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. Key man insurance costs from $100 to $2,000 per year.
The cost of key man insurance varies broadly because each policy will have unique requirements, such as the amount of coverage, the term of the policy, and the health of the key person. The best way to determine the appropriate key man insurance coverage at the right price for you is by getting a quote directly from an insurance provider like Policygenius.
How Key Man Insurance Works
Key man life insurance is an insurance policy that a business purchases to cover the loss of income or expenses that can result when a key member of a business dies or becomes disabled. It may include life insurance, disability, or a combination of both. The key person may be the business owner or another key employee.
What Key Man Life Insurance Covers
Key man life insurance is purchased by the business, and the term of the contract 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.
Here are more details that further define the profile of a key person or key employee:
- 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).
- Expertise and knowledge is 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. 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.
Key Man Life Insurance Exclusions
It’s important to read your key man insurance carefully for exclusions, which are items that are not covered in the policy. The most common key man insurance exclusions are fraud, misrepresentation and suicide. A claim can be denied if it is found that there was intentional dishonesty. Also, key man insurance will not cover suicide during the two-year contestability period.
Here are the most common key man insurance exclusions:
- Intentional dishonesty
- Suicide within contestability period
It’s important to note that during the first two years of every life insurance policy, there is a contractual clause known as the contestability period. If there is a claim during those first two policy years, the insurance company will investigate to determine if there were fraudulent or deceptive statements made or an omission of facts on the original application and insurance exam.
Key Man Insurance Costs
The cost of key man insurance is generally an affordable business investment, with premiums ranging from approximately $100 per year to a few thousand dollars per year, depending on the health and number of key people insured, the amount of coverage, and the term of the policy. If the business buys permanent/whole life insurance, premiums are generally higher than a term policy.
The cost of key man coverage varies based on the following:
- Key Person’s Age, Gender, and Health: In general, the older you are and the more pre-existing health conditions you have when you purchase your policy, the higher your premium will be. Men will pay 38% more than women for life insurance and smokers pay a 235% premium.
- Company Structure and Size: The higher the value of the business and the key person’s contributions to the business, the higher the premium will be because you’ll need more coverage.
- Industry: Premiums will be higher for riskier industries because of increased risk of premature death or disability.
- Amount of Coverage and Type of Policy: The more coverage you get, the higher your premiums will be. Term insurance is less expensive than permanent life insurance. Adding disability coverage will cost extra.
- Term of the Policy: If term insurance is purchased, longer terms are generally more expensive than shorter terms.
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.
Example of Key Man Insurance Costs
Example 1: The insured key person is a 40-year-old, non-smoking male in excellent health.
|Amount of Coverage|
|$1 million Policy|
Another Key Man Insurance Costs Example
Example 2: The insured key person is a 45-year-old, non-smoking woman in excellent health. The premiums are higher because of the insured’s older age.
|Amount of Coverage|
|$1 million Policy|
Key Man Insurance Quotes
Key man insurance is like a commodity in that the policies are generally the same at every insurance company; therefore, along with company reputation and experience in your industry, price is a key factor in choosing your provider. The right insurance company will also provide appropriate coverage based on your needs, outstanding customer service, and the financial capacity to meet its financial obligations to you and your beneficiaries.
Here are five of the best insurance companies that provide key man insurance quotes:
AXA is a leading financial protection company and one of the nation’s premier providers of life insurance and annuity products. Their financial backing and experience in providing life insurance products make them a top choice for your key man insurance needs. AXA understands small business and they have a range of life insurance and disability products to choose from.
Allstate is a large insurance provider with sound financial backing and a long history of providing a range of insurance needs to businesses and individuals. In addition to key man insurance, Allstate also offers other small business insurance types, such as commercial general liability, commercial auto insurance, and a business owners policy (BOP).
The Hartford is a large insurance agency 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 to small business owners.
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.
Policygenius is smaller in relation to some of the larger providers, which is why they know how to serve small business owners with the coverage that they need, and key man insurance is no exception. Policygenius can also help with key man disability, buy-sell agreements, and other crucial insurance products for small business owners.
