Key Man Insurance: Cost, Coverage & Providers

Key man insurance is life and disability that benefits a business if an important employee, like an owner or founder, dies or becomes disabled. The business buys the policy, pays the premiums, and receives the payout in case of injury, illness, or death. A $100,000 policy for key man insurance starts at $100 per month.

Key person insurance is more complicated than just buying life insurance because the policy is owned by and benefits the business. Owners must make sure the proper agreements are in place so the business can receive the 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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What Key Man Insurance Covers

Key man insurance covers business interests if the owner, founder, or an essential employee can no longer perform his or her duties. An essential employee is often defined as someone who brings in a large percentage of the profits or who has special knowledge or a unique talent that would be difficult to replace.

There are four areas of loss that key man insurance covers:

• Losses related to extended absences: Pays to recruit new talent or temporary staff
• Lost profits: Offsets lost sales, canceled projects, and lost business opportunities as well as the loss of specialized skills
• Shareholder or partnership protection: Allows existing shareholders or partners to purchase the key person’s shareholdings or interests, sometimes referred to as buy-sell insurance
• Business loan protection: Covers the value of any loans or guarantees the key person was integral in securing

Key person policies may include life insurance, disability coverage or both. If the key person dies or becomes disabled, the business receives money to help offset the losses that follow and help it survive the difficult transition. For that to work, businesses should purchase key man life insurance policies that extend through the duration of the key person’s usefulness to the business.

What Key Man Life Insurance Doesn’t Cover

In some cases, the insured’s death may not be covered by a key man life insurance policy. This is because life insurance policies typically have exclusions that limit coverage. The most common key man insurance exclusions are:

• Fraud
• Misrepresentation
• Suicide, usually within the first two years of the policy

Life insurance coverage, including that found in key person insurance, also have contestability periods where the insurance company can investigate and deny claims, even if the cause of death is unrelated to the reason for denial. Contestability periods usually last two years.

Additional Limitations on Key Person Insurance

As a type of employer-owned life insurance, key person insurance falls under a federal law that sets a couple of limitations. It’s important for business owners to know:

• Coverage is limited to five to 10 times the insured person’s gross compensation
• The insured must sign a consent agreement, or the business will be taxed on the death benefit

As the policyholder, the business owner must report any employer-owned insurance policies by filing Form 8529 with the IRS.

Key Man Insurance Providers

Policygenius

Policygenius is a great choice for sole proprietors and small partnerships that don’t need sophisticated and expensive buy-sell agreements. The company provides access to more than 25 top life insurance carriers, making it easy to compare rates for key person insurance. Moreover, Policygenius’ partnerships mean it has more options for startups that usually struggle to secure coverage.

Nationwide

Nationwide is a large insurance carrier that presents an ideal solution for small business owners who would like their key man insurance to accumulate value. The company offers two key person products, both of which are universal policies so a portion of your premium goes toward a tax-deferred savings vehicle. In particular, small business owners who want fixed premiums should consider Nationwide’s Future Executive UL product that can emphasize the death benefit or cash accumulation.

Petersen International Underwriters (PIU)

Business owners who have been denied by other carriers should work with Petersen International Underwriters (PIU). As a specialty carrier, PIU has developed flexible underwriting guidelines that allow it to offer cover key people traditional insurers often decline, including those with unique work situations, impaired health, or risky hobbies. Business owners can opt for benefits in monthly installments or one lump sum.

Embroker

Getting key person insurance from digital broker Embroker is the right choice for small business owners who want coverage quickly. Its platform is easy to use, and the application takes minutes to complete. Moreover, business owners who use Embroker can get additional coverage, including other essential small business policies, and manage them from their Embroker accounts.

Who Needs Key Man Insurance

Any business, no matter the size, may need key person insurance if the financial success of the business depends on one or two people, yet small businesses often overlook this coverage. This may be a mistake because smaller businesses may be more likely to depend on one or two key people for success.

Business owners get to choose who is an essential employee, and for small businesses, that’s usually the owner. But it can also be the head chef in a thriving restaurant or the programmer who’s responsible for product development. Additionally, banks and Small Business Administration (SBA) lenders may require key person coverage before they’ll extend a loan, and businesses may need a policy if they plan to go public or are considering a merger.

Types of Key Man Insurance

There are two main types of key person insurance: life and disability. Beyond that, key person insurance can be structured in several ways to protect the business’ financial interests.

