Key Man Insurance: Cost, Coverage & Providers

Key man insurance is life and disability insurance that covers key employees (including business owners and founders) important to the business’ success. The business owns the policy, pays the premiums, and receives the payout if the key person dies or becomes disabled. A $100,000 policy for key man insurance starts at $100 per month.

Key man insurance is more complicated than just buying life insurance. Ownership and beneficiaries must be the business and the proper agreements in place to allocate benefits. Work with an insurance provider such as Policygenius who understands the requirements to protect a business in the untimely death of a key man.

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Key Man Insurance Providers

It is important to buy key man insurance through a top-rated insurance provider that understands the nuances of how the policy must be structured to properly protect all parties. Providers should work with small business owners to determine the right amount of coverage for the company if a key person unexpectedly dies.

Top Key Man Insurance Providers

Here are five insurance companies that provide key man insurance policies:

Policygenius

Policygenius is an online broker that’s licensed in all 50 states and has relationships with more than 25 top carriers for life insurance. Policygenius makes it both convenient and easy to understand to buy life, disability, health, home, and auto insurance through its online portal.

Policygenius is a great choice for sole proprietors and small partnerships that don’t need sophisticated and expensive buy-sell agreements. Policygenius makes it easy to properly structure key man life insurance policies by allowing the business to create simple agreements for fund distribution.

The Hartford

The Hartford is a large insurance carrier that caters to small business owners. They understand that most maturing small businesses have a core group of key individuals who are essential to the financial strength of the business. Key man insurance and disability coverage are among many insurance products that The Hartford offers in addition to general liability, workers’ compensation, and business owner’s policies.

The Hartford is a great choice for businesses that have loans that may be called due upon the untimely death of a partner or key man. The Hartford’s business insurance specialists work with businesses to structure policies properly to satisfy preloan requirements for funding and efficiently settle financing debts upon an unexpected death.

Allstate

Allstate is a large insurance provider with sound financial backing and a long history of providing a range of insurance products to businesses and individuals. In addition to key man insurance, Allstate also offers other small business insurance such as commercial general liability, commercial auto insurance, and a business owner’s policy (BOP).

Allstate is a good choice for corporations or limited liability companies (LLCs) that need to replace a key person who dies and need to do more than transfer equity ownership or pay off debts. Allstate agents work with business and tax advisers to help the company to determine the optimal amount required to offset operations costs based on the business needs.

Nationwide

Nationwide is a large insurance carrier that provides a diverse selection of insurance products and services. Their large size does not get in the way of specializing in coverage for small business owners, including key man insurance. Nationwide can help with the broad categories of business succession, employee retention, and supplemental retirement.

Nationwide is the right choice for businesses concerned with turnover in key positions that want to have a business exchange rider in place. This allows the insured key man to be replaced on the same policy if he resigns or is fired from the company. The new key man avoids new underwriting and the premium is adjusted, keeping the entire protection in place consistently.

Petersen International Underwriters

Petersen International Underwriters is a specialty carrier that works with licensed insurance brokers to offer various disability, life, and health insurance policies. This company’s founder developed products addressing the needs of business owners based on his own experience with a disabling chronic condition.

Petersen International Underwriters is a great choice for small business owners prioritizing potential disability over death of key employees. Petersen International Underwriters offers the most comprehensive key man disability policies that address older employees or those with higher-risk lifestyles.

What Key Man Insurance Is

Key man insurance is a type of insurance policy designed to protect business interests from the financial loss of a key person who owns or leads the company. Key person insurance covers the loss of income or expenses resulting when a key member of a business dies or becomes disabled. It may include life insurance, disability, or a combination of both.

What Key Man Life Insurance Covers

Key man life insurance is purchased by a business with a contract term that should be long enough to extend through the duration of the key person’s usefulness to the business. Key man insurance covers potential financial losses to the business as a result of losing a key person to death or disability.

A key person or key employee is someone who:

• Brings in a large percentage of profits or revenues for the business.
• Provides special knowledge or talent to the business (e.g., an employee who develops a patentable product for the business).
• Has expertise or knowledge that’s difficult or costly to replace.

