A distribution company in Doral has two founders, forty employees and a line of credit at the bank. One founder runs operations. The other owns every important customer relationship and personally negotiated the company’s largest contracts. When he dies suddenly, the operations partner discovers that two major customers are reconsidering, the bank wants to review the credit line and recruiting someone who could replace those relationships will take a year and a salary the company cannot easily afford.
Every business has people it cannot easily replace. Key person life insurance gives the company cash to survive the loss of one of them.
What key person insurance is
Key person insurance is a life insurance policy the business owns on an owner or essential employee, with the business as beneficiary. When the insured dies, the company receives the proceeds and can use them however it needs: covering lost profits, recruiting and training a replacement, reassuring lenders and customers, or paying down debt. It protects the business itself rather than the insured’s family.
Who counts as a key person
The key person is anyone whose death would cause real financial harm to the company. That is often an owner, but it can also be a top salesperson, the engineer who holds the technical knowledge, the person with the licenses the business operates under or the face clients trust. In a small business, it is usually obvious who that is.
How much coverage
There is no single formula, but common approaches look at the person’s contribution to profits, the cost and time of replacing them, debts the business would need to repay and the amount lenders require. A bank or SBA lender may require key person coverage on the owner as a condition of a loan, with the lender assigned as collateral. Carriers will issue an amount that bears a reasonable relationship to the person’s value to the business, so the reasoning should be documented.
Structure and taxes
The business applies for and owns the policy, pays the premiums and is the beneficiary. The insured must consent in writing. Premiums are generally not deductible, and federal rules require specific notice and consent for employer-owned policies so the death benefit remains income tax free. These requirements are easy to meet at application and hard to fix later, so they should be handled with the company’s accountant from the start.
Term or permanent
Term coverage is the most common choice for key person needs, because the need usually lasts as long as the person works there or the loan is outstanding. Permanent coverage can make sense when the business wants the policy to build cash value it can later use, transfer to the insured at retirement or apply toward a buyout. Our article on funding a buy-sell agreement explains how a policy can serve both purposes.
Disability is a key person risk too
A key person who becomes disabled can hurt the business as much as one who dies, and for longer. Key person disability coverage and business overhead expense coverage address that risk. Our article on protecting your income covers disability coverage for owners.
Worth confirming on your policy
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That you have identified who the business could not easily replace
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That the coverage amount is supported by profits, replacement cost or debt
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That any lender requirement for key person coverage is met and assigned correctly
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That the business owns the policy and is the beneficiary
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That the insured’s written notice and consent were obtained before the policy was issued
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That disability of a key person has been considered as well as death
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That coverage is reviewed as the business and its people change
Talk to us
Prestige Insurance Group insures Florida businesses and offers life insurance for their owners and key people as part of the same program. Tell us who your business depends on and what a loss would cost, and we will help you size and structure the coverage with your accountant.
Call the office nearest you. Se habla español.
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Miami: 305-969-8776
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Orlando: 407-993-2331
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Stuart: 772-247-3788
This article is general information, not legal, tax or financial advice. Policy features, underwriting and pricing vary by carrier and change over time; review estate, tax and business planning with your attorney or accountant. Prestige Insurance Group, Florida agency license L057894.
