Key man insurance: Overview, definition, and example
What is key man insurance?
Key man insurance, also known as key person insurance, is a type of life insurance policy that a company purchases on the life of a key employee or executive who plays a critical role in the company’s success. This insurance provides financial protection to the company in case the key person becomes disabled or passes away. The company is typically the beneficiary of the policy and can use the payout to cover any losses or costs associated with replacing or finding a successor for that key individual.
In simpler terms, key man insurance helps a business protect itself financially if something happens to an important person whose skills, knowledge, or leadership are crucial to the company’s operations and success.
Why is key man insurance important?
Key man insurance is important because many small and medium-sized businesses rely on a few key individuals whose expertise or leadership is critical to the company’s survival and growth. If something were to happen to one of these individuals, the company could face significant financial loss, disruption, or difficulty in maintaining operations.
Having key man insurance helps mitigate these risks by providing funds to help the business recover from the loss of a key person. This insurance can also help maintain business continuity, pay off debts, or cover the costs of recruiting or training a replacement for the key employee.
Understanding key man insurance through an example
Imagine a small tech startup that relies heavily on its CEO, who is responsible for product innovation, investor relations, and overall company strategy. The business purchases a key man insurance policy on the CEO’s life, with the company as the beneficiary. If the CEO were to unexpectedly pass away, the company would receive a lump sum from the insurance policy to help cover any financial losses, hire a replacement, or manage the transition period without losing momentum.
In another example, a family-owned business might purchase key man insurance on the founder, who holds unique knowledge about the company’s operations and legacy. If the founder were to retire or unexpectedly pass away, the business would have funds to ensure a smooth transition to the next generation or to hire an outside expert to take over leadership.
Example of a key man insurance clause
Here’s how a key man insurance clause might appear in a business agreement:
"The Company agrees to maintain key man insurance for [Employee Name], who is recognized as a critical member of the organization. The policy shall be in the amount of [$X], with the Company as the beneficiary. In the event of [Employee Name]’s death or permanent disability, the Company shall use the proceeds from the policy to cover expenses related to the transition of leadership, replacement, or other operational costs as necessary."
Conclusion
Key man insurance is a crucial financial tool for businesses that depend on a few individuals whose skills, knowledge, or leadership are essential to their success. It provides the business with financial protection and helps ensure continuity in the event of the unexpected loss of a key person.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.