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Key man or key person insurance is crucial coverage that provides financial relief and protects your business if one of your critical employees suffers death or disability, but how much does key person insurance cost?
It falls under the umbrella of life insurance, and at its most basic form, can be viewed as a life insurance policy taken out by the business on one of its key contributors.
It will cover lost profits, debts incurred, and the cost of replacing the insured person. It can also provide the funds necessary to hire and train both a temporary stop-gap and true replacement.
It’s essential to note that there’s no clear definition of who or what constitutes a key person. It could be your best salesperson, an experienced executive, or a crucial team leader.
The only unifying distinction is that these are the people who are vital to a business’s success, meaning that their absence would be incredibly detrimental to the business and its continued growth.
Similarly, it’s almost impossible to give an exact answer on how much key person insurance costs to acquire.
What we can do is try to understand what influences key person insurance cost and what businesses that are looking to purchase key man insurance should understand about this coverage.
What Does Key Person Insurance Cost?
Key person insurance cost depends on several factors directly related to your company and the terms of the policy sheet.
Let’s discuss these and see what logic insurers commonly use when calculating premiums.
Type of Policy and Amount of Coverage
The terms of your policy are a crucial component that influences key person insurance cost.
The cheapest and most basic key person policies will only pay out in the case of a death.
However, companies can secure more comprehensive coverage to include provisions that require the policy to be paid out in cases of illness or disability.
This will typically cover serious conditions such as cancer, heart attacks, or incapacitating physical injuries. Naturally, the more situations that are covered by the policy, the more you can expect to pay for insurance.
Another important question that will affect premiums is whether you are buying a term life policy or a permanent life policy. A permanent policy offers coverage that never expires.
A term life policy will only pay out the death or disability benefit if the event occurs during the timeframe (or term) specified in the policy.
Once the term expires, you can either renew your key person insurance for another term, allow the policy to terminate, or upgrade it to permanent coverage.
Naturally, limited-term key person insurance cost will typically be less than permanent ones.
The coverage limit represents the maximum amount that the insurer will pay out if the insured key contributor dies or suffers an illness or injury.
How it affects premiums is simple and intuitive; the more coverage you have, the more you’ll have to pay for it.
However, there’s no hard and fast rule for determining how much coverage is necessary to properly insure your business against the loss of a key person.
Each company is different and will have different coverage needs.
The amount of coverage needed will depend on the nature and size of your business, the key person’s contribution to your bottom line, and even their current salary.
It’s a good idea to ask for quotes on several policy limits (for instance, a $500,000 and $1 million policy) and compare their costs before making a decision.
The Key Person’s Age, Gender, and Health
Like any life insurance policy, the health and age of the key person will heavily influence your premiums.
The older the insured person is and the more health conditions they have at the time of securing the policy, the more you’ll have to pay for insurance.
In fact, insuring elderly key employees or ones that have serious medical conditions may prove to be fairly difficult, even impossible.
It’s important to talk to your insurer and see what risk management options are available to you in such a situation.
Company Structure and Size
Insurers will try to quantify the key person’s contribution and importance to the company when calculating your premium.
Premiums will rise for more valuable and hard-to-replace insured persons.
Additionally, larger companies with more revenue stand to lose more due to an unfortunate death or illness of an important contributor, meaning that they will have to pay more for their key person insurance.
However, these factors also lead to higher payouts, since the insurer will have to cover both the lost revenue and the cost to replace the key person.
Key person insurance cost usually becomes more manageable as companies grow and scale. However, the need for key man insurance grows along with the company’s rate of success.
The industry that you’re operating in is an important factor when it comes to calculating key person insurance cost.
Certain industries will have an increased risk of premature death or disability, thus raising the premium to insure their employees.
Additionally, some industries may suffer from a shortage of talent in key positions, making it harder and more expensive to replace a key person.
Tax Considerations for Key Person Insurance
This may be bad news for you, but key person payments are not classified as business expenses, meaning that you can’t claim a deduction on your taxes for them.
However, potential payouts from the policy are typically not subject to income taxes. It’s important to note that there’s a set of rules that you need to follow for the key person insurance payout to be tax-exempt.
The insured employee must be notified that the company intends to take out a life insurance policy on them and fully consent to the policy in writing.
They will also have to consent to the employer being able to retain the policy even if they leave the company.
If you need further guidance on how to claim key person insurance cost as a business expense, we recommend that you consult a professional accountant on the matter.
The Cost of Not Having Key Person Insurance
Many companies may view key man insurance as a luxury. It’s often fairly expensive and covers a risk that most businesses hope to avoid entirely. However, for many companies, regardless of their size and revenue, losing a single key contributor could be devastating.
For instance, if a significant portion of your revenue or your technology depends on a particularly talented employee, founder, or partner, the fallout from their death may be very hard to recover from both immediately and in the long run.
Also, many key persons have name recognition with their industry and their death or disability may negatively impact the company’s reputation. This is why any company that heavily relies on the work and business presence of one particular individual should seriously consider purchasing a key man insurance policy.
Companies that are seeking funding should also strongly consider key person coverage. The pressure to secure the policy may come from venture capital firms who’ll want to know that their investment is fully protected, even in worst-case scenarios.
Key person insurance cost may prove to be minor compared to the financial assistance it could provide if the worst-case scenario does occur and you lose the most valuable member of your team.
To get a better understanding of what your key person insurance needs are, what policy terms would work best for your business, how much coverage you’ll need, and how much it will cost, don’t hesitate to reach out to one of our expert brokers at any time.
To get more details on the policies that are right for your business, check out Embroker’s digital insurance platform.
*The information contained herein is subject to Embroker’s Terms, is based upon Embroker’s experience as an insurance broker, available information, current insurance information, and marketplace, or may be of a general nature. Nothing in the content provided should be construed as tax, accounting, legal or actuarial advice. While we provide comments and recommendations related to the types and terms of insurance coverage, the decision to act or not act is ultimately the insurance purchaser’s alone.
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