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Most companies have at least one employee who is key to the success of the business. Whether it's the owner, a partner, a majority stockholder, or someone with a high level of expertise, the loss or death of that person could mean financial ruin for the company.
Key-person insurance protects your company's solvency in the event of losing a key employee or founder. Protecting your company from such potential disasters not only makes good business sense, but also, lenders and investors generally require that a business carries key-person insurance to protect their loans and investments in the company.
Many insurance companies require a company's board of directors to pass a resolution affirming the purpose of the business life insurance policy. Additionally, the key employee must be notified about, and agree to the purchase of, insurance on his or her life.
The business typically owns the policy, pays the premiums, and is the beneficiary. Most businesses purchase key-person insurance as a permanent life insurance policy; however, term life insurance may be less expensive and can be bought to cover the key person until he or she retires. The policy can be then transferred to the departing employee as a retirement benefit or to a different key person, upon the retirement of the original key person.
Key-person insurance benefits are often used to buy out the insured person's shares or interest in the company. Buy-sell agreements, which require the deceased executive's estate to sell its stock to the remaining shareholders, legally facilitates this process. Proceeds from key-person insurance can also be used to recruit replacement management.
Premiums for key-person insurance are based on a variety of factors, including age, physical condition, and health history of the key person, as well as the amount of coverage. Before purchasing key-person life insurance, a business owner should:
Estimate the value of key employees. It may be difficult to estimate the value of an irreplaceable employee, but you must do it to determine if you need to purchase key-person insurance and how much coverage you'll need. Consider factors such as projects that would be lost if the employee were no longer with the company, the amount of sales generated by the key employee, and the costs associated with replacing the employee.
Determine if separate key-person insurance is necessary. Credit insurance is one way to cover outstanding loans and debts. If you already have a credit-insurance policy, key-person insurance could be superfluous.

Have a business-continuation plan. Creating a plan that outlines how your business will survive a disaster is key in determining what type of insurance protection you need. An insurer will require that you have a business-continuation plan before they'll sell you key-person insurance.

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