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What is Key Person Insurance?

By Lori Murray, Manta Contributor - October 4, 2016

What is Key Person Insurance?

Insurance can protect your small business against the loss of an essential employee.

There’s a good chance someone in your company holds the keys to your organization’s success. That individual might be the owner, founder or a person with specialized skills, and he or she may be your most important asset. If that person was no longer around, the business would suffer—or collapse. Knowing that, it only makes sense to protect your business against any loss that might occur if that key person passes away.

That’s where key insurance comes in. It’s essentially a life insurance policy on a key employee, and here’s how it works:

  • A company purchases a life insurance policy on its key employee and pays the premiums. The company is the beneficiary of that policy.
  • If the key person passes away, cash from the death benefit covers the expense of hiring and training a replacement or any other expenses needed to keep the business up and running.
  • When the best option is to stop doing business, the cash makes it possible to pay off debts, pay severance to employees, and in some instances, pay investors.

Why Key Person Insurance is a Good Idea

In situations where a company’s success depends on the involvement of one or two employees, here’s how key person insurance can help:

  • Peace of mind: Creditors and shareholders will sleep better at night, knowing that the business will have the cash it needs to continue operating if the key person is no longer around. The same is true for your customers. They want to be assured that you’re in this for the long run—regardless of who’s running the company.
  • Cash in hand: The death benefit, which is generally received free of federal income tax, provides much-needed cash to keep the company running without that key person’s expertise.
  • Retirement option: If the key person does not pass away but instead reaches retirement, the company may decide to give him or her the cash surrender value of the policy.