Key person insurance: Overview, definition, and example
What is key person insurance?
Key person insurance is a type of life insurance policy that a business takes out on a key employee, such as a founder, executive, or other highly valuable employee. The business is the beneficiary of the policy, and in the event of the employee’s death or disability, the insurance payout is used to help the company recover from the loss. This type of insurance is designed to protect the business from financial losses caused by the absence of a key individual whose knowledge, skills, or relationships are critical to the success of the company.
In simpler terms, key person insurance is life insurance taken out by a business on a key employee, with the company receiving the payout if that person is no longer able to work.
Why is key person insurance important?
Key person insurance is important because it helps protect a business from the financial impact of losing an employee who plays a critical role in its operations, leadership, or success. The death or disability of a key person can disrupt business operations, damage client relationships, or result in financial instability. The insurance payout can be used to cover immediate expenses, hire a replacement, or help the business navigate through a period of transition. It can also help reassure investors, lenders, and clients that the business is prepared for unforeseen circumstances.
For SMB owners, key person insurance provides peace of mind by ensuring that the business can continue operating smoothly if a critical team member is unexpectedly lost.
Understanding key person insurance through an example
Let’s say you run a small tech startup, and the CEO is the driving force behind its product development and customer relationships. If the CEO were to unexpectedly pass away, the company could suffer significant financial and operational disruptions. To protect the business, you take out a key person insurance policy on the CEO, with the company named as the beneficiary. If the CEO passes away, the insurance payout helps cover the cost of finding and training a replacement, as well as mitigating any financial setbacks caused by the sudden loss.
In this case, key person insurance helps safeguard the business against the unexpected loss of a key individual.
Example of a key person insurance clause in a business agreement
Here’s an example of what a "key person insurance" clause might look like in a business agreement:
“The Company shall maintain a key person insurance policy on the life of [Key Person], with the Company named as the beneficiary. In the event of the death or disability of [Key Person], the insurance proceeds will be used to cover the costs of business transition, including the recruitment and training of a replacement.”
Conclusion
Key person insurance is a vital tool for SMB owners to protect their businesses against the loss of key employees whose roles are critical to operations and success. By ensuring that the business has a financial safety net in the event of an unexpected loss, key person insurance helps businesses stay stable and continue to grow, even during challenging times. For business owners, securing this type of insurance is an important step in managing risks and safeguarding the future of the company.
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.