Key Man 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 man life insurance policy in place.
If one of your most trusted employees or partners died unexpectedly, how quickly would your business recover from the loss of their skills, contacts, and experience?
In this type of situation, key man 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. Keep reading to learn more about key man life insurance.
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When a business purchases a key man 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 man life insurance is not a replacement for your personal life insurance. A key man policy is designed to protect your business, not your family.
A business can and should purchase a key man policy for each employee considered critical to the organization’s success.
In small businesses, the owner or founder should almost always have a key man policy on themselves so the business has a lifeline to sustain if they die. In bigger companies, executives are usually shoo-ins for key man policies.
Also consider that long-tenured administrative professionals, top salespeople, and promising new hires are all “key” in their own right. Read this JRC article if you are a small business owner and want to learn more about SBA loans.
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 man died unexpectedly.
- Multiply the number of years by the key man’s annual compensation (salary, commissions, benefits, and bonuses).
- Life insurance companies will typically allow you to insure up to 5 or 10 times a key man’s total compensation. For most businesses, 5-10 years of the key man’s compensation will be sufficient and affordable. If their compensation fluctuates, calculate an average from the past three years.
Key man life insurance is great for businesses of all sizes in all industries. The benefits of key man 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 man policy)
- Easy application process
- Tax-free distribution if the insured dies
- Most importantly, peace of mind
- 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
Key man 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 man 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 man 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 man insurance can replace lost revenues until the key man 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 man insurance are more attractive to potential investors.Loan Leverage Key man policies are considered assets by lenders, which means they help improve the overall credit worthiness of a business. A business with key man 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 man 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 man 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 man policy provides an influx of cash that can be used to fund compensation plans for a company’s executives.
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
- Percentage of ownership (if applicable)
- Date of birth
- Social security number
- Driver’s license
- Business name
- Type of entity
- In some cases, the insurance company will ask for tax documents or financial statements, typically for policies with death benefits exceeding $1 million.
No money is 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 account each month, quarter, six months, or yearly. Note that you can pay 3-6 percent less than monthly rates by paying annually.
Earlier this year we helped two Country Club restaurant owners, Judy and Susan, with their key man life insurance policies. Judy has an extensive background in restaurant management and runs the day to day operations of the restaurant and bar. Her duties include working with the Chef and head bartender to coordinate the food and beverage menus as well as managing the staff and their schedules.
Susan grew up in the area and has extensive ties to the community. Susan is responsible for finding new members, coordinating events for existing members, and overseeing the finances. If something happened to either owner, the business would suffer a financial loss.
Judy knows her way around the restaurant, but she would have to hire a book keeper and a membership coordinator if something happened to Susan. If something happened to Judy, Susan would need to hire a new restaurant manager to ensure that the restaurant continues to run seamlessly.
Judy and Susan also have a loan that they are paying off for the business, the remaining balance on the loan when we spoke was about $1,100,000. They hope to have the loan paid off in 10 years at which time they will likely sell the business and retire. Judy and Susan pay themselves a wage of $8,000 a month and the remaining profits are saved or used to pay off the loan balance.Judy and Susan felt that if either one of them passed away, they would need at least $8,000 per month to pay an employee or employees to handle the other owner’s previous responsibilities. In addition, the business may suffer financially during the process of training the new employee and they want to continue to pay down the loan.
Judy and Susan decided to purchase $1,000,000 of life insurance coverage on each-other to cover the cost of finding, hiring, and training a new employee. Whatever money is remaining would be used to pay down as much of the loan balance as possible.
Judy is 56 and in excellent health, Susan is 48 and she is also in good health. Judy was approved at a “preferred plus” rate class for the policy, and the rates are $103.00 per month. Susan was approved at a “preferred” rate and her policy is $69.00 per month. After 10 years, they will no longer need the life insurance because their loan should be paid off and they will most likely sell the business.
JRC Insurance Group has helped many businesses get the protection they need with key manal life insurance. As independent agents, our advantage is in our longstanding relationships with dozens of top-rated 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 request a free quote online here. All it takes is a 5 - 10 minute conversation, and we can send you competitive quotes for key man life insurance.
Managing Partner and Co-founder
Cliff is a licensed life insurance agent and one of the owners of JRC Insurance Group. He has helped thousands of families of businesses with their life insurance needs since 2012 and specializes with applicants who are less than perfect health. In his spare time he enjoys spending time with family, traveling, and the great outdoors.