What is Key Person Insurance?
Think of Key Person Insurance (or “Key Man Insurance”) as life insurance for your company. While normal life insurance policy will compensate one’s spouse or children after a debilitating or fatal injury (or any other permanent or extended incapacitation), a Key Man Insurance policy compensates the company of which the key person was an executive. Policies can also be expanded to cover not only death or incapacitation of the key person, but also certain types of other disabilities (that may fall short of “incapacitation”).
Unlike most types of insurance products purchased by companies, a key person policy doesn’t cover actual losses experience by the company. Rather, it fixes a lump sum that will be paid to the company upon a triggering event (death or incapacitation of the key person).
Why do I need it?
Most of the companies we work with need key person coverage because their investors require it in the term sheet. It’s as simple as that. And it’s not very hard to see why: if you’re putting $2M into a company that has a pretty good idea, no product, but an absolutely stellar team, what are you really betting on? Without those amazing founders, there’s not much there! Investors need to hedge their bets somehow…
Why might you want key person coverage regardless, you ask? Well think about yourself as invested in your own company, and more specifically your core team. Most likely, your co-founder is the “yin” to your “yang,” so to speak. What would happen if you were to suddenly lose your co-founder and CTO? It’s certainly not an easy situation to recover from. It makes sense to protect yourself and the company with compensation from a key person policy that can be used to attempt an exit or hire another all-star.
How do I protect my company and myself?
While VC’s require this coverage, it often takes their portfolio companies many months to secure it. There are many contributing factors here, including:
- Large amounts of paperwork required by traditional brokerages
- Scheduling/performance of necessary health tests required by the insurers
- A knowledge gap between most key man underwriters and the startup space
The Founder Shield Difference
We’ve created a custom project just for busy founders! Here’s how our product compares:
Traditional Key Person Insurance
- Length of term – though the available term varies by carrier, the standard options include one year increasing, five and ten year terms. Most carriers are in the 10 year space (with annual payments), so there are fewer options if you’d like a shorter term.
- Underwriting – full underwriting: blood, urine, possible EKG, retrieving doctor records and possible third party inspection. This has the effect of adding time and effort on part of the key person and the company. The process usually takes 4-6 weeks, but we find it often takes longer due to the fact that startup founders are just plain busy!
- Exclusions – a traditional policy will have a 2 year “contestability” period for the policy. This means that the insurance carrier has the right to investigate the claim and possibly deny the claim if there were misstated material facts on the application. Examples include an omission of one’s smoking status or a serious medical condition not reported on the original carrier application.
- Quality – one benefit to traditional policies is that they will always come from US “Admitted” carriers (when placed by Founder Shield), meaning that the insurance companies are subject to additional state laws and regulations. This potentially provides an additional layer of protection for the policy holder because the admitted status allows the consumer to bring complaints against the insurance company in front of the state board, and the state will pay out for claims if the carrier goes bankrupt.
- Pricing – pricing will often be lower for traditional policies (assuming the key man is healthy). This is due to the fact that the insurance carrier will have collected extensive information about the key person and the company over several weeks and will thus feel more comfortable quoting.
- Limits – traditional underwriting has more stringent guidelines that make it more difficult match the amount of key man life required by the company. Insurance carriers will factor in income, dollar value of company, and revenues, for starters. Because of this, carriers have hard time with valuations and the very few that are able to understand the unique financial standing of venture-backed startups are tough on offering higher limits.
Founder Shield Key Person Insurance
- Length of term – this policy is designed to be for shorter terms of 3 (and sometimes 5) years. This is by design and based on the average life span of venture-backed startups. After 5 years it’s worth going through the full underwriting process.
- Underwriting – NONE. No medical exams, no doctor visits or financial history requests. The policy can be bound within 24-48 hours of receipt of payment. A 5 minute questionnaire gets the job done. This product is designed to be held by VCs or startup companies (not the key person him/herself) and either party may apply. It’s frictionless!
- Exclusions – drug, alcohol and mental conditions. As a comparison- a traditional policy may deny the claim on drug overdose if during the investigation they discovered there was drug use prior to application and it was not stated. Both will not pay for suicide except traditional will after 2 years. This policy (and Lloyds generally) excludes coverage for claims resulting from acts of terrorism, but we can negotiate there.
- Quality – This policy is non-admitted, which means that the carrier did not have to jump through any extra hoops to get the blessing (and backing) of the states in which the policy is offered. However, it’s backed by Lloyd’s of London, one of the most-well respected and financially sound A+ carriers in the world.
- Pricing – completely uniform and transparent for any key person from age 20-45: $1850 + taxes per $1M of coverage.
- Limits – flexible limits are available upwards of $20M.