Insurance solutions
Key person insurance
Key person insurance is a life insurance policy a business owns on someone it cannot easily replace. If that person dies, the death benefit is paid to the company — money that buys time to stabilise, recruit, and reassure the people the business depends on.
The basics
What key person insurance is
The business applies for the policy, owns it, pays the premium, and names itself as the beneficiary. The person insured is whoever the company would struggle most to lose. If that person dies while the policy is in force, the company receives the death benefit.
The money is not earmarked. It can cover payroll while revenue dips, repay a loan the bank calls in, fund a search for a replacement, or simply keep the doors open through a bad quarter that would otherwise be terminal.
For a lot of small businesses — especially first-generation ones — this is the gap between a hard year and a closed company. If one person's absence would stop new work from coming in, that exposure is worth naming and covering.
Why it comes up
Why lenders and partners often require it
Plenty of business owners first hear about key person coverage from someone other than an insurance agent.
- Lenders. Banks and SBA lenders frequently require life insurance on the principal as a condition of a loan, often assigned as collateral. If the borrower dies, the lender is repaid rather than pursuing the estate or the business.
- Investors. Outside capital often comes with a requirement to insure the founder whose relationships or expertise the valuation depends on.
- Partners. A co-owner does not want to end up in business with their partner's heirs. That is what a funded buy-sell agreement prevents.
- Major clients. Some contracts require continuity assurances before awarding work.
Being asked for it under deadline is the expensive way to buy it. Underwriting takes weeks, and a rushed application rarely lands the best rate class.
Coverage amount
How much coverage a business actually needs
There is no formula that fits every company. Underwriters expect a business justification for the amount, and these are the usual starting points:
- A multiple of compensation. Five to ten times the key person's salary and bonus is a common anchor, and easy for an underwriter to accept.
- Contribution to profit. Estimate the share of gross profit attributable to that person, then multiply by the years it would take to replace them.
- Cost to replace. Recruiting fees, signing bonus, and the ramp period before a replacement is productive.
- Outstanding obligations. Loans, lines of credit, and lease guarantees that would come due or be called.
- Ownership value. For a buy-sell arrangement, the agreed value of the departing owner's share.
Whichever route you take, write the reasoning down. It supports the application and it gives you something to revisit as the business grows.
Buy-sell
Funding a buy-sell agreement
A buy-sell agreement is a contract among owners setting out what happens to someone's share when they die, become disabled, or leave. Life insurance is how most small businesses fund it, because it puts cash in the right hands at exactly the moment it is needed.
Two common structures:
- Cross-purchase. Each owner holds a policy on the others and uses the proceeds to buy the deceased owner's share directly. Clean with two owners; unwieldy once there are four or five.
- Entity purchase. The business owns a policy on each owner and buys back the share itself. Simpler to administer as the owner count grows.
Which structure suits you has tax and legal consequences beyond the scope of this page. The agreement must be drafted by an attorney — insurance funds a buy-sell, it does not create one. We are not tax advisors. Consult a qualified tax professional about your situation.
Fit
Who counts as a key person — and when this is not needed
Consider this if your business has
- An owner or founder who personally drives most of the revenue.
- A partner whose share you would need to buy out.
- A top producer, lead engineer, or sole holder of a license or certification the business trades on.
- Loans or lines of credit personally guaranteed by one person.
- Client relationships that live with an individual rather than the company.
This probably is not needed if
- The business would run essentially unchanged if any single person stopped working tomorrow.
- Your real concern is your own family's finances rather than the company's. That is personal term life, not key person coverage.
- You are a sole proprietor with no employees, no business debt, and nothing to wind down.
- The company could not sustain the premium. An unaffordable policy that lapses protects nobody.
Cost
What drives the price
Key person policies are priced like any other life insurance, on the insured individual. The business is the owner, but the underwriting is about the person.
- The insured's age, health, and tobacco use.
- Policy type. Most key person coverage is written as term life, because the need usually has a horizon — until the loan is repaid, or until the founder steps back. Where the need is permanent, or the business wants an asset on the balance sheet, whole life is used instead.
- Death benefit. Justified by the business case above.
- Occupation and travel. Some roles and travel patterns affect underwriting.
Bring us the loan covenant or partnership agreement if there is one, and we will make sure the coverage satisfies it. Request a free quote or talk it through with us first.
Common questions
Questions about key person insurance
Who owns the policy and who gets the money?
The business owns the policy, pays the premium, and is named as the beneficiary. The insured is the key person. When a claim is paid, the money goes to the company, not to the family of the person who died.
That surprises people, so it is worth saying plainly: key person coverage protects the business. If you also want to protect the person's family, that is a separate personal policy.
Does the key person have to agree to it?
Yes. The insured must consent in writing and go through underwriting, which usually means health questions and often a medical exam. You cannot insure someone without their knowledge or consent.
For employer-owned policies there are additional federal notice and consent requirements that must be satisfied before the policy is issued, or the tax treatment of the proceeds can change.
Is the premium tax deductible?
Generally no. Premiums on a policy where the business is the beneficiary are typically not deductible as a business expense, and the death benefit is generally received free of income tax if the notice and consent requirements were met.
The rules have exceptions and the details matter. We are not tax advisors. Consult a qualified tax professional and, for a buy-sell arrangement, an attorney.
What is the difference between key person coverage and a buy-sell policy?
Key person coverage replaces lost earnings and buys the company time to recover. A buy-sell policy funds a legal agreement that transfers a deceased owner's share of the business to the surviving owners or the company.
They are often bought together and can look similar on paper, but they solve different problems and a buy-sell arrangement needs a written agreement drafted by an attorney to work.
What happens if the key person leaves the company?
The business can usually surrender the policy, keep it in force, or in some cases transfer it to the individual. Transferring a policy can have tax consequences under the transfer-for-value rules, so check before you act.
If the departing person was a co-owner, this is usually the moment a buy-sell agreement is triggered rather than a question about the policy alone.
Coverage is subject to underwriting approval. Guarantees are backed by the claims-paying ability of the issuing carrier. Product availability, features, and rates vary by state and by carrier.
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