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What is Key Man Life Insurance? Also known as corporate-owned life insurance (COLI), key man life insurance is purchased by a business to insure the life of one of the company’s employees. It’s intended to help the company recover from the loss of an employee that contributes significantly to the business, if that person's death would reduce productivity or the company's value. People an employer might have covered by a key man policy include top salespeople, executives and other decision-makers, highly visible employees, and employees with unique knowledge or skillsets. As with any life insurance policy, key man policies have three primary roles: Owner: This is the person or entity that purchases the life insurance policy and typically pays the premiums. The owner has the right to transfer, sell or change the terms of the policy. Insured: This is the person upon whose death the policy would pay the death benefit. Therefore, premiums are directly tied to the health and lifestyle of the insured. Beneficiary: This is the person or entity that would receive the death benefit should the insured pass away during the period of coverage. Key man life insurance differs from other life insurance policies in that the business is both the owner and the beneficiary of the policy. The employee essentially has no rights or active participation in the policy. However, the business is legally required to notify the insured employee of its intent to purchase coverage on the employee, provide them with details of the policy, and obtain their written permission before purchasing it. All of this can be done using an Employer Owned Life Insurance Acknowledgement and Consent Form, which can be obtained from the insurer. What Types of Policy Can be Used as Key Man Life Insurance? Any type of life insurance policy can be structured as key man life insurance, including either of the two primary categories of life insurance: Term life insurance: Term life insurance only provides coverage for a predetermined amount of time, such as 10 or 20 years, and is significantly less expensive than permanent life insurance. Typically, for a key man policy, the length of the term is tied to a specific date—such as the employee’s expected retirement—or a projected timeline—such as time it might take to double the sales team. Permanent life insurance: In addition to providing lifelong coverage, a portion of permanent life insurance premiums are added to a cash value account which grows in value over time. The policy’s cash value is an asset that can be used the business as collateral for a loan and, if the policy was written by a mutual insurer, would make the business eligible to receive dividends. Since permanent life insurance policies accumulate value over time, they can also be sold in a life insurance settlement should the company decide that it no longer wants coverage. Given the high cost of permanent life insurance, and that company needs often evolve over time, term coverage is often used as key man life insurance. However, permanent life insurance can be structured as an employee benefit, as the policy, and its cash value, can be transferred to the insured after a certain number of years or at a particular milestone. No matter the type of policy you choose, you should make sure your key man life insurance offers flexible terms. For example, adding a business exchange rider to a permanent policy, allows you to change the person insured should that employee leave the company. Similarly, many key executive life insurance policies allow you to periodically increase or decrease the policy’s limits, as the needs of the company change. When Would Your Business Need Key Man Life Insurance? Key person life insurance is typically only required if your company wants to obtain a loan or investment. The SBA, as well as many banks, often require key man life insurance as part of their lending criteria, since small businesses tend to be particularly dependent upon one or two employees, usually, the co-founders. Similarly, if your business is trying to raise money, investors may want assurance that the loss of certain employees wouldn’t cause the company to go bankrupt. Aside from lenders' requirements, companies typically purchase key man life insurance as a form of financial protection. A key man policy is important if the loss of a particular employee would adversely impact your profits. This is often the case if: The company’s brand and strength are tied to a particular employee’s name or reputation. The company’s continued performance, or certain ongoing projects, are tied to the employee’s role or unique skills. The loss of the employee could trigger a reduction in existing or new business. The loss of the employee would affect the company’s credit or cause a business loan to become due. In the worst-case scenario, of your company so dependent on an employee that it could potentially go out of business if they were to die, key man life insurance can also provide an alternative to declaring bankruptcy. The key man policy’s death benefit could be used to pay any debts, provide employee severance, shut down the business, and distribute any remaining funds to investors. Key executive life insurance also can serve as part of a benefit plan that's used to attract and reward key employees, since the policy can be transferred to the insured. There are multiple ways to structure this perk. One way would be to purchase a permanent life insurance policy which would be given to the employee upon retirement, after a certain number of years with the company, or based upon a certain level of performance. While key man life insurance has much to offer a company, it wouldn’t make sense in some situations. For example, if you’re a sole proprietor with no one else directly involved in your business’s ongoing operations—such as lenders or employees—key man coverage would be unnecessary. Instead, you might consider an individual life insurance policy for yourself to protect your family if they were to suddenly lose your income.
