Find the Right Keyman Insurance to Protect Your Business from Loss

Find the Right Keyman Insurance
to Protect Your Business from Loss

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When a key person, such as a business partner, key employee or owner is unable to work or passes away, it affects business profits, revenue and expenses, and might even influence the business’s ability to attract new customers. Keyman insurance protects the company against the possible costs associated with the loss of a person, who is essential to the business.

Ask yourself, what would happen if a key individual in the company were to suffer an accident or illness and can no longer work? What impact would their death or disablement have on the business?

Reduce the financial burden that comes with losing a key person in your business with a keyman insurance policy.

What is key man insurance?

Key person insurance, or keyman insurance, protects the business against the loss of an individual who makes a significant contribution to the company. This type of insurance policy usually pays a lump sum benefit used to cover the unexpected costs associated with the loss of a key person, like hiring and training a replacement person, covering any debts or loans and filling gaps in revenue due to lost business opportunities.

The events that could trigger the loss of an individual need to be insured, for example, an accident, illness, injury, disablement or death.

Keyman insurance can take the form of life cover, TPD or trauma insurance. The lump sum benefit can be used to reduce the financial burden a business may suffer from the loss of a key person.

Keyman Insurance is designed to protect the business, not the individual.

Who is covered under this insurance?

A key person in Australia is defined as an individual whose continued association with a business provides that business with a significant and direct economic gain.

Economic gain means more than just profits. It can also include capital injections, cost efficiency, goodwill, access to credit and contacts with suppliers and customers.

A key man is that person or those people without whom the company will not be able to continue business as usual. For example:

  • Director of the company
  • Business partner
  • Key salesperson/manager
  • Financial controller
  • Key project manager
  • An employee with a specific skill set or knowledge, like a Computer programmer or Specialist engineer

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Who needs this cover?

If your business profitability hinges on the continued input of one or more people, principals and/or highly skilled employees, you probably need keyman insurance to cover:

  • Daily expenses: Provides the business with the ability to pay the day-to-day running costs of the company.
  • Loss of revenue: Keyman insurance can be used to offset lost income due to lost sales, cancellations, and loss of new opportunities.
  • Business loans: Protect your business by covering the person involved in guaranteeing business loans or bank facilities.
  • Recruitment and training: You’ll likely need to pay for hiring and training a suitable replacement.
  • Restructuring of the business: If the key person was a business owner, partner or director you might need funds to secure new partners without having to shut down the company.
  • Co-founder’s shares: If the co-founder of the company should die or become totally and permanently disabled, you might have to compensate the family to retain full ownership of the company.

How does key man insurance work?

Generally, key people can be insured for death, trauma and total and permanent disablement. The business purchases the keyman insurance policy and pays the premiums, making it the policy owner and will usually list itself as the beneficiary. Should the insured person die or be unable to work for an extended period, the business will receive a lump sum payout. The lump sum benefit can then be used to help the company continue as usual.

Because the business owns the key person insurance policies and pays the premiums, the key individual has no interest or right to the policy. In exchange for premiums paid, your key man life insurance policy covers the most important people in your business.

A key person Insurance policy can cover the essential individual for a combination of any of the following:

What does key man insurance cover?

Key person protection, generally covers the business against the loss of revenue or for capital purposes, like paying off debts. The sudden loss of a key individual via death or disability has a negative financial impact on sales and profits as well as the business’s capital value, goodwill and credit rating. Depending on the company’s circumstances, key person insurance can be used for recovering Revenue or Capital.

There are three main types of keyman insurance policies available in Australia: Revenue or Capital Protection, and Buy Sell insurance.

Loss of Revenue

This covers business profitability and is the type of coverage you want for revenue purposes. A keyman insurance policy provides compensation which allows the business to continue running smoothly.

Revenue protection is taken out when the loss of a key person would impact the business’ financial performance (e.g. profit/loss statement). Specific examples may include taking out insurance to cover recruitment costs, temporary replacement costs, training costs or bad debts.

Capital Protection

Keyman insurance to protect the capital value of the business and covers key people who are guarantors on business loans or credit facilities. When this person passes away or has an extended disability, the bank may call on the facility to be paid back or may no longer be made available.

Insurance may be identified for capital protection when the loss of a key person would affect the business' financial position (e.g. the balance sheet). Insurance proceeds could be used to repay loans, replace supplier arrangements or lost goodwill.

