Key person insurance, in less politically correct times known as key man insurance, is designed to offset a company’s financial loss which is due to the death of an important employee. In a nutshell, the company purchases a life insurance policy on this “key person.” The company pays the premium and is the beneficiary. If key person dies then the company receives the proceeds of the life policy. It can then use that money to hire a replacement, offset lost revenue, pay off creditors, etc.

Understand that, in the event of a high-tech start-up, the period of time that a key person policy needs to be in effect may be relatively short – probably less than 10 years. A VC, for example, may be insisting on the purchase of this policy and it plans to have exited from the venture well before 10 years is up. So it makes sense to the VC to purchase a cheap term policy with a 10 year level premium.

Now let’s say that you are the key person and you are 45 years old. You have plowed all of your savings into getting the venture off the ground – and certainly not spending it on life insurance. A $1 million policy has been purchased on your life. Time has passed and the VC has left the picture and you are exiting the company. Don’t forget that policy! It can typically be transferred into your name. This is important if your health status has changed and you are no longer insurable.

My point is that if you are in a position to influence the quality of the key person policy being purchased consider a decent insurer that has a favorable conversion feature. Maybe a 20 year level term would have suited the long-term needs of the key person in the example above – even though it is a bit more expensive a policy than the VC would have wanted to purchase.

Some day you may find that key person life policy purchased years ago to be an important part of your personal estate planning tools.