Key person insurance types: death vs disability
Key person insurance (also known as “key man insurance”) is a policy designed to pay a designated amount to a specified beneficiary if the named ‘key person’ dies during the policy period. A company in this situation has to deal with the cost of a serious interruption to business activities. Recruiting new talent, public relations, and whatever damage a company’s valuation sustains as a result of the absence of a key person will all cost the company extra.
There are a couple different key person insurance types, however, and it’s important to know the difference.
The purpose of key person insurance is to reduce the financial impact of the unexpected death of a person who is essential to a company. Such people are usually considered necessary for operations, strategy, public image, or shareholder confidence. Most companies begin the search for this policy when their prospective investors require it. Just like a normal life insurance policy, a key person insurance policy pays a lump sum of money to the company as beneficiary when a “claim” arises under the policy. The difference here is that the named beneficiary is the company or an investor and not the next of kin as is often the case with standard life insurance.
All key person policies, whether in the form of traditional life insurance or the relatively newer “contract protection insurance,” will pay to the beneficiary named in the policy in the event of the key person’s death. This is validated by submitting proof to the carrier. Proof may include a certificate of death, a physician’s report, an autopsy report, or (in the case of contract protection insurance) financial evidence which documents the “ascertained net loss”.
Disappearances of key people are also considered in some policies. Underwriters require a certain period of time to pass (at least 90 days) and they reserve the right to request whatever information then need to conclude that the key person has died. If the key person is then found alive, the beneficiary is required to refund the carrier the full benefit paid to them.
The death of a critical person would be devastating without question. Unfortunately, that’s not the only tragedy that would have a traumatic impact on a company. What about an injury that causes permanent total disability? As an example, take a CEO gets into a car accident and suffers severe paralysis. This person who was once able to travel the world on a moment’s notice to meet investors, respond rapidly to constant communication, and focus all of their energy on running a company would now have to overcome significant new challenges and limitations. They may not be able to perform their job at all: according to a 2013 Christopher Reeve Foundation study, only 15.5% of Americans living with some form of paralysis are employed. How does a company deal with the financial consequences of this situation?
Here, the “claim” is not the death or disappearance of the Key Person but rather their “total disability.” Total disability is usually defined as someone’s inability to perform the duties of their job as a result of an accident of illness. Physical injury is the focus. Coverage will usually not apply to mental or nervous disorders that occur as a result of an accident. Physician examinations and reports are reviewed by the underwriters to verify the disability.
Benefits are paid out to the company as a beneficiary but, in this case, the carrier would require an “elimination period” before the benefit is paid. Just like the time required for an official “disappearance” in Key Person insurance policies, PDT policies require a buffer period. This is designed to deter fraud and prevent a situation where the carrier pays a $1,000,000 benefit to the company only to watch as the key person returns to work a month later.
Purchasing companies choose how the benefit will be paid out. Usually, the benefit will take the form of either a single lump sum benefit payment or a monthly benefit. Lump sum payments will require longer elimination periods of 6 to 12 months, or more. Monthly benefit payments would require elimination periods as short as 60 or 90 days.
A PTD policy is underwritten using the same or similar information as a key person insurance policy. This means that your broker should provide a PTD quote alongside a key person insurance quote with little friction. Together, they provide a safety net for the many situations where a personal tragedy of key individual leads to serious financial losses for the company. Insurance is never fun to talk about and life and disability insurance are certainly no exceptions. But these are practical considerations that need to be made to properly manage business risk. It is vital to remember that insuring a company’s key people is more than just checking a box. Key person insurance protects the livelihoods of those involved in the company from top-to-bottom, from the board of directors to its most junior employees.
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