Key Person Insurance is vital for small business

BY: ANDREW STEWART 

Without proper life insurance protection, the sudden death or disability of a founder could derail a company, resulting in layoffs, bankruptcy and possibly the collapse of the business itself. From the day an entrepreneur starts a business, he exposes himself to certain risks. Even before the first employee is hired, a business is at risk, making it important to have the right insurance in place. When launching a business, entrepreneurs are supported by investors, teams and their families who all share in their company’s vision, but these groups are also the most at risk should that vision be cut short by an unforeseen event.

Entrepreneurs are natural optimists, but it is remarkably common for them not to take out life insurance. In fact, according to LIMRA’s Life Insurance Barometer study, 41% of business owners and individuals do not have life insurance, meaning they likely don’t have the necessary funds earmarked to support their business, employees and their loved ones in the event that something happens to them. No one likes to think about the unexpected events that could occur, such as an injury, disability or even death, to yourself or a business partner, but a good business person should anticipate all possibilities whether they are positive or negative.

Key person insurance is simply life insurance on the key person in a business. This person may be a partner, majority stockholder or someone with unique expertise or a business-critical skillset. These are the people who are crucial to a business, the ones whose absence would sink the company.

Here’s how key person insurance works: A company purchases a life insurance policy on its key employee(s), pays the premiums and is the beneficiary of the policy. If that person unexpectedly dies, the company receives the insurance payoff. The purpose of key person insurance is to help the company survive the blow of losing the person who makes the business work. The company can use the tax-free insurance proceeds for expenses until it can find a replacement person, or, if necessary, pay off debts, distribute money to investors, pay severance to employees and close the business down in an orderly manner. In a tragic situation, key person insurance gives the company some options other than immediate bankruptcy.

A key person policy is used to protect your business, not the key employee. If the key person becomes disabled, key person insurance coverage proceeds can be used by the company for any purpose. Premiums are based on several factors, including the key employee’s age, physical conditions, and health history. The amount of coverage also affects the premium.

If the company is a sole proprietorship and employs just you and no other employees or has no other people who depend on it, the key person insurance isn’t as necessary. You’ll notice I didn’t mention your family. Don’t confuse key person insurance with personal life insurance. If you have a spouse and/or children who depend on your income, then you should have personal life insurance for that purpose.

There is a wide range of insurance types that you have access to protect your business. Here are some other types:

• Professional liability insurance
• Property insurance
• Home-based businesses
• Product liability insurance
• Business interruption insurance

Check with your insurer to find out what forms of insurance are advised for your type of business and put those plans in place as soon as possible.