Key man life insurance could save your business

By Mye-Yun Lee

Contemplating the death of your company leaders is pretty dismal subject matter. But think of the consequences — businesses have bitten the dust due to the death of just one employee. Key man life insurance is an affordable way to prevent your business from sinking after a critical employee passes away.

Key man life insurance works like individual life insurance — when the insured dies the policy pays out a benefit. Instead of an individual insuring himself or a family member, however, the business owns the policy and pays the premium. If the insured dies, the business is the beneficiary and will receive the policy payout.

To ensure the livelihood of the company, the money can be used to pay off debt and keep creditors at bay, find a replacement for the deceased, buy out the deceased's shares in the company (buy-sell agreement), or even help to supplement the income of the deceased's family.

The founder or owner of a business shouldn't immediately be considered the right or only candidate for a key man life insurance policy. Rank is less important than who the critical employees in your business are. Your business couldn't function day to day without the founder, but it also may not be able to survive without your revenue-generating sales team or without the precious relationships a business development employee has with your vendors.

If you still think you and your employees are invincible and key man life insurance isn't for you, you may be forced to reconsider. Oftentimes investors and lenders will insist you purchase a policy to protect their own investment. Another reason to consider? Policies are very affordable.

How does it work? An insurance agent appraises the person you want to insure and sets a premium on that person. The premium is based on the current health of the employee, his (or her) health history, age, and salary. Keep in mind that not everyone can be covered — the insurance agent does have the right to deny coverage.

Structurally, many key life insurance polices are set up as permanent polices that build cash value over time. However, a smaller business can opt for a more affordable term life policy where premiums are paid until the employee retires or leaves the company, and then it can be transferred to that key person's replacement.

In general, coverage ranges from matching the key person's base salary to as high as 15 times his salary — or it can be a flat amount. Most small businesses find they do best with a payout of two to three times the key employees' salary, at a cost of less than $1,000 per year for the premium. A permanent policy will cost more, about 3 percent the face value of the policy.

It's not fun to think about, but key man life insurance is an affordable way to ensure the future of the business these critical employees you're insuring have worked so hard to make successful.

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