Does my business need key person insurance?

I was recently working with a long-time client of mine on this exact problem. He runs a medium-sized nutritional supplement manufacturing business and recently got clued into key person insurance (or key man insurance) at an industry networking event.

I'll tell you what I told him, but first let's go over key person insurance. It's essentially a life insurance policy that the business takes out on a person that is important to their business, whether it's an employee, a partner, an owner, or even a crucial board member.

Even though this is a form of life insurance policy, do not confuse it with your standard life insurance policy. When you buy a personal life insurance policy, it covers you and the beneficiaries are your loved ones (spouse, children, family members). But with a key person insurance policy, the company takes out the insurance policy, pays the premiums, and is the beneficiary, but it covers a particular individual, not the policyholding company. If that key person dies, the company can file a claim and get a payout that is meant to help it continue to thrive after losing a critical member of the organization and looking for a replacement (to find out how to get a claim paid on a personal policy, see How to Collect a Life Insurance Payout).

And that is the key to answering your question, and what I told my client. Ask yourself: is there a person in the company whose death would have a material impact on the business? Is there someone who is irreplaceable in the short run?

If the answer is yes, then you should look into purchasing key person insurance to ensure business continuity.

To figure out how much insurance you should get, work backwards. Figure out how much short-term cash you would need to keep the lights on while while looking for a suitable replacement, based on a conservative estimate of how long it would take to find someone.

Now, that being said, there are companies that have key people but still don't need key person insurance. If your company is a sole proprietorship or if you're the only employee, then the insurance isn't required. You'd be better off purchasing a regular life insurance policy to make sure your family is taken care of in your absence.