Key person insurance is simply life insurance on the key person in a business. In a small business, this is usually the owner, the founders or perhaps a key employee or two. These are usually the people who are crucial to a business–the ones whose absence would sink the company. You definitely need to consider key person insurance on those people.
Here’s how key person insurance works: A company purchases a life insurance policy on its key employee(s), pays the premiums and is the beneficiary of the policy. If that person unexpectedly dies, the company receives the insurance payoff. The reason this coverage is important is because the death of a key person in a small company can cause the immediate death of that company. The purpose of key person insurance is to help the company survive the blow of losing the person who makes the business work.
The company can use the insurance proceeds for expenses until it can find a replacement person, or, if necessary pay off company debts.
It’s basically a form of life insurance that gives the company directors peace of mind that if anything happens one of them there will be a lump sum there to replace their financial loss to the company.
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