As a business owner, are you worried that your business relies heavily on a key person? If so, consider getting key person life insurance.
Key person insurance, also known as key man insurance, protects your business if a key person dies or becomes disabled. This is important if you're business depends on one or a few persons’ knowledge, personal network, or performance.
A key person life insurance policy is purchased by a business on a specific person. The business is responsible for making payments and is usually the beneficiary. If the insured passes away, the business is paid the death benefit, which it can use to cover the cost of replacing the key worker or any other expense.
What is a Key Person?
If your business would lose significant revenues due to the loss of a particular employee, that individual is likely a key person (or a "key man") for your business.
You can also identify whether an employee is a key person or not by considering the cost of finding a replacement. If your business would need to hire a headhunting company to find a replacement, the individual in question is likely a “key person.”
The key person (or key man) might be the Marketing Director, the CEO, the President or any other employee who is responsible for a large part of your company’s revenue or who cannot be easily replaced.
How Key Person Life Insurance works
Key person insurance works the same way as any other life insurance policy. The contract involves three key parties:
- the insured (the person whose life is covered by the insurance policy)
- the policy owner (the person or entity that pays the premiums and has the right to make changes to the insurance policy)
- the beneficiary (the person or entity that receives the death benefit).
With key man or key woman insurance, typically the business is the policy owner and the beneficiary. The premiums of this insurance are generally not tax deductible, but the death benefit is tax-free. The beneficiary is free to use the payout however they like.
Types of key person insurance
Three types of key person insurance are available. These are:
Key person life insurance
Life insurance provides a death benefit upon the person's death. When you shop for key person life insurance, you will have the following options:
- Term life key person insurance
Term life policies are cheaper than other types of life insurance plans. A term life key person insurance policy has a predefined expiration date, which can be as short as one year or as long as 35 years. Depending on your policy, you may be able to renew it until the insured reaches a certain age. If you do not renew the coverage, the insurance policy will lapse. The insurer pays the benefit to your business only if the insured passes away during the policy term.
- Whole life key person insurance
Whole life insurance provides lifelong protection, provided you have your premiums paid. In addition, it bundles as an investment tool. A part of each premium payment goes into an investment account, which grows tax-deferred at a fixed rate. The insurance policy owner can withdraw the money from this account at any time by taking out a policy loan.
Upon the insured’s death, the insurer typically pays the beneficiary (in the case of key person insurance is usually the business owner) only the death benefit amount. Any unspent cash value stays with the insurance company.
- Variable life key person insurance
Similar to whole life insurance, variable life insurance offers lifelong protection and accumulates cash value. Unlike whole life insurance, variable life insurance may allow you to change the premium and the death benefit amount over time. In addition, the cash value is tied to sub-accounts selected by you and grows at a variable rate. If the sub-accounts you choose perform well, you can receive handsome returns. However, your cash value can also get wiped out if the market underperforms.
Disability key person insurance
You can purchase a disability insurance policy on a key worker. For the disability insurance, life insurance companies will pay a monthly benefit if the insured is unable to work due to illness or injury.
Critical illness key person insurance
Key person critical illness insurance helps you protect your business against the financial loss it will likely suffer if the insured develops a critical illness. The insurance carrier will pay a lump sum if the insured is diagnosed with a covered health condition.
Benefits of Key Person Insurance
Key person insurance can help your business:
- offset lost income due to the death of a key employee
- cover the cost of finding and training a replacement
- buy out the shares of the deceased
- provide financial assistance to the deceased’s family.
Key Person Insurance Cost
How much you will pay for key person insurance depends on several things. These factors include:
- The type of coverage:
Life insurance policies are either term or permanent. Term life insurance is cheaper and lasts for a specific duration. Generally, you can buy a policy for a term of up to 35 years and renew the policy up to a predetermined age. Compared to permanent life insurance, term life insurance is 10 to 15 times more affordable.
Permanent life insurance does not have an expiry date. The coverage remains in force as long as you pay the premiums. Your policy also includes an investment component, called cash value. The cash value earns interest or capital gains and grows tax-deferred. You can tap into it whenever you want by withdrawing money from it or taking a business loans against it.
- The amount of coverage:
The greater the death benefit amount, the costlier the coverage, all other things being equal.
The younger the insured, the lower the premium. That is because the cost of insurance increases with age.
How much you pay for coverage also depends on the insured’s life expectancy. The longer the insured is expected to live, the lower the premium rate.
Most life insurance policies involve medical underwriting. As part of the application process, the insured provides information about their current health and medical history. They will likely undergo a medical examination similar to an annual physical. The insurance carrier will assign the insured a risk class based on their test results, which determines the premium rate.
- Smoking status:
People who smoke or use tobacco in any form have a lower life expectancy than those who do not smoke. As such, they receive higher life insurance rates. On average, smoking can increase the insurance cost by three to five times.
Key person insurance is designed for businesses that are dependent on the expertise of one or a few key people/employees. By taking out a life insurance policy on a key employee, a business can ensure that it does not lose its financial footing, should that key person pass away.
With key man insurance, the business is the policy owner and the beneficiary. Upon the insured’s death the business receives the proceeds of the policy, which it is free to spend as it deems fit.
Considering if key person insurance is right for you? Talk to a Dundas Life licensed insurance advisor today.
Key Person Insurance FAQs
What kind of employee would be a key person?
A key person is a key woman or a man who is an employee or a business partner whose skills and intellectual capital are so valuable that your business would suffer substantial financial losses due to that person's death or inability to work. This person has knowledge, skills or talent that few others can duplicate. The industry he or she works in, or the nature of the work, may be so specialized (such as research or design) that there are few others with the skills needed.
In addition, the unique skills held by a key person may not have been acquired through education or experience but through their own creativity, talents and interests.
Is key person insurance so important?
Key person insurance can provide your business with the working capital it needs to keep operating. You can use life insurance proceeds to fund the recruitment and training of a replacement should a key person pass away or become totally disabled. In this case, the insurance could compensate you for a key person's contribution (or your other business owners) for lost income should your business have to close.
How long does key person insurance cover you for?
This depends on the type of life insurance plan you choose for the policy. For example, term life insurance can provide coverage for 10 or 20 years at a time. However, a permanent life insurance plan like universal life insurance could provide protection for the entire lifetime of the insured person.
How long does key person disability insurance provide coverage?
The key person disability insurance plan offers coverage until:
- The insured person reaches the specified age stated in the contract; or
- The date the insured ends active full-time employment for any reason other than total disability; or
- The date the maximum benefit period has been met for any one period of total disability; or
- The date benefits become payable under the replacement expense benefit provision in order to receive disability insurance coverage.
What is the definition of “total disability”?
Under the key person disability insurance plan, "total disability" means that because of injury or sickness, the insured person is under the regular and personal care of a physician. They are unable to perform the important duties of his or her regular occupation.
Steven has a deep background in life insurance. At Dundas Life, he's helped 1000s of clients find the right insurance coverage while also training dozens of insurance advisors during his career. Previously at Finaeo, Steven oversaw compliance and coaching for over 350 independent insurance brokers. Steven is also rated the #1 Insurance Agent in Toronto on Rate-My-Agent.