If you purchase key man insurance, your business will receive a payout if the key person identified in the policy dies or becomes disabled. This can help your business continue to thrive in the face of a difficult transition.

Key Man Life Insurance Exclusions

Exclusions on life insurance policies mean that the insured’s death may not be covered in certain cases, depending on how an application was made or how the insured person died. The most common key man insurance exclusions are fraud, misrepresentation, and suicide.

Here are the most common key man insurance exclusions:

• Fraud
• Misrepresentation
• Intentional dishonesty
• Suicide within contestability period (often two years)

Contestability periods are common during the first two years of every life insurance policy, where claims are investigated by insurance companies to confirm that no fraud or misinformation was provided during the application process. Key man life insurance is no different.

Who Needs Key Man Insurance

Any business, no matter the size, may have a need for key man life insurance if the financial success of the business significantly depends upon on one or two people. Small businesses should not overlook this coverage. Smaller businesses are usually more dependent on one or two key people for success.

Key man life insurance is not the same insurance you buy for your regular employees, which can be offered in a number of ways. For more information on that type of insurance, read our article on how to offer life insurance to your employees. Sometimes, SBA lenders or banks may also require a business to take out a key man insurance policy before it can obtain a business loan.

The types of people businesses identify for key person insurance policies include:

• Sought-after surgeon running a small plastic surgery office
• Chef responsible for menus that have a reservation wait list for weeks
• Starring actor in a movie
• Software programmer responsible for new intellectual property development

Key Person Insurance & Buy-sell Agreements

A buy-sell agreement is a contract that transfers equity ownership of one owner to others. They are created to address business interests in the event that an equity stakeholder either dies or leaves the company and sells (or otherwise relinquishes) equity control. In relation to key man insurance, buy-sell agreements are similar to a family trust dictating that proceeds be used in the transfer of ownership.

Without a buy-sell agreement, the company could use the life insurance proceeds for anything they wish, including paying down debt, hiring a replacement, or otherwise maintaining operations. There are situations where ownership must be transferred, but the deceased’s heirs still have rights to the equity ownership in the company.

Buy-sell Agreement Example

Let’s say a limited liability company (LLC) has three partners, each with equal ownership in the business. One partner dies in an auto accident and all his assets, including the shares in the LLC, are passed to his wife. She has no experience nor desire to replace her husband in the company and wants to be bought out. The buy-sell agreement accomplishes this, providing her with the cash buyout in exchange for her inherited interest in the LLC to the other two partners, who become equal owners.

Note that some company structures, such as a sole proprietorship, may encounter problems when passing a business on to heirs. Technically, the business dies with the sole proprietor and must be re-established with the funds of a buy-sell agreement.

The Uniform Partnership Act

The Uniform Partnership Act (UPA) addresses the needs of partnerships that don’t have binding contracts or legal entities established. It provides that when a partner leaves, the partnership is dissolved but allows for the remaining majority interest partners to continue the partnership. If this is triggered by a key partner’s death, the key man insurance and buy-sell agreement facilitate this to prevent business cessation if the company cannot pay off heirs within the 90 days.

Key Man Insurance Costs

Key man insurance costs vary depending on the types of policies chosen and underwriting risk, with premiums ranging from approximately $100 to a few thousand dollars per month. Premiums are based on the health history of each key person insured, the amount of coverage, and the type and term of the policy.

The cost of key man coverage varies based on the following:

• Key person’s age, gender, and health: Costs increase as you age or have more pre-existing medical conditions. Additionally, men pay an average of 38% more than women for life insurance and smokers pay a 235% cost increase.
• Company structure and size: Company valuation directly translates to the impact key individuals have on revenues. Bigger companies worth more need more coverage, increasing the premium costs.
• Industry: Premiums will be higher for riskier industries because of increased risk of premature death or disability. A key person working in a plant is at higher risk of accidental death compared to a partner in a CPA firm.
• Amount of coverage and term of policy: The size of the desired payout from the policy and the duration of coverage directly impact cost. More coverage for longer periods of protection increases costs.
• Type of policy: Term insurance is less expensive than permanent. Adding coverage for key person disability insurance also increase rates but builds more comprehensive protection.

