Disability Insurance Coverage on a Key Employee

What is it?

Key person disability insurance can protect your business in the event that a key employee becomes disabled, and as a result, the business suffers a financial loss. A key person disability policy will pay short-term benefits to the business until the key employee recovers from his or her disability, or until he or she can be replaced.

Who is a key person?

A key employee is an employee whose unique skills and talents contribute greatly to the financial success of your business. However, a key employee insured by this type of policy is usually not an owner of the business, although the key employee may own a minority interest in the business (less than 50 percent). If you are the majority owner, you may be allowed to buy coverage, but you can only cover a percentage of your salary, and key person coverage will probably be added as a rider to your individual disability policy. Your family members will also normally be excluded from coverage under key employee insurance.

As a business owner, you protect your business in the event you become disabled by buying a business overhead expense insurance policy.

How does a business lose money when a key person becomes disabled?

Your business can lose money when a key person becomes disabled and is unable to work. First, any income generated by the key person will decrease (e.g., if the key person is the primary salesperson for the business's products). At the same time your business expenses will increase, because you may have to hire a temporary employee or hire a permanent replacement. In addition, your company's cash flow may decrease if customers are lost because the company can't handle the increased workflow, or because other employees are lost due to concerns over the company's future.

When can it be used?

Key employee coverage should be used as one component of a business protection plan
Purchasing disability coverage on a key employee is one of several ways you can protect your business against financial loss in the event that you or one of your employees becomes disabled. Both your personal income and the personal income of your employees can be protected by group and individual disability income policies. You can also purchase an overhead expense policy that will pay the operating expenses of the business if you become disabled. In addition, disability insurance can also be used to fund a buy-sell agreement, in the event that your business must be sold due to an owner's disability. However, key employee disability coverage can add another layer of protection for a business by paying benefits to the business when it suffers a financial loss because an important employee becomes disabled.

Key employee coverage is normally sold to small to medium-size businesses.

Most key employee policies are sold to small to medium-size businesses because it's likely that a single key employee contributes greatly to the business's bottom line. If you own a large company that is more easily able to absorb the financial losses caused by losing a key employee, you may be unable to buy coverage.

Bryant R. Filter is President of Filter & Associates located at 153 Perry Hwy. Suite 101 Pgh., Pa. 15229. They can be reached at 412-459-0203 or www.filterandassociates.com