What is key person insurance?

While all employees contribute to the success of a small business in some way, there are those employees that just can't be replaced.

That’s why it’s important to have an insurance policy that will help keep a business afloat even without its most valuable employees. Key person insurance is a life insurance policy that a business takes out on its most valuable employee or employees. A policy can also include a rider for disability coverage to help if a key employee is disabled.

Key person insurance helps safeguard a small business if an imperative employee dies or becomes disabled.

What makes a key person?

For key person insurance, a business focuses on the employees it considers indispensable. A key person is often the business owner but could also be someone who has a highly specialized role or is responsible for bringing in a large share of sales. Such employees can be extremely difficult, and expensive, to replace, and their loss would resonate throughout the entire business. Sole proprietors may also opt for key person insurance to protect family members who will inherit their business.

Under a key person life insurance policy, the business owns the policy, pays the premiums and is the beneficiary. If a key person dies, the business then collects a death benefit. That money can be used to help a business replace lost revenue as they search for a replacement.

Keep in mind that some lenders mandate that businesses purchase key person insurance to receive financing.

How much key person insurance do you need?

There’s no exact formula for determining how much coverage is necessary to insure a key person, but thinking about how much it would cost to replace this individual is a good place to start. When coming up with this figure, it is helpful to consider the percentage of the key person’s contribution to the company’s bottom line, as well as his or her current salary, which companies will generally multiply by a factor of five to seven.

You will need to choose between a term or permanent insurance policy, depending on what makes the most sense for your business.

Under a term policy, the business receives a death benefit if the key employee dies while the policy is in force. Premiums are level for the initial time period – which is generally 10, 20 or 30 years, depending on the policy. A permanent insurance policy also pays a death benefit if the key person dies while the policy is in force, but the policy offers a cash value fund that the business can take advantage of.

Key person insurance can help provide a financial lifeline for your business at the loss of a key employee. Nationwide can help you understand the coverage your business needs, and the options you have to protect it.