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Any successful business owner will tell you that its key employees are the company’s backbone. If they suffered a disability, there would be a severe financial impact on the business. It may not even be able to survive over the long term. That’s what makes them the key people in a company.
If your business is dependent on one or more key people, you need to protect it with key person disability insurance.
Learn more about how key person insurance works and how it can ensure the survival of your business in the event of the disability of a key employee.
- Key takeaways:
- A key person is essential to a company's operations and cannot be easily replaced.
- Key person disability insurance pays a cash benefit to your company if an essential employee can't work because of an injury or illness.
- You can use the benefit to offset lost sales, cover the cost of hiring a replacement, and more.
What Is Key Person Disability Insurance?
Key person disability insurance protects your company financially from lost sales, increased expenses, or high replacement costs when a key employee is totally disabled.
It works by paying a monthly benefit to your company if the key employee cannot perform their substantial and material duties due to an injury or illness. You can use the disability benefits in a wide variety of ways, including:
Covering the cost of hiring and training a replacement,
Offsetting lost sales,
Supplementing overtime payments of existing staff to cover for the loss of the key employee,
Keeping the company’s operations going until the critical employee returns or you execute a business succession plan,
Or however you see fit to reduce the financial burden of the disability of the insured employee. The vital thing to know is that cash flow is uninterrupted, giving you financial flexibility during a tough time.
Monthly benefits last one year as long as the key employee is disabled during the entire benefit period. Although benefits payable monthly don’t start at the onset of disability, you will begin receiving them after a short waiting period. Also known as the elimination period, this is how long you have to wait before benefits kick in. Common elimination periods are 30, 60, and 90 days.
Because the business entity owns the disability policy, it pays the insurance premiums. As the policy’s beneficiary, it’s also the one that receives the policy proceeds.
Who is a key person?
A key person is an employee whose services are vital to small businesses. Their total disability would result in a financial burden that could threaten the company’s existence.
These employees have specialized knowledge, skills, and experience and are not easily replaceable. They typically work in industries where the nature of their work may be so specialized that few others have the skills to do their job. Often, their tasks have a component of design or research to them.
A key person may have the following characteristics:
Works on project type work often on an individual basis.
Engages in innovative, cutting-edge, or state-of-the-art work.
Designs processes or products.
Impacts the rest of the organization. For example, without a designer, the manufacturing process would stop.
Is the only one in the company with these skills.
Is the most highly paid employee other than the owner.
Loss of the key person would result in a lengthy job search to hire a replacement, unable to be filled by a temporary worker in the meantime.
How much coverage do you need?
The employee’s income limits the key person disability coverage you can get. For example, if the key employee earned $120,000, you can buy a monthly benefit of $10,000.
However, there is also a limit based on the person’s occupation class. Lower-risk occupation classes have a higher limit of $25,000, while higher-risk occupation classes have a lower limit of $8,000.
Typically, you will want to get the maximum amount to help your business offset the loss of the key person.
How much does it cost?
Since the policy benefit is triggered when the key person becomes disabled, the cost depends on the personal attributes of key employees. Factors that affect insurance premiums include age, gender, smoking status, and occupation.
$10,000 in benefits for a 45-year-old non-smoking male architect would cost $132 per month, while the same amount for a 40-year-old non-smoking female fashion designer would cost $163/month in premium payments. Both of these sample quotes have a 60-day elimination period.
One of the main features of key person insurance is that it is a non-cancellable contract. This means the insurance company cannot cancel or reduce your coverage until age 62. It also can’t increase the premiums, putting you in the driver’s seat of the policy.
How do you qualify for key person insurance?
The insurance company reviews the financial, lifestyle, health and medical history of the insured employee to see if they are a good candidate for disability coverage.
It will also try to gauge the employee’s importance to the employer by asking questions like:
How long has this person been working at the company?
Is there anyone in the organization with similar education and experience?
What is the anticipated first-year financial loss to the business?
Is key person coverage being applied for any other member of the company?
What measures will the employer take to ensure the employee’s duties are performed?
If the underwriter is satisfied that the employee is a key contributor to the company’s success, it will offer key person insurance.
