Your company’s most valuable asset isn’t a material asset, but rather your employees. Every employee is important, even those with less experience and skills.
That said, some employees — like executives and employees with niche technical knowledge — have an outsized impact on your organization. If anything happens to one of these key employees, it might take a long time to replace them. Your company might have trouble operating without them.
That’s where key person insurance comes in. This underrated benefit helps you keep your organization going if something happens to a key employee.
The Who, What and Why of Key Person Insurance
Key person insurance, also known as key man insurance, is a type of life insurance policy. It protects a business from disruption if something happens to a critical employee. If a key employee, whether an owner, executive, or other employee passes away, the company can use the key person insurance to recoup the loss of that person’s contribution to the business.
Key person insurance is important because it helps:
- Provide funds for hiring a replacement. Replacing an essential employee is not easy or cheap. Some employees have unique abilities, which makes them difficult to replace. Key person insurance helps cover the cost of the rehiring process.
- Pay off business debts. Key person insurance proceeds can help pay off business debts if the company has to close, such as a loan taken out for the business, or the mortgage for the company’s facilities. For example, if a business owner were to die, this type of insurance can help the heirs close out the company without having to take on the business debts.
- Provide emergency funds in case of the business closing. Sometimes when a key employee passes away or leaves, the business cannot survive. However, closing a business can be a costly, complicated, and long process. Key person insurance can help the company give money back to investors and pay severance to employees.
- Offset any short or long term business losses to keep the business afloat. When a key employee is responsible for a significant amount of business revenue, a sudden death can immediately result in less income and cash flow. The proceeds of key person insurance can help fill the financial gaps and bring some stability to the business.
In other words, key person insurance can be a form of financial protection for a company. If losing a key employee would have a major impact on a company’s profit, this type of insurance can help prevent financial disaster.
Who Needs Key Person Insurance?
Key person insurance is most effective when it covers the company’s most indispensable employees. These employees often include the owner of the company, employees in highly specialized roles, and people who bring in a large profit. Losing these employees would resonate and affect the entire organization.
The Specifics of Key Person Insurance
Similar to personal life insurance policies, there are different types of key person insurance you can buy. Most key person insurance policies fall into one of these four categories.
- Term Life: Term Life policies provide coverage if the employee passes away within a certain time period or term. Typically these policies hold for 10-, 20-, or 30-year terms. Although this type of coverage is temporary, many businesses prefer it because the policy lasts until the employee’s expected retirement or transition.
- Whole Life: Whole Life policies provide lifelong coverage as long as the premiums are paid. This type of policy is more expensive than term life policies, but it builds cash value over time. Some of the money goes into a savings account where it can be borrowed or withdrawn.
- Variable Life: Variable Life policies allow businesses to put their insurance cash value in investment accounts instead of a savings account. Depending on how you invest the money, these policies fluctuate in value based on the ups and downs of the stock market. Variable Life key person insurance can be a good way to accumulate cash as long as the policy owner understands the risk factor of it.
- Disability Key Person Insurance: Disability Key Person Insurance helps businesses when a key person experiences a disability that prevents them from working. The insurer will pay the company a benefit, usually 40 to 70% of the key person’s salary.
How Much Life Insurance Should You Purchase?
There is no standard formula or method to determine how much key person life insurance you should purchase. However, there are a few rules of thumb you can use.
One option is to buy eight to ten times the employee’s salary. This rule of thumb is easy to calculate, but it might not be the right amount to cover every key employee’s loss.
Another option is to determine how much it would cost to replace the key employee and buy that amount of insurance. You will need to factor in their financial contribution to the company’s profits, their current salary, and the cost to recruit, hire, and train their replacement. While this amount is more difficult to calculate, it will usually give you a better idea of how much key person insurance you really need.
It’s Time To Prioritize Insurance
There are many things to consider when building out your employee benefits package. If you have any employees who would be hard to replace, key person insurance should be a priority. It provides the financial security every company needs to stabilize their businesses after an employee loss.
But where to start? It can be hard to figure out which key person insurance option makes the most sense for your company. Luckily, the LG Resources Employee Benefits Consulting service makes setting up an impressive benefits package easy. We can help you save on the best solution.
If you need help figuring out which type of key person insurance is right for your organization, talk to an LG Resources Benefit Consultant today.