Key Person insurance is a life and/or disability policy taken out by the business as a beneficiary in the event of death or disability to a particular key employee.
The policy works by paying the business in the event of the death or disability of a person who is so important to the business that their loss could destroy the business.
Here’s how key person insurance works: A company protect itself by by purchasing an insurance policy on its key employee and is also responsible for paying all the premiums. If that person dies unexpectedly, the company is entitled to receives the insurance payoff. In simple words, company paid the premiums to be the beneficiary of the policy. Key person insurance is needed if the sudden loss of a key executive would have a large negative effect on the company’s operations. The insurance payout provided from the death of the executive essentially buys the company time to implement other strategies to save the business or to find a new person.
The company can use the insurance proceeds for expenses until it can find a replacement person, distribute money to investors, pay off debts, distribute money to investors, or to pay severance to employees and close the business down in an orderly manner. In a disastrous situation, key person insurance gives the company some options other than immediate bankruptcy.