A key person is someone whose skills are essential to the success of the business, such as an owner, partner, or employee.
If something fatal were to happen to this person the business would experience major setbacks, such as loss of key accounts, diminished earnings, and unexpected replacement costs. Life insurance can protect against the untimely death of a key person and create an influx of cash into the business during this transitional period.
Most key person life insurance is structured with the business being the owner and beneficiary of the life insurance policy. The death benefit amount a company can purchase on a key person depends on the insurance company’s underwriting guidelines but a general rule of thumb is a maximum of ten times the key person’s salary. For example, if a key person makes $100,000 per year the maximum amount of life insurance an insurance company will offer is $1,000,000.
The face amount of the life insurance policy should be determined by the key person’s contribution to the company. The correct amount of life insurance on a key person creates liquidity in the event of an unexpected death. Think about it from a standpoint of how much revenue the key person generates for the company and how much it will cost to replace them. Without life insurance the business could suffer serious financial loss and may have to borrow money to train a replacement. An inexpensive term life insurance policy could be the difference between a business flourishing or going bankrupt.