Every company has employees that would be difficult, if not outright impossible, to replace. These key employees are vital to the continued success and daily operations of the business, whether it is due to their years of experience, specialized knowledge, or far-reaching business connections.

What would happen if one of your most valuable employees suddenly became ill and lost the ability to contribute to your business? Would your company struggle to get work done, lose valuable clients, or go out of business altogether? These are questions worth considering, especially if you own a small or medium-sized business. Small and medium-sized businesses employ fewer people and operate on a tighter budget than large businesses, so the loss of a key person could have a devastating effect on the production and future of the company.

Who is a key person?

While there are no hard and fast rules regarding the definition of a key person, a key person is generally someone who is extremely important to the success of a business and someone whose absence or inability to work could cause major problems or the outright failure of the business.

Some examples of key people could be:

• An advertising manager with personal ties to several high-profile athletes
• A chief financial officer whose background and expertise allows the company to run a difficult and unique sales strategy
• The co-founder of a financial tech start-up with two decades of experience in the industry
• A top salesperson who brings in 70% of a health and fitness company’s revenue

Regardless of the position or title of a key person, he or she is strongly tied to the continued success and operations of a business. A key person’s loss or absence could mean the difference between success and failure.

What is Key Person Disability Insurance?

Key Person Disability Insurance, also known as Key Man Disability Insurance or Key Employee Disability Insurance, is a type of business insurance that provides short-term financial benefits to a company if a key employee is no longer able to fulfill the demands of the job due to the onset of an illness, injury, or accident.

If a business loses a key employee due to disability, financial losses are likely to mount. From lost revenue to the costs of finding a replacement, the absence of a key employee can be of immense strain on the financial resources of a company. Key Person Disability Insurance provides financial protection for these types of situations and will pay out funds to the business to stymie losses and cover expenses.

Key Person Disability Insurance differs from key person life insurance in that it covers for disability and not the death of a key employee. It also differs from personal disability insurance in that the beneficiary is the business rather than the individual.

Example:

• The manager of a small automobile repair shop experienced a debilitating stroke and was no longer able to fulfill the duties required of him at the shop. Luckily, the owner purchased Key Person Disability Insurance for the manager three years ago because the manager played an indispensable role in keeping the business afloat. The owner was able to receive monthly benefits from the insurance company to cover the costs of finding and training a replacement.

Do I need Key Person Disability Insurance?

While all businesses would suffer if a key person became disabled, certain types of businesses are more vulnerable to financial hardship and bankruptcy than others. Small and medium-sized businesses are particularly vulnerable to business failure if a key person becomes disabled due to the size of their workforce and limited reserves. Businesses that are highly dependent upon one or two select employees for the majority of their revenue are also quite vulnerable and may want to consider Key Person Disability Insurance.

Finally, if one or more of your key employees struggles with a health condition or has dealt with a serious illness in the past, it may be wise to consider purchasing Key Person Disability Insurance. Though we all hope for good health, relapses and health scares can occur, and it pays to have a plan in place should a health condition ever recur.

What does Key Person Disability Insurance cover?

While exact coverage varies from insurer to insurer, Key Person Disability Insurance generally provides the funds needed to keep your company afloat and replace the disabled employee. Some examples of what these costs may be used to cover include:

• Hiring a recruiter or agency
• Advertising the position through job postings and online communications
• Offsetting revenue lost by key person disability
• Offering an early signing bonus to a replacement hire
• Training the replacement
• Paying for overtime work and staffing costs needed to cover for the key person

The entire process of losing an employee to finding a suitable replacement can take a lot of work and time. Key Person Disability Insurance makes sure your company has the cash and financial means necessary to stay afloat and keep operations going until the business has stabilized and a suitable replacement has been found.

What are the key exclusions of Key Person Disability Insurance?

Insurance companies will not cover claims borne out of fraud, misrepresentation, or intentional dishonesty. Disabilities caused by acts of war, self-inflicted harm, and personal hobbies and activities that present a risk of injury are also typically excluded from disability coverage. Exclusions may exist for pre-existing conditions and illnesses incurred before purchasing the policy, but they usually vary based on the insurance company and involve a close examination of treatment history and medical records.

What are the important provisions of Key Person Disability Insurance?

Key Person Disability Insurance policies are typically custom-made for businesses and pay out in terms of a monthly benefits option or a one-time lump sum option. The cost of the policy and the premium paid to the insurance company will depend on which one of these two options you choose.

Two important concepts to understand before choosing a Key Person Disability Insurance policy are elimination period and benefit period. The elimination period of an insurance policy is the length of time that must elapse after a key employee suffers an injury or disability before an insurance company will provide you the benefits agreed upon in the policy. The benefit period is the length of time the insurance company will pay you benefits as agreed upon in the policy. The elimination period and benefit period of a Key Person Disability Insurance policy will differ depending on whether you opt for monthly payments or a one-time lump sum payment.

Monthly Benefits Option

After the elimination period is over—typically 90 days, but can vary from 30 to 180 days—Key Person Disability Insurance policies with a monthly benefits option payout monthly until the benefit period ends. The benefit period for monthly benefit options can range from 6 to 24 months.

Lump Sum Option

The elimination period for lump sum policies is longer, lasting for 365 days, typically, or one year. Once the elimination period passes, your company will receive the lump sum payment agreed upon in the policy. Because this option is a one-time payment, the benefit period will end as soon as you receive your money.

Which option is better for my company?

A major factor to consider when deciding between monthly benefits or a lump sum payment is the cash flow of your company and the expected funds and time needed to secure a replacement. If your company has sufficient funds and a strong, flexible workforce, you may be able to wait for a lump sum payment. On the other hand, if your business will be immediately and irreversibly affected by the loss of your key employee, monthly benefits may be the more pertinent choice. Regardless of what you choose, thinking through the possible implications of losing your key person will help your company make a wise decision on whether Key Person Disability Insurance is right for you.

How much does Key Person Disability Insurance cost?

The cost of an insurance policy depends on a variety of factors, but the biggest determining factor is the amount of coverage promised after the elimination period. Other key factors include the age, gender, and health condition of the key person. The greater the risk of disability, the higher the cost of the premium and insurance policy.

Other factors that influence insurance cost include:

• Company Structure and Size: Premiums increase with company value and profitability.
• Type of Policy: Premiums will vary depending on whether you purchase a monthly benefits or lump sum policy.
• Length of Elimination Period: The longer the elimination period, the lower the premium.
• Length of Benefit Period: The longer the benefit period, the more expensive the premium.
• Key Person Salary: Premiums typically increase with a key person’s salary.
• Revenue Tied to Key Person: Premiums increase with the amount of revenue brought in by the key person.

Final Word

No company wants to lose an employee, much less a highly valuable one, but misfortunes can and do happen, and it is important to consider and prepare for these situations should they ever occur. Key Person Disability Insurance provides crucial benefits and cash flow in case a key person becomes disabled and is unable to carry on with his or her job or duties to the same extent and capacity as before the incident. If anyone in your company is highly valuable or irreplaceable, Key Person Disability Insurance may be a wise choice to consider for the longevity and future of your business.