Key Person Insurance: Coverage, Sizing and Loan Covenants

Consider it when the loss of one person would threaten revenue, relationships or compliance. Typical candidates are:

• A founder or CEO whose relationships carry the sales pipeline.
• A technical co-founder who holds knowledge that is not documented anywhere else.
• A rainmaker in a services business who owns the top client accounts.
• A licensed or credentialed executive whose role is required to operate, such as a regulated professional.

Key person insurance is different from a buy-sell policy, which funds the purchase of a deceased owner's shares, and from personal life insurance, which protects a family. Sometimes one policy is owned by the company, and another by a co-owner for a buy-sell. Make sure each policy does a separate, defined job.

Also ask whether coverage is required by someone else. Some lenders require it as a loan condition, and a startup's investors may ask for it in a financing. If you are weighing SBA financing, the personal guarantee guide explains related obligations.

There is no standard formula, so use two or three methods and compare the results:

1. Replacement cost: recruiting, onboarding and the ramp-up period before a successor performs. SHRM's 2025 benchmarking found an average cost per hire of $5,475 for nonexecutive hires and $35,879 for executive hires¹, but that covers recruiting alone.
2. Lost profit: the profit the person is responsible for, multiplied by the months it would take to recover.
3. Debt obligations: loans that may become due or covenanted if the person leaves.
4. Multiple of compensation: a rough rule some advisors use, which is easy but arbitrary.

Say the search and onboarding would cost $150,000, you would lose $400,000 of profit during a twelve-month recovery and a lender's covenant is tied to $500,000 of debt, so the total need is $1,050,000. You can then decide how much to insure and how much to self-insure with cash reserves.

Tax treatment depends on your facts and your jurisdiction, so confirm with your CPA. In general terms, when the company is the beneficiary, premiums are usually not deductible, and death proceeds are generally received income-tax-free.

Employer-owned life insurance has an additional requirement. Federal rules generally require that the insured person be notified in writing and give written consent before the policy is issued, and the employer files a reporting form each year. If the notice and consent steps are missed, the tax-free treatment of proceeds can be lost.

Ownership and beneficiary details matter as much as tax. The company should be the owner and beneficiary. A policy that names a spouse, or a personal policy that the company pays for, may not deliver funds to the business when it needs them. The insured person's consent is also required for the underwriting itself, which involves health information. Have counsel review the policy documents and any assignment to a lender.

Match the coverage type to the risk and the time horizon.

• Term life insurance covers a fixed period, such as the length of a loan or the years you expect the person to be critical. It costs less per dollar of coverage, which is why most companies choose it.
• Permanent life insurance builds a cash value and lasts for life, at a higher cost. It fits when you also want a funding vehicle, though it adds complexity.
• Key person disability insurance pays if the person can no longer work. It is a separate policy with its own definition of disability, waiting period and benefit period, so read those terms closely.

Underwriting depends on the age, health and occupation of the insured person. Premiums vary by insurer, and quotes from several carriers or a broker are the only reliable way to price it. Compare the policy against other coverage you need at your stage in the guide to startup insurance by stage.

If a lender or investor requires key person insurance, read the covenant before you sign:

• Amount: is it a fixed dollar figure, a multiple or tied to the loan balance?
• Assignment: does the policy need to be assigned to the lender, and does that limit how you can use the proceeds?
• Trigger: does the covenant apply on death only, or also on resignation, disability or a change in role?
• Replacement period: how long do you have to find a successor before it becomes a default?
• Maintenance: what proof of premium payment must you provide, and how often?

Founders sometimes accept a covenant that is impossible to satisfy, such as a requirement that a named person remain in role. Negotiate a reasonable cure period and a definition of qualified replacement.

Review coverage yearly, since a raise, a new loan or a change in the person's role can make an old policy too small.