Key Man Life Insurance

A Guide for Businesses with Key Employees
Bennett Bier - Life Insurance Agent and Owner of Spectrum

Updated By: Bennett Bier

Expert Life Insurance Agent

April 26, 2023

Key man life insurance sometimes called, simply, key man insurance or key person life insurance is a critical type of insurance for business owners.

If you own a business and have one or more employees that generate the majority of the revenue for your business, key man insurance should be part of your overall risk control strategy.

Below you’re going to learn exactly what key man life insurance is, and how you can use it to help protect your business.

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What is Key Man Life Insurance?
Who Needs Key Man Insurance?
How Much Coverage Do You Need?
How Much Does Key Man Life Insurance Cost?
About Key Man Disability Insurance
Apply for Key Man Life Insurance

Key Man Insurance Guide

What is Key Man Life Insurance?

In a business, a key man, or key person is anyone who contributes substantially to the bottom line.

The cost and time that it would take to replace a key man or person would be astronomical. If losing one of your most talented employees would place your business at risk, then your business needs to protect its financial interests. This is where key man life insurance can help.

A key employee normally generates substantial revenue for your firm, has specialized knowledge, or handles major responsibilities.

How Key Man Insurance Works

Considering this is an important strategy for any business with mission-critical staff, key man term life has a fairly straightforward implementation.

  1. The business purchases a term life insurance policy on the key employee insuring his or her life. The business owns, pays the premiums for, and is the beneficiary of the policy.
  2. Should the employee die (assuming that the policy is still in force), the business receives the death benefit, normally tax-free.
  3. The proceeds from the insurance policy can be used to find, hire, and train the key person’s replacement. It can also be used to offset any loss in income to the business due to the loss of the employee. Essentially, the funds can be used any way that the business sees fit.
Helping protect your key assest with key man insurance

Key man term life is normally used since employees have a fairly predictable retirement date. Any financial loss incurred by a death that is predicted by a time frame (income from a job, your mortgage, etc.) is most efficiently protected by term insurance due to its low cost.

There may be circumstances where key man term life can be combined with an excess plan, providing both substantial death benefit protection for the business and a future benefit to the employee. Proper planning and business objectives will determine the optimal strategy.

Who Needs Key Man Life Insurance?

Any business who has a key employee should at least consider buying key man insurance, especially if losing that employee would put the company at risk.

Let’s look at an example:
DBGA has a fantastic technology and service-based business. But, because their business model is in a unique niche market, not all of the salespeople who offer their services are productive. But Jane is. She is responsible for 45% of DBGA’s sales, even though they employ 10 salespeople.

Would Jane be considered instrumental and vital to DBGA’s success in their industry?

Of course!

Jane would be considered a “key person” at DBGA and thus, DBGA should make sure that they put measures in place should something happen where she was unable to fulfill her duties of being their top salesperson.

A key man or key person doesn’t necessarily need to be on the sales side of the business.

The person who develops and maintains the technology at DGBA, a critical part of their success, would also be considered a key person. The CFO who is instrumental in helping to broker their major deals could also be a key man.

The bottom line is that anyone who is crucial to the success of your business is a key man or key person. Key man term life insurance is one way to protect your business should something happen to that person.

How Key Man Insurance Helps Employee Retention

Retaining key employees is critical to any business.

Business man with key man life insurance

A number of factors go into employee loyalty, such as environment, business ethos, management style, compensation, and benefits. And while the business owner has a lot of control over most of these components, being able to keep a top employee using compensation and benefit-based strategies may be one of the most simple.

Purchasing life insurance as an employee retention strategy is very popular for any sized busine.

Known as “golden handcuffs”, this concept uses deferred compensation that ties your key people to their position. This coverage can be very meaningful. It helps you hold on to your most valuable staff while rewarding them for their loyalty.

The strategy is technically referred to as an excess plan. These plans are part of a larger category called non-qualified deferred compensation (NQDC).

They help your highly compensated employees, some of which are likely to be your key employees, save additional funds for retirement. They also allow you, the business owner, to retain control over those assets. The funds in these plans also remain on the company’s balance sheet and are very simple to administer.

Employees who have additional compensation paid through these plans have their money subject to forfeiture should they leave prior to a predetermined time. Having substantial funds in an excess NQDC plan is a major disincentive to them leaving you.

How Much Coverage Should You Get?

The death benefit is normally determined by the key employee’s income and the difficulty in replacing him or her.

How long the insurance lasts (the “term”) is dictated by the likely length of future employment.

Let’s look at an example:
Abigail has a successful business that largely relies on Jason’s (her employee) ability to network and get contracts signed. Jason makes 100k per year.

Using a sophisticated insurance analysis calculator, it is determined that Abigail should purchase 650k of 20-year key man term life on Jason. This is based on Jason’s likely time of employment, how hard it would be to replace him, and his annual income.

Determining the right amount of death benefit and the right length of the term should only be handled by a skilled, independent (able to shop the policy amongst all of the major carriers), licensed insurance agent.

How Much Does Key Man Life Insurance Cost?

There are a number of factors that determine the cost of a key man policy. The main factors include:

  • The key person’s age
  • The key person’s health
  • The length of the term – usually you want coverage until they retire.

The cost of the key man insurance policy above would depend on Jason’s health, and age. Assuming he is in good health, and around 40 years old, the policy might cost the business around $450 per month.

Key Man Disability Insurance

As terrible as losing a key person in your company to death can be, having one unable to work due to disability can be equally challenging. In addition to retention plans and key man term life, having a key person disability insurance plan in place is necessary. The loss of your most valuable talent due to disability can be just as financially damaging as their death.

Having a plan in place that will provide a lump sum or monthly payout should that key person be unable to perform the required duties of his or her profession is needed. Building a key person disability insurance strategy is similar to that of a key man term life plan.

An expert, licensed, independent insurance agent performs a business loss analysis and helps you, the business owner, determine the potential for loss. Once the risk is assessed, your agent can help you shop all of the major disability insurance carriers to find the best policy for your needs.

Should your key employee become disabled for an extended period of time (for example, more than 1 year), your policy would pay either a lump sum or a monthly benefit.

The payout/waiting period is determined by how you set up your policy. Lump sum payouts cost more than monthly and longer waiting periods cost more than shorter ones.

If you own a business with a key employee, making sure that your employee is covered should they become disabled is not a luxury, but a necessity.

Apply for a Key Man Life Insurance Quote

Owning a business is a challenge. Administration, overhead, marketing, and all of the other moving parts in a successful (or even unsuccessful) business can be overwhelming. The last thing that a business owner needs is to lose a key employee to a competitor, death, or disability. The most productive way to protect your business is to utilize insurance to share or offset this risk.

You can use “excess” compensation plans to encourage retention. You can use key man life insurance to hedge against the untimely death of an employee and even incorporate key person disability insurance to shield your business from your top talent being unable to work.

For those key employees who drive your revenues and growth, consider insurance as a core strategy in your business risk management.

Use our compare quotes tool above, and call one of our independent agents who specialize in business protection to get the best key man life insurance for your business.