Understanding Key Person Insurance: Meaning, Expenses, Varieties, and Operations

Key person insurance, also known as key man insurance, is a type of life insurance purchased by a business to protect itself from the financial impact of the death or disability of a key individual within the organization. The key person is typically an employee whose skills, knowledge, experience, or relationships are crucial to the company's operations and financial success. Here is a breakdown of key person insurance, including its meaning, expenses, varieties, and how it operates:

1. Meaning of Key Person Insurance:

• Key person insurance is a policy where the business is the policyholder and beneficiary, and it pays the premiums. It is designed to provide financial protection to the business in the event of the death or disability of a key employee, allowing the company to recover from the loss and address financial challenges that may arise.

2. Expenses of Key Person Insurance:

• The cost of key person insurance varies depending on several factors, including the key person's age, health, the amount of coverage needed, and the type of policy (term or permanent life insurance). Premiums are typically paid by the business and are not tax-deductible. The business must report the insurance as income if it receives a payout, while the payout itself is generally tax-free.

3. Varieties of Key Person Insurance:

• Term Key Person Insurance: This type provides coverage for a specified term, such as 10, 20, or 30 years. It is generally more affordable than permanent life insurance and is suitable for situations where the key person's value to the company is expected to decline over time.

• Permanent Key Person Insurance: Permanent life insurance, such as whole life or universal life, provides coverage for the lifetime of the key person. It also accumulates a cash value component that can be accessed by the business. This type is more expensive but offers long-term protection and potential savings growth.

4. Operations of Key Person Insurance:

• Identification of Key Person: The business identifies key employees whose loss could have a significant financial impact. These individuals are typically executives, founders, key salespeople, or employees with specialized skills or industry knowledge.

• Application and Underwriting: The business applies for the policy and goes through an underwriting process. This process may include a medical examination and a review of the key person's health and financial background.

• Ownership and Beneficiary: The business is the owner and beneficiary of the policy. If the key person dies or becomes disabled, the business receives the death benefit, which can be used to cover various expenses, such as finding and training a replacement, paying off debts, compensating for lost revenue, and stabilizing operations.

• Payout: If the key person dies or becomes disabled, the business can make a claim to the insurance company and receive the death or disability benefit. The funds can then be used at the discretion of the business to address the financial consequences of the loss.

• Riders: Some key person insurance policies may offer additional riders, such as a critical illness rider, which pays a benefit if the key person is diagnosed with a severe illness, or a disability income rider, which provides periodic payments in case of disability.

Key person insurance plays a critical role in safeguarding a business's financial stability by providing a financial safety net in the event of the loss of a key employee. It is a valuable risk management tool that can help businesses continue their operations and navigate the challenges that arise when a key person is no longer able to contribute to the company.