Life insurance can be purchased by an individual to protect their family, or by a business to mitigate their risk. One of the most common reasons that businesses purchase life insurance is to protect against the loss of an important employee—this is also known as “key person” life insurance.
Typically a “key person” has a unique knowledge of the business, a relationship with existing clients, and/or a skill-set that provides value to the business. If this employee were to pass away, they would be difficult to replace, and could cause your business to suffer a financial loss.
If your business has one or more employees that fit this criteria, you may want to consider purchasing key person life insurance.
In this article we’ve provided 4 easy steps to buying life insurance for a key employee, and real-life example of a business we recently helped.
Quick Article Guide:
1. 4 Easy Steps to Purchasing Business Protection Insurance
2. Example of A Business We’ve Helped with Key Person Insurance
3. Illustrative Rates From A Business we’ve Recently Helped
4. We Can Help With Your Business’ Life Insurance Needs
4 Easy Steps to Purchasing Business Protection Life Insurance
Below we’ve outlined the steps to purchasing a life insurance policy for your business’ key employees.
1. Identify your Business’ Key Staff or Key Employee(s)
A key person is typically defined as an employee (including yourself) whose death could financially impact your company. Key employees typically include business owners, officers, technical staff and top sales people.
When purchasing a key person life insurance policy, the business pays for the cost of the policy and lists itself as the beneficiary. It’s also common for companies to pay for an additional policy owned by the employee to protect their family as a way of thanking them for protecting the business.
2. Determining the Amount of Coverage Needed
How many years would it take your business to recover from the loss of a key executive?
To determine the amount of coverage needed, multiply the employee’s complete compensation (wages, salary, bonuses, commissions, medical, etc.) by the amount of years the business would likely suffer from a financial loss due to the lost production and recruitment of a replacement.
Most insurance companies will allow the business to insure up to 10 years of compensation, but most of our clients feel that 5 years is sufficient. If the key person has income which varies widely, it’s acceptable to average the last 3 years of income and multiply this by the number of years needed.
For Example: If a key employee’s income over the last 3 years has been $60,000, $120,000, and $90,000, add their total income and divide by 3.
$60,000 + $120,000 + $90,000 = $270,000
$270,000 / 3 = $90,000
In this example, the employee’s average income is $90,000 and they could apply for up to $900,000 of key person coverage.
3. Setting Up Key Person Policy Correctly
When purchasing key person life insurance, the policy’s beneficiary, owner, and payer should always be the business, just like a Buy-Sell Agreement. The business pays for the life insurance, controls the policy (allowing them to cancel the coverage if it is no longer needed), and collects the death benefit. Insuring executives/key employees is a commonly used method for reducing a business’ taxable income while protecting it at the same time. To learn more about these potential tax benefits we recommend reviewing your state’s tax guidelines or consulting with your company’s CPA or tax professional.
Payment for a key employee life insurance policy is not required until the applicant receives final approval. At that time, you’ll have the ability to pay for the policy monthly, quarterly, semi-annually, or annually. Most insurers provide a 4-8% discount to clients or businesses who pay annually.
4. What Information Do I Need to Start the Application Process?
Most life insurance applications require the same information. To get the application process started you’ll need:
• The name of each key person being insured, their title, approximate income, ownership share if any, date of birth, driver’s license and social security number. This information can be provided by an authorized person or the employee directly.
Please note: When buying life insurance for a key employee, the employee does not need to show an ownership share in the business, but if they do, your business may also want to consider purchasing life insurance for a Buy-Sell Agreement.
• The businesses’ name, industry, and type of business entity (corporation, partnership, LLC, etc.). If you are applying for a death benefit of $1,000,000 or more, the life insurance company underwriter may request additional documentation such as a tax return or financial statement from the business. Every company has a slightly different underwriting process and some companies are more lenient with these requirements than others. At Term Life Advice, our agents will work with you to make the process of applying for coverage as swift and as minimally intrusive as possible.
• Our licensed and experienced agents will reach out to your key employees within 24 hours to ask any private or sensitive health and lifestyle questions. Asking these questions allows our agency to match each applicant with the best coverage options available, ensuring that your business does not overpay for the cost of their coverage. We’ll also schedule a convenient time for a free 20 minute health screening that can be conducted at your office or the employee’s home.
Once the applicant completes their free exam, and their lab results are processed, our agency has the ability to re-shop each company’s guidelines with our applicant’s actual lab results. If another highly-rated insurer is able to offer an affordable option, we’ll advise our client’s before they accept their approval.
Our goal is to match each applicant to the insurance company that will offer the best rates for their specific health and lifestyle. Our agency has over 50 years of collective experience and access to more than 60 life insurance carrier’s unique underwriting guidelines. There is no charge for our shopping services, the application, or the medical exam, and applying for key person coverage is completely risk-free. If you decide not to accept the coverage, there are no penalties or fees.
Example of A Business We’ve Helped With Key Person Life Insurance
John Anderson and Frank Bentley equally own a CPA Firm. They’ve owned their company for nearly 15 years and amassed a significant number of clients. If John or Frank were to die, the business would struggle to service their existing customers, and their business would likely suffer a financial loss.
Anderson & Bentley CPA Services employs 8 full-time employees. Each owner’s book of business represents roughly $400,000 in annual income. John and Frank agree the business would likely recover within 5 years if either of them suddenly died. This means that their business could be out as much as $2,000,000 if either of them passed away unexpectedly.
To protect the business against an unforeseen income loss, and to cover any transition expenses, John and Frank decided to purchase a $2,000,000, 20-year level term life insurance policy on each other. John and Frank intend to sell their business within 20 years, but if they decide to sell sooner, they can cancel the policies without any penalties or fees.
Frank and John are both considered to be in good health for their ages, John is 47 and Frank is 51. John was approved by Prudential at a “Preferred” rate class, or the second best rate category available. John was approved at a “Preferred” rate class due to his weight and the medications he’s prescribed to control his anxiety.
Frank was approved by Lincoln Financial for their top rate class or “Preferred Best” despite taking a medications to control his blood pressure and elevated cholesterol. Like Prudential, Lincoln Financial is also A+ rated by AM Best.
Below are Frank and John’s actual rates for a $2,000,000, 20-year, level term life insurance policy.
$2,000,000 – 20-year Level Term Policy for A 47 and 51 Year Old
|John’s Monthly Rate:||Frank’s Monthly Rate:|
*Coverage amount and rates are guaranteed not to change for 20 years.
*Displayed monthly rates are for illustrative purposes only and are accurate as of 04/01/2017.
We Can Help With Your Business’ Life Insurance Needs
At Term Life Advice, we make protecting your business easy. Whether your business needs key person life insurance or life insurance to fund a Buy-Sell agreement, we can help. Our agency is owner-operated, and we’ve helped thousands of clients with their life insurance needs.
We provide our clients with a consultative, no-pressure approach to life insurance, and our agents do not have quotas or daily sales goals to meet. By shopping more than 60 top-rated companies, we are able help our clients obtain the most affordable, high quality life insurance coverage available.
Give us a call today and we’ll help you get the process started. We can be reached toll-free at: 855-902-6494, or you can request a free quote below to instantly compare rates from dozens of highly-rated life insurance providers with no obligation.