Key Employee Insurance

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If one "key" employee defines your business' success, you may need this coverageSeven out of ten small businesses (71%) are “very dependent on one or two key people” for their organization’s success. Yet only 22% have key person life insurance in place, according to research conducted by the National Association of Insurance Commissioners. What exactly is the other 50% missing? And might your business be facing this same gap? Here’s a closer look:

What is key employee insurance?

Also known as “key man insurance,” “key executive insurance,” or “corporate owned life insurance” (COLI), this coverage is essentially a life insurance policy. It is owned by the key employee’s business, and the business is its beneficiary.

Companies that could not survive without the skills, knowledge, and other essential contributions of a particular employee often purchase this coverage to hedge against his or her untimely death. If the key employee dies, the insurance payoff can be used to sustain the business until a replacement is located, or else to close the business in an equitable way (e.g. providing severance to employees, settling debts and repaying investors). Funds can also be used to buy out ownership rights from estate heirs.

Who needs key employee insurance?

Any business that is dependent on one or two specific employees should consider this coverage. Examples might include breweries or restaurants (where a brew master or head chef is uniquely equipped to create a specific product). Another example involves companies that rely on team members with very specialized skills, who are difficult to replace (e.g. licensed arborists). This coverage can also be valuable for any employees who maintain close relationships with valued clients (e.g. sales reps or agents that represent a major portion of your revenue stream).

How is key employee insurance different from personal life insurance?

Key employee life insurance is different from personal life insurance in a few significant ways. First, the company pays the annual premium (not the individual employee). Second, the payoff goes to the company (not to the individual’s family or other private beneficiary).

Is a health test required for key employee insurance?

Usually a medical evaluation—conducted by the insurance company—is required, along with official health records, driving records, and financial records. But some carriers do offer “no exam” options. Keep in mind, no-exam options are typically more expensive, in terms of annual premium, and the available coverage limits may cap at a level that doesn’t sufficiently meet your company’s needs.

Are there different types of key employee insurance (term, whole)?

Yes! And you’ll find pros and cons associated with these different options. Generally speaking, the advantage of a term-based employee life policy is that it costs less. The company can elect the term period that makes sense (5, 10, 15 years, etc.).

Alternatively, a whole life policy costs a bit more but does not expire. Instead, the policy builds up cash value, which you (the employer) can tap at any point as a tax-free loan. If your key employee remains with the company for the long haul, a whole life policy could end up being more cost effective than a term policy, which requires a repeat of the underwriting process at the end of the designated term (with an older, potentially less-healthy employee).

Is there such a thing as disability insurance for a key employee?

Yes! It’s called key employee disability income insurance. Like key employee life insurance, it is purchased by and paid out to the employee’s company. Unlike the life insurance version, this type of policy pays some percentage of the employee’s annual salary—usually between 40 and 70%, according to the Insurance Information Institute.

What does key employee disability income insurance cover?

This type of coverage can help pay your businesses operating costs and overhead when a key employee is temporarily or permanently disabled. It may also help cover the cost of a temporary replacement.

How much key employee insurance should you buy?

This is an important question, and there are several ways to approach it. Some companies look at how long it would take to find a replacement, along with the cost of recruiting and training someone brand new. Others base their coverage limits on some multiple of the employee’s annual salary, or on what percentage of the company’s bottom line he/she impacts. Whichever way you’re leaning, it’s important to discuss this issue with a licensed agent, who has experience arriving at strategic figures in this context. Your agent should be able to provide multiple quotes, allowing you to compare premiums based on different policy amounts. 

When it comes to disability insurance for a key man or woman, the amount of the monthly benefit is strictly based on the key man’s income. You can’t purchase more than 66% of that employee’s monthly income. The only variables that an employer can adjust are 1.) the length of time for which you want the benefit paid (5 years, 10 years, up until age 65, etc.) and 2.) the waiting period that exists until the benefit kicks in (30 days, 60 days, 90 days, 180 days, etc.).

As part of your application, you will likely need to explain how you arrived at the desired coverage amount.

What does key employee insurance cost?

Costs vary, of course—depending on the type of key man policy (term, whole, universal), the desired coverage limits, and a list of specifics about the employee himself. Rating factors may include age, weight, smoker versus non-smoker status, preexisting health conditions, etc.

Can a key employee insurance policy be transferred if the employee leaves?   

Yes, usually it can. Although some carriers may not offer “portable” policies, most key man life insurance can be reassigned to the employee if he or she parts with the organization. This can be an attractive benefit to prospective employees—knowing they have the opportunity to take a life insurance policy with them when they retire or make a career change. 

Looking for more specific advice about insuring a key member of your team? We’d love to help! Give our team of Massachusetts business insurance experts a call today: 508.339.2951.