There is no strict legal definition for key man insurance, but it can be defined as a policy taken by a business to cover potential financial losses stemming from the death or an extended period of absence for a member of the business. This type of policy is not only taken out to cover losses, but it also helps the business maintain continuity in a time of need. Note that the compensation is more often than not a fixed sum predetermined by the insurer and the insured.

Basically, an employer takes out a life and health insurance policy on any employee that is absolutely essential to the day-to-day ministrations of a company. This person could have intimate knowledge of the company, perform a task necessary to the company’s daily operation, or be “uniquely valuable” to the company. Obviously, this definition is open to interpretation – but that is something to be sorted out with the insurance company.

When determining your policy, you have four loss-compensation categories. First, you can receive compensation for losses related to an extended period that the key person can’t work. You may also receive compensation for temporary personnel and the potential recruiting and training of a replacement. The second category helps offset profit losses from lost sales or from project delays or cancellations. Furthermore, a policy could cover a company’s loss of ability to expand if a key member is lost. The third category insures shareholder or partner interests to be purchased by existing shareholders or other partners. Finally, you can insure the person if he/she is involved guaranteeing business loans.

Remember, you have to determine who is a key person, then you have to determine the value of that person to your company. This is something that will be discussed between you and your chosen insurance carrier. Make sure you explore all possibilities with key man insurance, as it could be one of the most important business decisions you make.