Most insurance companies provide key man policies in 10-, 15-, and 20-year terms, as well as year-to-year renewable terms. Because coverage lasts for a lifetime, premiums for permanent life insurance are generally about 5 to 10 times more expensive than term life insurance. Below we compare average rates for term policies because it’s the more popular policy.

Typical Key Man Life Insurance Costs

Types of Key Man Life Insurance

There are different ways to structure the key person insurance policy to best protect the business’ financial interest in key management and owners. A permanent policy best serves a small business owner who needs to cover his value in the company even after death or a company seeking to preserve the policy over changing key figures over the years. Term policies are more affordable with limited coverage periods.

Here are four types of insurance policies to consider when buying key man insurance:

Term Life Insurance

Term life insurance is a limited-duration policy covering a person’s life for terms of 5, 10, 15, 20, or 30 years. Term life insurance is less expensive than permanent life insurance because it has a finite ending period within the normal life expectancy of the insured. Most key person term insurance policies use a 10-, 15-, or 20-year term.

Permanent Life Insurance

Permanent life insurance is a life insurance policy that remains in full force as long as premiums are paid by the policyholder. Examples of whole life insurance include whole life, variable life, and universal life insurance. These policies have a cash savings value in addition to the death benefit, which becomes an asset a small business can access if needed within the scope of key man loss needs.

Return of Premium Life Insurance

Return of premium (ROP) is a hybrid of term insurance with a cash value component. ROP policies are more expensive than standard term insurance policies because the premium is returned to the policy owner if the insured survives the term. In most policies, all premium is returned, making this policy a low-risk way of protecting a life.

Key Man Disability Insurance

Disability insurance pays benefits in the event that a person is unable to work due to injury or illness for either short- or long-term periods. Key person disability insurance provides financial benefits to the company if a key man is out of commission and unable to work. These funds are used to help the company continue operations and move forward with resources to replace the key man either temporarily or permanently.

Similar to personal disability plans, disability key man insurance policies pay benefits for a defined period of time and up to a percentage of the income. Key man disability pays up to 150% of the employee’s compensation to help the business offset costs associated with the loss. These policies often have a waiting period of 90 to 180 days before benefits start and pay up to 24 months of benefits.

How to Determine Amounts of Key Man Coverage

Getting the right amount of coverage is important so the business isn’t over or underinsured. While buying personal life insurance can raise some unknowns, there are some approaches that help you get a good idea of the right amount of key person insurance needed.

There are three primary means of determining key man insurance coverage:

Determine the Key Person’s Compensation

Generally, key man policies are assessed as a five to 10 times multiple of the key person’s compensation (salary, bonus, and benefits). For example, if the key person earns $100,000 per year, then you might consider getting, at a minimum, a $500,000 key man policy. Longer terms are often needed in companies with stronger growth orientation requiring longer planning.

Estimate the Cost of Replacing the Key Person

While there are a lot of unknowns about what replacements will demand for compensation packages and the cost to search for one, it’s worth taking the time to check. Defining replacement costs is most important if your key man is a stakeholder who maybe didn’t take as much compensation while building the business. Factor in cash reserves to help keep the company running, even temporarily.

Calculate the Key Person’s Contributions to the Business

Key individuals significantly contribute to profits, intellectual property, or public relations of the business. One guideline for key man policies is to calculate the percentage of company profits that the key person contributed and then multiply that by the number of years it would take to replace the individual.

For example, if the business’ net profits were $1 million and the key person brought in $250,000 in income, they contributed 25% of the company’s profits. If it would take two years to find and train a replacement for the key person, you may want to purchase a $500,000 key person insurance policy ($250,000 x 2 = $500,000).

