Glossary
Key person insurance, defined
A life or disability policy a business buys on an owner, founder or employee whose death or incapacity would cause a financial loss, with the company as owner, payer and beneficiary.
In practice
The proceeds replace lost revenue, fund a search and training for a replacement, reassure lenders, or buy time to wind down. Lenders sometimes require it as a loan condition. It is usually term life sized to a few years of the individual's contribution to profit, though permanent forms can double as a company asset. The insured must consent in writing. Premiums are generally not deductible and the death benefit is generally received free of income tax, though employer-owned policies have notice and consent requirements worth confirming with a tax advisor. It is not a buy-sell arrangement, though the same policy is often used to fund one.
A worked example
Suppose a design firm's founder brings in most of the client work. The firm buys a ten-year term policy on her for $2,000,000 at $2,400 a year. If she dies in year four, the firm receives the benefit, keeps paying staff while it rebuilds the client list, and settles a line of credit the bank had tied to her. Hypothetical.
Applies to: Life InsuranceBusiness Owners Policy (BOP)