Key Takeaways
- Key person insurance may help protect a company from financial loss in the event that a vital executive, founder, or employee dies or becomes disabled.
- Coverage can provide funds to stabilize operations, repay loans, or recruit and train replacements.
- Both small and large businesses may benefit from key person coverage as part of a broader continuity and risk management plan.
- Capital Formation Group can assist business owners in identifying risks, selecting policies, and integrating key person insurance into wider financial strategies.
Businesses devote significant energy to safeguarding equipment, facilities, and data. Yet one of the most valuable assets a company may depend on is human capital: the expertise, relationships, and leadership concentrated in a few people. If a founder, top salesperson, chief engineer, or finance leader is suddenly absent, the impact can be immediate. Revenue may decline, projects might stall, and lenders or investors can become cautious. Payroll, rent, and vendor obligations typically continue, even as the organization adjusts and resources are stretched.
Key person insurance, sometimes called key employee or key man insurance, may serve as a financial buffer when a main individual dies or becomes disabled. By directing benefits to the business, the policy can provide liquidity to cover expenses, reassure stakeholders, and support recruitment or interim leadership. This coverage may function as one element within a broader continuity plan that also includes succession planning, cross-training, and documentation of important processes.
What Is Key Person Insurance?
Key person insurance is a life or disability policy purchased by a business on the life of an important individual.
- Policy owner: The business.
- Premium payer: The business.
- Beneficiary: The business.
If the insured key person dies or becomes disabled, the policy’s benefit may be payable to the company. Proceeds can be applied to stabilize operations, address debts, maintain payroll, or fund the search for a qualified replacement.
Distinction from Other Coverage
- Personal life insurance: Designed to support the insured’s family or estate.
- General liability or property insurance: Designed to address third-party claims or physical losses.
- Key person insurance: Designed to address internal financial risk from losing an important contributor.
Because it targets the financial consequences of losing a specific individual, key person insurance may be relevant for startups that rely on founders, professional firms built on relationships, and established companies with specialized technical staff.
What Is a Key Employee (or Person)?
A key person is someone whose absence could materially affect revenue, operations, or strategic direction. Titles alone may not identify these individuals; the focus is on impact.
Examples of Potential Key Employees
- Founders and owners who carry institutional knowledge, vendor relationships, and the strategic vision.
- Executives such as a CEO, COO, or CFO who coordinate operations, credit relationships, and financial reporting.
- Lead salespeople or rainmakers who generate a disproportionate share of new business.
- Technical specialists: engineers, product architects, clinicians, or scientists whose expertise is difficult to replace.
- Relationship managers with exclusive access to major accounts, investor networks, or strategic partners.
Attributes That May Indicate “Key” Status
- Material revenue contribution or unique profit influence.
- Specialized knowledge, certifications, or intellectual property familiarity.
- Leadership that shapes culture, decision-making, and retention.
- External credibility that underpins lender, investor, or client confidence.
A practical assessment may combine quantitative metrics (revenue influence, margin impact, pipeline ownership) with qualitative factors (trust, reputation, and the ability to mobilize teams).
Why Key Person Insurance Matters for Business Continuity
The loss of a key individual can create layered risks that extend beyond immediate revenue.
Financial Impacts
- Lost sales or slower collections if relationships or negotiations depended on the individual.
- Stricter terms from lenders if the person’s involvement underpinned credit decisions.
- Unplanned costs for executive search, relocation, signing bonuses, or temporary consultants.
- Potential covenant pressures if results dip while the company transitions.
Operational Impacts
- Delayed product launches or paused projects when domain expertise is unavailable.
- Gaps in approvals or sign-offs that slow purchasing, hiring, or strategic decisions.
- Knowledge drain if processes and client histories were not fully documented.
Strategic Impacts
- Reduced investor confidence or valuation during fundraising or M&A discussions.
- Difficulty executing a growth plan if the lost person anchored partnerships or innovation.
- Less agility in competitive situations while the organization reassigns responsibilities.
Reputational and Morale Considerations
- Clients may question continuity and service quality, especially in relationship-driven industries.
- Employees can experience uncertainty, which may impact their retention or productivity.
