Protect your business with key person insurance

Published 9:53 am Friday, January 31, 2020

By David Whitlock

Financial Focus

If you have a family, you understand the importance of life insurance when it comes to protecting your loved ones. Businesses need similar protection, especially when they rely on one or two significant employees for their special skills or ability to generate income. These are most likely individuals who are crucial to the ongoing success of the business. If one of them passes away or is disabled, the business may not survive.

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Consider this example: Sam and Jack are key employees at a successful software company. While Sam is the programmer who developed much of the custom software, Jack is skilled at selling the product. Both of them play a critical role in the business, and it’s questionable whether the business would survive if something happened to either one of them. Key person insurance can help protect the company from a potential loss.

• How does it work? Your business purchases a life insurance policy on the key person and pays the premiums. The business is both the owner and the beneficiary of the policy. The key person is the insured individual, but he or she does not receive any benefits. If the key person passes or becomes disabled, your company receives the benefit.

The payout can then be used to help your company survive the impact of losing that individual. The outcome will vary based on the circumstances, but it could range from covering expenses until you find a suitable replacement all the way to paying off debts and closing down the business.

• When do you need it? Let’s go back to Sam and Jack. If something happened to either one of them, the software company would be in jeopardy. Losing a key person threatens the company’s ability to generate income, mainly because that person has skills that would be difficult to replace.

But this is not the only situation. Because the loss of a key person could make it difficult for your company to pay off any debt, most banks and other lenders, including SBA lenders, require that key person insurance is in place before extending a loan or investing in the business.

• How much do you need? This depends a great deal on the size of your business and what the money would be used for. In the previous example, if Jack passed, the owner of the company might need to search for another sales person. In the meantime, he would need to replace the sales income that Jack had been providing in order to keep the company up and running. If the company has debt, that needs to be factored in as well.

The cost of the coverage depends on the insured’s age, health and gender. Coverage is typically more expensive for males than females.

• What are the types of key person insurance? Much like life insurance, key person insurance is available either as a term policy or a permanent policy. Term insurance is generally the better choice because it’s more economical and also because you can’t be sure how long employees will stay with the company. With term insurance, you can cover the employee for a specified number of years.

If the loss of key people could put your business in financial ruin, you may need key person insurance. Talk with your financial professional to learn more about protecting what matters most to you.

This article was written by Edward Jones for use by your local Edward Jones Financial Advisor.

Edward Jones, its employees and financial advisors cannot provide tax or legal advice. You should consult your attorney or qualified tax advisor regarding your situation.