Key Person Insurance: What It Covers and Why Your Business Might Need It

Every successful business has someone whose absence would create a serious operational or financial challenge. Maybe it’s a founder, a lead salesperson, or an executive with years of specialized knowledge. If losing that person would jeopardize your company’s future, key person insurance might be one of the smartest risk management tools you can invest in.

This guide breaks down what key person insurance covers, how it works, and how to decide if it makes sense for your business.

Table of Contents

• What Is Key Person Insurance?
• How Key Person Insurance Works
• Optional Riders and Coverage Customization
• What Happens If the Key Person Leaves the Company?
• Key Person Insurance Tax Considerations
• When Does a Business Need Key Person Insurance?
• How to Choose the Right Key Person Coverage
• Key Person Insurance vs. Other Business Protection Tools
• Final Thoughts: Should You Get Key Person Insurance?
• Frequently Asked Questions (FAQs)

What Is Key Person Insurance?

Key person insurance, sometimes called key man or key woman insurance, is a life insurance policy a business takes out on a crucial employee. The business pays the premiums and becomes the beneficiary of the policy. If the insured person passes away or becomes disabled, the business receives a payout that can be used to cover financial disruptions caused by their absence.

Typical candidates for key person insurance include:

• Founders and co-founders

• CEOs or senior executives

• Top salespeople

• Employees with rare or technical skills

• Partners whose contributions are difficult to replace

In many industries, including healthcare, finance, tech, and even homecare, the loss of one person can lead to lost revenue, disrupted operations, and reduced investor confidence. Key person insurance helps you prepare for the unexpected.

How Key Person Insurance Works

To issue a policy, the business must notify the individual in writing and obtain their written consent. This ensures transparency and also complies with legal requirements for taking out life insurance on another person.

Consent must include:

• The face amount of the policy

• Who the beneficiary is (usually the business)

• Whether the policy remains in effect if the person leaves the company

Once the policy is active, the business pays regular premiums. If the key person passes away or is rendered unable to work due to a covered illness or injury, the insurance benefit is paid directly to the company.

These funds can be used to:

• Offset lost income

• Pay down business debt

• Fund the recruitment or training of a replacement

• Reassure investors and maintain business continuity

Optional Riders and Coverage Customization

Many policies can be tailored with riders, or optional add-ons, that expand the coverage. Some common riders include:

• Disability coverage

• Accidental death or dismemberment

• Waiver of premium

• Buy-sell agreement funding

• Term conversion options

Be sure to speak with a qualified insurance advisor about which riders make sense based on your company’s structure and industry risks.

What Happens If the Key Person Leaves the Company?

If the insured individual leaves your company, you have a few choices:

• Surrender the policy: Cancel the policy and either keep any available cash value or transfer it to the former employee (both are taxable events).

• Transfer ownership: Give the policy to the key person, allowing them to maintain it personally.

• Keep the policy active: If the person might return or their departure is temporary, continuing coverage may be a strategic move.

In any scenario, consult with your accountant to understand the tax implications.

Key Person Insurance Tax Considerations

While key person insurance can offer stability and peace of mind, it also comes with important financial and tax considerations.

• Premiums are not tax deductible: Since the business is the beneficiary, premiums are typically not considered a business expense.

• Cash value grows tax-deferred: For permanent policies, any accumulated cash value can grow without immediate tax liability and may be borrowed against, depending on the plan.

Pro Tip: Consult a tax advisor before purchasing a policy to ensure proper setup and to avoid any surprise tax obligations.

When Does a Business Need Key Person Insurance?

Not every business needs key person insurance, but for many, it’s a smart form of financial planning. You might want to consider it if:

• Your company relies heavily on one person for revenue, strategy, or operations

• You’re applying for a loan or seeking investors (they often require it)

• You operate in a specialized or regulated industry like homecare or healthcare

• You’re in a partnership and want to fund a buy-sell agreement

If your business is growing fast and depends on a few key leaders to maintain that momentum, protecting them with insurance is just good sense.

How to Choose the Right Key Person Coverage

To determine the right amount of coverage, evaluate:

• The estimated loss in revenue from the person’s absence

• Costs to recruit and train a replacement

• Time needed for the business to recover operationally

• Outstanding debts or financial obligations tied to the person’s role

Coverage amounts typically range from $100,000 to several million dollars, depending on business size and risk.

According to the National Association of Insurance Commissioners (NAIC), small businesses are particularly vulnerable to the loss of key personnel, and over 70% would cease operations within a year if they lost a founder or top executive unexpectedly.

Key Person Insurance vs. Other Business Protection Tools

Key person insurance is just one part of a broader business protection strategy. It complements other tools like:

• Buy-sell agreements

• Succession planning

• Disability insurance for business owners

Final Thoughts: Should You Get Key Person Insurance?

If your company’s success is closely tied to a few critical individuals, then yes, key person insurance is worth considering. It helps stabilize operations, protect against financial loss, and reassure stakeholders that your business has a continuity plan.

For growing businesses, especially those in healthcare, homecare, finance, or tech, protecting your leadership and high-performing team members isn’t just smart, it’s essential.

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Frequently Asked Questions (FAQs)

©2025 - Content on this blog is intended to provide helpful, general information. Because laws and regulations evolve, please consult an HR professional or legal expert for guidance specific to your situation.