Employees are essential components of most businesses and key person or keyman insurance is designed to protect workers considered the most vital to ongoing business operations. The death or unexpected serious illness of one of these individuals could have a serious financial impact on the organisation, especially if the business is of small or medium size. Key person insurance provides a financial benefit designed to mitigate this risk and keep the company going during these times.
There are several types of key person policies that cover different situations. Some cover the death or critical illness of key staff and others cover the death of a significant shareholder in the organisation.
Payouts are designed to cover re-organisation costs, repay outstanding financing, pay staff recruitment and training costs, and purchase shares from the estate of a deceased shareholder.
Policy riders include accident and sickness protection that pays a small benefit if a key person is absent for a prolonged period due to illness or an accident.
When financial institutions lend money to a business, they may require a personal guarantee from a partner or director.
This represents a promise to repay debt and the business can purchase a key person policy to insure against the individual being unable to fulfil this process. The business and family members of the insured are protected and the liability can be repaid using the lump sum benefit.
The insured is still entitled to purchase a personal life insurance policy that provides loved ones with additional financial protection.
Any type of business may purchase this insurance, but the legal business structure affects the policy setup. For example, a sole trader or company may purchase a policy that covers its key employees. However, in Wales and England, partnerships are not considered a separate legal entity.
Therefore, a key person policy for a partner must be structured in one of two ways. All partners can purchase the policy jointly, making it an asset of the partnership, or the key partner being covered can buy the policy and put it into trust for the remaining partners.
The appropriate level of key person insurance depends on the nature and financial status of the business and what financial effect the covered event would have on the organisation. Different events will impact an organisation differently and our professionals can help you find a key person policy that protects against particular risks determined by you. Our representatives can even provide guidance regarding who would be considered key people within your organisation and can help you determine the appropriate level of coverage.
In general, key employees are those who manage company finances, generate sales leads, manage the production process, are responsible for key accounts, and manage the legal aspects of the organisation. The type and number of key staff, shareholders, company turnover rate, and cost to recruit and retrain staff to fill affected positions can influence the type and level of key/man person coverage.
The generally accepted calculation for coverage level is the earnings of the key individual, inclusive of bonuses and other perks, multiplied by five or ten. If the policy is taken to cover profits that would be lost, the calculation should be five times the annual profit or no more than two years’ of gross profits divided by the number of key employees or shareholders. A consultation with a financial advisor should prove helpful when calculating these figures.
Regulations dictate the tax treatment of premiums and benefits for this type of insurance. In some cases, the business may qualify for tax relief and deduct policy premiums. If tax relief is permitted, proceeds from the policy are usually taxed as a trading receipt. If it is not, a chargeable event is typically taxed as a capital receipt. Death is considered a chargeable event but critical illness of a covered key person is not.
If the policy is not taken to compensate for profit loss, premiums will not be tax-deductible. Examples include if the coverage features an investment element or is being used to underwrite a business loan. In addition, a business may attempt to prevent the benefit from taxation by foregoing tax relief.
Ultimately, the local tax inspector determines tax treatment for premiums. Even if the company does not file a claim for tax relief of premiums, the tax inspector may determine that premiums are tax deductible. If the policy is established on the correct basis, taxation should not become an issue.
Key person coverage is really a life insurance (or life plus critical illness) policy for a key employee or shareholder. A company buys this policy, names itself the beneficiary, and makes premium payments. If the insured dies (or in the case of critical illness rider, becomes critically ill), the company receives the lump sum benefit. This provides the organisation with an option other than bankruptcy.
It may take several months to recruit and train a replacement for the insured individual and the insurance benefit can cover profits lost in the interim. Other companies use the benefit to make distributions to shareholders or pay employee severance as part of an orderly shutdown process for the organisation. This is preferred to having to file bankruptcy, a complex and lengthy process that has long-lasting financial consequences.
To prevent general financial strain, insolvency, bankruptcy, or closure, businesses should always be prepared for the unexpected. If a key employee or shareholder dies or becomes seriously ill, key person coverage provides a lump sum benefit designed to make things easier on the business from a financial perspective. Company leadership will have time to create a plan of action to deal with the situation.
If your business has employees, consider keyman or person insurance essential coverage. Being insufficiently insured exposes your organisation to unplanned closure. The expense required to cover the death or critical illness of key workers or shareholders is typically much less than the financial impact resulting from one of these events.