Key person life insurance (often called “key man” or “keyman”) is a type of life insurance available to companies that have vital employees whose absence from work would mean a discontinuation of day to day operations.
This is usually the case when the person has a special skill set that cannot be easily replicated, making their presence at the company crucial to the company’s profitability and even its lifespan.
A key man could be an early executive or founder, but not necessarily. It could be someone who is a master at a craft. A good example would be a master coffee roaster. If that coffee roaster was to die unexpectedly it would be difficult for the company to replace his skills. Someone else is likely trained to do the work in an emergency, but there may be a drop-off in quality that could ultimately impact sales.
Key man life insurance may not make sense for every company. Notable exceptions would be one-man operations and large companies with thousands of employees.
Key person insurance is available in both term life and whole life variations, with lots of customization available.
We’ve put together a list of 10 reasons that most companies should consider purchasing key person insurance to protect themselves in the event that something tragic happens to a key employee.
1. Resolving Debt
Imagine a situation where one of your employees holds the formula for a proprietary beverage. As a company you’ve decided to keep the formula a secret as you wait to have your patent receive a pending status. Due to the very competitive nature of your industry, you know very well that if the secret formula was to get out it would mean certain death of any future prospects for your company. And so without great fanfare, it is decided that very few people should be kept in the loop. At the time this looks like a very wise idea. No?
If something were to happen to the person holding the formula (key person) and somehow the formula didn’t receive a pending status from the United States Patent and Trademark Office, how would you deal with the situation?
Even if you had a lab full of scientists capable of tweaking the formula so as to get your patent and become the envy of your industry, where would you start? The key person wouldn’t be able to help you out.
To make matters worse, in order to come up with your winning recipe your company had borrowed heavily and your creditors are knocking. Your only option it seems would be to file for bankruptcy.
Key person insurance would provide you with enough funds (depending on the specifics of your coverage) to pay off the debt. Your product may or may not make it, but at least you’ll be debt free.
2. Continuance of Operations
The creation of proprietary products means that a company needs to hire personnel with a specialized skill set. Even then, more training may be required for employees that will play a key role in the development of your product or service. Needless to say, this is usually a resource-intensive endeavor. Scarce resources mean that training will not be available for everyone so a company may find itself inadvertently placing all of its eggs in one basket.
So how can key person life insurance help you in the unfortunate event that your key person dies? The money from the payout can be used to recruit and train capable individuals to continue from where the last man left off. Instead of having to cease operations your company would slow down its operations at most.
3. Improves Chances of Getting VC Financing
Most, but not all, venture capitalist (VC) firms require key person life insurance when issuing the first round of financing. This convinces the VC that their investment will be safe in the event that the key person is no longer in a capacity to run the firm’s operations. The key person life insurance is usually taken out on the CEO, CTO, or both.
This allows a VC to be able to recoup part of their investment should something happen.
4. Morale Booster
If the company ends up taking out a key person life insurance policy on an individual or number of people, it means that the company sees them as a crucial part of the company. It is a tacit acknowledgment of their importance.
Instead of viewing themselves as a liability to the company in the case of unforeseen circumstances, such individuals may get a morale boost from their recognition as a key part of the company. By extension, this may lead to their happiness in the workplace.
According to research conducted by Warwick University, happy employees are 12% more productive than their counterparts. Decreased productivity is estimated to cost US companies between $450 – $550 billion dollars on an annual basis.
The argument, in this case, is that people who are involved in startups are already passionate about their projects. By taking out a key man policy on them and showing them how important they are to the company can only enforce their resolve to succeed.
5. Cost Free for The Employee
Premiums are paid by the company, which is also the beneficiary and receives payouts in the event that the key person dies. Since the key man has no financial obligations towards the policy, they have no reason to object to such a policy being taken out on them as it’s not a burden to them or any of their dependents.
It also might serve as a morale booster to know that the company is incurring additional costs due to the crucial role they play in the company.
Sample Key Person Life Insurance Rates
Below quotes are priced per month based on a 45 year old male at the Preferred health class. Rates shown are not an official offer of insurance and require qualification.
|Policy Face Amount||10-Year||20-Year||30-Year||UL to Age 100|
Below quotes are priced per month based on a 45 year old female at the Preferred health class. Rates shown are not an official offer of insurance and require qualification.
|Policy Face Amount||10-Year||20-Year||30-Year||UL to Age 100|
6. No Long Term Obligation
Keyman life insurance policies were conceived in a long gone era when most employees stayed with the same company until retirement. This, of course, is no longer the case. According to CompData surveys, voluntary employee turnover in 2015 was almost 11.6%. One-third of new hires quit their job after 6 months.
In the event that a key person decides to leave a company before the end of the cover period for key person life insurance, the company would NOT want to be in the tough situation of being forced to make premium payments on an employee no longer working there. Fortunately, this is not a concern.
The company that owns the key man policy can cancel and quit making payments at any time, for any reason.
On the flip side, the company gets the benefit of locking in the rates for the duration of the policy they choose. For example, if a 20-year level term policy is purchased, the rates cannot rise for 20 years.
It’s good to be in the position of the business owner with keyman life insurance. The company is not locked in or obligated to continue however the insurance carrier is.
Under Section 37 (1) of the Income Tax Act, any company purchasing keyman insurance for its employee may claim a deduction for any premium payments as a business expense.
The benefits also extend to the payouts. However, that is contingent upon a number of conditions being met:
- The employee has to be notified in writing that their employer intends on taking a life insurance policy on them and the maximum amount applied for on their life
- The employee is also required to give consent in writing that the employer has the option of keeping the policy in force even after they cease being employees
- The employee must be notified in writing that the employer will be the beneficiary of all or part of the proceeds.
Unfortunately, if these conditions are not met prior to the issuance of the keyman life insurance policy, the proceeds will not be tax exempt.
Not all keyman life insurance policies mature after a person’s death. Sometimes a partial payout will be made to cover healthcare costs of the insured. This includes:
- If the insured suffers from invasive cancer, a first heart attack, bypass surgery, first angioplasty, stroke etc, depending on the policy the insurance company may pay up to $25,000 in cash to the company which owns the policy.
- In the event that the key man suffers from a chronic disease that incapacitates them requiring the need for assisted living or home health care, the insurance company can pay up to $250,000 depending on the policy.
9. Stock Buyouts
If the key man was a major shareholder in the company, the surviving partner(s) can use the life insurance proceeds to buy back stock from the estate or the key man’s heirs. This is often beneficial to everyone involved. It allows the surviving shareholders to retain full control of the company and the key man’s estate or heirs are well compensated.
10. Employee Incentive
If whole life insurance is purchased on the key man, the cash value that builds can be given to the key man when he leaves or to his estate if he’s deceased. Since this grows over time, it’s an extra incentive for the key man to remain with the company.
Factors That Affect Key Person Insurance Rates
Our infographic explains the major factors that influence the rate that a company will actually pay for key person insurance.
Key person life insurance is a pretty simple concept, but businesses don’t utilize it enough. There are plenty of things that could go wrong in the event that a key person is no longer able to perform. Key person insurance is designed to protect companies against bankruptcy or even business closure. Often times, if a company relies on a key person (or more than 1 key person) then key person life insurance is the right thing to do.
Insurance companies offer slightly varying policies and as a company, you’ll definitely want to enlist professional help. Take time doing some due diligence before settling down on any given policy. The future of your company could depend on it.
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