Key Person Insurance Explained: Protecting Your Business from the Unexpected

Many businesses, especially small ones, depend on at least one person for their survival and success. This person could be the founder, a top sales executive, or a technical expert whose knowledge is irreplaceable. These individuals aren’t just employees; they’re central to the company’s value, revenue, and ability to succeed.

But what happens if that person is suddenly gone?

That question is common, and the reason for key person insurance. At Ensign Partners, one of the issues we evaluate for our business clients is whether they should obtain key person insurance and what the value should be. It is also relevant for companies merging or acquiring a business that is dependent on particular individuals. The value of the business they acquire may be primarily based on the contributions that key personnel bring to the table.

What Is Key Person Insurance?

Key person insurance is a life or disability insurance policy a business takes out on a specific individual, usually an owner, founder, or high-level employee. The business owns the policy, pays the premiums, and is the beneficiary. Thus, if the key person dies or becomes disabled, the company receives a tax-free payout. This money can be used to:

• Offset lost revenue
• Cover recruiting, training, or even salary costs for a replacement
• Pay off business debt
• Stabilize relationships with investors, lenders, or customers
• Fund a buy-sell agreement or ownership transition

Essentially, it is “disaster recovery funding” for your leadership team.

Why It Matters

Most small and mid-sized businesses don’t have deep management benches. If one person is the lynchpin for critical business relationships, institutional or technical knowledge, or decision-making power, their absence can quickly throw a company into disarray. Without key person insurance, when that key individual is unable to fulfill their obligations:

• Clients lose confidence, and revenue drops
• Creditors tighten terms or call loans
• Partners, family members, or other owners may be forced to sell or liquidate
• Remaining team members may burn out trying to fill the gap

These are not just setbacks. They represent existential risks for your business.

Who Qualifies as a “Key Person”?

A key person is not related to job title, but business impact. A key person is anyone whose absence would materially affect a business’s revenue, operations, or strategy. To evaluate who qualifies, ask:

• Who brings in or influences the majority of revenue?
• Who holds essential relationships with clients or suppliers?
• Who has specialized knowledge that no one else in the business can provide?
• Whose departure would trigger panic from investors, lenders, or partners?

Typically, key personnel might include:

• Founders or co-founders
• Top sales executives
• Product designers or lead engineers
• Managing partners or financial leaders

In many cases, there is more than one key person. That’s okay; insurance coverage can be customized accordingly.

Types of Coverage

There are two primary forms of key person insurance:

1. Key Person Life Insurance
These policies are essentially the same as any other type of life insurance, and pay out a death benefit if the key person dies unexpectedly. The only difference is that the beneficiary is generally the business itself, and the premiums are paid by the company and expensed as a business cost.

2. Key Person Disability Insurance
Disability insurance provides a benefit if the individual cannot work due to illness or injury. It may be harder to qualify for, but it addresses a more likely scenario than death. Many plans will cover both death and disability.

How Much Coverage Will You Need?

The amount of the policy payout will depend on a valuation of what that key person contributes to the business. However, common approaches to setting a coverage amount include:

• Multiple of the individual’s salary (e.g., 5 or 10 times the salary)
• Revenue replacement
• Cost to replace the individual
• Outstanding debt or capital needs of the company

Coverage should align with a business’s financial structure, succession plan, and liquidity strategy—not just a guess at what seems safe.

Make Key Person Insurance Part of an Overall Plan

Key person insurance can be powerful, but only if it’s connected to the rest of your business and estate planning. It should work hand-in-hand with:

• Buy-sell agreements
• Ownership succession plans
• Executive compensation strategy
• Entity structure and tax planning
• Estate needs

Ensign Partners helps business owners integrate insurance into a broader risk management and continuity strategy so they are not just covered, but confident.