Key person insurance (formerly key man insurance) is a life and sometimes disability policy on the founders, executives, or critical employees a business cannot easily replace. The business pays the premium, owns the policy, and is the named beneficiary, the goal is to give the company a cash cushion to recruit a replacement, reassure investors, and meet loan covenants if the key person dies or is disabled.
How to size key person coverage
Three common approaches. Multiple of compensation: 5 to 10 times salary plus bonus. Replacement cost: estimated cost to recruit and onboard a replacement (often 2 to 3 times annual comp for executives). Contribution to profits: capitalized value of the key person's contribution to EBITDA. For early stage startups, investor required minimums (often $1M to $5M) usually drive the number.
Term vs. permanent
Almost always term life. The need for key person coverage is finite (until the person retires, the company can replace them, or the loan is repaid). Term is dramatically cheaper and matches the time horizon.
Tax treatment basics
Premiums paid by the business on a key person policy are generally not deductible. Death benefit proceeds received by the business are generally tax free. The Pension Protection Act of 2006 added notice and consent rules that must be followed at policy issue or the death benefit can become partially taxable, work with a tax advisor.
Buy-sell agreements and disability buyout
For partnerships and closely held businesses, key person coverage often pairs with buy-sell agreements (life insurance funded cross-purchase or entity purchase) and disability buyout policies. Together they ensure the business survives an owner death or disability without forcing a fire sale.
Quick comparison
| Trigger | Typical coverage | Premium driver |
|---|---|---|
| Founder of seed-stage startup | $1M to $3M term | Investor requirement |
| CEO of mature SMB | $2M to $10M term | Replacement cost |
| Surgeon-owner of practice | $2M to $5M term + disability buyout | Revenue dependence |
| SBA loan covenant | Loan balance | Lender requirement |
Key takeaways
- Three common approaches.
- Almost always term life.
- Premiums paid by the business on a key person policy are generally not deductible.
Final word
Insurance is at its best when you understand the product before you need it. Bookmark this guide, share it with anyone shopping for key person insurance this year, and reach out via our contact page if you have a question we have not answered.
Related reading on InsureLab
Sources & further reading
Frequently asked questions
Is key person insurance required by law?+
No, but most SBA loans, venture debt facilities, and many institutional investors require it as a covenant.
Can the key person also be the owner of the policy?+
Yes, but a business owned policy is more common for tax and beneficiary clarity.
Is the death benefit really tax free?+
Generally yes, if Pension Protection Act notice and consent rules were followed at policy issue.
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