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Key Person Life Insurance: Is Your Business Protected?

In a survey by the National Association of Insurance Commissioners (NAIC), 71 percent of small business owners indicated they were “very dependent” on one or two key staff. Meanwhile, only 22 percent of respondents reported having a key person life insurance policy in place.

If one of your most trusted employees or partners died unexpectedly, how quickly would your business be able to recover from having lost their skills and experience?

In this type of situation, key person life insurance can help you ease the shorthanded period and allow you to patiently put forth the time and resources needed to find, hire, and train a replacement.

Quick Article Guide

1. How Key Person Life Insurance Works
2. How Much Key Person Coverage to Buy
3. Advantages of Key Person Life Insurance
4. Common Uses for Key Person Life Insurance
5. Applying for Key Person Life Insurance
6. Get Key Person Life Insurance Quotes

How Key Person Life Insurance Works

When a business purchases a key person policy, the business is both the owner of the policy and the beneficiary. They pay the monthly premiums and collect the death benefit if the insured dies.

One of the most important things to understand is that key person life insurance is not a replacement for your personal life insurance. A key person policy is designed to protect your business, not your family.

A business can and should purchase a key person policy for each employee considered critical to the organization’s success.

In small businesses, the owner or founder should almost always have a key person policy on themselves so that the business has a lifeline to sustain if they die. In bigger companies, executives are usually shoo-ins for key person policies. Also consider that long-tenured administrative professionals, top salespeople, and promising new hires are all “key” in their own right.

How Much Key Person Coverage to Buy

After identifying your key people, you can start to run preliminary estimates of how much coverage you should buy for each person using this formula:

  • Estimate how many years your business would likely suffer if a key person died unexpectedly.
  • Multiply the number of years by the key person’s annual compensation (salary, commissions, benefits, and bonuses).
  • Life insurance companies will typically allow you to insure up to 10 or 15 times a key person’s total compensation. For most businesses, 5-10 years of the key person’s compensation will be sufficient and affordable. If their compensation fluctuates, calculate an average from the past three years.

Advantages of Key Person Life Insurance

Key person life insurance is great for businesses of all sizes in all industries. The benefits of key person life insurance are:

  • Full control over which employees you purchase policies for
  • Affordable rates (10-year level term life insurance, generally the least expensive of the market, is usually sufficient for a key person policy)
  • Easy application process
  • Tax-free distribution if the insured dies
  • Most importantly, peace of mind

The death benefit from a key person policy is typically used to cover:

  • The business income loss caused by the sudden death of an employee with specialized skills
  • The time and resources needed to interview potential replacements
  • The time and resources needed to hire and train the chosen replacement

Common Uses for Key Person Life Insurance

Key person life insurance can be used in a variety of ways, including:

Recruiting, Hiring, and Training

If a key employee passes away, the proceeds from their life insurance can be used to mitigate the costs of recruiting and training a new employee to handle their responsibilities.

Debt Payments

The life insurance payout from a key person insurance policy can be used to pay any outstanding debts, bills, loans, or unforeseen expenses. There are no restrictions on how this money can be utilized, making it extremely advantageous for a business that is in the process of transferring ownership to future successors or a family member(s).

Loss of Revenue

When a key person dies, existing clients who worked closely with them might be reluctant to do further business, or they might find a new provider altogether. The death benefit from key person insurance can replace lost revenues until the key person is replaced.

In cases where a business actually closes its doors due to a key loss, the insurance policy can pay employee severances, investors, or outstanding debts. For this reason, businesses with key person insurance are more attractive to potential investors.

Loan Leverage

Key person policies are considered assets by lenders, which means they help improve the overall credit worthiness of a business. A business with key person life insurance will usually have an easier time getting approved for a commercial loan (assuming they meet all of the standard requirements).

Stock

After a key person dies, the life insurance death benefit can also be used to buy any stock in the company that they had previously held.

Income Replacement

Key person life insurance policy can provide the deceased owner’s spouse or dependents a form of salary, allowing them to maintain the same lifestyle they had before their loved one died.

Compensation Plans

The life insurance payout from a key person policy provides an influx of cash that can be used to fund compensation plans for a company’s executives.

Applying for Key Person Life Insurance

To begin the application process, insurance companies will need some basic information for each applicant from an authorized individual, such as a personal assistant or HR representative.

  • Approximate annual compensation
  • Tile
  • Percentage of ownership (if applicable)
  • Date of birth
  • Social security number
  • Driver’s license

Then you will be asked to provide:

  • Business name
  • Type of entity
  • Industry
  • In some cases, the insurance company will ask for tax documents or financial statements, typically for policies with death benefits exceeding $1 million.

Each key person will complete a 5-10-minute health and family history phone interview, followed by a free health screening. This may be a good time to also consider purchasing a buy-sell agreement, as the same health screening can be used for both policies. Learn more about using life insurance for a buy-sell agreement here.

Premiums are not due until policies are approved, which is usually 4-6 weeks after the health screening. The death benefit can be reduced, and/or term length finalized when the application is approved and final risk ratings are assigned. Your payments may be automatically deducted from your business checking each month, quarter, six months, or year. Note that you can pay 3-6 percent less than monthly rates by paying annually.

Get Key Person Life Insurance Quotes

JRC Insurance Group has helped countless businesses get the protection they need with key personal life insurance. As independent agents, our advantage is in our longstanding relationships with dozens of insurers.

While captive agents at big-box insurance companies are only able to sell policies from their employer, we’re able to shop multiple carriers and find the best coverage at the best rates.

Our agents can also combine the business life insurance process with your personal life insurance needs, making JRC a one-stop shop. Speak with a JRC owner-agent today at 855-247-9555 or get a free quote online here. All it takes is a 15-minute conversation, and we can start sending you competitive quotes for key person life insurance.



This post first appeared on JRC Insurance Group: Term Life Insurance Quotes, please read the originial post: here

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Key Person Life Insurance: Is Your Business Protected?

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