Why Business Partners Should Buy Life Insurance

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Jeffrey Johnson is a legal writer with a focus on personal injury. He has worked on personal injury and sovereign immunity litigation in addition to experience in family, estate, and criminal law. He earned a J.D. from the University of Baltimore and has worked in legal offices and non-profits in Maryland, Texas, and North Carolina. He has also earned an MFA in screenwriting from Chapman Univer...

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Written by Jeffrey Johnson
Insurance Lawyer Jeffrey Johnson

UPDATED: Jul 15, 2021

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If you think life insurance is only for individuals or for families, think again! Small business life insurance, or key person life insurance, is purchased by business owners to ensure the continuation of their enterprise when there is an untimely death of one of the founders or operators. If you are a business owner and you are trying to decide if you should purchase small business life insurance, you need to consider whether or not the business could survive without your contributions.

How Key Person Insurance Works

Key person life insurance is primarily purchased to ensure the continuation of the business should a key player die, so the policy is taken out on the life of the important members of the operation. Deciding which individual to insure depends on the type of business and the role the individual plays in that business. Typically a small business will rely heavily on the financial contributions of one or more people, and it is those people who the business should insure. Although the insured party is one of the key individuals in the business, the business pays the premium payments, owns the policy, and is the named beneficiary.

Why Buy Life Insurance for Your Business

Key person insurance can help a business by paying out a benefit amount in the event a key person’s death. This benefit is meant to replace the loss of an important financial contribution and allow the business to wind down or to continue operations without suffering a financial loss.

Consider the following examples:

  • Example 1: ABC Company that is owned by three individuals who started the business about ten year ago. Two owners are now married and one is divorce. They all have children. They own an equal amount of the company, one-third each. The company is now worth considerable more than when they started out 10 years ago. If one of the owners should die, the other two would have to pay his spouse or his children to purchase his share of the business from the family. To make sure the business can afford to do so and continue operating, ABC Company purchased a $2 million dollar life insurance policy on each owner. The company paid the premiums and the beneficiary is ABC Company. When one party dies, the company would receive the life insurance payout which will allow it to pay the family what they are owed for the deceased partner’s share and continue to operate without a devastating financial hit. If it were not for this key man life insurance, the company may have had to go into debt or even bankrupt.
  • Example 2: This type of life insurance for businesses is also helpful when there is a key man or person that brings substantial revenue to businesses. For example, a doctor’s practice where you have 10 doctors that own and operate a practice. Each doctor sees patients and bills for office visits and surgeries. They not only make money for the practice but they get paid a salary for their services. If a doctor (key person) should die, the practice could stand to lose all the money that this physician brought to the practice for years to come. However, Key Person insurance would allow the practice to continue to operate without a large devastating lost while they seek another doctor to add to the practice and built clientele. This would be the same for a lawyer in a law practice, or any business in which each individual brings in substantial income.

In each example, key person insurance allowed the company to absorb the financial hit of losing one of its key players. If you and your small business are operating without a life insurance policy, you need to be sure that the business can survive without the continued financial support of its primary owners.

Benefits of Key Man Insurance

In addition to the life insurance payout, key person insurance can benefit the company in many ways:

  • It can increase the credit worthiness of the business as lenders see that with small business life insurance in place, you can sustain in the event of the death of a key person.
  • Depending on the type of policy the business buys, the cash value can be a source of interest free loans for the business in lean times.
  • It is possible to have policy ownership transferred to the key man upon retirement as a retirement bonus and thus allowing him pull the cash value if needed or have a large death benefit for his heirs.
  • It allows a company to continue to operate by giving them the financial ability to buy-out family of the deceased employee or mitigate any lost income by key players.

Types of Key Person Insurance

There are two types of Key Person insurance-Term and permanent life. Term insurance is for a specific term. A business may purchase 30 year term on a person and possible layer it with another term in the coming years to extend coverage. Permanent life insurance products are for the entire life of the employee and would also allow the company access to cash value that builds in the policy. As term may expire by the time the employee retires, the whole life would allow the company if it chooses, to transfer ownership at the end of employment. Depending on the revenue being generated by the employee being insured and the type of business, a term small business insurance policy might fit the company’s needs. It might feel that the peak performance years of the employee would be the first 30 years, realizing he may taper off his clientele in the later years of his career. However there are some businesses (again depending on the type of business) that might need permanent coverage for the entire life of the employee.

The type of small business life insurance you need and how much you should buy depends entirely on the type of business you have, the revenue you need to replace, the structure of the business (joint partnership, single owner, multiply owners, etc) and the company budget and goals. Compare term vs permanent plans, review your insurance needs and options, and talk with a financial advisor or ask a life insurance agent to guide you on which type of small business life insurance would be best for your company.

When you know what you need out of your key person insurance, start shopping and comparing online quotes. You can get free online life insurance quotes from Free Advice by clicking here and visiting our insurance quote center.

Read more about finding the right type of life insurance by clicking here.

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