In the fast-paced world of a business owner, there is always something urgent to attend to, which often leads to overlooking certain important things. In the case of most business owners, life insurance happens to be commonly overlooked. From time to effort, we place a substantial amount of investment into the growth of our business, talent as well as employees. As such, it makes sense to insure these invaluable individuals so that your company continues to run smoothly under any circumstances.
In this article, we share what key man insurance is and why your business needs it.
What is key man insurance?
Simply put, key man insurance is life insurance taken out on the key person in a business. This individual could be the owner, business partner, a colleague, or employee who has a special skill set or substantial responsibility and contributes significantly to the profits of that organisation.
In the event of the death, critical illness or disability of this individual, the insurance helps to keep your business afloat and can be used to replace lost revenues, valuable assets, repay investors and pay employees while a replacement is sourced. If necessary, the policy can even be used to close down the business in an efficient manner without extensive loss for involved parties. In a nutshell, the key person insurance gives the company some options other than immediate bankruptcy.
It’s particularly important to invest in this insurance policy if your company is relatively small or new. This is when you would be most reliant on your employees, including where losing a key member could severely impact the business – even resulting in its failure.
It is important to note that since the insurance is not a personal life policy, its coverage would not apply to the family of the deceased individual. Instead, the business owns the policy, would pay premiums, and as a result, is the beneficiary of the key man policy.
How do you determine a key person?
The following are questions that will assist you in identifying the key person in your business:
- Are there any loans or overdrafts depending on this individual?
- Would the absence of the individual affect any ongoing project, growth or expansion plans?
- Would the absence of the individual affect the brand or reputation of the company?
- With their loss, would the business lose clients, partners, suppliers, goodwill, etc.?
- Would it cost (monetary or otherwise) the company to replace this individual?
- Does this individual contribute to a significant amount of the company’s revenue?
- Would the business be impacted without their contribution in fields of administration or management?
- Are daily tasks dependent on this individual?
Types of insurance policies
There are many ways to structure your key man life insurance policy. The following are three most common types of insurance you can consider.
- Term life insurance
Under this policy, an individual can be insured for a certain period, whether it is five, 20, or 30 years. A popular option due to its simplicity and finite duration, term insurance is a less expensive option. However, protection is only available during the length of the policy term before it expires.
- Whole life insurance
Unlike the former policy, whole life insurance never expires, providing lifelong protection, provided you can keep up with the premium payments. It also provides some cash value that can be a source of funds for future needs, considering the business falls within the scope of the policy. However, whole life insurance is a pricier option than comparable term policies.
- Disability insurance or total permanent disability (TPD)
This insurance policy helps offset any financial burden of a key contributor becoming disabled, which then results in the inability to perform or fulfil work responsibilities. In order to receive the benefits of this policy, the insured individual must meet the definition of “total disability”.
Categories of insurable loss
When investing in a new policy under any insurance company, it is essential that you understand the policy coverages. The following are four main situations that are covered by key man insurance.
- Inability to perform. The policy will set in motion when the key person is unable to perform their duties, find and train a replacement.
- Protecting profits. The insurance offsets possible income losses from business revenues, which includes delays or cancellation of projects that were handled by the key person.
- Protecting the partnerships or shareholders. Businesses typically purchase the key man insurance to safeguard the interests of the surviving partners or shareholders.
- Business loan insurance. Disruption of business credit lines can seriously affect the business following the death of the key person. Financial assistance acquired from the insurance can help as a guarantee of loan repayment. This is often why banks require small businesses to purchase this policy prior to obtaining its funding.
How to determine attribution of worth?
The coverage amount will depend on the size and nature of the business, as well as the key person’s role. The answers to the following questions will assist your business in determining the coverage.
- If this individual were to pass away, how much would be required for the company to bounce back from their loss?
- How much of the company’s profit will be affected?
- How much would it cost to find, hire and train a replacement for the key person?
- What is the estimation of client and revenue loss?
An effective way to determine attribution is to look at the key person’s yearly salary and obtain a coverage that is 5-10 times that amount. The following is a simple ‘formula’ to guide you;
[Key person yearly salary] x [5-10*] = Attribution of worth
[$200,000] x  = $1,000,000
Keep in mind to buy a policy that fits into your budget and will address your short-term cash needs in case of tragedy.
*This range is dependent on the affordability of the company.
When undertaking key man insurance, make sure to speak to insurance experts for the best possible investment.