Shopping for key man insurance isn’t something you do often, so it can be tough to know if you’re getting the best deal. We recommend getting at least three quotes to make sure you have the right coverage at the right price. Policygenius makes that easy by letting you compare key man insurance quotes from dozens of companies. Fill out their online form and see what your best options are.
How to Determine the Key Man Coverage You Need
Just like buying personal life insurance can raise some unknowns, there’s no single way to figure out how much key man coverage you’ll need. But there are some approaches that insurance agents often recommend and that have worked well for small businesses.
There are three primary means of determining key man insurance coverage:
1. Determine the Key Person’s Compensation
Many key man policies are assessed as a five- to ten-time multiple of the key person’s compensation (salary plus bonus plus other perks). 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.
2. Determine the Cost of Replacing the Key Person
The biggest disruption from losing a key person may be the time and money it takes to find a replacement and train that individual. To help figure out how much coverage you need, you can calculate how much money it would take to hire and train a replacement for the key person. You should also factor in the decline to company revenue during the hiring/training period.
3. Calculate the Key Person’s Contributions to Business
A key person may have contributed profits, intellectual property, or valuable customers to 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 $1,000,000, 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).
The best approach is to come up with an estimate of the amount of coverage you think you might need and then to confirm that with a trusted business advisor or insurance agent. Your insurance agent will go through your income statements and books with you to ensure you are purchasing adequate coverage. You can compare the policies and costs of 12+ companies at once with Policygenius.
5 Tips on How to Apply for Key Person Insurance
The need for key person insurance will be unique to each business. For this reason, it’s important to know which key features apply to your business before you begin the application process. When you are ready to begin shopping and applying for key man insurance coverage, there are at least five tips to keep in mind.
The five important tips when applying for key man insurance include:
1. Consider Higher Coverage Limits and Terms
You can significantly increase your coverage limit for a relatively small increase in premium. You may think that a $1 million key man policy is going to cost 10 times more than a $100,000 policy. However, premiums are not priced that way. Premiums on a $1 million policy will cost you only about 4 times as much as the premium on a $100,000 policy.
2. The Cheapest Policy Isn’t Always the Best Policy
Think about the future when deciding how much coverage and what term to get. For instance, if you get a 10-year policy, it may be cheap now. However, if the key person lives and remains healthy well beyond the term, you’ll have to renew. And because the key person will be a decade older (and possibly less healthy) at the start of the new term, premiums will go up significantly.
3. Be Flexible and Adapt as Your Business Grows
Your coverage limits may change as your business evolves. A $100,000 policy may be enough today, but the value of a key person to your business may increase two or threefold over the next several years. Fortunately, most key man policies allow you to periodically update your coverage limits, so you don’t have to start from scratch and get a new policy each time.
When applying for key man insurance, you should keep these points in mind and choose your term and limit accordingly. According to Michael DiPiazza, National Director of the Business Strategies Group at AXA:
“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.”
4. Consider Including a Business Exchange Rider
It’s important to plan for and cover the cost of replacing a key person. A business exchange rider allows the business to substitute a new key person for the key person identified in the insurance policy. There may be a change in premiums, coverage level, and the cash value of the policy (if it’s permanent life insurance). However, if you have this rider, the insurance company will not charge you money for a new application or for underwriting, allowing you to save money.
If your key person leaves and you don’t hire a replacement, you can simply cancel the policy. There’s usually no charge to cancel a term policy; you just stop paying the premiums, and the coverage ceases. Permanent (cash value) coverage typically has a surrender charge that decreases over time, which may diminish the amount of cash value you get back (depending on how long the policy is in force before you surrender it).
5. Add On Key Person Disability Coverage
While you can purchase disability and life insurance policies independently for more comprehensive disability coverage, the disability policy is usually a rider on the key man life insurance policy. Most insurers will pay a portion of the key person’s salary, usually 50% – 60%, if he or she becomes disabled. 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.
