What is Key Employee Life Insurance?
Nearly every business has key employees who are critical to the overall success and profitability of the business. Key employee life insurance is insurance on the life of a key employee, purchased to help reimburse the employer for the economic loss caused by the death of the employee.
Typical Key Employees
A key employee is anyone having a substantial impact on the financial success of a business. Smaller companies tend to have a greater need for key employee insurance since they do not have a pool of employees from which to select a replacement if a key employee dies. Further, the success of a smaller business can be directly attributed to the vital contributions of a few individuals. In general, a key employee can be anyone who:
- Is responsible for management decisions.
- Is highly paid.
- Has a significant impact on sales, or
- Has a special rapport with customers and creditors
The Purpose of Key Employee Life Insurance
The purpose of key employee insurance is to help protect a business from economic losses that can occur when a key employee dies.
Losses From a Key Employee’s Death
A business can typically suffer in four ways if a key employee dies:
- The death may cause a loss of management skill and experience. This can be particularly devastating for companies without management depth.
- There may be a disruption in sales or production. And, if clients recognize the key employee as vital to the business operations, they may delay orders or refrain from doing business until they find out how the organization will respond to this loss.
- The business may experience credit difficulties. A drop in income may make it more difficult to make credit payments. Creditors may hesitate to extend loans or favorable terms to a business that has lost a key employee, particularly if that employee’s talents or resources were factors that encouraged the creditor to extend loans or special terms in the past.
- The business may incur expenses associated with hiring and training a replacement. Even if the company can promote from within, business losses may continue until the replacement becomes thoroughly familiar with the job.
Advantages of Key Employee Life Insurance
There are serious financial consequences when a key employee dies. There are advantages to having key employee life insurance in place:
- The employer receives needed funds that can be used to help meet financial obligations and train a replacement if the key employee dies.
- Death proceeds are exempt from regular income tax, but may be subject to the alternative minimum tax.
- While the employee is alive, the cash value of a permanent policy is available for use in a variety of ways.
