What Is Key Person Life Insurance?

Small business owners and executives juggle many responsibilities on a daily basis. Some entrepreneurs may excel at marketing, while others may have operational wisdom — the ability to keep overhead expenses in check while coddling the bottom line. Suffice it to say that prematurely losing such an important member of the team can spell disaster to a small organization, but plans can be made to deal with such a loss. This is where key person life insurance¹ comes in.

key person life insurance is essentially life insurance that a company purchases to ease the financial strain felt after the death of an owner, partner, or top performer. In contrast to personal life insurance, which typically names a spouse, child, or other family member as beneficiary, death benefits of key person insurance fall to the organization itself. Those funds can be used to help continue business as usual or on the other hand, ensure a softer landing if the business is sold or shuttered.

Who Does Key Person Life Insurance Apply to?

There's no hard and fast rule on who should be insured in a key person arrangement. But, in the small business world², it's not too difficult to figure out who ranks as the major contributors to an organization's success. That analysis starts at the top. In a partnership, two or more owners often blend different skill sets, and suddenly removing any component of that chemistry could cripple sales and profits. In a sole proprietorship, surviving decision-makers might not be able to sustain operations if the owner passes away.

key person life insurance does not exclusively extend to ownership and executive levels. A company might employ an invaluable business development specialist who generates a huge chunk of revenue through a wide network of contacts and customers. Thus, that employee, based on their economic standing, is also viewed as a crucial team member whose contributions and contact base would be extremely difficult and costly to replace.

How Does Key Person Life Insurance Protect a Business?

In any life insurance contract, the person or entity purchasing the policy must have an insurable interest in the named insured on the policy. In other words, the policy owner or beneficiary would suffer a substantial financial hardship should that insured individual die unexpectedly. So, like a family who loses a wage-earner, businesses can likewise have trouble maintaining fiscal health under the most dire circumstances. The forsaken skills, knowledge, and expertise resulting from the death of a key person often equate to less revenue and diminished viability.

As with other business insurance strategies that safeguard assets, company- or corporate-owned life insurance exchanges a premium for a death benefit in the event that a key team member dies. It may be difficult to put a number on the worth of an owner or executive to a business. However, as a very general guideline, it's wise to set a budget and acquire the highest face amounts possible while that owner or top contributor qualifies for such coverage. Business life insurance does not differ from personal life insurance in that the insured individual must meet certain age and/or medical criteria before a policy gets issued, especially at higher death benefits that exceed $1 million.

Once the policy takes effect, should that key person suffer an untimely demise, proceeds from the life insurance plan can be used for a few different purposes. Principals or other stakeholders left behind may decide to use the money to plug revenue gaps until a suitable replacement can be recruited and hired. A family may decide on a succession plan and use those dollars to fund operations until a spouse, daughter, or son can capably fill the shoes of the deceased. On the far side of the spectrum, those in charge might decide to sell the company, using the assets to pay down existing debt or market the liquidation.

What Businesses Benefit Most from Key Person Life Insurance?

Large corporations usually have the financial wherewithal and contingency plans to deal with the departures of even their most iconic leaders. Unfortunately, at the small business level, that scenario is rare. As such, key person life insurance is utilized more by sole proprietorships, partnerships, and small limited liability companies. It's mostly these entities that could not survive the death of a founder or owner whose vision and determination have carried the business through both profitable periods and lean years. Consequently, a look at key person life insurance makes sense for any company in the small business segment that produces nearly half³ of the nation's economic output.

Thinking of the worst circumstances in a family or small business can be unsettling, but failing to prepare for an unexpected death can be devastating. While key person life insurance benefits could never replace the lifeblood of your company, those funds could help further the wishes of its visionaries or help create new chapters for those left in the wake of tragedy. AIG Direct can help with either of those objectives as you carve out long-range goals for your business. Contact AIG Direct today to learn more about which life insurance is right for you.