What's a Key Employee?
A key employee is someone with major ownership and/or decision-making role in the business. Key employees are usually highly compensated either monetarily or with benefits, or both. Key employees may also receive special benefits as an incentive both to join the company and to stay with the company.
How a Key Employee Affects a Business
Key employees are considered to be a critical part of a company’s operations. Such an employee could be influential in securing capital for the business, which may occur through their connections or by virtue of their work.
For example, the employee may hold a role tied directly to sales channels for the company, intertwining their performance and business activities with the cash flow. The employee might be the top-performing salesperson at the company, driving a significant portion of the regular revenue. The employee, for a variety of reasons, may represent a public face associated with the company’s brand and is thus seen as crucial to maintaining the investment and support of shareholders and customers.
Key person insurance offers a financial cushion if the sudden loss of a certain individual would profoundly negatively affect the company's operations. The death benefit essentially buys the company time to find a new person or to implement other strategies to save (or shut down) the business.
In a small business, the key person is usually the owner, the founders, or perhaps a key employee or two. The main qualifying point is whether the person's absence would cause major financial harm to the company. If this is the case, key person insurance is definitely worth considering.
Key Person Insurance Process
For key person insurance, a company purchases a life insurance policy on certain employee(s), pays the premiums, and is the beneficiary of the policy. In the event of the person's death, the company receives the policy's death benefit.
That money can be used to cover the costs of recruiting, hiring, and training a replacement for the deceased person. If the company doesn't believe it can continue operations, it can use the money to pay off debts, distribute money to investors, provide severance benefits to employees, and close the business down in an orderly manner. Key person insurance gives the company some options other than immediate bankruptcy.
To determine whether a business needs this kind of coverage, company leaders must consider who is irreplaceable in the short term. In many small businesses, it's the owner who does most things, such as keeping the books, managing employees, handling key customers, etc. Without this person, the business can come to a stop.
Cost of Key Person Insurance
How much insurance a company needs will depend on the size and nature of the business and the key person's role.
The cost will also depend on whether the company buys a term life policy or a permanent life policy. Term life is almost always significantly cheaper.
In addition, the cost of the coverage will vary according to the insured person's age and overall health, just like most other types of life insurance.