Key Man Insurance Taxation

Traditionally designed life insurance policies do not have tax deductible premiums and the distribution of benefits go to beneficiaries tax-free. This is counter-intuitive because it is considered a business expense by business owners. In most cases, key man insurance is not a deductible business expense.

Deductibility of Key Man Insurance Premiums

Key man life insurance is not generally tax deductible. The IRS rule is that “You generally cannot deduct the premiums on any life insurance policy, endowment contract, or annuity contract if you are directly or indirectly a beneficiary. The disallowance applies without regard to whom the policy covers.” The business benefits from the life insurance and thus cannot deduct it.

However, purchasing disability coverage on a key person may be a deductible expense. Keep in mind that key man insurance is different from other types of business life insurance and business disability insurance, such as life and disability insurance used to fund a buy-sell agreement. In buy-sell insurance arrangements, often (for long-term tax considerations) the business is not the owner, beneficiary, or premium payer for the policy, as is the case with key man insurance.

Taxation of Benefits in Key Person Insurance

When a business files a claim for key man insurance, the proceeds are generally not considered taxable income. This means the business will get the full face value of the policy without withholdings or a tax bill. In other words, a $1 million policy means the business will get $1 million to use for business operations and finding a replacement of the key man.

As with many things in both insurance and taxation, there is a caveat. In order to enjoy the beneficial tax treatment of key man insurance, the business must obtain the written consent of the key person whose life is insured. Essentially, they have to agree to waive their rights of control to the policy and agree to how benefits are assigned.

This is designed to protect employees from exploitation and also to allow employers to make “quid pro quo” arrangements. For example, the business might agree to make some of the death benefit available to the key employee’s heirs.

Key Man Insurance IRS Requirements

Under the Pension Protection Act of 2006, businesses that own life insurance policies on employees of a business must do all of the following:

1. Notify the employee in writing of the amount of coverage.
2. Notify the employee that the business is the beneficiary under the policy.
3. The employee must provide written consent to the coverage.

There’s no exception to these rules if the key person is the business owner. If the business owner is the key person, he or she should still sign a form providing consent for the policy. Insurance companies provide you with an Employer Notice and Consent Form to obtain the necessary consent.

Check with your tax professional and lawyer to determine what will work best for your business. Note that these same notice and consent requirements do not apply for key man disability insurance.

Other Key Person Insurance Types

Disability Insurance

Disability insurance pays an employee a percentage of their wages if injured. Injuries may occur at home, work, or elsewhere, with benefits potentially covering short-term and long-term disabilities. Disability insurance pays employees, while key man disability insurance pays the business to mitigate financial loss due to losing a key man.

Group Benefits Plans

Small business owners can attract and retain more qualified employees by offering group benefits such as term life insurance, health insurance, and disability insurance. While this is often a cost small business owners might not think they have the budget for, working with professional employer organizations (PEOs) allows benefits plans to be implemented effectively and for reasonable pricing.

Tips on Getting Key Man Insurance

The need for key person insurance will be unique to each business because of the dynamic between business needs and the insured’s life expectancy and lifestyle. For this reason, it’s important to systematically approach shopping, pricing, and selecting the right policy or combination of policies.

Four tips when applying for key man insurance include:

Consider Higher Coverage Limits & Terms

Typically, double coverage for life insurance doesn’t mean double premium. In many cases, you can get 10 times the coverage for three to four times the cost in premium. A $1 million key man policy costs approximately four times as much as the premium on a $100,000 policy. Consider the worst case scenario and what is realistically needed to protect the business’ future.

“The best rule of thumb is to choose coverage for as long as you anticipate it will be needed for the least amount of cost. For example, if you have a key employee who is 55 years old, a 10-year key man policy might be sufficient because it’s likely that they will retire in the next decade. However, if you have a 47-year-old key person, you may need a 20-year term to protect yourself until he or she retires. Locking in a 20-year term also means your premiums won’t increase down the line before the employee reaches retirement age.”