Key person insurance may not solve every risk. Still the liquidity it provides can help the business maintain optionality, like time and resources to choose an appropriate path rather than react under pressure.
Types of Key Person Insurance Policies
Key Person Life Insurance
- Term life insurance: Offers coverage for a defined period: often 10, 15, 20, or 30 years. Premiums are typically lower than for permanent policies. Terms may suit situations where the individual’s centrality is expected to diminish over time or where the business wants cost-efficient coverage for a defined horizon.
- Permanent life insurance (whole or universal): Offers lifelong coverage and may accumulate cash value. The cash value can be accessed under the policy terms to address opportunities or temporary needs. Accessing cash value may reduce the policy’s death benefit and could have tax consequences. We do not provide tax advice; consult your tax professional.
How death benefits may be used:
- Stabilize cash flow during leadership transitions.
- Repay lines of credit or term loans tied to the key person.
- Support retention bonuses for core staff and reassure customers or suppliers.
- Fund recruiting, onboarding, and training for a successor.
Key Person Disability Insurance
- Disability benefits may be paid as monthly income, a lump sum, or a combination, after a waiting period.
- Because long-term disability can be statistically more likely than premature death during working years, many businesses evaluate disability coverage alongside life insurance. (source)
- Proceeds can help cover operating expenses, maintain payroll, or hire interim leadership while the company adapts.
Additional Considerations
- Riders that expand flexibility, such as waiver of premium, accelerated benefits, or guaranteed insurability options. (Guarantees are based on the claims-paying ability of the insurance carrier offering the guarantee)
- Layered strategies that combine life and disability coverage to address multiple scenarios.
- Industry-specific tailoring; for example, practices that rely on licensure or reputational continuity may emphasize disability coverage more heavily, while firms with capital-intensive projects may prioritize debt protection.
How Key Person Insurance Works in Practice
Typical Setup
- Identify key roles and individuals whose sudden absence could materially affect results.
- Determine appropriate coverage types (life, disability, or both) and benefit amounts.
- Complete underwriting; the business is the applicant, and the key person undergoes medical and, in some cases, financial screening.
- The business pays premiums and is named as both owner and beneficiary.
- Internal documentation outlines how proceeds may be used and who oversees deployment during a transition.
Common Uses of Benefits
- Bridge operating cash while revenue stabilizes.
- Retire or service debt, including obligations with personal guarantees tied to the key person.
- Fund executive search, relocation, signing incentives, and overlapping compensation for a successor.
- Retain clients through service credits or account-management support.
Policy Limits and Exclusions
- Coverage amounts are subject to underwriting guidelines and financial justification tied to the individual’s role.
- Policies may include exclusions (for example, fraud, early-policy suicide limitations, or specific disability causes).
Determining the Right Coverage Amount
Approaches That May Be Used
- Salary-multiple method: Select a multiple of total compensation that reflects responsibility, influence, and replacement difficulty.
- Revenue or margin contribution: Analyze the portion of revenue, gross margin, or pipeline that the person directly influences.
- Replacement-cost method: Model the full cost of recruiting, onboarding, and the likely ramp period, plus interim consulting or overtime.
- Credit support method: Align coverage with lender expectations or covenants when credit availability depends on the person’s involvement.
Refinements and Safeguards
- Factor in cross-training and documented processes; strong systems can reduce necessary coverage.
- Revisit amounts after funding rounds, geographic expansion, major contracts, or product launches.
- Avoid “point-in-time” assumptions that ignore ramp delays, customer concentration, or hiring seasonality.
Common Underestimation Pitfalls
- Assuming revenue returns immediately once a replacement is hired.
- Overlooking the cost of lost opportunities while leadership attention is diverted.
- Ignoring morale effects that can increase turnover and recruiting costs.
Periodic review, annually or after major changes, may help keep coverage aligned with reality.
Tax Treatment of Key Person Insurance
Premiums
Premiums for key person life insurance are generally not deductible as a business expense.
Benefits
- Death benefits are often received income-tax-free by the business, though exceptions can apply based on ownership, transfers, or non-compliance with certain notice and consent rules.
