# Key Person Insurance: Essential Guide for Businesses

![Key Person Insurance: A life insurance policy that a company purchases on the life of an owner, a top executive, or another individual considered critical to the business.](https://www.investopedia.com/thmb/x82tW4nVi5LNGXqen1RljBVSJRo=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/keypersoninsurance.asp-final-8b538bb0719d4861ae2ebfcf53c898ad.png)

*To determine the need for key person coverage, leaders should consider who is irreplaceable short-term. — Zoe Hansen / Investopedia*

> **Definition**
>
> Key person insurance is a life policy bought by a business on an essential employee, with the company as the beneficiary, to protect against financial loss if the employee dies or becomes incapacitated.

## What Is Key Person Insurance?

Key person insurance is an important [life insurance](https://www.investopedia.com/terms/l/lifeinsurance.asp) policy for businesses. A company buys a key person policy on an owner, top executive, or critical individual, protecting them against financial risk.

The policy covers costs during the transition period following a key person's loss. Business continuity is supported by covering recruitment and other expenses.

Key person insurance is recommended if the loss of a leader would harm finances. The policy is considered a safety net to maintain business operations post-crisis.

### Key Takeaways

*   Key person insurance protects a business against the financial impact of losing a vital member, such as an owner or top executive.
*   The company purchases the insurance, pays the premiums, and receives the death benefit if the key person dies.
*   Benefits from the policy can be used to cover recruitment and training costs, pay debts, and ensure business continuity.
*   Coverage can be more affordable through term life policies but depends on factors like the insured's health, age, and company's industry.
*   Recommended coverage is often eight to 10 times the key person's salary or estimated financial value to the business.

## The Benefits and Necessity of Key Person Insurance

Key person insurance provides a financial cushion if losing a key individual would hurt the company. The [death benefit](https://www.investopedia.com/terms/d/deathbenefit.asp) essentially buys the company time to find a new person or to implement other strategies to save (or shut down) the business.

In small businesses, the key person is often the owner, founders, or key employees. The key factor is if the person's absence would harm the company's finances. If this is the case, key person insurance is definitely worth considering.

> **Important**
>
> In addition to life insurance, key person insurance is also available as disability coverage in case the individual is incapacitated and no longer able to work.

## How to Implement Key Person Insurance in Your Business

For key person insurance, a company purchases a life insurance policy on certain employee(s), pays the [premiums](https://www.investopedia.com/terms/i/insurance-premium.asp), and is the [beneficiary](https://www.investopedia.com/terms/b/beneficiary.asp) of the policy. In the event of the person's death, the company receives the policy's death benefit.

That money can be used to cover the costs of recruiting, hiring, and training a replacement for the deceased person. If the company can't continue, it can use the funds to pay debts, repay investors, give severance benefits, and close orderly. Key person insurance offers alternatives to immediate [bankruptcy](https://www.investopedia.com/terms/b/bankruptcy.asp).

To determine the need for this coverage, leaders should consider who is irreplaceable short-term. In many small businesses, it's the owner who does most things, such as keeping the books, managing employees, handling key customers, etc. Without this person, the business can come to a stop.

### By Any Other Name

Key person insurance is also called "key man insurance," "key woman insurance," and "business life insurance."

## Types of Risks Covered by Key Person Insurance

Key person insurance can cover a company against a range of risks. For example, it may provide:

1.  Insurance to protect profits—for example, offsetting lost income from lost sales or losses resulting from the delay or cancellation of any business project involving a key person.
2.  Insurance designed to protect shareholders or partnership interests. Typically, this enables the surviving shareholders or partners to purchase the financial interests of the deceased person.
3.  Insurance for anyone involved in guaranteeing business loans or banking facilities. The value of insurance coverage is arranged to equal the value of the guarantee.

## Evaluating the Cost of Key Person Insurance

How much insurance a company needs will depend on the size and nature of the business and the key person's role. It's worth asking for quotes on $100,000, $250,000, $500,000, $750,000, and $1 million policies and comparing the costs of each.

The cost will also depend on whether the company buys a [term life policy](https://www.investopedia.com/terms/t/termlife.asp) or a [permanent life policy](https://www.investopedia.com/terms/p/permanentlife.asp). Term life is almost always significantly cheaper.

In addition, the cost of the coverage will vary on a variety of factors, such as the health of the key person, their gender, their age, the type of policy, the amount of coverage, the type of company, its structure, and the industry it is part of.

## What Are the Benefits of Key Person Insurance?

Key person insurance financially protects a company against the death or incapacitation of its key person. The money from the insurance helps a company replace the key person and the costs associated with doing so. It can also be used to pay off debts, pay back investors, or cover any other financial costs the company may incur when losing its key person.

## How Much Key Person Insurance Do You Need?

The amount of key person insurance needed for a business will vary depending on the business and the type of role the key person plays. Purchasing key person insurance that is eight to 10 times the key person's salary is often recommended or the monetary value of the key person. The latter option can be difficult to value, but methods include the amount of revenues/profits associated with the key person or the costs required to replace the key person, which includes recruitment, training, and the loss of revenue in the time it takes to replace the individual.

## Who Pays for Key Person Insurance?

The company that purchases the key person insurance is the entity that pays the premiums for the insurance. The key person does not pay the insurance.

## The Bottom Line

Key person insurance secures the financial stability of a company following the loss of an essential individual. The death benefit offers a financial buffer, enabling the company to recruit and train replacements or restructure as needed.

The loss of a key person can be devastating to small businesses, making key person insurance crucial.

Businesses should assess their specific needs and consider factors like the key person's role, the cost of replacement, and potential financial obligations. They should also consider policy types and coverage amounts, including term and permanent life policies, based on the company’s budget and needs.

Key person insurance can also cover disability, providing added protection if the individual is incapacitated.