– Michael DiPazza, National Director of Business Strategies Group, AXA Financial

Be Flexible & Adapt as Your Business Grows

Buying insurance shouldn’t be an event that you do and then forget about. Business needs change and your key man insurance needs may change also. If the business grows, you might need more to protect the key person’s impact. On the flip side, if someone retires or their impact on the company changes, you may need to make adjustments to coverage.

Consider Including a Business Exchange Rider

Business owners and key managers don’t always stay with the company. A business exchange rider allows the business to substitute a new key person for the key person identified in the insurance policy. Premiums, coverage level, and the cash value of the policy (if it’s permanent life insurance) are adjusted to the new person’s health, gender, and age considerations, but it allows businesses to skip underwriting a new key person.

“Some forms of business entities lend themselves to an easier transfer of ownership interests (e.g., shares or membership units), while some forms make this process more burdensome. Corporations typically allow for the most seamless transfer due to the standardized structure of these enterprises and predictability that comes with that standardization. There are multiple other factors that should be considered in selecting a business entity, such as tax implications, the desired ownership structure, and whether or not the entity will own real estate. These are all things that should be discussed with your attorney and accountant prior to formation.”

– Travis McConnell, Attorney, Law Office of Travis J. McConnell

Structure the Policy Correctly

Without the correct contractual structure, it is possible that a key person could change the policy beneficiary from the company to a spouse or other beneficiary. The owner of the key man policy must be the business who is also the beneficiary. Owners must provide written consent to make sure the policy is structured properly according to IRS rules.

“The key man policy can provide significant funds in the case of an unexpected loss of a revenue producer. Those funds can be used to buy out a departing equity owner or to replace income lost on the departure of a key employee.”

– Staneley P Jaskiewicz, Esquire, Spector Gadon & Rosen

Add On Key Person Disability Coverage

While you can purchase disability and life insurance policies independently for more comprehensive disability coverage, a disability policy can also be a rider on the key man life insurance policy. Unlike disability benefits established to pay the disabled employee 30% to 90% of their monthly income, key man disability pays the business up to 150% of the salary to offset expenses of having a key man out.

Waiting periods do apply before disability coverage kicks in under a key man policy, usually ranging from 90 to 180 days, and benefits are limited to two years. There may be a waiting period to receive benefits, depending on whether you purchase short-term disability insurance or long-term disability insurance.

Since a key person is statistically more likely to become disabled than to have an untimely death, it’s important to get both key person life insurance and disability insurance. The Council for Disability Awareness estimated that more than one in four people will become at least temporarily disabled before retirement. However, only about 15% of small businesses have key man disability coverage, based on a survey by the National Association of Insurance Commissioners.

Key Person Insurance Frequently Asked Questions (FAQs)

Getting a key person insurance plan is a big next step to protecting your business growth and financial strength.

What if the person resigns with a key man insurance policy in place?

If a key man leaves but a key man policy remains in force, you can cancel the policy and get any cash value less surrender charges returned or assign the policy to a new key man who replaces the old. This option is only possible if the existing policy has a business exchange rider.

Can I deduct key man insurance policy?

Key man insurance is not a deductible business expense, even though the business is paying the premiums. The IRS is clear on this matter and has several disclosures that the insured party must sign to acknowledge the business’ insurable interest in his or her life.

Is key person insurance permanent?

Key person insurance can be permanent insurance such as whole or variable life, but it’s normally term insurance. For a business with an owner or major partner, permanent insurance might be worth the added premium while term insurance is less expensive and often a better option for someone who is valuable but without ownership interest.

Bottom Line

Key man insurance can be critical in protecting your small business if a key person central to its continued success dies or becomes disabled. Coverage amounts and costs vary significantly. At a minimum, you’ll need to insure the cost of losing and replacing the key employee being covered. Costs for a key man policy may range from $100 to $2,000 per month.

Most small businesses can’t afford to go without key person insurance and, in many cases, partners or lenders will require you have a policy to protect everyone’s interest in the company. Find an insurance carrier through a broker such as Policygenius, which is capable of shopping the best rates with the top key man insurance provider to get the right coverage for the right price.

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