Key person insurance is a life (or disability) insurance policy owned by the business on a critical employee or founder. The business pays the premium and is the beneficiary — if the insured person dies or becomes disabled, the payout provides the business with capital to manage the loss, cover revenue gaps, recruit a replacement, or repay business debt. Some lenders require it as a loan condition.
Key person insurance recognizes that many small businesses are critically dependent on one or two individuals — often the founder, CEO, or a top revenue-generating employee. If that person dies unexpectedly or becomes permanently disabled, the business may face revenue collapse, loss of key relationships, or inability to service debt. Key person insurance provides a capital buffer. Structure: the business (not the individual) owns the policy and pays premiums. The business is also the beneficiary — the payout goes to the company, not the employee's family (the employee's family benefits from separate individual life insurance). The insured must consent to the policy. For life insurance: term life is most common (lower premiums, covers a defined period). For disability: a 'business disability buyout' policy or key person disability policy is available. Payout uses: (1) Revenue bridge — covers lost revenue while the business searches for and onboards a replacement. (2) Loan repayment — lenders may require key person insurance specifically to ensure the business can service debt if the key individual is gone. (3) Buy-sell funding — in multi-owner businesses, key person insurance may fund a buyout if one partner dies (life insurance funds the remaining partners buying out the deceased's estate). (4) Investor confidence — some investors require key person insurance as a condition of equity investment. For lending: SBA lenders and commercial banks sometimes require key person life insurance as a loan condition for businesses heavily dependent on one person. The SBA's SOP 50 10 references life insurance as a legitimate loan requirement (https://www.sba.gov/document/sop-50-10-lender-development-company-loan-programs). The loan proceeds may trigger assignment of the policy to the lender as collateral.
Not universally required, but SBA lenders have the authority to require it on loans where the business is critically dependent on one individual. In practice, SBA lenders often require key person life insurance when: the business's revenue is heavily concentrated in one person's relationships, the loan-to-value is high, or the loan amount is large. It's a standard risk-management tool for lenders, not a bureaucratic hurdle.
Generally no. Premiums paid on key person life insurance are typically not deductible by the business if the business is the beneficiary (IRS Revenue Ruling 2005-74; see https://www.irs.gov/irb/2005-49_IRB). The payout (death benefit) is also generally tax-free to the business (with some COLI rules applying to larger corporations). Consult a CPA on your specific structure.
Group life insurance is an employee benefit — employer-provided coverage for all (or most) employees, typically 1-2x annual salary, with premiums partially or fully deductible. Key person insurance is targeted coverage on a specific critical individual, owned by the business as beneficiary, with the business purpose of protecting against operational and financial risk — not as an employee benefit.