What is Key Person Insurance?

Instructor: Deborah Schell

Deborah teaches college Accounting and has a master's degree in Educational Technology.

A business that relies on one person to keep things going is at risk of a significant business interruption if that individual dies. In this lesson, you will learn about key person insurance.

What Is Key Person Insurance?

Mr. Chip is the owner of the Tech Chip Company that designs and manufactures computer chips. Mr. Chip oversees all operations including design, manufacturing and sales. His business is successful, but he is wondering what would happen to his business if he were to die. A friend told him about key person insurance and he wants to learn more about it. Let's see if we can help Mr. Chip with this problem.

Key person insurance is a life insurance policy that insures the life of a key person in a business. The key person is an individual or individuals who are critical to the success of the business and without him/her, the company would have difficulty with day-to-day operations. A key person could be the owner of the company, as well as employees that the company considers important to daily operations. In the case of the Tech Chip Company, Mr. Chip as well as his key designer are critical to the business as they have specialized knowledge that cannot be duplicated.

The business is the owner of the key person insurance policy and pays the premium or the cost of the policy. The business is also the policy's beneficiary or the one that receives the proceeds from the insurance policy in the event of the key person's death.

Benefits of Key Person Insurance

Without key person insurance, the death of an owner or a key employee could result in the business having to shut its doors, as it may not have the expertise to continue operations and pay its debts. A business can use the proceeds from a key person insurance policy to:

  • Pay its creditors or the people or businesses to whom it owes money
  • Find and train someone to take over the business
  • Provide financial stability to the family of the key person
  • Provide a reserve for the business as it prepares to operate without the key person
  • Provide assurance to employees, shareholders, and customers that the business will continue operations without the key person

It is likely that Mr. Chip and his key employee are so critical to the business that it will take some time to recruit and train a replacement that can carry on the business if one of them were to die.

Categories of Loss Covered by Key Person Insurance

A key person insurance policy could provide payments in the following situations:

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