Key Person Insurance — What Every Private Physician Should Know
You may not have heard much about key person insurance in the past. Unlike the umbrella insurance policies most physicians carry, it’s a fairly specialized and nuanced form of insurance, partly because it only applies once you reach a more advanced level of business.
Single physician practices that aren’t looking to grow or add employees don’t need key person insurance. But if you want to grow and scale your practice, or if you already have, then we recommend taking a little time to understand key person insurance and the conditions in which you would use it.
This blog post will provide a 100-level class (for PhD-level readers) on key person insurance before you ever talk with an agent. We want to give you a basic foundation of information you can use to consider this form of insurance so you don’t walk in blind for a conversation with an agent.
What Is Key Person Insurance?
A medical practice differs from many other businesses in that its revenue comes not from selling items off a shelf, but from physicians actively seeing patients.
Because revenue depends on a service provided by people, the continued health and ability of those people are paramount to the business’s success.
So not only do patients depend on a physician’s well-being, but employees and partner providers do as well. If you (or one of your partners) dies suddenly or becomes unable to practice, will the business struggle? Will it survive?
Key person insurance protects your practice in the event of a worst-case scenario — like the death or disability of you or one of your practice’s partners. Instead of being owned by an individual and paying out to an individual, key person insurance is owned by the practice and pays out to the practice. While personal life insurance will help to support your family if you pass, key person insurance helps to support the continued operation of your practice.
If the worst happens, whether it’s a death or a disability, your practice will suffer an initial revenue loss followed by an additional outflow of expense. Key person insurance protects your practice from both aspects of such financial hardships.
Pays Replacement Costs
Key person insurance can cover the expense associated with replacing a physician who, for one reason or another, becomes unable to practice.
We’ll first look at what happens if a partner physician becomes disabled.
Key Person Disability Insurance
Practices own key person disability insurance on contributing physicians to offset expenses if those physicians become unable to function normally.
Ideally, those physicians will also carry disability insurance on themselves, something which practices can require. Personal disability insurance will make sure the physician has an income in the event of an extended illness or injury. That takes care of the practice’s moral obligation to pay a doctor unable to participate in the business. (Though depending on how your employment agreements are written, you could still be obligated to pay the doctor as either a physician employee and or as an owner of the practice.)
The personal disability policy takes care of the physician, but your practice now has a patient load that’s not being serviced, and a corresponding loss in revenue.
If the physician can return to work after a short time, that’s wonderful. But if the illness or injury promises to last for an extended time, you have to either replace them or assign greater workloads to everyone else (a short-term solution at best). So in addition to losing a physician and the revenue they bring in, you also have to pay to replace them.
Key person disability insurance is meant to protect your practice from both the lost revenue of a disabled doctor and the additional expense of replacing them.
For example, if a physician is out for six months to a year, key person disability can pay out to the practice in order to defray the cost of losing a trained physician with a full patient panel as well as the cost of bringing in either a short-term or long-term replacement.
Replacing a seasoned physician, especially for the longer term, is no small expense. It means bringing in a new doctor who’s not familiar with your practice or your patients. You have to find them, train them, and pay them — perhaps even enough to entice them to leave an existing practice, and on short order too.
Key Person Life Insurance
Key person life insurance also protects the practice from lost revenue and unexpected expenses, but in the event of a partner physician’s death.
In cases like this, you still have the problem of lost revenue, but you also know immediately that you need to replace the physician. Key person life insurance allows you to start the process right away without a further financial hit to your business.
Pays for Owner Shares
In addition to the problems of lost revenue and replacing a physician, it takes a significant amount of capital to buy out another doctor’s shares of a practice. This is another area where key person insurance protects the business.
Key Person Disability Insurance
If a doctor’s illness or injury persists long enough, perhaps a couple of years, then the issue arises of whether you should buy out their shares of the practice. Should they be an owner in the business when they aren’t involved in the practice? How will you fund the purchase of their shares of the practice?
For cases like this, practices can insure what’s called a buy and sell agreement against disability. A buy-sell agreement protects the practice against losing a revenue generator, someone they’ve spent time training and who’s built a patient panel, but is now unable to participate. It funds the practice both to replace the physician and to buy out their shares of the practice.
A buy-sell agreement sets down in writing several important factors ahead of time:
- How much are a partner’s shares worth?
- In what circumstances does the practice buy a partner out?
- How long does a physician have to be disabled or deceased before the practice buys them out?