- Disability benefits may be taxable or non-taxable, depending on the policy design and who pays premiums.
We do not provide tax advice; consult your tax professional.
IRS and Regulatory Considerations
- Corporate-owned life insurance (COLI) may involve specific notice, consent, and reporting requirements.
- Transfer-for-value rules may cause a portion of death benefits to be taxable if a policy is transferred improperly.
- State-specific rules and creditor-protection laws can vary.
We do not provide legal or tax advice; please consult your professional advisors.
Key Person Insurance vs. Other Business Protections
- Buy-sell agreements funded by insurance: Address ownership transitions among partners or shareholders. Key person coverage focuses on protecting the enterprise itself, not purchasing equity from heirs.
- General liability, property, or cyber coverage: Address external claims or physical losses, not the financial impact of losing a main contributor.
- Business interruption insurance: Typically tied to physical damage triggers; it may not respond to the loss of an individual.
- Broader succession planning: Leadership development, documentation, and cross-training may complement key person insurance by reducing single-point-of-failure risk.
When Should a Business Consider Key Person Insurance?
- Startups: Often rely on founders for vision, client relationships, and investor confidence.
- Growing firms: Lenders and investors may require coverage before providing capital.
- Mature organizations: May depend on niche experts whose technical leadership is central.
- Family-owned businesses: Policies may support continuity during generational transitions.
- Professional practices: Client loyalty and reputation are often tied to specific individuals.
Steps to Obtain Key Person Insurance
- Identify key roles and quantify exposure.
- Select coverage types and target amounts.
- Prepare for underwriting, including health exams and financial documentation.
- Finalize ownership and beneficiary designations.
- Document a spending plan for proceeds.
- Review policies annually or after major changes.
Underwriting Timeline and Practical Notes
- Underwriting can take several weeks, depending on exams and riders.
- Larger benefits may require additional financial justification.
- Maintaining internal records of notice and consent for COLI may support favorable tax treatment.
FAQs About Key Person Insurance
Which companies may need key person insurance the most?
Businesses that rely on a small number of individuals for revenue, expertise, or leadership.
Who pays for the policy?
The business generally pays premiums and is listed as the owner and beneficiary.
Can a business cover multiple key people?
Yes. Separate policies can be arranged for multiple individuals.
How much does coverage cost?
Premiums vary based on age, health, coverage amount, policy type, riders, and underwriting results.
Does the key employee benefit directly?
No. The policy is designed to support the business.
Can policies be transferred if the employee leaves?
Sometimes. Options may include surrender, assignment, or repurposing.
How We Can Help Protect Your Business Future
At Capital Formation Group, we can work with business owners to design strategies that address the financial risks associated with the loss of a key employee.
This May Include:
- Reviewing existing policies and business continuity plans.
- Identifying potential gaps or overlaps in coverage.
- Aligning benefits with broader succession, lending, and operational priorities.
- Coordinating with tax and legal professionals on structure and documentation. (We do not provide tax or legal advice; please consult your professional advisors.)
Contact Us or Schedule a Meeting
You can schedule an appointment online or call/text us at (781) 237-0123. A customized review may help you feel more confident that your business is prepared for unforeseen risks and has a practical plan to navigate transitions.
Required Disclosures:
The material is for informational purposes only and is not intended to provide specific advice or recommendations for any individual, nor does it take into account the particular investment objectives, financial situation, or needs of individual investors. This information is not intended for use as legal or tax advice. Persons should consult with their own legal or tax advisors for specific legal or tax advice. Guarantees are based on the claims-paying ability of the carrier offering the guarantee.
This blog was created with the assistance of ChatGPT. The content has been reviewed and curated to ensure accuracy and relevance.
Securities offered through Valmark Securities, Inc., Member FINRA, SIPC. Investment advisory services offered through Valmark Advisers, Inc., an SEC-registered investment advisor. 130 Springside Dr., Suite 300 Akron, Ohio 44333-2431 • 1-800-765-5201.
Capital Formation Insurance Agency, Inc. and Capital Formation Group, Inc. are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc. Diversification cannot assure a profit or guarantee against a loss.