Term Life Insurance

Term life insurance is a policy that only covers a person’s life for a set time, often five, 10, 15, 20, or 30 years. This coverage is usually less expensive than permanent life insurance because it has a finite end date within the normal life expectancy of the insured. Most key person term insurance policies use a term that covers the employee’s life through retirement.

Permanent Life Insurance

Permanent life insurance is a policy that remains in force as long as the policyholder, such as the business, continues to pay premiums. Policies can be broken down further into whole life, variable life, and universal life insurance. These policies have a cash savings value in addition to the death benefit, which a small business can use as collateral for a loan.

Return of Premium Life Insurance

Return of premium (ROP) policy is a type of term life 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. This type of policy a low-risk way of protecting life. ROPs can also be sold as a rider to a traditional term life policy.

Key Man Disability Insurance

Disability insurance pays either a single lump sum or monthly benefits if the insured person is temporarily unable to work due to injury or illness. The business can use the payout to demonstrate financial stability to stakeholders, hire temporary help, and offset other financial losses attributed to the key person’s absence.

Key Man Insurance Costs

Key man insurance costs vary depending on the type of policy, the amount of coverage, and the health and habits of the person being insured. Premiums range from less than $100 to a few thousand dollars per month.

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

• Key person’s age, gender, health, and habits: Key man life insurance costs are partially based on life expectancy, so people with pre-existing medical conditions or risky hobbies like scuba diving often pay more. Additionally, men usually pay more than women for term coverage because their average life expectancy is shorter.
• Company size: Bigger companies worth more need more coverage, increasing the premium costs.
• Industry: Premiums may be higher in riskier industries because of increased risk for premature death or disability.
• Amount of coverage and policy term: A policy insuring a key person for $100,000 will usually cost less than one insuring her for $1 million. Similarly, if you opt for a 30-year term, you will most likely pay more than if you chose a 10-year term.
• Type of policy: Because coverage lasts for a lifetime, premiums for permanent life insurance are generally about five to 10 times more expensive than term life insurance.

Typical Yearly Key Man Life Insurance Costs

How Much Key Man Coverage Do You Need?

Unless you’re getting key man insurance to satisfy a lender’s requirements, the amount of coverage is up to you. However, you don’t want to leave your business either over or underinsured. Essentially, you want to purchase enough coverage that losing your key person has as little impact on your business as possible. You can estimate that using one of three methods:

1. Multiply the key person’s compensation: With this method, you take the employee’s compensation in its entirety and multiply it by the number of people you anticipate it will take to replace the employee.
2. Estimate the cost of replacing the key person: Replacement costs may include recruiting and training a new hire as well as the potential compensation the hire might need. Compensation may be tricky to estimate if your key person is a stakeholder who took a small salary while building the business.
3. Calculate the key person’s contributions: One guideline for this is to calculate the percentage of company profits the key person contributed and multiply it by the number of years it would take to replace the individual.

Tips on Getting Key Man Insurance

Key person insurance policies are unique to each business because of the dynamic between the company’s needs and the insured’s lifestyle. For this reason, it’s important to take a systematic approach to shopping, pricing, and selecting coverage.

Weigh Your Coverage Limits & Terms Carefully

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, which can make a higher coverage limit a better value. Conversely, you want to select a term that makes sense for your situation. For example, you probably only need a 10-year term if your key employee is likely to retire in the next decade.

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 too. 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 adjust your coverage.

Consider Including a Business Exchange Rider

A business exchange rider allows the business to substitute a new employee 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 getting the rider allows businesses to skip underwriting a new key person.

Structure the Policy Correctly

The business must be the owner of the key man policy, or else a key person could change the policy beneficiary from the company to a spouse or other beneficiary. Owners also must provide written consent to make sure the policy is structured properly according to IRS rules.

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, but the coverage can be complicated. Below we’ve answered some of the additional questions about key person insurance.

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

The business owner has a couple of options if the insured key person leaves the company. The first is to surrender the policy, which means the owner sacrifices the premiums already paid. The next is to sell the policy to the key person’s new employer or to arrange a settlement by selling it to a third party. Finally, the business owner can assign the policy to the employee who replaces the old one, but only if the existing policy has a business exchange rider.

Can I deduct key man insurance policy?

Key man life insurance costs are not a deductible business expense, but key man disability premiums may be. Additionally, the benefits 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. However, the business must get written consent of the insured to receive the benefits tax-free.

Bottom Line

Key man insurance can be critical in protecting your small business if an individual is central to its continued success. Coverage amounts vary significantly but, at a minimum, you’ll need to insure for the amount of losing and replacing the employee. 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 require you to 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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