- Does the practice pay in a lump sum or over a period of time?
- Does the practice fund the buy-sell agreement with disability and/or life insurance?
Buy-sell agreements are detailed legal documents that need to be drafted by an attorney. It’s also important to work with your accounting, legal and insurance teams to make sure the agreement contains an up-to-date valuation of your practice.
If the practice’s value increases dramatically but isn’t updated in the agreement, then you could have a significant problem on your hands. Key person insurance will fund the buyout up to the valuation recorded in the buy-sell agreement, but whatever the partner’s shares are worth over that still needs to be paid — and it will come out of the practice’s pocket.
Reviewing the agreement every one to two years should ensure a current valuation of the practice.
Key Person Life Insurance
If a partner physician dies suddenly, you will be buying their shares of the practice from their estate rather than from the doctor directly. But it will take the same significant outlay of cash.
If the practice doesn’t have a buy-sell agreement funded by key person life insurance, then you could struggle to come up with the necessary capital. While in the case of disability, you could speak with the doctor personally and work through a method of payment, that’s not possible if the partner dies. Nobody wants to be the person to tell the spouse of a deceased partner that they don’t have the money to pay for what their spouse helped build, and that they’ll have to wait for their money.
Key person life insurance with a buy-sell agreement protects you from having to go through this experience, and it protects the partner’s family by establishing the up-to-date value of the practice and the funding to pay out the partner’s shares.
It also allows you to avoid the complications of the spouse or estate continuing to own part of your practice. Such a situation may not be desirable to you, and it may not be legal depending on the state where you’re located.
Special Considerations
Key person insurance is deeply specialized and involves a lot of nuance, much of which can only be defined through conversations with your legal team, accountants and/or insurance agent. We’ll address just a few of the more detailed questions here.
Does Key Person Insurance Require Medical Underwriting?
Yes, key person insurance policies do require medical underwriting. The requirements for disability insurance are usually more stringent than for life insurance. In general, you can expect to provide a blood sample, a urine specimen, physical measurements and perhaps an EKG, depending on the age of the person being insured.
Fortunately, the exams required for underwriting overlap and are often transferable between life and disability policies. You don’t need two separate sets of exams if you’re applying for both types of coverage.
Can You Insure Non-Owners?
Often, yes, many practices take out key person policies on non-owner physicians. Because non-owner physicians can be responsible for large portions of revenue in the practice, you have the same problem of lost revenue and hiring a replacement as in a partner’s case. You’ll have to get the acknowledgement and agreement of the physician both for the policy itself and for the amount of the coverage.
You can also look into key person insurance even if you aren’t in an actual partnership with other physicians. For instance, maybe you and a group of physicians all operate as independent contractors, but you share an office space. Because you share significant expenses, you could take out key person policies on one another to protect against the loss of a contributing doctor.
How Much Does It Cost?
The cost of key person insurance differs significantly depending on many variables. Everyone’s situation is unique, but roughly speaking, you can expect to pay around $1,000 per million dollar policy per year.
Are There Tax Implications?
Key person insurance will bring up some tax considerations. Rather than get into those here, we recommend you consult your CPAs during the application process and be sure to discuss options with both your accountants and insurance agent.
Conclusion
No one plans to get into an accident, but we all have car insurance. No one plans for their house to burn down, but we all have home insurance.
No one imagines they’ll suddenly lose the ability to practice medicine, or lose a business partner prematurely. But it does happen. And when it does, in addition to the personal loss, the business also suffers.
Key person insurance is a way to plan for the unexpected and avoid significant strain to your business if the worst should happen.
We’re not attempting to sell you key person insurance; in fact, we don’t sell any insurance products at ROAMD. We simply think successful private physicians can benefit from considering key person insurance, and we hope to arm you with knowledge so you can protect your practice in the best way possible.
Dr. Scott Pope serves as the Chief Growth Officer at In Scope Ventures, a growth consulting firm focused on early stage healthcare companies. Scott is passionate about healthcare entrepreneurship and has been involved in various advocacy efforts to promote innovation in the industry.
Scott earned his PharmD from Ohio Northern University, where he participated in Habitat for Humanity, Phi Mu Delta, Order of Omega, and NCAA basketball. After graduating from ONU, Scott completed a pharmacy residency at Cone Health, followed by a specialty residency in infectious diseases, internal medicine, and academics at Campbell University and Duke University Medical Center.
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