What is 'key person insurance' and who owns the policy?

KEY PERSON INSURANCE (also called key man insurance) is a business planning use of life insurance that addresses a specific financial risk: what happens to a business when an irreplaceable person dies?

Structure:

Insured: The key employee (must consent to be insured).

Owner: The business entity (not the employee).

Beneficiary: The business.

Premium payer: The business.

Purpose: The death benefit received by the business provides funds to: recruit and train a replacement executive; compensate for lost revenue while the replacement is brought up to speed; reassure lenders and investors of business continuity; repay loans that the key person personally guaranteed.

Insurable interest: The business has insurable interest in a key employee because the business would suffer genuine financial loss from their death.

Income tax treatment: Premiums paid by the business are generally NOT tax-deductible; death benefit received by the business is generally income tax-free (IRC Section 101(a)) — BUT: COLI (corporate-owned life insurance) policies must comply with IRC Section 101(j) notice and consent requirements; if these are not met, the death benefit may become partially taxable.

Consent requirement: The employee must give written consent to be insured; the business cannot secretly take out insurance on an employee's life.

Examples: Software company insures its lead developer; restaurant group insures its master chef; manufacturing company insures its chief engineer.