needs additional individual coverage and the insured meets certain income and, possibly, physical requirements.
There are two primary methods of employee valuation to determine how much life insurance is needed.
- Estimating the cost of finding, hiring, and training a replacement including employment agency fees, moving expenses, and the owner’s time spent interviewing and training the replacing person.
- Determining the dollar amount of profit brought to the business each year by the employee and the number of years it would take for a replacement employee to perform at the same level of competence.