Key person insurance is when a company buys a life insurance policy on a key person in a business. In a small business, this may be the owner, the founders or a top-performing employee. The main reason to purchase a key person life insurance policy is to protect a business in the event of the untimely death of the insured.
Here's how key person insurance works: The business purchases a life insurance policy on its key employee(s), pays the premiums and is the beneficiary (and/or owner) of the policy while the employee is insured. If that person dies unexpectedly, the company receives the insurance payoff and may use the proceeds to help offset the financial loss that may occur by the death of a key employee.
The company can use the insurance proceeds to pay expenses until it can find a replacement, or, if necessary, pay off debts, distribute money to investors, pay severance to employees and close the business down in an orderly manner. In a tragic situation, key person insurance gives the company some options other than immediate bankruptcy.
This coverage offers peace of mind to business owners because the death of a key person in a small company can cause extreme financial hardship to company. With a key person insurance policy, a company can survive the unexpected blow of losing the person who makes the business work.
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