What is Key Person Insurance?

Key Person Insurance safeguards against operational risk by covering the costs associated with the loss of a key person in a business.

The funds can be used to limit any interruption to the business should the unexpected happen. It does so my minimizing the impact on cash flow. The most valuable resource of any business is its people and loss of key staff can affect every aspect of a business including revenue, profit, goodwill and the value of your business.

Ask yourself, ‘would your business be able to maintain its revenue and profit if one of its key people died or couldn’t work for an extended period due to illness or accident?’. If the answer is no, key person insurance might be a good idea for your business.

Who is a Key Person?

A key person can be anyone directly associated with the business whose loss can cause financial or operational strain to the business. It may include a director, managing director or CEO, a partner, an employee with a unique skill or technical expertise, or a senior manager.

Who is it paid to?

Key Person Insurance is generally held by the business.

This is usually paid out as a lump sum, but some insurers offer monthly benefits to cover lost revenue.

 

What cover is available?

There are three types of risks that can be covered by Key Person Insurance:

• The death of a key person (Life Insurance)
• Their total and permanent disablement (TPD insurance)
• Them suffering from trauma such as heart attack, stroke, cancer, and paraplegia (Trauma Insurance).

There are two categories of loss that Key Person Insurance can cover and it is important to understand the difference between the two.

1. A revenue purpose

This category protects the business against loss of revenue and increased costs in the event of the loss of a person such as recruiting costs, training costs, fall in sales or profits.

2. A capital purpose

This category protects the business from financial difficulty that would arise from meeting its debt obligations. It also protects against other losses in capital value such as credit rating and general goodwill.

Dual purpose

If the business needs cover for both it could consider taking out a separate policy for each purpose. Alternatively, a single policy may allow for greater flexibility if revenue and capital needs fluctuate. However, you will need to document which portion of the premium relates to which purpose for tax reasons (see below) which increases the complexity of the product.

 

Tax Considerations

1. Key Person Insurance for a revenue purpose usually means insurance premiums are tax deductible. However, the insurance proceeds are typically taxable.
2. Key Person Insurance for a capital purpose usually means your insurance premiums are not tax deductible. However, the insurance proceeds are typically non-taxable.

 

Coverage

The amount of coverage your business needs requires consideration of:

• The renumeration of each key person
• The cost of recruiting a replacement
• Business debts
• Business size/turnover
• The likely impact on the capital value if the key person was lost
• The effect on the revenue and profitability of the business.

Costs

The cost of Key Person Insurance will depend on the level and type of cover, the age, health and occupation of the key person, the policy term and the waiting period.

• A shorter waiting period generally means more expensive premiums,
• A longer benefit period generally means more expensive premiums.