Key‑Person Insurance Explained: Why Business Owners Need It

Business owners and small firms rely heavily on a few individuals—founders, top salespeople, or technical experts. Losing one of these key people unexpectedly can lead to revenue loss, operational disruption, or even business closure. That’s where key‑person insurance steps in.

What Is Key‑Person Insurance?

Key‑person insurance (also called key‑man or key‑woman insurance) is a life or disability policy purchased by the business covering a critical person whose loss would significantly harm the company. The company owns the policy, pays premiums, and receives tax‑free proceeds if the insured person dies or becomes incapacitated, providing a financial safety net.

This form of coverage helps with:

• Lost revenue or profits
• Hiring and training replacements
• Covering debt or funding operational gaps
• Supporting investors or loan requirements

Why Business Owners Need It

Safeguard Business Continuity

Without a plan, the unexpected death or disability of a key individual can stall critical projects, disrupt customer relationships, and shake stakeholder confidence. Insurance provides liquidity to cover interim losses and maintain operations.

Support Succession & Buy‑Sell Agreements

A key‑person policy offers funds to enable buy‑sell agreements, allowing partners or co‑owners to acquire interests smoothly and avoid ownership or leadership conflicts.

Increase Creditworthiness

Lenders and investors often view businesses with key‑person coverage as more stable. This can improve chances of securing loans or favorable terms.

Who Qualifies As a Key Person?

A key person may be:

• The business owner or founder
• A top salesperson or revenue driver
• A specialist with unique technical knowledge
• Anyone whose absence would cause significant financial or operational loss

Types of Coverage

Coverage Type	Description
Term Life Insurance	Affordable coverage for a fixed term (e.g., 10–30 years). Ideal for specific needs like loan terms or project timelines.
Permanent Life Insurance	Whole or universal life plans that last indefinitely and build cash value anyone can borrow against. Higher premium but long-term asset.
Disability Insurance	Pays a portion of income (commonly 40–70%) if a key person cannot work due to illness or injury. Helps maintain stability while replacement is sought.

How Much Coverage Is Enough?

Common methods include:

Revenue Contribution Method

Calculate the annual revenue or profit tied to the key person and multiply by the expected time to replace them (e.g., 2–3 years, or longer if needed).

Replacement Cost Calculation

Sum costs for recruiting, hiring, and training a replacement plus lost revenue during transition (~8–10× salary or revenue contribution).

What It Costs & Tax Considerations

Cost Overview: Premiums vary widely—based on the insured’s age, health, industry, and policy type. Averages around $180/month but can be much higher or lower depending on coverage and risk factors.

In the U.S., premiums are typically not tax‑deductible, but benefits received are tax‑free, provided the insured gives written consent and IRS Form 8925 is filed, which is common in C‑corporations.

How to Set Up Key‑Person Insurance

1. Identify critical roles and calculate exposure.
2. Choose a policy type (term, permanent, disability).
3. Work with a licensed broker or advisor—compare quotes from multiple insurers.
4. Get written consent from the insured person and complete underwriting (which may require a medical exam).
5. Document the ownership and beneficiary.
6. Review periodically as business needs change—update or cancel if personnel or risk changes.

Integrate with Business Strategy

Embedding key‑person insurance into broader risk management and succession planning makes it more effective:

• Coordinate with buy‑sell agreements or ownership transition plans.
• Use it to secure or enhance financing for business loans.
• Reassess coverage periodically—especially after promotions, acquisitions, or new hires.

Summary

What it is: Insurance that a business buys on a key individual it depends on.

Why it matters: Mitigates financial shocks, supports continuity, improves borrowing capacity, and enables owner succession.

Types: Term, permanent, or disability coverage.

Cost/Tax: Premiums vary; benefits are usually tax‑free; premiums typically not deductible.

Best fit: Firms relying on one or two individuals whose unexpected loss could be hugely disruptive.

Disclaimer

This article is for educational purposes only and does not constitute financial, investment, or insurance advice. Consult licensed insurance professionals and tax advisors to tailor a solution that fits your business structure and objectives.