Key Person Insurance
A key person insurance policy, sometimes known as a key man policy, is a type of insurance that protects against the loss of a business partner. It serves two main purposes:
- To help cover the lost income from that partner.
- To enable the other partner(s) to buy out the heirs of that lost partner.
The first purpose regarding income is a given. One less person doing work means less money coming in. In the example discussed above, the company still had ongoing sales that were coming in after my family member left work, but they lost out on many new orders and the other sales persons had to take up the slack. They couldn't afford to hire another sales person and weren't sure when my relative could return because there is so much uncertainty with cancer treatment.
The second purpose of this policy is most important, in my opinion. Because my relative had a 1/5th stake in the company, that ownership was transferred to his wife after he died. His wife already worked another job and had no interest doing sales or even in being part of the company, so this meant the partners needed to buy out her share. Otherwise, they'd have to work out some kind of rental agreement or put her on payroll.
I won't say what the total amount of the policy covered, but imagine what 20% of an office building, warehouse, downtown city property, vehicles and a boat would be worth. On top of that, you have to consider the ownership part of the business itself. It's like buying someone out of their job. How much would it take to make someone give up a job? That's very much how a buyout like this works.
Lawyers and accountants had to get involved before it was all over, but a fair deal was reached and the remaining partner bought out the wife's stake in the company. By the time it was all over, very little of the money from the insurance policy remained. The company would very likely have gone under if they didn't have that cash on hand.