Key Man Disability Income Insurance

Because the success of a small business can depend upon a few employees, the loss of any of these key employees due to a disability, whether from illness or injury, can be devastating. To protect against economic loss if a key person does become disabled, a company can purchase key man disability income insurance on its key employees. In this case, the company not only buys the insurance but also is the beneficiary if a key employee becomes disabled. The benefit is often a level monthly payment, similar to an individual disability income policy, except that the company, not the insured, receives the benefit. In the event of a disability, the policy specifies that benefits will be paid as long as the key employee cannot perform the regular duties. The company may use the benefit to stabilize the company financially until the key employee returns or a replacement is hired. This type of policy assures small businesses and their key employees that the business can continue to operate without major disruption if a key employee becomes disabled.

Some important questions for a small business to ask

If a small business is considering purchasing key man disability income insurance, here are some questions to consider:

• What are the contingencies if a key employee is disabled?
  
• Who are the key employees? Why are they “key”?
  
• How hard will it be to locate and train a replacement for each key employee?
  
• What type of compensation will be needed to hire a replacement?
  
• What percentage of revenue is directly attributable to the key employee?
  
• Would the key employee’s disability result in the loss of clients?
  
• Is the company willing to self-insure rather than purchase an insurance policy to protect itself?

Key man disability plan options

Not all traditional disability income insurance companies offer key man disability income insurance. Often key man disability policies are custom designed to meet the specific needs of a small business. Typically, these policies provide a very short benefit period, assuming that a capable replacement for the disabled employee can be found within 12 to 24 months.

In the event of a claim, either a level monthly benefit or an annual lump sum benefit are the usual payment options.

Monthly benefit payout: The monthly benefit payout option states that, after the initial elimination (waiting) period, benefits are payable at a set monthly amount for the life of the policy, usually between 6 and 24 months. Both the length of the elimination period (typically between 30 and 90 days) and the length of the benefit period are determined at the time of application for the insurance policy.

Lump sum benefit payout: This is different than a traditional individual disability income insurance policy. The lump sum benefit approach mandates a longer elimination period than a traditional individual disability insurance policy and is, in fact, a critical part of the policy. The typical lump sum elimination period is 365 days before benefits are paid. At that time, if the key employee still cannot perform the regular and substantial duties, the lump sum benefit is paid to the company and the policy terminates.

In either case, the amount of the benefit is determined by a number of factors, including the income of the key employee, the cost associated with replacing that employee and the employee’s contribution to the company’s earnings.