Key person insurance involves the use of life insurance to create immediate working capital for a business to meet immediate cash needs and find a replacement in the event of the death of a business owner or key executive. Premiums for key person insurance are not deductible to the business, but insurance proceeds would be received by it tax free.
The business owner and key executives spend considerable time and effort acquiring the knowledge, experience, judgment, reputation, relationships and skills that make them valuable to the business. The death of a key member of the management team can have a severe financial impact. For example, during the resulting disruption, lenders may curtail credit, creditors may press for immediate payment, debtors may delay making payments, employees and customers may lose confidence and competitors may consider this an opportunity to take advantage of the situation. Life insurance provides the business with funds to meet a wide range of potential cash needs.