Key Person Life Insurance: Important For Small Business Owners

A “Key Person” is someone who is vital to the survival of a business. A Key Person can be the CEO, the systems engineer, or the research scientist with all the secret proprietary business information stuck in his or her head.

As the owner of Financial Samurai, who also writes 99% of all the content and records 100% of all the podcasts, I am certainly a Key Person for my online media business.

Given I'm also a father of two children with a stay-at-home spouse, I have a $1 million term life insurance policy to take care of my family just in case I die. But I've been thinking about getting more life insurance since my term policy runs out at the end of 2023 because I am a “key person” in Financial Samurai.

What Is Key Person Insurance?

Key Person Insurance is a life insurance policy that a company purchases on a key executive's life. The company is the beneficiary of the plan and pays the insurance policy premiums.

This type of life insurance is also known as “key man insurance,” “key woman insurance” or “business life insurance.” But for simplicity's sake, we'll call it key person life insurance.

Key person life insurance is important because every business has value. Not only does a business generate revenue and hopefully operating profits, a business can be sold down the line based on a multiple of any number of income streams. If a key personnel dies, the business's value could take a tremendous hit.

Again, I think about my own situation and what were to happen if I died. Financial Samurai is worth a significant part of my family's net worth now. I get offers to buy the site from multiple parties every year given it is a cash cow in a low interest rate environment where many businesses have been forced shut due to lockdowns.

I know it will still continue to generate revenue given there are over 2,000+ articles over its 10 years of operation. But these articles need updating. My business is a key part of my passive income portfolio that provides for my family.

However, I want a key person life insurance policy to make up for any valuation loss as the company finds a new person or people to write and record all the content.

When a new team is in place, my wife can then decide to keep operating the business until our children grow old enough to operate the company, or sell the company.

Important Points About Key Person Life Insurance

  • Key Person Insurance is a life insurance policy a corporation buys on the life of its top executives. 
  • Such insurance is needed if that executive's death or inability to work would be devastating to the future of the company.
  • For small businesses, the key person might be the owner or founder, and in some cases, the only person capable of running the business, such as the main technology person.
  • The company pays for the insurance, pays the premiums and is the policy beneficiary, should the person die or become incapacitated.

Digging Deeper Into Key Person Life Insurance

Before getting key person life insurance, you have to analyze your business and recognize whether it is large enough and successful enough to warrant key person life insurance.

For example, if your business is still losing lots of money or barely making any money after five years, having key person life insurance is probably not necessary.

If your company has a fantastic team in place, who can all do each other's jobs, perhaps having key person life insurance is not necessary either.

For example, lets say the CEO of Apple dies. That would be a blow, however, Apple has over 120,000 employees and a very deep executive bench. One person can't make a huge difference. However, Apple is also so rich that they could easily afford to take many key life insurance policies for all their top executives.

Key person insurance is needed if the sudden loss of a key executive would have a large negative effect on the company's operations. The ideal company is a smaller company that is profitable and dependent on a key executive to execute the vision, the operation, the sales, and/or the technology.

The payout provided from the death of the executive buys the company time to find a new person or a new team to take over what was lost. The payout also buys time for the company to implement new business strategies to maintain and grow the business.

In a small business, the key person is usually one of the owners, co-founders, or several key employees. In my business, the key person would be me, then my wife. If I go, the content protection on Financial Samurai suffers, and content is my main product. If my wife goes, the backend finances and operations suffer, given that's her main responsibility.

The main qualifying point would be if the person's absence would significantly hurt the company. If the answer is yes, key person insurance is definitely worth considering.

Key Person Insurance Process

For key person life insurance policies, a company purchases a life insurance policy on its key employees. The company then pays the premiums and becomes the beneficiary of the policy.

In the event of the key person's death, the company receives the insurance payoff. These funds can be used for expenses for pretty much anything the company deems necessary. These expenses can include:

  • Paying a headhunter to find a replacement person
  • Paying off corporate debt
  • Creating a more automated system to protect the business from future catastrophes
  • Client entertainment expenses to make sure clients are retained
  • Distributing money to investors in the form of dividends
  • Paying severance to employees (I wrote a severance negotiation strategy book if you're interested)
  • Costs to wind down the business in the form of lawyer fees if it gets too bad and the key person is not replaceable

To determine whether a business needs key person life insurance coverage, company bosses should hold a meeting and go through an honest assessment of which personnel loss will do the biggest damage.

The company should then come up with a list and make a decision. During this time, these employees should probably be considered for a raise or a promotion, if one hasn't been given in a while.

Main important roles:

  • Production
  • Sales
  • Bookkeeping
  • Technology
  • Research & Development

The amount of key person life insurance depends on the size of your business, the cost of the policy, and the time it takes to replace the person, if possible.

Companies can get key person life insurance quotes ranging from $100,000, $250,000, $500,000, $750,000 and $1 million policies. Just note that the higher the policy amounts, the higher the chance for a medical exam as well. Medical exam requires bloodwork.

There are other life insurance options to choose from if a business person is looking to insure his or her life and help protect loved ones. It behooves all of you to learn what they are.

Key Life Insurance Coverage Categories

Key life insurance can be used to cover the following categories:

1) Losses related to a key person who is unable to work, but who has not yet died. For example, the person could be in a medically-induced coma for months from a car accident.

2) Overall business income profits from lost sales, losing clients, delays in collecting accounts receivables, and cancellation of future business partnerships due to the loss of the key person.

3) Protecting shareholders and partnerships from losses. For example, you might sell a portion of your business to an investor who earns dividends.

4) Protecting any financial institution from loss after guaranteeing a loan. The value of insurance coverage is arranged to equal the value of the guarantee. In this case, perhaps the banking institution might also be the one to underwrite the Key Person Life Insurance policy.

Key Person Life Insurance Is Worth Considering

Being a business owner has full of ups and downs. You want to protect your business as much as possible given it generates revenue and has a value that can be monetized if sold.

If you are a small business with key personnel, including yourself, I highly recommend getting Key Life Insurance. The cost is a business deduction and you will sleep better knowing that one of your most important assets, if not most important asset is better protected.

The most efficient way to get competitive life insurance quotes is to check online with PolicyGenius, the #1 life insurance marketplace where qualified lenders compete for your business.

It's much easier to apply on PolicyGenius for free than go to each carrier one-by-one to get a quote. I've know the founders for years and they have truly build a fantastic resource for individuals and small business owners.