Every company in every industry has its key personnel, from the senior executives who make important business decisions to the vital administrative professionals who keep daily operations running smoothly.
To provide protection in the event that a key employee dies, businesses small and large purchase what is called “key person” life insurance.
A restaurant might insure its head chef; a construction company, its foreman. A corporation will often buy key person policies for every member of its management team.
Quick Article Guide
1. How Does Key Person Life Insurance Coverage Work?
2. Securing Key Person Life Insurance
3. Key Person Life Insurance Example
4. Key Person Life Insurance for Small Businesses
5. Applying for Key Person Life Insurance
6. Compare Key Person Life Insurance Rates
Key person policies differ from traditional life insurance policies in that a business entity is both the owner and beneficiary. The business purchases the policy, pays the premiums, and receives the death benefit if the insured dies.
A key person policy is designed to protect your business, not your family. 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
It’s important to purchase a key person policy for each employee who is critical to your short-term and long-term success.
Once you’ve identified the key people on your team, you’ll want to get an idea of how much coverage to purchase for each person before you speak with a life insurance agent. For a ballpark figure, first estimate how many years your business would likely suffer if a key person died unexpectedly. Then, 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.
A key person policy is modeled much like a buy-sell life insurance agreement. The employer is both the owner and beneficiary of the policy. In addition, the employer will be the payer of the premiums, controlling all aspects of the key person’s coverage. In some cases the business will receive tax benefits for setting up a key person policy. Since regulations vary by state, it’s best to check with your CPA or tax professional.
10-year level term life insurance is the most common type of key person insurance, as these policies are generally the least expensive on the market. If you’re insuring an owner or officer who you expect will stay with your company for more than 10 years, you may want to consider a 15 or 20 year policy so that you don’t have to repeat the process and pay higher premiums down the road. A level term policy can always be cancelled if the employee departs.
JRC typically recommends applying for the highest amount of coverage you are considering. Once the employee’s final approved rating and price options come in, you can finalize the death benefit and term. Most term life insurance policies can also be reduced once during the life of the policy. This can be helpful if your business’ finances and/or the employee’s responsibilities change.
To help you better understand key person life insurance, here’s a typical scenario:
Business partners Gina and Larry each own 50 percent of the family law practice they started in 2003. Having been in business for 13 years, they have built a large client and referral base. Each partner employs a secretary and a paralegal. The partners share a receptionist and an office clerk.
Gina and Larry’s CPA estimated that each partner generates roughly $500,000 per year for the business. If one of the partners were to die, the firm would likely lose many of its clients. Even if the other partner were to find an immediate replacement, the firm would suffer financially for at least three years.
To protect the law firm and its six employees, Gina and Larry each purchase a 20-year term life insurance policy with a $1.5 million death benefit (covering for three years of $500,000 in lost revenue if one partner dies). The two agree that after 20 years, they will both be well on their way to retirement.
Gina is 42 and in relatively good health. She is approved by a top insurer at “Preferred” rates (the second best rate class), with a monthly premium of $103.35. Larry is 38, with parents who lived well into their 90s in excellent health. He qualifies for the top rate class, “Preferred Best,” with a monthly premium of $92.66 per month. In all, the firm pays $196.01 per month to protect the business in case a partner dies.
For small business owners who have a personal life insurance policy, your knee-jerk reaction will be to dismiss this whole conversation. That would be a huge mistake, because a business protection policy is different from a personal policy.
Personal life insurance provides a death benefit to your family or heirs, not your fellow business partners or your business in general. So, you’ll want to secure business coverage in addition to your personal coverage.
Without key person life insurance, your hard work is at risk for collapse. If you die, or if a partner dies, life insurance becomes a life raft that can keep the business afloat through a difficult transition.
- To begin the application process, insurance companies will need basic information for each applicant. This information can be provided to a JRC life insurance agent either by the insured or by an authorized individual such as a personal assistant or HR staff member.
- Approximate annual compensation
- Percentage of ownership (if applicable)
- Date of birth
- Social security number
- Driver’s license
- Applicants do not need to show any ownership in the company, but if they are owners, it might be a good time to also purchase a buy-sell agreement, as you can use the same health screening for both policies.
- The life insurance underwriter will need your business name, type of entity (LLC, Sole-Proprietor, Partnership, or Corporation), and industry. In some cases, the insurance company will ask for tax documents or financial statements, typically for policies with death benefits exceeding $1 million.
- After this information is gathered, your JRC agent will contact each key person individually for a 5-10 minute health and family history phone interview. Your application will be processed in 24 hours, and we’ll help set up everyone’s free health screening. As an additional benefit, we’ll also provide copies of lab results and underwriter’s analyses, which can replace the need for an annual physical.
- Premiums are not due until policies are approved, which is usually 4-6 weeks following a free in-home/in-office 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. Paying annually saves 3-6 percent compared to monthly rates.
Unlike captive agents who can only sell through one insurance company, JRC Insurance Group works closely with dozens of insurers to 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. All it takes is a 15-minute conversation, and we can start sending you competitive quotes for key person life insurance.
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