Key Employee Insurance: Do I Need It?

image of key employee working

What if your business lost much of its value overnight?

No, we're not talking about stock valuation. Instead, we're talking about what happens if one of your most important employees suddenly passes away.

Every business owner understands that it takes plenty of time and money to replace key employees. But what if you could make that transition easier with an insurance policy?

Key employee insurance provides a great way to protect your business from the unexpected. Keep reading to learn more about what this kind of insurance is and why it is so important for your business!

What Is Key Employee Insurance?

Our guide is going to help you learn all about the benefits of key employee insurance. Before we go any further, though, we need to answer a simple question: what is key employee insurance?

Basically, this is a type of life insurance that a company takes out for one of its employees. If that person should pass away while covered by life insurance, the company receives a death benefit. In turn, this money helps to pay for the lost wages and other financial losses involved in recruiting and training a replacement for the former employee.

For many businesses, this type of insurance is relatively new. But it is helpful to remember that it functions very similarly to a standard life insurance policy. The primary difference is that it is a business taking the policy out for an employee rather than someone simply taking a policy out for themselves.

Insurance By Any Other Name

Another reason that key employee insurance may not sound familiar is that this type of coverage goes by multiple names. Understanding what those names are can help you better understand what this coverage is and why it is so important.

For example, some businesses refer to this type of coverage as "key person insurance." While mild, this distinction serves as a reminder that your business can take out a policy on anyone within the organization so long as the business has that person's permission.

In some cases, a business may simply refer to this type of coverage as "keyman insurance." But the concept is the same, and this name is a reminder that you should only consider such a policy for your key employees.

How Do We Define "Key Employee?"

It's one thing to talk about taking out an insurance policy on your key employees. But it's another to answer that crucial question: who, exactly, qualifies as a key employee?

Strictly speaking, any business can determine who its own key employees are and take out an insurance policy. That is because a key employee is anyone who your business deeply relies on for its current level of success and/or future plans.

Realistically, though, key employees tend to be people like business owners and key executives responsible for developing and executing a vision for the company. Key employees may also include your top sales professionals who help generate the majority of your profits. Ultimately, though, a key employee is anyone that you determine is critical for your company's success, and you can take out policies on multiple employees at once if needed.

The Benefits of This Insurance Coverage

Now you know more about how insurance for key employees works and who you can get insurance coverage for. But if you're on the fence, you likely have another question: why is this insurance coverage so important?

The most direct reason that this coverage is so important is that it financially protects your business. While you can define "key employee" however you wish, most businesses use this designation for employees they are financially reliant on. If such an employee should pass away, this form of life insurance will financially protect your business until you have time to hire and train a suitable replacement.

This type of insurance also protects the value of your company in the eyes of investors. Shareholders can rest assured that the loss of a key employee will not financially disrupt your business. In turn, this insurance coverage also helps partners to buy out the interests of a deceased partner who was covered as a key employee.

Interestingly, key employee insurance can also help you out when your business needs to take out a loan. That is because with this insurance in place, you can take out a lien on a key person so that a creditor has the collateral needed to process a loan.

The final reason is related to the first: financially protecting the company against the death of a key employee is also a way to provide safety and stability to other employees. In other words, employees don't have to worry about mass layoffs in the event that a top sales associate or important executive should unexpectedly pass away.

How Much Does This Insurance Cost?

If you're considering getting key insurance for important employees, then you now have a very straightforward question: how much will this coverage cost? But as with all forms of life insurance, there is no true "one size fits all" answer.

For example, the size of the policy plays a role in the premium you pay. The type of business you run and the relative size of that business are also major factors. And insurance carriers will also closely examine both the role of the key employee in question and different factors that affect their health (including their age and health).

Because of all these different factors, no two key employee insurance policies are the same. Fortunately, a reliable insurance company can answer all of your questions and help devise a policy that best suits both your needs and your budget.

What Type of Insurance Is This?

Previously, we touched on the fact that insurance for key employees is very similar to standard life insurance policies. But there are different types of life insurance policies out there. And it comes to insuring key employees, what kind of life insurance are you likely to get?

