How Much Key Person Insurance Does a Business Need?

This guide answers the most common questions about how much key person insurance does a business need.

Key person coverage only helps if the amount fits the real impact of a loss.

Here is how to size it with confidence.

Part of our complete guide: Key Person Insurance: The Complete Guide.

Key person insurance amount: how much key person coverage does a business need?

Start with what would actually happen if this person were gone tomorrow. Which clients might leave? Which projects would stall? How long would it take to replace them? Put rough numbers on those questions.

Insurers will review financial statements for larger amounts. A coverage amount tied to a clear business reason is easier to approve.

We cover this in detail in Key Person Insurance Tax Treatment, Explained.

What would really happen?

1. List the revenue tied to this person's work or relationships.
2. Estimate how long it would take to replace them and get back on track.
3. Add recruiting, training and any temporary help.
4. Add loans or credit lines that could be called or that they personally signed for.
5. Compare the total with any savings the business could use.

Write down how you arrived at the number. Insurers ask, and the reasoning helps you revisit the amount as the business grows.

Term or permanent coverage for a key person?

Most businesses use term life for key person coverage. It is the most affordable way to cover the years the business depends on someone, such as until a successor is trained or a loan is repaid.

Permanent coverage can make sense when the need is long-term, for example a founder whose loss would affect the business for as long as they're involved, or when the policy may later be transferred to the person as a benefit. It costs more, and the cash value belongs to the business.

Why small businesses need it most

Large companies can absorb the loss of a key person. Small businesses often cannot. Key person insurance buys time and options when the business needs them most.

When a lender asks for life insurance

Some lenders, including on certain small business loans, ask the owner to carry life insurance and assign part of it to the lender. This is called a collateral assignment.

With a collateral assignment, the lender is paid the outstanding loan balance first if the owner passes away, and the rest goes to the beneficiaries. When the loan is paid off, the assignment is released.

Term life is often the most affordable way to meet this kind of requirement. Match the term to the loan.

How insurers decide your rate

Underwriting is how an insurance company decides whether to offer a policy and at what price. It sounds technical, but the idea is simple. The insurer wants a clear picture of your health, your habits and how much coverage you are asking for.

The application

You answer questions about your age, height and weight, tobacco use, medical history and prescriptions. Answer every question fully and honestly. A wrong answer can give the insurer grounds to contest a claim later, especially in the first two years of the policy.

Database checks

Most insurers check prescription history and a shared industry database of past applications. Many also look at your driving record. These checks are why some policies can skip a medical exam: the records answer many of the same questions.

Exam or no exam

Some policies ask for a short exam at home or work, usually a quick health check and a blood and urine sample. Others decide from your answers and records alone. A policy without an exam is faster, but it can cost more or cap how much coverage you can get.

Once the insurer finishes, it offers a rate class. Healthier applicants get better classes and lower rates. If the offer is higher than the quote, an independent agent can often take the same application to another carrier that views your history more kindly.

Why compare with an independent agent

A captive agent works for one insurance company and can only offer its policies. An independent agent is appointed with several carriers and can compare them side by side.

That matters because carriers price the same person differently. One may be friendlier to a past health condition, another to tobacco users, another to larger coverage amounts. Comparing several gives you a better chance at a fair price.

You do not pay extra to use an independent agent. Agents are paid by the carrier you choose, and the premium is the same as buying from that carrier directly.

Two different jobs for business life insurance

Many businesses need both. Key person coverage keeps the company running; buy-sell funding gives the surviving owners cash to buy the departed owner's share at a fair price.

Who key person insurance is for