What would happen to your business if a critical member of your team or a company founder died? It's not pleasant to think about, but it is an event you should prepare for. The death of someone your business absolutely relies on can be devastating to your company. Key person insurance (sometimes called "key man" insurance) protects your business, because it helps keep it up and running in the event that a crucial partner or colleague dies.

You would purchase key person insurance in addition to the typical life and disability insurance you choose to offer. Your company purchases a life insurance policy on a key employee (or employees). Your company pays the premiums and is the beneficiary of the policy. If the person unexpectedly dies, your business receives the insurance payoff. This can be enough to keep the company going even though someone necessary to its operation is gone, and it can give you the time you need to make a plan for moving forward.

You might use the money paid out by key person insurance to pay off business debt, pay expenses until you can replace the person who died, pay investors, or pay employee severances and other costs associated with closing the business.

Key person insurance does not replace personal life insurance. Executives and key employees should still buy enough life insurance on their own to take care of their dependents in the event of their death. Key person insurance, on the other hand, is designed to take care of your company.

Who is covered by key person insurance?

Key person insurance covers anyone who is irreplaceable to your business over the short term. If you are a sole proprietor, key person insurance probably is not necessary. But if you have employees, take a look at the people who:

• Manage the books
• Oversee the employees
• Oversee production
• Design your products
• Handle your customers
• Perform other irreplaceable duties

If these people were suddenly gone, your business might come to a halt. Those are the employees who should be covered by key person insurance.

How much key person insurance do I need?

Shop around for key person insurance for the best rates. In many cases, you can get it from the same agent where you purchased your Group Life policy. You should plan to buy as big of a policy as your business can comfortably afford, and usually Term Life Insurance is the best choice for this type of insurance.

How much you purchase is up to you. Think carefully about how much money your business would need to keep going after the loss of a key person. You would need to replace the employee, train him or her, and take time to get your company back to running smoothly. Or, you would need to close the business. Take out a policy that is large enough to fulfill those needs for short-term cash.