If your business profitability hinges on the continued input of one or more people, principals and/or highly skilled employees, you probably need key person insurance or keyman insurance to cover all your risk bases.
Do you insure your key people? And in answer perhaps you have a blank look on your face right now? That’s because less than half (43%) will have ever even heard of keyman insurance or key person insurance and only one in 14 (7%) taken out life insurance for this purpose, sometimes for all the wrong reasons.
The purpose of keyman insurance or key person insurance
Contrary to a popular misconception, the purpose of key person or keyman insurance (contingency) cover is not to help the principals buy out each other’s share of the business in the event one of them dies, suffers a traumatic illness or becomes totally and permanently incapacitated. That’s the domain of business succession planning or buy sell insurance.
While the two insurance strategies share common objectives (ie to ensure the business stays healthy after losing a key person) and common funding mechanisms (ie a combination of Life, Trauma and Total and Permanent Disability [TPD] cover), the purpose of key person is very different to that of business succession.
This in turn impacts everything from the amount of cover that’s required to the most appropriate policy ownership structure and tax treatment of premiums and benefits.
Indeed, one key difference between the two strategies is that the business owns key person insurance policies and pays the premiums (ie the key person/estate has no interest or right to the policy), whereas business succession insurance can be structured in numerous ways (eg self-owned, cross-owned, super or trust ownership).
The difference between keyman insurance & business succession insurance
Business succession insurance is there to protect the interests of the company’s principals by addressing transfer of ownership issues.
Meanwhile, key person insurance protects the business itself by addressing the potential loss of expertise and associated costs.
Invariably, the sudden loss of a key person via death or disability has a negative financial impact on sales/profits as well as the business’s capital value, goodwill and credit rating. Depending on the company’s circumstances, key person insurance or keyman insurance can be used for the purpose of recovering Revenue or Capital: revenue (eg lost profit) or capital (eg lost goodwill), an important distinction for tax purposes that’s addressed later in the story.
For most businesses, both key person/key man insurance and business succession are essential considerations, regardless of whether the life/lives insured are one and the same. Replacing a key person who’ also a principal can be a catch 22 situation unless the company has both covers, given the business’s asset value hinges on their successful replacement.
People that matter need keyman insurance coverage
The most important asset of most companies is the people, especially those individuals whose special talents, expertise, skills, ideas and drive provide the business with a competitive advantage.
Key person insurance or keyman insurance quotes are designed to protect the business should it lose someone who makes such a significant contribution towards the company’s profitability, stability and growth potential.