Key-Person Insurance

Many businesses safeguard their financial investment in new ventures by taking out a life insurance policy on key individuals whose presence in the company is vital to success. This “key-person” insurance can be used in a variety of other instances as well. In today’s Workshop, Jeffrey Moses outlines the use of this common business tool.

No one really likes to think about life insurance (expect insurance salespeople, of course), but when chances for the success of a venture would be seriously compromised should anything happen to one or more of the individuals involved, life insurance can be taken out for these key people. The stated beneficiaries of the policy would be either the other individuals involved or the business itself. The goal is to reduce financial risk by assuring an influx of cash that would either reimburse lenders and/or help stabilize the venture until new key individuals could be located and trained.

The amount of insurance taken out in the policy depends entirely on the size of the business, how much debt has been assumed and how much the business would lose while finding another person. Typical policy amounts vary from$50,000 to $1 million and more. This figure should be worked out with attorneys, accountants or insurance brokers experienced in the field.

Often the success of new businesses (particularly partnerships) will be dependent on one, both or all of the company’s founding members. In such a case, the business might consider taking out insurance on one or all of the members to safeguard the initial expenses.

Many lenders (banks and venture capital groups) insist on key-person insurance for specific members of the management team when lending to a new business or venture. The amount the lender is concerned with is the principal that they have lent to the business. As a result, lenders will want a policy that covers this amount, with themselves as beneficiary. Any insurance taken out for the benefit of the surviving members of the company will be in addition to the insurance taken by the lenders. Who makes payment of the monthly or quarterly premiums when a lender insists on insurance? It’s negotiable, but quite often it’s the company or individual members, not the lender.

If you’re considering taking out key-person insurance for your venture or business, here are a few questions to ask yourself:

1. How much debt would the company have to pay back if the new venture were forced to cease or temporarily halt activities due to the death of one of the key members? If this sum is substantial, key-person insurance may be for you.

2. Would the business have to be liquidated or sold in order to settle the estates of any members? This is a common reason to take out key-person insurance.

3. Will lenders require insurance?

4. Would any additional financial obligations fall upon the venture or partnership after the death of a member? This could include contractual payments taken on by the partnership or its members.

When taking out this type of insurance, always consult an attorney if there is any ambiguity about who is the true beneficiary. For instance, a lender might want a policy taken out to safeguard its investment, and as a result would be the beneficiary. Confusion may arise, however, if additional beneficiaries are named on the same policy. The time to determine all beneficiaries, and the percentages each will be due, is at the time of taking out the policy.