Keyman, or keyperson, life and disability insurance policies are bought by companies to protect their income and survivability by covering individuals who are responsible for a substantial portion of their revenue. Keyman insurance intends to make up financially for the contributions of an individual whose absence would be a significant loss to the business.
Unlike personally owned insurance, the business is the beneficiary of a keyman policy, not an individual. The business is compensated if the key person dies, in the case of keyman life insurance, or, for keyman disability insurance, can no longer fulfill role their due to an illness or disability. The insurance compensates either for the lost revenues or for the time the company needs to replace the lost person. Typically keyman insurance is bought to cover business owners, partners, top sales executives, any individual whose loss would make it difficult for the company to continue as it is.
Keyman life insurance can provide a lifeline to a company in the event of the death of a key executive. A Business News Daily study (June 29, 2022) reported an average loss of 60 percent of sales in the following year and a drop of 20 percent in survivability over the subsequent two years for a small business following the death of its owner.
The amount of keyman life insurance appropriate to cover a key person is typically determined by a combination of factors:
- the size of the business, and
- the revenue the person generates or that is attributed to the person, if that can be quantified, or
- how much it would cost to hire and train a replacement, and
- the cost to continue doing business without that key person.
As the amount of insurance is typically large, companies often use term insurance in a keyman policy. Permanent insurance is more expensive, but it will accumulate a cash value over the years; the company can transfer policy ownership to the covered executive to provide, in essence, a retirement benefit.
Keyman life insurance policies are also commonly used in buy-sell agreements. Typically in a buy-sell application, the company as beneficiary uses the proceeds to purchase the deceased’s ownership stake from a spouse or other heirs. As well, companies use keyman life insurance as collateral for loans; the policies are generally accepted as collateral by banks and other lending institutions.
Keyman disability insurance works similarly to keyman life, but is a short-term benefit for the loss of a covered executive who is sick or injured and cannot work for a period of time. It is designed to cover the revenue loss while the executive is out or the cost to find a replacement if the covered person does not return. Like all insurance covering individuals, the cost of disability insurance depends on the age and health of the person being insured.
Collecting on keyman disability insurance usually involves a delay or “elimination period,” an amount of time before benefit starts, typically 30 to 180 days. Some policies cover the elimination period once they kick in. Benefits, which are based on lost revenue, are paid in one of two ways: monthly for 6 to 24 months, depending on the time the person is out or the time it takes to find their replacement, or as a lump sum at the conclusion of the elimination period, typically a year. The lump sum payment policy is the more expensive.
Note that financial statements and thorough recordkeeping are vital to collecting benefits. With all keyman disability insurance, the insurance provider will require documentation proving the person’s worth to business and detailing company revenues.
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