What is “key man” insurance and why does it keep coming up?

in business together

“Key man” otherwise known as key person or main person coverage is life and disability insurance that a business owns on a specific individual or set of individuals that create the driving force behind profitability. Vague? Here are a set of examples:

  1. A Subchapter S Corporation that is comprised of two equal & actively engaged members. They each bring with them a desirable set of skills, talents, recognition, or ability that makes them critical to the success of the firm. i.e.: One loves to manage multiple working crews, is held in high regard by suppliers, and has a knack for getting things done ahead of time under budget. The other knows little about landscape construction, but generates wonderful referrals, has a positive and engaging personality whom prospective customers want to work, and handles all paperwork and change orders necessary to be profitable. Without one or the other (and no clear hierarchy of succession waiting in the wings) the business could at least struggle for years, if not completely fail.

Thus, the company could insure each of them for a factor of annual remuneration. So that if one or the other were lost unexpectedly, the firm would have the resources available to search out, recruit, negotiate with, hire, train, and theoretically not skip a beat in profitability. If this method of continuity fails, then the key man lump sum could be used to purchase a competing firm, whose team contains a suitable substitute to step into the lost members’ duties to continue to proliferate.

  1. An LLP that has two officers: a specialist that is five years from retiring, and the other that is only five years into practice. The makeup is that the former “recruited” the latter to come in, slowly take over the patient base, and the organization would survive in the community. Both have the same specialty. Both generate an equal amount of revenue. However, perhaps the profit margin of the practice is only 45%. From this basic formula we can see that without either practitioner the organization could fail, because the margin is short of the revenue generated by either party. (At this point I’ll point out that there are fixed costs and variable costs. However, making intelligent cuts to variable costs to succeed strategically can have catastrophic affects on tactical operations. Emotions come into play here, where, in the struggle to act quickly that sometimes the best people are terminated and those that struggle the most are retained, damaging the long-term profitability of the practice.)

The corporation can insure each of them as “key men” for a factor of operating expenses plus net profit for a specified length of time so that the right decisions can be made to try to reduce the long-term losses and continue to operate in case of disability or death of either.

  1. An insurance agency could be an LLC, and could have three equal full-time agents. They have very unique talents, skills, interests, and approaches to managing the business. One conducts sales & marketing, one finance & IT, and the third oversees operations of two branches.

Were any one lost or disabled suddenly then the company would have instant capital available (via the “key man coverage lump sum” to either: a. search out, recruit, negotiate with, hire, train, and perhaps continue moving forward, no less profitable than before. B. Were a suitable replacement not found, then the agency would be financially able to simply promote a suitable member of the current staff to increase productivity to step into the lost member’s shoes, and operations would continue, potentially without interruption or a decrease in profitability.

These topics are become ubiquitous in the world of commerce, commercial lending, entity by-laws, entity articles of incorporation, venture capital investing, etc. because they specifically address risk and risk tolerance of stakeholders. Consider this: If, in any of the three examples above, the agents were all 30 years old, it is easy to consider that a commercial lender would be less careful than if the agents were each 70 years old. Make sense? The lender would be interested to know how their organization’s risk would be managed, were one of the agents to be suddenly and unexpectedly lost. The cornerstone is that some organizations thrive in risk, and others are very risk-averse.


Please notice glaring omissions in these three potential challenges:

No mention was made of how to buy the stock or shares of the lost principal from that person’s estate, family, spouse, or partner!

No terms were yet shared that address income continuation for the family of the lost owner.

No mention was made of family protection life insurance.

Cost basis, stepped up cost basis, tax ramifications, owner’s equity distributions, stock transfer agreement (buy-sell contract), cash flow arrangements, debt payoff, critical illness settlements, “Non own-occupation” income continuation, division of company assets, share value management procedures, tax planning, prudent reserve preservation, trust management, company financials, policies and procedures, term vs. permanent insurance, etc. were never mentioned in these examples.

The items in this section are separate from the three examples above. Confused? PLEASE DON’T BE! Let’s schedule a discussion to determine where your risk is, and what keeps you up at night. We offer solutions.