Key person insurance is a business-owned life or disability policy intended to provide funds if the loss of a critical employee materially affects the firm.
Definition
The firm owns the policy, pays its premiums, and is generally the named beneficiary. Coverage may apply to the death or disability of a principal or another person whose expertise, client relationships, licensing role, or leadership is important to operations. The proceeds can help cover recruiting, transition costs, lost revenue, or a planned ownership purchase, depending on the policy and the firm’s arrangements. Owners decide whom to insure and how much coverage to seek based on the exposure they want to address; the amount is not a standard formula. Some firms focus on replacing revenue, while others consider hiring and transition costs. This is a funding tool, not a succession plan or a guarantee that the firm can replace the person’s knowledge or relationships. Policy terms control when benefits are payable. It also differs from personal life insurance intended to benefit an individual’s family. For broader continuity planning, see business continuity planning.
How owners use it
- An owner reviews key-person coverage alongside succession plans to see whether the firm has funds for a leadership or ownership transition.
- A firm estimates $300,000 in transition costs and selects $300,000 of coverage as a funding target, subject to policy terms and underwriting.
- Owners compare policy terms with the specific risks tied to a principal’s client relationships, technical role, and responsibilities.
- A firm records who owns each policy, who pays premiums, who receives benefits, and what business purpose the coverage is intended to serve.
