Key Person vs. Buy-Sell Practice Questions

Updated 29 September 202611 min read

Key takeaway

Key-person coverage addresses a business’s financial exposure when an important person dies; buy-sell coverage funds an agreed ownership transfer after a triggering event.

The policyowner, insured, beneficiary, and agreement must fit the objective.
This set tests those distinctions with original exam-style scenarios, not recalled Pearson VUE items.

On this page11 sections

Compare the objective before the structure
Question 1: key employee disruption
Question 2: funds for an owner’s interest
Question 3: policy proceeds do not automatically transfer shares
Question 4: cross-purchase structure
Question 5: entity-purchase structure
Question 6: business receives key-person benefit
Question 7: multiple purposes require separate analysis
Question 8: value of coverage versus buyout price
Question 9: classify the purpose from the last sentence
A reliable decision sequence

Business life insurance questions often mention the same people and dollars but test different objectives. Key-person coverage is intended to help the business manage financial disruption from the death of a person important to operations. A buy-sell arrangement addresses what happens to ownership when an owner dies or another agreed trigger occurs; life insurance may fund the purchase. Do not choose by who is insured alone. Identify the business problem, then check who owns the policy and who is expected to receive the proceeds.

The Texas Life Agent outline places key-person and buy-sell uses under business insurance needs. It does not require the candidate to draft an agreement or make a tax recommendation. Actual planning depends on entity form, agreement terms, valuation, consent, tax law, underwriting, and state law. The scenarios here are original and educational, not legal, tax, or investment advice. When a stem specifies a particular ownership-transfer goal, follow that goal rather than assuming every business policy is key-person coverage.

Compare the objective before the structure

Question	Key-person coverage	Buy-sell funding
Main need	Help the business manage financial effects of losing a key individual	Provide a source of funds for an agreed purchase of an owner’s interest
Typical insured	Important employee, owner, or other contributor, depending on plan	Business owner whose death can trigger the agreement
Main recipient	Often the business, if it owns the policy and is beneficiary	Buyer or entity as established by the chosen structure and contract
Exam cue	Revenue, loan, replacement, or continuity disruption	Transfer, purchase, valuation, or ownership succession

Question 1: key employee disruption

Business wants funds after a critical employee dies

A company depends on a technical director whose relationships and expertise are difficult to replace. It buys a policy on the director and is named as beneficiary so it can address disruption costs if the director dies. Which business use is described?

Key-person insurance
Cross-purchase buy-sell funding
Personal family income replacement
Group conversion

Answer: A. The company is insuring a person whose loss could disrupt its operations and expects the business to receive the benefit. That is the basic purpose of key-person coverage, making A correct. A cross-purchase buy-sell arrangement is used by co-owners to buy each other’s interests under an agreement. Personal income replacement is usually designed around the insured’s family’s financial needs. Group conversion concerns an individual’s right to continue group coverage after eligibility ends. The scenario does not describe an ownership interest or transfer, so a buy-sell label would be unsupported. A real company should align ownership, beneficiary, notice and consent requirements, and tax treatment with its plan; the exam question asks only for the use category.

Question 2: funds for an owner’s interest

A death triggers a purchase under an agreement

Two owners sign an agreement stating that if one dies, the surviving owner will purchase the deceased owner’s business interest at a value determined under the agreement. The owners arrange insurance intended to fund that purchase. Which use is the best fit?

Buy-sell funding
Key-person coverage only
Return-of-premium term
A group-life conversion option

Answer: A. The key fact is an agreed transfer of an ownership interest after a triggering event. Insurance is arranged to provide purchase funds, which is a buy-sell funding purpose. A is correct. Key-person coverage can support a business after an important person’s death, but it does not by itself establish an ownership purchase. Return-of-premium term is a personal policy feature. Group conversion applies when group eligibility ends. The entity may choose different structures, such as cross-purchase or entity-purchase, and the owner of each policy can vary with that structure. Do not assume from the phrase “business policy” that the transaction is key-person; look for the ownership-transfer agreement and purchase obligation.

Question 3: policy proceeds do not automatically transfer shares

Insurance funding and the legal transfer are distinct

A business has a life policy on an owner and expects to receive proceeds at death. The question asks whether those proceeds automatically transfer the deceased owner’s shares to the surviving owners. Which response is most accurate?