The bottom line is that a small investment now in key man insurance can save your business thousands, even millions, of dollars when it’s in its most vulnerable state. And getting a great policy is easy with Policygenius. You can fill out a short, online form and get quotes from more than a dozen companies. There’s no obligation and comparing your options is completely free.
Additional Key Man Insurance Information
There are two types of life insurance that you can purchase for your key man policy: term life and permanent/whole life. The most popular type of key man life insurance is term life, but there are scenarios where permanent/whole life makes sense for the business.
Term Life Insurance
This is the most common type of life insurance. The death benefit is paid if the key person dies during the term. For example, if the business purchases a 20-year term life insurance policy, it will pay premiums for 20 years and will receive money if the key person dies during the 20-year period.
Most small businesses go with term life insurance because it’s more affordable than a whole life policy. The lower cost allows you to buy more coverage. For example, a $200/year budget might allow you to buy a $100,000, 20-year term life insurance policy, but you’d need $1,000/year to purchase a $100,000 whole life policy.
Permanent or Whole Life Insurance
Whole life insurance offers lifetime coverage and a cash value that builds up over time. No matter when the key person dies, the policy will provide coverage. While the key person is alive, the business can get cash by surrendering the policy or borrowing from the policy if needed.
Sometimes it makes sense to use permanent/whole life insurance, according to Sam Price, Assurance Financial Solutions:
“It’s also important for a company to determine how long they would like to insure the key person. For a shorter duration, term life insurance policy can be a good fit and more cost effective. If the key person is younger and perhaps an owner who intends on being with the company for a long period of time, it may make more sense to use a permanent insurance policy to protect the company’s interests.”
The benefits of permanent life insurance include:
- Simplicity: The policy has no expiration date and doesn’t have to be renewed. If the key person named in the policy leaves the business, the policy can be bought with riders so that the insured’s name can be changed if the key person leaves the company or retires.
- Incentivizes a Key Employee: You can incentivize a key employee by allowing him or her to share in the policy’s cash value. Some businesses use a deferred compensation arrangement. The key person foregoes some portion of his or her income while employed and the business pays for the premiums. When the key person retires, the business can use the cash value built up in the policy to pay a monthly retirement benefit.
- Future Financial Flexibility: The company can borrow against the cash value in the policy if it’s in a cash crunch.
Some term life insurance policies are convertible to whole life insurance, so check with your insurance agent or broker to see if you’ll be able to switch and when.
Key Man Insurance Taxation
It’s important to understand the tax treatment of key man insurance. If 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. In other words, a $1 million policy means the business will get $1 million if a valid claim is filed.
However, 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. 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.
Under the Pension Protection Act of 2006, businesses that own life insurance policies on employees of a business must do all of the following:
- Notify the employee in writing of the amount of coverage.
- Notify the employee that the business is the beneficiary under the policy.
- 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. Your insurer will usually provide you with an Employer Notice and Consent Form to obtain the necessary consent.
We always recommend checking 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.
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.” Find out more info at IRS.gov. Note, however, that if you choose to purchase disability coverage on a key person, you may be able to deduct those premiums.
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, and premium payer for the policy, as is the case with key man insurance.
Who Needs Key Man Insurance
Any business, no matter the size, will need key man life insurance if the financial success of the business significantly depends upon an owner or just a few key employees. Small businesses should not overlook this coverage. The smaller the business, the more dependent it usually is on one or two key people for its 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.
There are a few basic reasons that a business would need to buy key man insurance, according to Chris Jarvis, Founder, JarvisTower:
“Key man insurance is for any business with a key person who is important to the organization and whose untimely death or disability would cause a significant financial strain on the business. This strain could be the loss of customers or clients, time and cost of recruiting a replacement, or costs of buying out the family in the event that the death or disability triggered a buy-sell agreement. Also, if your business has any outstanding loans, the bank may require this coverage as protection.”
The Bottom Line
Key man insurance can be critical for your small business if there’s a key person who is central to its continued success. Coverage amounts and costs vary. 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 year.
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 get the coverage you need without overpaying, we recommend comparing more than a dozen companies at once at Policygenius. Look at key man policy coverages and costs side-by-side and pick the policy that’s right for you.