What is Key Man Insurance?
Key man insurance, also called key person insurance, is an important form of business insurance. There is no legal definition for “key man insurance”. In general, it can be described as an insurance policy taken out by a business to compensate that business for financial losses that would arise from the death or extended incapacity of an important member of the business. To put it simply, Key Man Insurance is a standard life insurance, TPD insurance or trauma insurance policy that is used for business succession or business protection purposes. The policy’s term does not extend beyond the period of the key person’s usefulness to the business. Key Man Insurance policies are usually owned by the business and the aim is to compensate the business for losses incurred with the loss of a key income generator and facilitate business continuity. Key person insurance does not indemnify the actual losses incurred but compensates with a fixed monetary sum as specified on the insurance policy.
Many businesses have a key person who is responsible for the majority of profits, or has a unique and hard to replace skill set such as Intellectual Property that is vital to the organization. An employer may take out a key person insurance policy on the life or health of any employee whose knowledge, work, or overall contribution is considered uniquely valuable to the company. The employer does this to offset the costs (such as hiring temporary help or recruiting a successor) and losses (such as a decreased ability to transact business until successors are trained) which the employer is likely to suffer in the event of the loss of a key person.
As key man insurance is more of a type of insurance policy than an actual policy, the term is used somewhat loosely and may include other insurance used for other business specific purposes, including:
- Buy/Sell Insurance (Shareholder Insurance)
- Debt Protection
- Revenue Protection
There are four categories of loss for which key person insurance can provide compensation:
- Losses related to the extended period when a key person is unable to work, to provide temporary personnel and, if necessary to finance the recruitment and training of a replacement.
- Insurance to protect profits. For example, offsetting lost income from lost sales, losses resulting from the delay or cancellation of any business project that the key person was involved in, loss of opportunity to expand, loss of specialised skills or knowledge.
- Insurance to protect shareholders or partnership interests. Typically this is insurance to enable shareholdings or partnership interests to be purchased by existing shareholders or partners.
- Insurance for anyone involved in guaranteeing business loans or banking facilities. The value of insurance coverage is arranged to equal the value of the guarantee.
Who can be a key man?
A key man can be anyone directly associated with the business whose loss can cause financial strain to the business. For example, the person could be a director of the company, a partner, a key sales person, key project manager, or someone with specific skills or knowledge which is especially valuable to the company.
Key Man Insurance Policy Ownership
Key Man Insurance policies can be owned in a number of ways depending on the needs of the business. It is common for a business to own the policy with claim proceeds being paid directly to the business. There is no legislative or insurable requirement for a policy to be owned by a specific party or entity and there may be circumstances be it for taxation or policy continuation purposes where policies may be owned and paid for by the insured person directly, or owned by another individual.
The tax treatment for premiums paid for key person insurance and the treatment of monies received from a claim vary among countries. Premiums are generally not tax deductible in the U.S.