We recently sat down with Scott Levy, Partner at Prehmus Financial Partners, boasting over 20 years of experience in financial planning and asset management, to learn more about Key Man Insurance. Here are the highlights of that conversation.

What is key man insurance?

According to a survey by the National Association of Insurance Commissioners, “only 22% of American business owners have key man life insurance, leaving their business unprotected if a key person passes away.”

Key man insurance is a policy that covers the loss of a key employee, manager, owner, or partner. In most cases, Key Man Insurance gives the entrepreneur’s equity to his/her surviving spouse. This person has been around for the blood, sweat and tears that went into building the business and this protects them.

It also protects the surviving business owner in the event that their partner dies. Most partners complement each other’s strengths and weaknesses, so if something happens to partner A, partner B may quickly come to realize that they have no ground to stand on. Key Man Insurance helps the surviving partner keep your business running without missing a beat, providing the cash necessary to stay afloat during a difficult transition.

What’s the difference between key man insurance and buy-sell agreements?

“Great question. Key Man Insurance refers to the policies acquired by companies on executive and key employees. Buy-Sell Agreements are legally binding between the co-owners of a business, typically funded by life insurance. Most often, a Key Man policy is used to fund a Buy-Sell agreement. You need a Key Man policy if you want the company to be the beneficiary from the policy to survive. Buy & Sell is used to give the surviving spouse some liquidity.”

Have you ever experienced a scenario where a business owner ignored key man insurance and it backfired?

“This has never happened to one of my clients personally, but a good friend in the business did experience something about four years ago. Two great friends were in the business of buying and flipping houses with about $4 – $5M in liability on the books. One of the partners unfortunately passed away and had no life insurance. His spouse reached out asking for his share of the business, but the houses weren’t done yet and it wasn’t time to sell. The other partner was forced to start selling homes even though they were not yet liquid. What could have been avoided for around $1,000 turned into a legal nightmare when the spouse ended up suing the business owner. It’s sad to see.”

“No one ever likes to talk about insurance – it brings up their own mortality. But at the same time, it’s easy to plan for and super cost effective for businesses. Bottom line, it’s important.” – Scott Levy

What are the typical costs associated with key man insurance?

When it comes to Buy-Sell, the most cost effective way to get coverage is through term insurance. For my clients in their 30s and 40s, I recommend purchasing a 10 year term for a number of reasons. First, it’s relatively cheap. When you’re in your 30s, it might cost between $500 and $750 a year. When you’re in your 40s, it might be between $750 and $1500 a year. It depends on the size of the death benefit, but definitely reasonable. Secondly, if your business is still around in 10 years, the valuation will be a lot higher than it is today. In my mind, it’s a no brainer. The Buy-Sell agreement should be reviewed and updated every three or four years.

What’s the first step someone needs to take when buying key man insurance?

Get quotes and have your advisor shop it out online and pull costs on a spreadsheet for you. You could also go to a licensed insurance professional, an independent financial advisor, or do your own online shopping. Of course, we at Prehmus Financial Partners would love to help you get started.

Any closing words of wisdom?

Three things. 1) if you are a business owner and you have survived the first two years, you have already passed the first stage: survival. Now, it’s time to get serious about your business. If you’ve never had it evaluated, hire a professional to do that. Invest in your company. Show that you’re serious about it. Your clients will also appreciate it because they will have comfort in knowing that you plan to be around for a while. 2) Once you’ve had the business evaluated, talk to your advisor about Key Man Insurance or a Buy-Sell Agreement. 3) If you haven’t had your business reviewed in the last 5 or 6 years, do it. An outdated Buy-Sell won’t do anyone any good.

This post is part of Acuity’s Master Class Series, dedicated to shedding light on financial and other influential industry topics. Our goal is to provide expert insights to empower the business community to make more strategic decisions.