Frequently Asked Questions
What is a key person in a business?
A key person is a critical individual who is indispensable to the company’s operations and whose death or disability would have a severe financial impact on the company’s survival in the short and long term.
Who owns a key person policy?
Unlike a long-term disability insurance policy that an individual owns, a business entity owns a key person disability insurance policy. As a result, the business pays for the insurance coverage.
How is key person disability insurance taxed?
Although premiums paid for key person disability insurance are not tax-deductible, your company receives the benefit tax-free.
What other types of business insurance should you get?
Besides key person disability insurance, you should also consider the following types of insurance policies to protect your business.
Key person life insurance
While key person disability insurance provides a financial cushion to help handle the disability of an essential employee, key person life insurance does the same if death occurs.
The life insurance policy pays a lump sum death benefit to the company. Since there isn’t an elimination period with a life insurance policy, your company receives the cash benefit immediately.
Key person critical illness insurance
Besides death and disability, a critical illness like cancer or heart attack on a key employee can have a massive impact on an organization’s finances. Like with life insurance, key person critical illness insurance pays a tax-free lump sum benefit to the company upon the diagnosis of a covered condition.
This crucial support covers lost revenue, offsets increased expenses, and helps manage replacement costs while the key employee recovers.
Group disability insurance
Group insurance usually includes disability coverage alongside other benefits like life insurance, dental, and extended health coverage as an employee benefit.
Unlike other types of insurance in this list, a group disability insurance policy offers financial protection for the employee rather than the employer. Nevertheless, a competitive group benefits package can help attract qualified employees and is a vital part of their compensation.
Wage loss replacement plan
A wage loss replacement plan may be the answer if you’re looking for better disability coverage for your key employees. Not only does it pay a higher policy benefit, but it also has a more comprehensive definition of disability. Also, terminated employees can convert their coverage into an individual plan.
Business overhead expense insurance
If key person disability insurance protects the company if key employees become disabled, then business overhead expense insurance protects it if the business owner becomes disabled.
As the company’s primary revenue generator, your total disability will cause a significant financial crisis. Fixed business expenses like rent, employee salaries, and utilities continue while money stops flowing into the company.
A business overhead expense insurance policy reimburses you for these fixed expenses for up to two years so that you can focus on recovery instead of your company’s prospects.
Business loan disability insurance
Business loan disability insurance makes funds available to pay outstanding business loans and interest when the owner becomes totally disabled. Eligible loans include those for equipment, property, and buildings.
You have a choice between a monthly and lump sum benefit. The elimination period is either 30, 60, or 90 days for the monthly payment option. On the other hand, the elimination period for the lump sum option is 365 days.
Disability buy-sell insurance
Do you have a business partner? What happens to the shares of the disabled owner if they can’t return to work? Disability buy-sell insurance provides liquidity for the working owner to purchase the disabled owner’s shares to complete a buyout.
Do You Have Key People In Your Business?
If so, you may wonder about the financial impact their disability will have on your business. If they are genuinely vital to your company, the answer to that will be ‘substantial.’
That’s why the time is now to protect your business with a key person insurance package that includes both life and disability insurance. With these two coverages, your business will avoid a financial disaster if an unexpected event occurs to a key contributor.
Because there are many policies and coverage out there, getting the right one can be a challenge to the uninitiated. Reach out for a complimentary consultation where we assess your business to determine the right policies for you. Contact us at info@briansoinsurance.com or 604-928-1628 today.
Get Your Key Person Disability Insurance Quote Now
While we make every effort to keep our site updated, please be aware that timely information on this page, such as quote estimates, or pertinent details about companies, may only be accurate as of its last edit day. Brian So Insurance and its representatives do not give legal or tax advice. Please consult your own legal or tax adviser. This post is a brief summary for indicative purposes only. It does not include all terms, conditions, limitations, exclusions, and other provisions of the policies described, some of which may be material to the policy selection. Please refer to the actual policy documents for complete details which can be provided upon request. In case of any discrepancy, the language in the actual policy documents will prevail. A.M. Best financial strength ratings displayed are not a warranty of a company’s financial strength and ability to meet its obligations to policyholders.
