Protect Your Engineering Firm When a Key Person Is Lost

Key person insurance for engineering firm owners is a life policy the business buys on one of its essential people. The business is both the owner and the beneficiary. If that person dies, the death benefit goes to the firm, which decides how to use it.

What key person insurance is and who it fits

Insurance Information Institute describes key person coverage as compensation for a business’s financial losses after the death or disability of a key employee.

Engineering and design firms often tie client work to one principal. That person may hold the main client relationships, approve designs, or carry project knowledge nobody else has. When that person is gone, clients may pause work, and staff may wonder what comes next.

A personal life policy works differently. An individual buys it, and it usually protects the family. A key person policy is bought by the firm, and the firm receives the money. For the general framework, read our key person insurance overview.

What the policy pays for and what it does not replace

The death benefit goes to the business, and the business decides how to use it. Common uses include covering payroll and overhead during a transition, recruiting and training a successor, and paying down business debt. The money helps the firm adjust. It does not bring the person back or keep every client in place.

Revenue often drops before a firm adapts. Our guide on how long a business can survive losing a top producer explains how those gaps can build.

Key person life insurance does not replace other coverage. Engineering firms still need professional liability (E&O) insurance for design errors and omissions, and general liability insurance for other project risks. A life policy does not respond to those claims.

Life coverage pays on death. It does not pay for the principal’s disability or illness while living, so disability needs its own review. See what key person insurance does not cover for the full list of limits.

Choosing the principal and understanding premium drivers

The right principal is the person whose loss would hurt the firm most. Start with three questions. How much revenue depends on that person’s relationships? Must that person approve work or sign licensed documents? How much of the staff depends on that person’s leadership?

Several factors shape the premium:

• The insured’s age and health history
• The coverage amount
• The policy term
• Whether the policy is term or permanent, such as whole life insurance

Health questions are required, and issue may depend on insurability. The insurer may also set medical requirements. Because premiums depend on these facts, the figure is worked out during a coverage review.

Term coverage lasts for a set period. A whole life insurance policy shows guaranteed and non-guaranteed values separately. If a policy pays dividends, those dividends are not guaranteed. Keep these two sets of values apart when you compare options.

How the process works, step by step

The process starts with a coverage review. It then moves through information gathering, underwriting, policy issue and periodic review. Timing varies with the insurer and the facts of the case.

1. Coverage review. We discuss the firm’s structure, the principal’s role, and why the firm wants coverage.
2. Information gathering. You provide ownership records, revenue by client or project type, and the principal’s health history.
3. Application and underwriting. The insurer asks health questions and may set medical requirements. The insurer decides the final terms.
4. Policy issue. The business is named as owner and beneficiary. Ask us to explain the consent steps for a key person policy during your coverage review.
5. Periodic review. As ownership, revenue and staffing change, we check whether the coverage still fits. If ownership changes, see transferring a key person policy to the owner.

Tax and cash-flow points a CPA reviews

Life insurance death benefits are generally excluded from gross income under 26 U.S.C. § 101(a). Interest the insurer pays on proceeds it holds is taxable, according to the IRS life insurance proceeds FAQ.

A transfer of a policy for valuable consideration can limit the excluded amount. See IRC § 101.

Interest on loans against policies is generally not deductible under IRC § 264.

Federal law also sets return and record duties for employer-owned life insurance. Those duties may reach a key person policy depending on how it is set up. The return reports employee counts, insurance in force, and whether each insured employee gave valid consent. See IRC § 6039I.

Premiums are a steady cash outflow. Plan them the way you plan payroll or rent. How they are recorded depends on the policy and the firm’s structure, and we review that during the coverage review.

Frequently asked questions

Talking with our team about your principal’s coverage

NR CPAs & Business Advisors is a Miami CPA firm. For more than the basics, our team helps business owners choose and buy life insurance, including key person and buy-sell coverage, with attention to tax and cash flow.

Nischay Rawal is the responsible agent for this page. He acts as a licensed insurance agent when he discusses insurance products with you. Insurance is offered by the licensed agent, separately from the accounting practice.

Any insurance commission is disclosed to you in writing in an engagement letter before the engagement starts. The firm offers no rebates or inducements. For any specific policy discussed, the insurer is named once the carrier confirms it.

If a principal’s health has changed, or a major client depends on one person, you may be researching this for your firm or on behalf of a co-owner. You don’t have to sort out the coverage question alone. Call NR CPAs & Business Advisors, or send us a message, to set up a coverage review.