Who Is a Key Person?

Deciding exactly who is a key person in a business is sometimes easy, sometimes more difficult. Generally, in a smaller business owned by one person or just a few people, the owners can easily be identified as key people. However, even in very small businesses, certain employees who are not owners may also play key roles. The example of a chief photographer mentioned previously serves well here. Even if the photographer is a non-owner employee, he obviously is important to the success of the ad agency and is a candidate for key person insurance.

Critical Financial Role

Whether the person is an employee or an owner-employee, the individual must serve a role that is critical to the financial health of the business. The role might be in management, finance, sales, professional or technological expertise, production or any other area or combination of areas in which, without that person's contribution, the business would be in danger of suffering financial loss. As you attempt to identify employees or owner, employees who qualify as key people, look for unique skills, business contacts, technical knowledge or other contributions that could not easily or quickly be replaced by someone else. Having an employee who serves in such a capacity gives a business an insurable interest in the key person-an interest that may legitimately be fulfilled by insurance.

It is interesting to contrast the characteristics that identify a key person with someone who does not fit that profile. For example, sometimes high compensation is used as a guideline, but salary alone is not adequate for identifying a key person, especially when the person works for a larger business. High compensation may equate with a highly competent executive of a large business, but if others in the business could step in immediately to assume that person's responsibilities, very little, if any, negative financial consequences would occur. Without an adverse financial result, there is no need for key person insurance.

On the other hand, a similar individual employed by a small or medium-sized company that employs no one else with the same talents is likely to be a key person whose absence could cause financial problems. You'll find that some insurers will not even write key person insurance for large businesses that employ many people in similar capacities.

Proprietorships, Partnerships, Corporations

Key person Insurance is available to all forms of business, regardless of the type of ownership. Sole proprietors may purchase key person insurance on their own lives and/or the lives of one or more key employees.

Each partner in a partnership may be covered, typically by a policy the partnership entity owns. Partners, too, might have key non-owner employees for whom key person insurance is appropriate.

And both C and S corporations are eligible to purchase key person insurance on owners and key employees. In all cases, however, the best prospects are smaller or closely held companies where business success hinges on relatively few people-possibly just one person. As you might suspect, the tax consequences may differ depending on the type of business ownership: we'll see how soon.

How Key Person Life Insurance Works

Let's first consider key person life insurance, which pays benefits if the insured key person dies while the policy is in force. Remember, this insurance is written for the benefit of the business, not the key person.