No. The policy may provide funding, but ownership transfer depends on the agreement, entity documents, and applicable law.
Yes. Every business life policy automatically transfers ownership without a contract.
Yes. Naming the business as beneficiary makes it the insured’s heir for all purposes.
No. Life insurance can never fund an ownership purchase.

Answer: A. Insurance can supply cash for a planned ownership transaction, but it does not itself create every legal term for transferring an ownership interest. The agreement and governing entity documents define the obligations and process, subject to law. A keeps the funding role separate from the transfer mechanism. B and C treat a beneficiary designation as an automatic ownership succession document. D goes too far in the opposite direction; life insurance can be used to fund buy-sell arrangements when properly structured. The exam distinction is between a policy’s benefit and the agreement governing business ownership. Do not infer that proceeds alone resolve valuation, timing, purchaser identity, or the deceased owner’s estate rights.

Question 4: cross-purchase structure

Owners insure one another

Three business co-owners each own a policy on the other owners and are named to receive proceeds when an insured co-owner dies. The plan is meant to help the surviving owners purchase the deceased owner’s interest. Which structure is described?

Cross-purchase buy-sell plan
Entity-purchase plan
Key-person plan only
Group term life plan

Answer: A. In a cross-purchase structure, the individual owners generally own policies on one another and use proceeds to purchase a deceased owner’s interest under the agreement. The facts describe that arrangement, so A is correct. An entity-purchase or stock-redemption plan generally places the purchase obligation on the business entity, with policies commonly owned by the entity. Key-person coverage may protect the company from disruption but is not the ownership-cross-purchase structure described. Group term life covers a class of employees and has a different purpose. Actual plans can use varied legal and insurance arrangements, so review the agreement rather than assuming the exam’s basic model covers every implementation detail.

Question 5: entity-purchase structure

The business entity is the purchaser

An operating company owns policies on each owner. Under its agreement, the company is responsible for redeeming a deceased owner’s interest using available proceeds. Which structure is most directly described?

Entity-purchase buy-sell plan
Cross-purchase plan
Key-person-only coverage
A survivorship personal policy

Answer: A. An entity-purchase arrangement generally assigns the buyout obligation to the business itself, which may own policies on the owners and use proceeds to redeem the deceased owner’s interest. A fits the stated obligation and ownership. In a cross-purchase arrangement, the other owners typically buy the interest individually, often with policies they own on one another. Key-person coverage is about business disruption, not necessarily an ownership redemption. Survivorship personal insurance covers two lives and does not alone establish a business redemption structure. The exam cue is who has the purchase obligation: the entity or the co-owners. Do not assume that the business’s policy beneficiary designation alone creates a valid redemption agreement.

Question 6: business receives key-person benefit

Business proceeds are not automatically the family’s benefit

A corporation owns a policy on a key employee and is the named beneficiary. The employee dies. Which statement best follows from the arrangement as described?

The corporation is the named recipient of the policy benefit, subject to the contract and applicable law; the facts do not say the employee’s family receives it.
The employee’s family automatically receives proceeds because the employee was insured.
The benefit must be paid to the employee’s estate regardless of the beneficiary designation.
The corporation becomes the insured after the employee dies.

Answer: A. The stated policyowner and beneficiary are the corporation, so the corporation is the named potential recipient when a covered claim is payable, subject to contract terms and law. A is supported by the facts. Being the insured does not by itself make the employee’s family the beneficiary. B and C ignore the designation. D confuses the business’s ownership role with the identity of the insured life. In practice, employer-owned life insurance has notice, consent, and tax rules that may affect the arrangement. The exam point is role separation: owner, insured, and beneficiary are different capacities, and a business-insurance purpose does not change those roles automatically.

Question 7: multiple purposes require separate analysis

A plan may address continuity and ownership differently

A company wants funds to recruit a replacement executive if its chief operating officer dies. The company also has three owners who want an agreed process for buying an owner’s interest at death. Which statement is most accurate?

The two needs are distinct: key-person protection may address operational disruption, while a buy-sell agreement addresses ownership transfer and may be funded separately.
A key-person policy automatically satisfies the ownership agreement even if the policy terms do not match it.
A buy-sell plan cannot involve life insurance if the business has employees.
One beneficiary designation guarantees both objectives with no agreement needed.

