Gus was the very definition of an indispensable employee… More than just a hard worker, Gus was his company’s top salesman. His employer’s fast-growing American import business cleared more than $150 million in sales each year — and Gus’ top client (a major retail chain) accounted for nearly half that total amount.

Like any elite sales professional, Gus owed his success to a little bit of luck combined with a lifetime of hard work. He’d dedicated the bulk of his professional life to this one client, even moving his family halfway across the country just to be right around the corner from his client’s rural headquarters.

Gus was well-compensated for his efforts and planned to stick with the company for life. But his employers had no illusions about their situation. If anything ever happened to Gus, that might jeopardize the future of the business at large.

So the company funded what’s called a “Key Person” life insurance policy. (Historically, we called these “Key Man,” but we’ll keep it progressive for the sake of future readers.)

A key person life insurance policy is owned and funded by the company, with the company listed as the beneficiary. The key person is generally notified of the decision, but they’re otherwise uninvolved with the process. When this individual passes away, the company receives the policy’s death benefit.

As the name implies, these policies are generally used to cover top executives, company leaders, technical specialists, or any other employee whose contribution is crucial to a company’s continued success.

How can a company calculate the amount of coverage it needs for a specific individual?

As with any other life insurance policy, it’s best to start with an individual’s contribution — in this case, many companies gauge that as a percentage of the company’s bottom line. Combine that number with an individual’s salary, multiply that by 5-7, and you’ll have a general range for your ideal coverage.

There’s ultimately no hard and fast formula for calculating ideal coverage levels. But the mere existence of these types of policies is often enough to provide comfort and peace of mind for stakeholders, counterparties and other employees. Funding a policy like this communicates serious operational foresight on a company’s behalf, and signals that they’re making plans to have plenty of liquidity if worse comes to worst.

Investors and lenders will sometimes even require companies to fund key person policies prior to doing business — since these plans can help to reduce overall default risk and ensure a contingency in the event of unexpected gaps in company leadership. If a company’s being assessed for a new line of credit or new funding, key person life insurance policies can be a powerful asset to have on the balance sheet.

Another powerful use for this type of insurance is to create special “buy-sell” agreements for smaller businesses with multiple owners…

For instance, let’s say that Gus has been granted an ownership stake in the company he helped to build. Normally, these shares would be included in his estate and potentially subject to various taxes and delays before being passed along to his beneficiaries.

But with a “buy-sell” agreement in place, the company would automatically use the cash death benefit to buy out Gus’ shares instead.

In this scenario, Gus’ heirs get a cash payment instead of the potential hassle of expense of working their way through the estate process. And the ownership of Gus’ company stays more or less intact, without the risk of unpredictable involvement from new owners.

Moreover, a buy-sell agreement gives the company a way to buy Gus’ shares back gradually over time, from one premium to the next, instead of paying all at once and depleting liquidity just as they lose a top employee.

Even if all goes well and Gus far outlives his life expectancy, key person life insurance can still be tremendously valuable for his employer — provided that they chose a whole life insurance policy.

Because a whole life insurance policy’s cash value still represents a unique strategic reserve for the company can tap into as needed.

Loans against the cash value of life insurance often come with competitive rates and generous repayment schedules. So if the company frequently finances new equipment purchases, they can potentially take out loans against the cash value of the policy instead, saving a small fortune in interest payments over time.

And even after you’ve borrowed against a policy’s cash value, it keeps growing tax-deferred, right on schedule (along with extensive protection from creditors in most jurisdictions).

Key person life insurance isn’t about replacing irreplaceable employees. It’s about buying more time, optionality and tax protection for a portion of your company’s war chest. It’s not about preventing future business disruptions; it’s about softening the blow when those disruptions do happen. Likewise, key person life insurance won’t cover potential losses related to an employee’s disability unless you’ve added specific riders to the policy (separate coverage is also available).

Another important feature is that key person life insurance is wholly owned and funded by the company. Unlike other popular policy types (like split-dollar life insurance), key person life insurance is generally separate from compensation with no material benefit to most employees. Shareholders may recognize the policy as an incentive, especially in the presence of other arrangements like a “buy-sell” agreement.

Life insurance is a popular asset in various forms for various businesses, and with good reason. Its long-term performance is independent of any external market, with scheduled dividend payments and steady guaranteed growth over time.

Beyond just the loss of key personnel and shareholders, life insurance can help mitigate losses resulting from a wide range of different scenarios — from adverse market conditions to unexpected legal issues.

Key Takeaways

• Key Person life insurance protects the financial stability and continuity of a business by insuring crucial employees whose contributions significantly impact company revenue and operations.
• Companies can use Key Person policies to secure liquidity for unexpected disruptions, as well as to attract and reassure investors and lenders by reducing default risk.
• Whole life Key Person policies build cash value that businesses can borrow against for strategic financing, providing a tax-advantaged reserve beyond just death benefit protection.
• Buy-sell agreements funded by Key Person insurance enable smooth ownership transitions without estate complications, preserving business control and minimizing tax consequences.
• Key Person insurance is a company-owned, company-funded asset that signals serious operational foresight and risk management commitment for business sustainability and generational growth.
• These policies are not for replacing irreplaceable employees but provide time and financial flexibility to manage leadership gaps and soften business impacts from key losses.

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