It takes a few key individuals to form the successful companies that you see around. More often than not, businesses are wholly dependent on these “key employees”.
There is nothing wrong with a company being run by a few people. The problem comes in when one or more of these individuals dies or becomes incapacitated. It means that whatever contributions the employee was bringing to the table come to a stop.
Thankfully, it’s easy to safeguard your firm against such a loss. That is by taking a key man life insurance on your key employee(s).
Let’s delve more into what key man life insurance means.
Overview of Key Man Life Insurance
It’s also known as “key person insurance”, “key woman insurance” and “business life insurance”. It is a policy that a company takes on an individual whose absence would cause a large negative effect on the firm.
Thus, in case this key employee dies, the business has funds to sustain its operations. In the meantime, they can look for a suitable replacement. Having this coverage could mean the difference between bankruptcy and solvency.
To fully understand what this policy is about, let’s consider a scenario where this policy is not in place.
A start-up company, we’ll call it ABC Limited has two main founders, who run the majority of operations. Each one has a 50% stake in the firm, and they distribute roles equally among themselves. So while one owner manages finances, the other is in charge of sales and marketing.
Five years down the line, these founders become the sole providers of their firm. Not one single firm in the country can replicate the products this company has invented.
After much success, a tragedy strikes and one of the owners (owner A) passes away unexpectedly.
So, what happens?
Owner B has to put in double the effort, time and money to keep things running as usual. As if that’s not enough, owner A’s wife shows up, requesting for continued income. After all, she is entitled to her husband’s half in the firm. Such a situation would cause the remaining partner financial stress, at best. In the worst case scenario, this founder would have to shut down operations.
How Key Man Life Insurance Works
You should think of this insurance policy as a buy out that occurs when a key business employee dies. The surviving partner(s) can now take his share in the firm. The proceeds from the insurance policy are then used to pay for this transaction.
Let’s briefly go back to our illustration. Now assume that the key man life insurance was in place, and it was worth $500,000 with two ways of disbursing it:
- The owner’s wife gets $500,000 as a lump sum payment and the remaining partner takes full ownership of the business
- Company ABC retains the $500,000 and the late owner’s wife becomes the equity partner.
At the least, this insurance cover gives the company adequate time to decide how it’s going to proceed.
Other Ways Key Man Life Insurance Can Be Used
The payout from a key man insurance policy can be used to pay off outstanding debts, loans and bills. In Salt Lake City and other parts of Utah, there are no restrictions on how a business can spend key man life insurance. This makes the policy very beneficial to a company. And more so, for one that is in the process of transferring ownership to a family member or other successor.
Continuance of Operations
The most common application of this policy is sustaining business operations.
In particular, most companies use it to recruit, hire and train a new employee who serves as a replacement. This way, the firm doesn’t have to cease its operations. Instead, it finds another individual to fill the gap created by the key employee.
Boosts Chances of Qualifying for VC Financing
The majority of venture capitalist (VC) companies require a key man life insuranceto be in place before offering financing. By investing in this insurance policy, a company guarantees safety of the venture capitalist’s investment. Essentially, the policy means that the VC can recoup his investment in case something happens to the key employees. This is why the insurance policy is often taken out on the CTO, CEO or both.
Acts as a Morale Booster
We’ll look at the aspects that companies consider when choosing key employee(s) in a sec. But before then, having this policy taken on one or more of the employees boosts their morale.
If your business took out key man life insurance on you, it means that they see you as an important part of the company. It shows that they acknowledge just how important you are to the company.
This simple act of valuing your employees goes a long way in keeping them motivated. In turn, these workers are more productive in what they do. According to a study done by Warwick University, motivated and happy workers are 12% more productive than unhappy workers.
It’s Cost-Free on the Part of the Employee
The way a key man life insurance works is that the company pays premiums up to that point when the key employee dies. When this happens, the company – being the beneficiary- receives lump sum payout.
But at no point is the key employee required to pay any premiums. Since the key person has zero financial obligations, they have no reason to oppose the policy.
Depending on the insurance company you choose in Salt Lake City, you might be offered a policy with different conditions. Usually, the key man life insurance matures when the key person dies. But this is not always the case. Some firms give you partial payouts, which help to cover healthcare costs of the key employee. For instance the insurance firm can pay up to $250,000 in cash if:
— The key person is diagnosed with invasive cancer, suffers a heart attack, stroke or undergoes bypass surgery.