As with traditional life insurance policies, you can usually choose between two forms of coverage. And these forms of coverage are term life insurance and permanent life insurance.

Term life insurance, as the name implies, provides coverage for a specified term. Typically, you can take out a policy that provides coverage for somewhere between 10 and 30 years of coverage. The death benefit pays out if the employee dies during the coverage term, but after that term, your company would need to take out a new policy to continue the coverage.

By contrast, permanent life insurance provides coverage for the rest of an employee's life. Businesses receive a death benefit when the employee dies, and the policy gathers cash value over time that your business can borrow against as needed.

Which Is Better For My Business: Term Life Insurance or Permanent Life Insurance?

Now you know that your business has different options when it comes to life insurance coverage for key employees. But which choice is better for your business: term life insurance or permanent life insurance?

Each type of insurance has its own benefits and drawbacks. For example, term life insurance lets your business potentially lock in a low premium for a key employee for up to 30 years. But when the term ends and you want to continue coverage, the new term policy will likely be more expensive because the employee is older and potentially has more health problems.

Permanent life insurance means you never have to worry about the employee re-qualifying and the rates going up. And the ability to borrow against the cash value of the policy may be useful for your business. But permanent life insurance tends to be more expensive, and the payout is usually smaller than with term life insurance.

Bottom line: which form of life insurance is better? While every company must decide for itself, most businesses prefer to take out term life insurance because it offers a "sweet spot" of lower premiums and a higher death benefit. However, it's important to take out coverage for as long as you need or you may end up losing that lower premium when you reach the end of the term and apply for a new policy.

Determining the Right Amount of Coverage

Earlier, we touched on the fact that how much coverage you get plays a role in how much you pay for your premium. Obviously, a policy with a large payout is going to cost more than a policy with a smaller payout. With that in mind, how much coverage do you really need?

Once again, there is not a "one size fits all" answer to this because you would likely need different levels of coverage for different key employees. For example, you would likely need different coverage amounts for a business partner than you would for a sales associate.

However, there are some good rules of thumb you can follow for determining a coverage amount. You can start by reviewing the employee's salary and then multiply that salary by five or more. This can help provide a safe amount so that you won't be rushed to replace a key employee and can financially weather their loss.

In addition to multiplying someone's salary by five, you should also try to determine roughly how much money they bring into the company each year. If you lose someone like your top sales associate, you are also losing out on all the profit they might reasonably bring in within the coming months and years. But getting a coverage amount large enough to handle this loss can protect your business from the sudden death of such an employee.

Long story short? Every policy is different, and your best bet is to speak with an experienced life insurance company to discover a policy that is best for your needs and the needs of your company.

Who Owns the Policy?

We have noted that a key employee insurance policy is very similar to a traditional life insurance policy. But with a traditional policy, the owner is typically the same person that is being covered. When your business takes out a policy, then, who actually owns it?

While it is possible to set the insurance policy up differently, most key person insurance policies make the business the owner of the policy. This typically makes the entire process easier and makes processing a payout go much more smoothly (more on this in a minute).

Of course, the fact that the business retains ownership of a life insurance policy on an employee is the primary reason that your business must get consent from the employee first. Without their explicit permission, you cannot take out a key insurance policy and receive all of the potential benefits from this coverage.

Who Benefits From the Policy?

Now you know who owns the key employee insurance policy that your business takes out. But should an employee that is covered pass away, who is the beneficiary of the death benefit?

Once again, it is possible for your business to structure the insurance policy differently. But most of the time, the company that takes out the policy on a key employee is the direct beneficiary of any payout from that policy.

Obviously, no business ever wants to lose an important employee. But with the right key employee insurance plan in place, such a loss doesn't have to financially disrupt your company.

Your Next Move

Now you know what key employee insurance is and why it is so important. But do you know where you can find a policy to best protect your business today?

Here at Hummel, we specialize in all things insurance. To see how we can help protect the company you have spent years building up, all you have to do is contact us today!

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