Key Person Insurance Definition

Cite this article as:"Key Person Insurance Definition," in The Business Professor, updated March 21, 2019, last accessed August 7, 2020, https://thebusinessprofessor.com/lesson/key-person-insurance-definition/.

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Key Person Insurance Definition

This is a life insurance policy bought by an organization on the life of one of its key executives. The organization pays the policy premiums and is the sole beneficiary in case of the death of the executive. It usually referred to as ‘key man insurance,’ ‘business life insurance’ or ‘key woman insurance.’

A Little More on What is Key Person Insurance

This type of insurance policy is usually purchased if the unexpected death of a principal executive would result in a significantly negative impact on the operations of the company. The company uses the amount paid upon the death of the executive in buying time to find a replacement or implement corrective strategies that may save the business.

The key person in a small business usually is the owner, founders or a key or few key employees. The key person is determined by the fact that their absence would amount to the sinking of the company. In such cases, key person insurance is considered.

How Key Person Insurance Works

The company purchases the policy on its key executives, pays the premium and is the beneficiary of this policy. If death occurs, the insurance firm pays off the policy to the company.  The company uses these funds in a variety of ways including paying off debts, paying severance to employees, distributing money to investors and also shutting down the business in the correct procedure. This insurance policy provides companies with several options apart from bankruptcy.

The top officials of companies consider an irreplaceable employee in the short term to decide if the company should consider such coverage. In most small businesses, the owner does most of the work so without him/her the business would dissolve.

The amount of insurance needed depends on the business although usually, companies ask for quotes on $100,000, $250,000 up to $1 million policies and then compare the costs associated with each policy.

Categories of Loss Covered by Key Person Insurance.

The losses arising from an extended period in which the key person is not able to work but is still alive.

  •         Insurance to safeguard profits such as losses that may arise from the delay or cancellation of a business project in which the key person is a part of.
  •         Insurance to protect the interests of shareholders or a partnership. It allows the shareholders or partnership interests to be bought by the existing shareholders or partners.
  •         Insurance for people who are a part of guaranteeing business loans or banking facilities. The value of the insurance coverage is adjusted to be equivalent to the value of the guarantee

References for Key Personal Insurance

Academic Research on Key person Insurance

  • A theoretic analysis of key person insurance, Nie, P. Y., Wang, C., Chen, Z. Y., & Chen, Y. H. (2017). Economic Modelling, 30, 1-7. This paper aims at capturing both the positive and negative effects of key person insurance through a microeconomic analysis. It states that although it reduces the risk, this insurance decreases the salaries of employees, the output as well as the anticipated profits.
  • Key person insurance: Who needs it, Fabris, M. (2008). Australian Journal of Financial Planning, 3(1), 29. This article investigates the issues affecting key person insurance and the various policies that can be enacted to protect the business and maintain its strategic advantages.
  • Key person insurance premiums and proceeds, McEwan, I., & Davies, B. (1968). Taxation in Australia, 36(6), 315. This paper explains how the premiums of this insurance policy are paid and how the total proceeds are calculated.
  • Key Person Insurance Essential In The Family Business, Seguro Del Hombre Clave Indispensable En La Empresa Familiar, Sandoval, R. H. H., de la Garza Cienfuegos, S. P., Tamez, L. L. G., Contreras, Y. S., Diaz, F. M. R., & Hernandez, R. M. T. (2016). Revista Global de Negocios, 4(3), 73-83. This paper uses scientific methods to show the deductibility of the expense for key man insurance. Should the key man disappear, the company will receive income from the coverage?
  • Ethical challenges in the two main segments of the insurance industry: Key considerations in the evolving financial services marketplace, Cooper, R. W., & Frank, G. L. (2002). Journal of Business Ethics, 36(1-2), 5-20. This paper makes and supports various points based on the results of several research studies by experts in the industries of property-liability insurance and life insurance.
  • Key man insurance and market reaction: a comment, Nicholson, J. E., & Corbett, R. B. (1987). The Journal of Insurance Issues and Practices, 10(1), 53-61. This article comments on the reaction of the market to key man insurance. It explains how market participants have embraced key man insurance.
  • Steps to getting key person claims paid, Block, A., Keenan, M., & Malone, C. (2006). Risk Management, 53(2), 28. This paper details the procedures that businesses follow when they require the claims of key personnel to be paid.
  • The AIDS insurance crisis: underwriting or overreaching, Schatz, B. (1986). Harv. L. Rev., 100, 1782. This paper describes the AIDS insurance crisis in the US and how the victims of this disease have steadily increased.
  • Predictive medical information and underwriting, Dodge, J. H. (2007). The Journal of Law, Medicine & Ethics, 35(2_suppl), 36-39. This article provides information on the application of actuarial science to analyze medical data and predict the future risk of a claim so that the individuals with the risk are required to pay premiums that equivalent to the risk of the future claim.
  • Key man insurance: an empirical investigation of market reaction in large firms, Chandy, P. R., Davidson, W. N., Garrison, S., & Worrell, D. L. (1986). The Journal of Insurance Issues and Practices, 73-89. This paper tests the effects of a key person’s death on the value of the firm’s stock by using data on 127 key executives who passed away between 1967 and 1981.

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