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Key person life insurance
Also called key man insurance, key person insurance, collateral assignment life.
Life insurance on an owner or essential employee, collaterally assigned to the lender, so the debt can be repaid if the person the business depends on dies.
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What it means
In a small business the owner frequently is the business — the licences, the customer relationships, the technical capability. A lender financing that business is financing one person's continued presence, and key person insurance is how it hedges that.
Collateral assignment
The borrower owns the policy and pays the premiums. A collateral assignment is filed with the insurer giving the lender the right to claim proceeds up to the outstanding balance. Anything above that goes to the named beneficiary — typically the family or the estate.
This is different from naming the lender as beneficiary, which would give the lender the entire proceeds regardless of the balance. Lenders ask for collateral assignment; they should not be named as outright beneficiary, and a policy set up the wrong way is a real problem for the family.
In SBA lending
SBA rules require lenders to consider life insurance where the business depends on one individual, and to obtain it where the loss of that person would put repayment at risk — most obviously in a sole-owner business. Whether it is required on a given loan, and in what amount, is determined by the lender applying the SOP in force, and the requirement has been tightened and loosened over the years.
Type and amount
Term insurance for the loan term is usual and cheapest. The amount is typically the loan balance rather than the value of the person. Existing policies can normally be assigned rather than buying new coverage, which is worth raising before a lender orders a new policy.
Where this one catches people
The requirement is continuous, not a closing condition. Loan documents make maintaining the policy an affirmative covenant, so a lapsed premium is an event of default on a loan that is fully current — and the covenant usually also requires you to provide evidence of payment on request. The second trap is structural: if the policy names the lender as beneficiary rather than collateral assignee, the insurer pays the full death benefit to the lender even if only a small balance remains, and the family has to chase the surplus.
Where you will meet this term
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Key person life insurance — common questions
What does key person life insurance mean?
Life insurance on an owner or essential employee, collaterally assigned to the lender, so the debt can be repaid if the person the business depends on dies.
Where does key person life insurance catch people out?
The requirement is continuous, not a closing condition. Loan documents make maintaining the policy an affirmative covenant, so a lapsed premium is an event of default on a loan that is fully current — and the covenant usually also requires you to provide evidence of payment on request. The second trap is structural: if the policy names the lender as beneficiary rather than collateral assignee, the insurer pays the full death benefit to the lender even if only a small balance remains, and the family has to chase the surplus.
Is key person life insurance the same as an interest rate?
Key person life insurance is defined above; if you are comparing it against a rate, check whether the two measures share a time dimension before you put them side by side.
Which products does key person life insurance apply to?
Term Loan, SBA Loan, Equipment Financing.
Is there a worked example of key person life insurance?
Not on this entry. Where a term is arithmetic, the arithmetic is shown; this one is not primarily a calculation.
What else should I read alongside key person life insurance?
Covenant, Default, Guarantor, Insurance requirement, Loss payee.
Has this definition been checked?
Not yet. This entry is drafted and live, and the notice at the top says so. Confirm anything you are about to act on.
Is this legal advice?
No. It is a definition. What a clause does in your contract, in your state, is a question for a lawyer licensed where you are.
Can I suggest a term?
Yes — [email protected]. The glossary grows from what people are actually shown in contracts.