What Is Key Person Insurance?
Key Person Insurance is any insurance policy purchased by a business to compensate itself for the financial losses which would arise from the unfortunate events of death or extended incapacity (such as: being diagnosed with one of the critical illnesses specified on the contract, becoming terminally ill etc.) of an important member of the business. This insurance can be a standard life insurance, Total and Permanent Disability Insurance (TPD insurance) or trauma insurance policy to be used for business succession or business continuity purposes. Key Person Insurance, sometimes named as Business Executive insurance, is no special plan, but is just an application of life insurance towards a special need.
In other words, it is an insurance policy where the employer is the proposer and the premium payer, a key employee of the same employer is the insured and the beneficiary, in case of a claim, is again the employer. The key employee needs to receive a written notice of the proposed policy and must provide a written consent to the company owning the policy, before its issuance.
The ‘Key Person’ can be any valued employee, partner or proprietor on whom the business depends for continuous and successful operation. This person must possess a special skill set or carry out substantial responsibilities to contribute significantly towards the profits of the organization. In case of a small business, this person is usually the owner, members of the founders or perhaps just a key employee.
While applying for the policy, some proofs of the critical role that this proposed life (the Key person) plays in the business, is required to be submitted.
Benefits of Key Person Insurance
- If the business’ reputation and/or financial sustainability are critically associated to the key employees’ name, reputation or unique skills, then the key employee’s death could eventually end the business too. It protects against this business risk in the event of unfortunate death of the key person.
- Similarly, if the death or critical and/or terminal illness of a key employee (maybe a top salesperson) could quickly cripple the company financially, key person insurance should be able to provide some cushion of protection from the immediate impact. This is especially useful for small scale businesses.
- The premiums paid by the business for the company-owned key person policies aren’t a deductible business expense. But, upon meeting the stated conditions of the Pension Protection Act of 2006, the death benefit amount generally passes to the beneficiary (the business) as tax-free.
- Disruption of flow of business credit caused by the death of the Key person can have serious downfall on the business. With Key Person Insurance in place, the insurance money can become a guarantee of loan repayment after the death of the Key person.
- Also, the morale of the Key employee gets boosted as the insurance makes him feel important. The increased sense of belonging heightens productivity and retention of the efficient employee(s).
- Having this insurance in place also helps to keep the market price of the business’ shares stable post the death of the Key person. If the investors are well informed that any financial loss owing to the death of the Key person could be made up by using the insurance proceeds, they might not want to offload the shares immediately.
- Similarly, it protects the business’ valuation. In case of the business being put up for sale, the prospective buyers will be likely to put the company at a higher value, if they were to know that it had a monetary back-up plan (the insurance) to manage the cost of replacing its key person(s).
Any company, irrespective of its big or small scale of operation, can utilize the insurance proceeds for covering expenses until it finds a replacement person, or if necessary, can pay off debts, distribute pending money to investors and then pay severance to existing employees to close the business down in an orderly fashion. Adding a silver line to an unfortunate situation, the Key person insurance gives a company some options other than declaring immediate bankruptcy.