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Disability Insurance to Protect Business Owners

September 01, 2022
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Disability insurance can help protect business owners through key person disability insurance and disability buy-sell agreements.

Questions answered in this article:

  1. Who is considered a key person?
  2. What is key person disability insurance?
  3. What is key person life insurance?
  4. What is a disability buy-out agreement?

Most smart business owners will admit that it’s their employees that are the backbone of the company. They may even admit that there are specific employees that, without them, their business would take a hit. It’s these specific employees that can be considered key persons.

Which employees are considered a key person?

Key persons exist in all companies, and are not defined by occupation, salary, or title alone. Key persons may be employees or employers. Their performance and value dictate the success or failure of companies.

Typically, we consider key employees to be top sales people who hold large accounts or executives that maintain important business relationships. While this may statistically be the most common use for key person disability insurance, it is not the rule.

A key employee is anyone who provides significant value to a company and whose long-term absence would cause significant loss to that firm.

Examples of key employees include:

  • A well-known dentist who attracts patients.
  • A makeup artist who is on the cutting edge of fashion.
  • A stockbroker who seemingly can foresee the future.
  • A singer whose popularity brings in the crowds.
  • A craftsman whose unique designs are in high demand.
  • An internet technician who single-handedly supports a company’s companies network.
  • A DJ whose shows create a line around the block.

The loss of a key person can be devastating, not only affecting the profitability of the firm, but also productivity, customer relations, employee morale, and the general overall effectiveness of the firm.

What is key person disability insurance?

Key person disability insurance provides financial protection for the company if a key person were unable to work due to a disability. Key person coverage provides cash flow to help companies move forward and maintain a profit in the event that a key employee becomes disabled.

The most common uses for key person disability benefits are:

  • to cover expenses of a recruiter to find a replacement,
  • to reimburse losses due to reduced productivity,
  • to provide travel expenses for a new account manager to meet with clients, and
  • to supplement overtime payments for the existing staff to cover the additional workload.

Unlike a personal individual disability insurance policy, the business buys a key person disability insurance policy. The business pays the premiums and is the beneficiary. If the key person becomes disabled and can’t work, the business receives benefits.

The cost of a key person disability insurance policy is based on the employee’s age, gender, occupation, tobacco status, and state of residence.

Features of a Key Person Disability Insurance Policy

Elimination Period

The elimination period is the time which must pass after the date of the injury or sickness, prior to the business receiving benefits. A variety of elimination periods are available. The most common are 30, 60, 90, or 180 days.


Benefits can be paid in a lump sum or a combination of monthly and lump sum, and are generally received income tax-free. The benefit period is the number of months that benefits are payable during a period of disability. Benefit periods may range from six months to age 65.

Presumptive Disability

If the covered employee loses the use of both hands, or both feet, or one hand and one foot, or the sight of both eyes, or the hearing of both ears, or the ability to speak, this is considered a presumptive disability. A presumptive disability is exempt from an elimination period. The monthly benefit will be paid for the entire benefit period or as long as the loss exists.

Recurrent Disabilities

If after a period of total disability, the employee returns to work full-time and within six months are disabled again, the policyowner has two options: continue the previous claim without the need for a new elimination period or choose to have a new elimination/benefit period. Once a period of six months has passed after returning to work, any new claim will have a new elimination and benefit period.

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Key Person Life Insurance

Key person disability insurance is often paired with key person life insurance. Just as the disability policy would pay a business if a key person became disabled, the key person life insurance would pay the business if the key person died.

How key person life insurance works:

  1. The business obtains the employee’s written consent.
  2. The business follows the formalities necessary to approve the purchase of the key employee policy. (For example, if the business is a corporation, the board of directors must authorize the purchase.)
  3. Business applies for, owns, and is the beneficiary of insurance on the key employee’s life.
  4. Business pays all premiums and meets all reporting and record-keeping requirements.
  5. If an employee dies, the business receives the policy proceeds upon the employee’s death to use as needed to cover losses and find and train a replacement.

Run a term life insurance quote for an estimate of what it would cost to ensure your business would stay afloat during difficult times. Input the data for the key person and know that your company can purchase an affordable term life insurance policy just as an individual would on our website. It takes seconds to run no cost, no obligation comparison quotes from major brands.

You won’t have to disclose your personal contact information to compare quotes from dozens of trusted life insurance companies to protect your business today.

What is a disability buy-out agreement?

What if you become disabled and are no longer able to work? Statistics show that at all working ages up to at least age 67, the odds of becoming disabled for 3 months or more far exceeds the odds of dying.

A disability may be a double expense to a small business. In partnerships, without an agreement in place, a disabled owner may still receive a share of the profits or a salary even though he or she can no longer contribute. In addition, if the owner was active in the management of the business, the business may have to hire a suitable replacement, thereby “paying twice.”

For most businesses, this would not be an attractive long-term prospect. In fact, without a disability buy-out agreement in place, an otherwise healthy and prosperous business could be headed down the road to financial disaster.

A properly structured disability buy-out agreement can avoid a potential future conflict between active owners and a disabled owner. Such an agreement provides for the acquisition of the disabled owner’s share by the surviving owners at an agreed-upon price.

Funding a disability buy-out agreement is a very similar design to funding a buy-sell agreement but, instead of life insurance, disability insurance is used.

Because a disability buy-out agreement is triggered by the total disability of an owner, the definition of total disability for purposes of the agreement is very important. The degree of disability that would prevent a business owner from contributing productively to his or her business or profession must be determined and explained in the agreement.

When determining the agreement’s definition of “total disability” the owners need to also consider what the insurance company’s definition is. Even if the owners are flexible on what disability may entail, the insurance company has very strict guidelines.

A disability buy-out agreement allows the remaining active business owners to:

  • Obtain the disabled owner’s business interest at an agreed-upon price.
  • Retain voting control of the company.
  • Keep the disabled owner’s family members out of the business and ensure that only active owners will participate in the future growth of the business.
  • Prevent competitors from purchasing the disabled owner’s business interest.
  • Maintain a continuity of management, which usually makes the business more attractive to customers, creditors, and employees.
  • Ensure adequate funding through disability income insurance to help avoid borrowing and/or disrupting current cash flow.

A disability buy-out agreement allows the disabled business owner to:

  • Ensure a market for the business interest at an agreed-upon price so the disabled owner can convert the interest to cash.
  • Prevent a spouse and/or children from being forced to become involved in the business to protect their interests.
  • Be free from the risks of future losses related to this business.
  • Use the money received under the agreement for any purpose (e.g., medical bills, living costs, etc.), thus helping to protect the rest of the estate from depletion.

Buy-sell agreements are extremely important so it’s smart to hire an experienced attorney to draft these contracts to make sure everything is structured properly.


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