Key person insurance is a life insurance policy a business owns on an owner or essential employee, with the company as beneficiary. If that person dies, the business receives funds to absorb lost revenue, recruit and train a replacement, and reassure the lenders and customers who were counting on that person. It protects the business's value — not the individual's family, which is a separate need.
Concentration risk
The risk it addresses
Many businesses quietly depend on one or two people: a founder who holds the key relationships, a rainmaker who drives sales, a technical lead whose knowledge isn't written down anywhere. If that person dies suddenly, revenue can fall, projects can stall, lenders can get nervous, and the value the owner spent years building can erode fast. Key person insurance converts that concentrated risk into a funded plan.
Owner, insured, beneficiary
How it's structured
The business applies for, owns, and pays for the policy on the key person's life, and the business is the beneficiary. Coverage can be term — inexpensive protection for a defined period — or permanent, which some companies choose so the policy's cash value can also serve as a business asset. To preserve the income-tax-free death benefit, employer-owned life insurance notice-and-consent requirements must be handled correctly before the policy is issued.
- Term key person: lowest cost, protects for a set period (e.g., through a loan term or until a succession plan matures).
- Permanent key person: higher cost, builds cash value the business can access, coverage doesn't expire.
- Notice-and-consent paperwork completed up front to keep the death benefit tax-favored.
Not in isolation
Where it fits in a coordinated plan
Key person coverage rarely stands alone. It usually sits alongside a buy-sell agreement (who buys a departing owner's share, and how it's funded), executive-retention strategies for the very people you'd insure, and the owner's personal and estate planning. Coordinating these — with your CPA and attorney in the room — is what turns a stack of policies into an actual continuity plan.
When this is the wrong tool — and what can go wrong
Key person insurance is the wrong tool — or wrongly used — when:
- No single person's loss would materially hurt the business. If the risk is diffuse, the coverage may be unnecessary.
- The notice-and-consent requirements are skipped, jeopardizing the income-tax-free death benefit.
- It's confused with the owner's personal or buy-sell coverage, leaving the wrong party as beneficiary.
- The amount is pulled from a rule of thumb rather than sized to the real financial impact.
- A permanent policy is bought for its cash value when a cheaper term policy would fully cover the actual risk window.
Common questions