Nobody likes to dwell on unforeseen circumstances, especially when it involves sickness or death. However, when you build your business from the ground up, it’s important to plan for the worst and protect the assets you worked so hard to accumulate.
At the core of every great organisation is a team of skilled people dedicated to running the business. But what happens when those key people are no longer able to come to work every day?
In a similar fashion to a life insurance policy, key person insurance can provide financial relief to your business in the event of an emergency.
Definition of key person insurance
Also known as key person protection insurance or key person cover, a key person insurance policy is designed to pay out when an owner or significant employee passes away or is diagnosed with a terminal or critical illness.
The business will receive a cash lump sum that helps safeguard the company against any financial impacts the loss may incur. It can help the organisation continue trading, mitigate potential profit losses, and find a quick replacement.
Is key person insurance taxable?
No, although the premiums are not tax-deductible, key person insurance benefits and proceeds are typically distributed to the organisation free of tax. The key person insurance tax treatment is typically governed by a set of guidelines known as the Anderson Rules.
Who can benefit from key person business insurance?
Start-up companies that rely on a select number of individuals are more likely to struggle in the absence of a key person.
However, key person insurance can create financial safety for both large and small businesses. Bigger companies may suffer from larger overheads and the loss of a key person reduces an organisation’s stream of revenue.
This type of insurance is extremely helpful if the reputation of a company is linked to a key person’s set of skills or overall reputation. It’s also a viable option for companies that rely on a top salesman or director to fuel company profits.
If a creditor requires collateral for a business loan, organisations can set a lien on a key person policy. If the business is a partnership, key person protection insurance can ensure one partner has sufficient funds to buy out the other’s shares in the event of death or illness.
How does key person protection insurance work?
- An organisation takes out a key person insurance policy on the key employee
- The organisation becomes the beneficiary of the policy and pays for the subsequent premiums
- In the case that the key person dies or falls ill, within the policy terms, the organisation receives the payout
Who you designate as a key person depends on the nature of your business. More often than not, your key employee runs the most vital day-to-day operations and guarantees the financial success of your company. However, it could be anyone from the founder to a director, or even a specialised tech guru.
What is the purpose of key person insurance?
So, what is the purpose of key person insurance and why would a business opt for this kind of financial protection? Death is not a possibility, it is an eventuality Therefore, it must be prepared for. It’s not the most pleasant scenario to consider, but the loss of a key person can be extremely detrimental to any organisation.
Key person protection insurance can instil confidence in stakeholders by letting them know that the business will both survive and succeed, even if one of its most prominent employees can no longer tend to their responsibilities. It provides organisations with sufficient cash flow to cover sick pay, recruit new employees, and fund vital business procedures.
In the worst-case scenario, key person business insurance can be used to pay off outstanding debts, distribute payments to investors and close the company down. However, its main function is to avoid bankruptcy or financial disruptions in the case of an emergency.
How much cover should a business have?
The amount of insurance coverage your business needs ultimately depends on the financial value that the key employee holds. Unfortunately, there’s no set formula that can help you determine this amount.
For example, as a sole proprietor, you may only need enough coverage to pay off company debts and close down your business. Larger companies may need more extensive coverage to help replace downfalls in revenue and find a quick replacement for the loss of a key employee.
The benefits of key person insurance
There are countless key person insurance benefits, however, one of the most profound advantages is the net of financial security this policy can create. Other notable benefits include:
- Availability of funds to recruit or train new staff
- Avoids any loss of confidence in the business from both suppliers and investors
- Provides assurance to outstanding debtors
- Protects your business from a substantial loss of profits
- Helps maintain vital business contracts
The limitations of key person insurance
As with all types of insurance policy, the key person income protection insurance comes with certain limitations. The main drawback is the extra expenses key person life insurance entails and the possibility that you may never claim on the policy.
Another disadvantage is that if your key person decides to leave, there is no pay-out from the insurance company. In these circumstances, you will have been paying high premiums for nothing.
Although the key person insurance benefits far outweigh the negatives, it’s up to you to decide whether this type of insurance is the right fit for your organisation.
Running a successful business is all about preparing for the future, no matter how difficult or unpleasant this planning may be. You need to consider all possible outcomes and ensure your company is financially secure. Many organisations are nothing without their best employees, so make sure to protect your assets and safeguard your company against the death or illness of a key member of staff.
If you’re not sure whether key person insurance is the right step for your business, it’s always best to get a second opinion from a professional. If you have any questions or concerns regarding the key person life insurance policy, don’t hesitate to get in touch with a qualified member of our team.