— The key person suffers a chronic disease that makes them incapacitated. However, the insured has to show proof of the key employee’s inabilities. A good example would be the employee being committed to an assisted living facility.
In most cases, the key person is one of the major shareholders of the company. If this individual dies and leaves his portion of the business to a family member, the company can buy out his stake.
This is usually the best route to take since it provides a win-win situation. The heirs receive adequate compensation. On the other hand, the remaining stockholders retain full ownership of the company.
Defining a Key Person
A key person is any individual who plays an integral part in the running of a business. These people could be business owners, founders, partners, executives or salespeople. As long as this person is making a significant contributions, then they are key employees.
Examples of key employees:
Workers who are very creative or have technical expertise that cannot be replaced easily. This includes employees like:
- Software developers
- Any other individual with a niche-specific talent.
- Top salesmen with vast experience and a proven record of exemplary performance. These employees go as far as building relationships with vendors and high-end clients. These relationships turn out to be very beneficial as they translate to customer retention and greater revenue.
- Senior level executives, who are in charge of the day-to-day operations. These individuals might also be responsible for development programs that set the company ahead of its competitors.
- Anyone whose absence would jeopardize the company’s finances. When we say the firm’s finances, we mean aspects such as its credit and solvency.
- License holders who are important to the continuance of business operations. Contractors with vocational licenses are a good example.
- The organization’s leaders like the heads of non-profit companies or pastors.
Types of Key Man Life Insurance
There are two main types this life insurance policy:
- Key Man Life Insurance
- Key Man Disability Insurance
1.Key Man Life Insurance
This insurance policy is very similar to ordinary life insurance. The only aspect where key man coverage differs is that it’s paid for by a company, which is also the beneficiary. In the unfortunate event that the key man dies, the benefits are paid directly to the beneficiary.
There are two main variations of key man life insurance: term life insurance and permanent life insurance.
Term life insurance is more common and it’s purchased for a given time. Term refers to the number of years, which could be 5, 10, 20 or more years. With term life insurance, the company receives death benefits only. Also, this policy only matures when the key person passes away.
With whole life insurance, the insurance coverage extends parallel to the life of the company. In other words, it covers the company for life. Another perk of this policy is that accumulates cash value overtime. So in addition to the benefits, the company also gets cash value that has built up over time.
2.Key Man Disability Insurance
One point that companies keep in mind is that key employee life insurance doesn’t mature if the key person suffers a disability. This means that the firm is still susceptible if the key employee becomes disabled. Statistically, a disability is more likely to happen than death. Fortunately, if the firm has key man disability insurance, they’ll be able to receive income as they look for a suitable replacement.
However, it’s not mandatory that the firm replaces the disabled key employee. They have another option of giving this key person time to rehabilitate.
Key Man Insurance Costs
Most insurance firms in Salt Lake City offer affordable rates for key man life insurance policy. This can range anywhere from $100 annually to a few thousand dollars each year. This amount varies based on these factors:
- Key person’s health, gender and age
The older the key person is, the higher the premiums will be. If the employee also has many pre-existing health conditions, the premiums are likely to be high. In contrast, those without health problems will pay lower premiums.
When it comes to gender, women pay 38% less for life insurance than men.
- Company structure and size
If the insured is a large corporation and the key person makes significant contributions to this company, the premiums will be high. The reason for this is that both situations warrant more coverage.
- Type of industry
For key employees who work in high-risk industries, the premium for this insurance policy will be quite high. This is due to the increased risk of premature death and disability. Examples of such occupations are:
· Iron and steel workers
· Aircraft pilot
· Grounds maintenance workers
· Construction workers
· Electrical power-line installers
· Truck drivers
- Extent of Coverage
The more coverage the insured gets, the higher the premium will be. For instance, a company that incorporates disability coverage to the policy will end up paying more.
Companies usually have key figures whose skills and capabilities are vital to the success of these firms. From the tech savvy to the influential marketer, some talents are simply too hard to replace.
Key person or key man life insurance is meant to provide financial support in case these key figures pass away. This policy also covers the company when the key persons suffer permanent disabilities. The purpose of this policy is to ensure that a business can still carry on with its operations. In the meantime, they can find a replacement.