Buy Sell Insurance

Buy sell insurance covers shares in the business and/ or partnership interests and generally provides a mechanism by which business interests can be transferred between owners on death, disablement or critical illness.

A Buy Sell agreement usually allows for small business associates to rest easy knowing the company can survive should anything happen to their business partner.

The type of policy that’s right for your business depends on the purpose of the key man insurance policy. It’s best to speak to a specialist that can help you decide which cover type is best and how much cover you need.

A case study

William runs a successful chemical manufacturing company and employs a certified industrial chemist, Karl, who is critical to the business’ core activities.

Karl's loss would have a significant impact on the business, resulting in temporary replacement costs, recruitment costs and perhaps additional training for a replacement. Thus, William would like to ensure the company is protected should Karl’s be unable to work due to illness, disability or death.

The manufacturing company purchases a life, TPD and trauma policy on Karl’s life with the intention of using the policy proceeds to temporarily replace Karl while they attract a replacement with his specialised skills.

In this example, key person insurance would be for revenue protection, which means the insurance premiums would be deductible, and the policy proceeds would be taxed as ordinary income by manufacturing company.

Guides for Keyman Insurance in Australia

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Buy Sell Options

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Succession Planning

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Capital Protection

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Business Loan Cover

How much cover should I have?

The amount of keyman life insurance coverage you need depends on the size of your business and the purpose of the keyman insurance policy, i.e. for revenue or capital purposes. Generally, the smaller the enterprise, the more likely it is to be dependent on one or a few key people.

Businesses that are especially vulnerable to key person risk include those whose owners are ‘the face of the company’ and those whose principals are indispensable, either because of their unique skills/expertise or extraordinary and often undocumented, input.

However, generally, the amount of cover required might be calculated based on the amount of profit a key person brings to the company and the loss that would occur without them.

To help you determine how much coverage you need, consider how much time and money the business would need to recover if:

  • A key income producing Executive Director dies or becomes disabled;
  • A business loan guarantor dies;
  • A key business employee suddenly suffers a traumatic event (such as cancer) and is unable to work, having to take 6 months off work;
  • A joint business partner dies, and the company shares are passed onto a former business partner’s estate. The former business partner now owns this part of the business and might become a decision maker.

Each business or company is different, and so each keyman insurance policy should be tailored to meet the company’s unique needs. If your business already has credit insurance which covers outstanding loans and debt amounts, you might not need as much keyman insurance.

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What does this type of insurance cost?

The cost of a keyman policy varies from insurer to insurer and will depend on several factors, including; the level of cover you want, he key person’s age, health and specific occupation, and the size and complexity of the business.

The average cost of keyman insurance in Australia

Insurer Policy Average Monthly Premium
Priority Protection Vitality $42.19
Elevate Insurance Solutions – Healthy Start $44.24
Accelerated Protection – Health Sense $46.11
Complete – Healthy Life Option $48.90
Life Solutions $52.33
Insurance with On Track $52.92
Wealth Protection $55.68
Protection $55.88
OneCare $57.34
Protection Plans $61.48

Above costs of keyman insurance were calculated on $1 million life cover for a non-smoking, male key person aged 40, living in NSW (April 2018).

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Frequently asked question and answers

Is keyman insurance tax deductible?

The taxation treatment of keyman insurance depends on whether the proceeds are for a capital or revenue protection purpose. The purpose of insurance will impact the deductibility of premiums and the receipt of proceeds.

Premiums for revenue protection are generally deductible, and the policy proceeds are taxed as income. A deduction may be available where any policy proceeds are used to pay business operating expenses.

Premiums for capital protection are usually not deductible, and the policy proceeds are not taxed as they are not included as income. However, capital gains tax (CGT) may apply.

What's the difference between key man insurance and life insurance?

The main difference between key man insurance and life insurance is the ownership structure. Key person insurance protects the company against the financial loss of a key employee, and the business will usually be the owner of the policy. Life insurance usually protects the insured person's family against the loss of financial security and the owner of the policy is generally the person paying the premiums.  

What type of people are usually insured as key persons?

Generally, business owners, directors, senior executive and employees with essential knowledge and experience that are invaluable to the running of the business are seen as key people.

What is the purpose of this insurance in Australia?

Keyman insurance is designed to protect the business should it lose someone who makes a significant contribution towards the company's profitability, stability and growth potential.

Businesses, large and small across Australia should consider taking out a keyman policy on any essential employee in their business.

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