Answer: A. Operational disruption and ownership succession are different business risks. A key-person arrangement may provide the business money for a loss such as recruiting or transition costs, while a buy-sell plan sets out how ownership changes and can use insurance to fund the purchase. A recognizes the distinction without requiring separate policies in every case. B and D assume that one policy or designation automatically answers all legal and financial objectives. C wrongly excludes business-owned insurance. The exam asks you to identify the purpose rather than design a full corporate plan. In real planning, the policy amount, owner, insured, beneficiary, agreement trigger, and purchase price need to be coordinated.

Question 8: value of coverage versus buyout price

Policy face amount does not prove agreement value

A buy-sell agreement values an owner’s interest at a specified amount, but the life policy’s proceeds may be lower. What is the best conclusion from this information?

The funding may be insufficient for the agreed purchase; the policy amount and agreement value should be reviewed together.
The policy automatically changes the agreed valuation to its face amount.
The surviving owner must abandon the agreement because insurance exists.
The insurer decides the business valuation after the claim.

Answer: A. Insurance proceeds and the agreed purchase price are separate amounts. If the proceeds fall short, the plan may need another source of funding or a review of the policy and agreement. A states the practical implication without assuming the precise legal result. B incorrectly lets the insurance face amount rewrite a contract valuation. C and D assign decisions to parties that do not automatically control the agreement. The exam concept is that insurance may fund a buy-sell but does not itself set the value of the business interest. Real planning should revisit coverage as ownership values, debt, and agreement terms change.

Question 9: classify the purpose from the last sentence

Ignore details that do not change the objective

A stem describes a business that insures its founder. It then says the proceeds are intended to reimburse the company for lost sales and transition costs, with no purchase of ownership interest mentioned. Which purpose is most likely?

Key-person coverage
Buy-sell funding
Personal income replacement
Group-life conversion

Answer: A. The final sentence identifies the intended use: offset the business’s loss of revenue and transition costs. That is consistent with key-person coverage. A buy-sell purpose would typically mention the transfer or purchase of an ownership interest under an agreement. Personal income replacement is directed to the insured’s household, and group conversion is a continuation option after group eligibility ends. The fact that the insured is the founder does not alone make the coverage buy-sell insurance; many founders are also key contributors. Always let the stated obligation or objective control the classification, not a job title or the name of the insured.

A reliable decision sequence

Ask in order: What loss does the business want to address? Is the purpose operational continuity or purchase of an ownership interest? Who is the insured? Who owns the policy? Who receives the proceeds? Is there a written agreement that directs the transfer? This sequence exposes a mismatch, such as a buyout obligation with a policy designed only to pay the business for lost revenue. The exam may not ask you to solve that mismatch, but it rewards recognizing the different functions.

If the question names cross-purchase, think about owners buying policies on one another and using proceeds individually, subject to the arrangement. If it names entity-purchase or stock redemption, the entity is generally responsible for purchasing the interest. If it names key-person, focus on the company’s exposure to losing a valuable person. Policy ownership and beneficiary designations should align with the chosen approach. Avoid saying a specific structure is always best; the exam tests labels and objectives, while actual decisions require legal, tax, and financial analysis.

Read the Texas Life Agent exam outline, key-person insurance, and buy-sell life insurance. For lessons and practice tailored to the standalone Texas Life Agent examination, visit the exam prep course.

Common questions

What is the difference between key-person and buy-sell insurance?

Key-person coverage generally helps a business manage the financial effects of losing an important person. Buy-sell coverage is arranged to help fund an agreed purchase or transfer of an owner’s interest after a trigger. A policy alone does not create the transfer agreement.

What is a cross-purchase plan?

In a typical cross-purchase arrangement, co-owners own coverage on one another and use proceeds to purchase a deceased owner’s interest under an agreement. Actual ownership and tax consequences depend on the documents and structure.

What is an entity-purchase plan?

An entity-purchase plan generally makes the business responsible for buying back or redeeming an owner’s interest. Insurance may fund that obligation, but the agreement and policy must be coordinated.

Are these actual exam questions?

No. These are original practice scenarios based on business insurance needs in the published Pearson VUE Texas Life Agent outline, not recalled secure items or score predictions.