Key Person Insurance: A Beginners Guide
Key person insurance is also known as key man insurance. It aims to provide coverage for the key person, normally the owner, partner, or director of a business. The company receives benefits if the injury or illness of the “key person” leads to losses. The policy pays out the key person’s family for their shares in the company if he dies.
Who is the Key Person?
The key person is a member of the team without whom the company will not function. Some examples include:
- Business partners
- Essential technicians
- Talented salespeople
- Those that have connections and business relationships
Importance of Key Person Insurance For the Business
Key person insurance is quite helpful. This depends on how your company wants to bounce back from losing the key person.
- It can pay off debt, especially secured business loans where the company loses vital assets if left unpaid.
- It can fund liquidation and employee severance procedures if the company can’t continue without the key person.
- It can fund the hiring, training, and salary of the replacement. It can also fund additional incentives and transfers to help you hire a top-notch replacement.
- The key person’s partner will inherit his shares of the company when he passes away. You need to buy it off if you want the shares to get back in the business.
- It can be used to give clients incentives or discounts to encourage them to stay during the transition period.
Steps Needed Before Getting a Key Person Policy
- The insurer may need the board of directors to pass a resolution that affirms the purpose of the insurance policy.
- The key person needs to be informed of the policy. He should agree to the insurance on his life.
- The company owns the policy. It will pay the premiums. It will also be the beneficiary when the key person dies.
How Much Key Man Insurance Do You Need?
There are three aspects to consider:
- The cost to replace the key man and size of business
The company’s size and financial status are major considerations. In most cases, it is safer to insure the key person for as much as you can afford. You can apply for coverage from $500,000 to $1,000,000 in Australia.
- Business structure
The business structure affects the amount of cover needed. You may need to purchase shares from the family members left behind. This is important to make sure that you are still in control of the business.
- Check cover regularly
Check that the level of coverage is regularly evaluated. Make sure that the benefit is sufficient to fund all costs during the loss of a team member. This is important, especially if you want to buy back the shares from an estate.
Who Owns and Manages the Key Man Insurance Policy?
The owner depends on the life insured and nature of the business.
If the key person is:
- A sole trader – the policy owner is himself or his spouse.
- A principal of a one-man organisation – his spouse will insure him or by his own policy
- An employee of the company – the owner will be the employer (may include partnership, sole trader, partnership, company, or trust)
Selecting the Right Key Insurance Policy
- Choose a key person by calculating the proportion of the company’s revenue that will be impossible without them.
- Build a plan for funds in case of a payout. The plan should specify how the funds will be spent. This will differ on who the key person will be and what they do. This is legally required due to the different tax implications involved.
- Compare different policies based on their exclusions, limits, benefits payable premiums, and other conditions.
- It is highly recommended to seek the help of an accountant, financial adviser, or insurance broker. They will assist in navigating tax-related issues.
- Make use of a comparison website like Makes Cents to compare different insurers.
This is intended as a helpful guide in navigating some complex financial decisions and in no way should be treated as personal or general advice about the suitability of a product or service. We havent been able to take into consideration your specific details or situation and these decisions can be exactly that: complex. We recommend that you consult licensed financial adviser to help navigate any terms and conditions and help clarify any specific product disclosures, should you choose to proceed with life insurance.