Safeguard Your Small Business With Key Employee Insurance

Penn Mutual

By Penn Mutual | December 26, 2017

Good employees are the foundation on which successful small businesses are built. The best employees bring an unparalleled degree of knowledge and expertise to the table that can be difficult to replace.

One of the most important aspects of owning a small business is protecting your assets, and that includes the most valued members of your team. That’s where key employee insurance comes in.

What Is Key Employee Insurance?

Key employee insurance, also referred to as key man or key person insurance, is an insurance policy that’s designed to protect your business from financial losses if one of your key employees dies or becomes disabled. Key employee policies may include disability coverage, life insurance coverage, or both. But who’s considered a key person?

The answer to this is different for every business, but generally, a key person is someone who:

  • Has a specialized skill set, knowledge base or talent that’s critical to the operation of your business; OR
  • Has developed a significant client base that you wouldn’t want to risk losing; OR
  • Drives a substantial amount of revenues for the business

Following that definition, key employees could include yourself, as the owner; your partner or partners; founding members of the management or leadership team; top salespersons; or anyone else whose loss would be keenly felt by the business.

Why Purchase Key Employee Insurance?

Typically, with key employee insurance, the business itself serves as both beneficiary and owner of the policy, and is responsible for paying the premiums. When a claim is filed, the proceeds are paid directly to the business. Having an infusion of capital after the loss of a key employee yields several benefits:

Smooth the transition to a new employee.

When a key person passes away or becomes disabled and can no longer have hands-on involvement in the business, that creates a void that must be filled. Doing so means the business now has to bear the cost of recruiting, hiring and training a new employee to take their place.

Key employee coverage allows you to cover those costs without directly impacting your business’s cash flow. It could also help to make up for any temporary dip in revenue associated with the loss.

Help you keep your long-term plan intact.

Key employees can play an instrumental part in helping to fuel growth and expansion within a small business. If that person dies or becomes disabled, that could jeopardize your future plans for the business. But that impact may be minimized if you have insurance in place to protect against the worst-case scenario.

Provide reassurance to your creditors.

If you use any type of financing in your business—such as a business loan or line of credit, vendor line of credit or a business credit card—knowing that you’ll be able to continue making payments on those debts after losing a key employee is invaluable. With key employee insurance, you could maintain the payments or clear the debt altogether, preserving both your reputation with the lender and your business’s credit rating.

How Much Key Employee Coverage Is Needed?

The right amount of key employee insurance varies from one business to the next. There are, however, some basic criteria you can use to evaluate what size policy you need:

  • Replacement costs: How much would it cost you to hire and train someone to replace a key employee? How much revenue might be lost in the interim?
  • Business income: How much profitability does the key employee add to your business? Multiply this figure by the number of years it would take for a replacement employee to contribute that same amount.
  • Compensation: How much is your key employee earning? Multiply this factor by five or 10 to give you a ballpark idea of how much key employee insurance is necessary.

A trusted financial adviser can help you explore your options for key person insurance and guide you towards a policy that best fits your business needs.


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