What would happen to your business if your partner, top sales rep, chief engineer or technical specialist suddenly died? Coping with death is difficult enough. Now your business could take a hit in revenue and credibility. How would you cope with the loss and keep operations going? 

The simplest — and likely least expensive — solution is called key person life insurance. This insurance offers protection if:

The death of a key employee threatens the company with financial ruin.

A cushion is needed when the financial viability or ongoing operations of a business depend on a key employee’s name,  reputation or skills and that employee dies.

A business loan requires the option of putting a lien on a key person policy. This lien is often referred to as a collateral assignment. Loans backed by the U.S. Small Business Administration almost always require key person life insurance on the loan guarantors and sometimes other key employees.

The business is a partnership and each partner wants to buy out the others’ shares in the event of an untimely death. Depending on how the purchase, covered persons and ownership are structured, key person life insurance also could support the funding requirements of a buy-sell agreement.

What are the types of life insurance most commonly used to fund key person needs?

If there’s no need for cash value, the most common choice is a 10-, 20-, 30-year or longer level term life insurance policy. This type of term life insurance is reasonably priced as long as the proposed insured is relatively healthy. The most important consideration is to ensure the duration of the policy is at least as long as the anticipated need to cover the key person. If, for example, the proposed insured is 30 years old, you might want  to consider a 30-year level term life insurance policy. While the insured person could move before the end of the 30-year guarantee, her or she might not. And you’ll have acquired a valuable financial tool at a reasonable cost.

If there’s a team of two or more people essential to business operations, you might want to consider first-to-die life insurance. This is a more permanent form of life insurance with a cash value. The premiums are higher than for term life insurance. But if you’re insuring several people on this policy, the cost might not be that much more. It’s important to look for a first-to-die life insurance policy that allows you to insure more that two people if that is your need and is reconstitutable to cover the remaining insureds after the first death.

If there’s a team of two or more people, any one of which provides the support or knowledge your business needs, you might consider second- or last-to-die life insurance. Since one or more people need to pass away before the policy pays a benefit, it can be comparable in cost to having several longer duration term life insurance policies.

In most cases, the company purchases, pays for and owns key person life insurance. The proposed insured needs to agree, in writing, to allow the policy to be purchased. The premiums aren’t tax deductible. On the other hand, the death benefits are usually tax-free.

Disclaimer: The examples and information presented here are for illustrative purposes and aren’t intended as financial, legal, tax or other forms of advice. Always consult with financial, insurance, legal and tax advisors.