Key Person Disability Insurance and Key Person Life Insurance: What Business Owners Need to Know
Any good business owner knows that people are a company’s most valuable resource. Making sure you have the right people in the right roles can make or break your company.
That is especially true in a small business, where the loss of even one key employee may be enough to shut down an entire department, halt workflows, and jeopardize client relationships. While most companies try to avoid putting the health of the entire organization in the hands of just one or two key employees, it’s not always feasible for smaller operations.
Key person insurance policies, like key person disability insurance and key person life insurance, offer some protection for business owners. These policies pay out if a key employee dies or becomes disabled, giving you some needed cash to cover temporary staffing needs, hire and train replacements, and more.
What Is Key Person Insurance?
While personal and group disability and life insurance policies are meant to protect individuals and their families if they die or become disabled, a key person policy (sometimes called “key man” insurance) protects the company from the financial damages of losing an important employee’s ability to work for the company. Key person insurance can include:
- Key person life insurance. Also sometimes known as business life insurance, this is similar to a regular life insurance policy, except that the company pays the insurance premiums, is listed as the beneficiary, and receives the policy’s death benefit if the employee passes away.
- Key person disability coverage. This type of key person insurance policy provides short-term benefits to the employer if the key employee becomes disabled due to injury or illness and is unable to work. Often this is offered as a rider on a key person life insurance policy rather than a standalone policy.
While key person life insurance tends to the better known of the two types of policies, it is far more likely that a key employee will become disabled during the course of their employment.
Who Should Be Insured as a Key Person?
You should consider purchasing key person coverage for any individual who is indispensable to your business. In other words, losing them unexpectedly would cause significant financial harm to your business, whether due to lost sales, loss of shareholder or client confidence, inability to provide promised services, or any other reason.
Key people might include:
- A sole proprietor (insuring yourself can help take the burden off your heirs whether they decide to continue or close the family business.)
- A business owner, managing partner, or top executive
- People with highly specialized skillsets or knowledge
- People who have developed close relationships with key clients or customers
- Top performing salespeople who bring in a significant percentage of revenue
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What Does Key Person Insurance Cover (And How Much Coverage Do I Need)?
Companies typically can spend key person insurance benefits however they see fit to best offset the loss of a critical individual. Think carefully about the economic impact losing a key person would have on your business and the additional expenses you would incur. This might include things like:
- Overtime pay for existing staff
- Cost of temporarily hiring contractors or outside help
- Cost of hiring and training a replacement
- Offsetting lost income
- Operational disruptions
- Purchasing a key person’s ownership stake in the business
- Paying off debts, investors, employee severance, etc. (if you determine it would be better to wind down the business than try to go on without the key person).
One common rule of thumb is that a business should purchase about 5-7 years’ worth of the key person’s full compensation (including salary and all benefits) in coverage on average. However, this will vary based on the specific circumstances, so it is wise to work with a financial professional beforehand to determine how much coverage you will need.
Additionally or alternatively, you may consider purchasing business overhead expense (BOE) insurance, particularly if you are a small business or sole proprietorship. A BOE policy is designed specifically to cover fixed overhead costs (such as rent, utilities, maintenance, payroll, etc.) while an important individual (typically although not necessarily an owner) the company relies on to pay the bills is disabled.
Dealing With Key Person Claim Denials
Most people, when they buy insurance coverage, expect that it will be there for them if they ever need it. Unfortunately, the sad truth is that insurance companies regularly deny insurance claims, including key person life insurance and disability insurance. Sometimes these denials are reasonable—but far too often, they are not.
Here are a few common obstacles:
A Key Person Must Be “Totally Disabled” to Be Covered
Most key person disability insurance require the insured employee to be “totally disabled” in order to pay out benefits. This means two things:
- The key person must be unable to perform the “substantial and material duties” of their role, and there are no reasonable modifications or accommodations that would allow them to continue to do so.
- The employee cannot be working another job for your business with similar duties or with a comparable impact on company earnings.
Employers can run into problems here if the insurance company does not agree that key person is totally disabled from their role, or that their newer, lesser role with the company is comparably valuable.
In particular, insurance companies are notorious for only focusing on physical disabilities and underappreciating the impact of cognitive and emotional disabilities. This is an acute problem for key person insurance claims, as key people are often in roles that require a lot of cognitive sophistication—like planning, memory, complex problem-solving skills, and emotional intelligence.
Deaths That Occur During the Contestability Period Are Often Denied
As with typical life insurance plans, a claim can potentially be denied if the key employee’s death occurs within the contestability period (usually 24 months from the start of the policy).
However, it is important to understand that any mistake or misrepresentation the insurance company discovers during its investigation can result in a claim denial, even if it had nothing to do with the death. For example, if the insurance company discovers that you failed to report a key employee’s previous drug problem during the application process, even if their death occurred in a freak accident that had nothing to do with drugs or their physical health.
Unfortunately, insurance companies have been known to look for any technicality they can possibly use to unjustly deny a legitimate claim.
The Type of Death or Disability Is Excluded Under the Policy
Almost every insurance policy will exclude specific types of death or disability. For example, deaths or disabilities resulting from a suicide attempt, drug use, illegal activities, or dangerous hobbies are often excluded.
Because these exclusions are often written very broadly, the insurance company might look for any possible connection—even a tenuous one—to a listed exclusion as a justification for denying a claim.
Other Key Rules, Restrictions, and Exclusions to Consider
A few other quick things to keep in mind:
- The key person must consent. You cannot insure a key person without their knowledge or consent. Moreover, they will likely be required to take a medical exam and provide written information before they can be insured.
- Carefully consider the elimination period for key person disability insurance. Disability benefits will not start to kick in until the policy’s elimination period has ended, which could be 30 days, 60 days, 90 days, or sometimes even longer. However, not every company can afford to wait 90 or even 30 days when one of their most valuable employees becomes disabled unexpectedly. If you expect the financial damage of losing your key employee to be swift and immediate, it may be worth spending extra to purchase a plan with a shorter elimination period.
Bryant Legal Group: Chicago’s Key Person Insurance Attorneys
If you are a business owner struggling with a key person insurance claim denial, or you need help with your claim, contact the team at Bryant Legal Group for a consultation.
Our lawyers have extensive experience working with small, medium, and large businesses throughout Illinois. We can help you understand what is in your key person insurance policy, gather the necessary documentation and evidence you will need to support your claim and fight any unfair denials, and work to protect your company financially.