Keyman Insurance
Key person insurance, also commonly called keyman insurance or ‘key employee insurance’. is an important form of business insurance. There is no legal definition of “key person 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 person insurance is a standard life insurance or trauma insurance policy that is used for business succession or business protection purposes. In a small business, this is usually the owner, the founders or perhaps a key employee or two. These are the people who are crucial to a business–the ones whose absence would sink the company. You need key man insurance on those people! The policy’s term does not extend beyond the period of the key person’s usefulness to the business. Key person 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 in 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 organisation. 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. The purpose of key man insurance is to help the company survive the blow of losing the person who makes the business work. The company can use the insurance proceeds for expenses until it can find a replacement person, or, if necessary, pay off debts, distribute money to investors, pay severance to employees and close the business down in an orderly manner. In a tragic situation, key man insurance gives the company some options other than immediate bankruptcy.
If the company is just you and doesn’t have any employees or other people who depend on it, then key man insurance isn’t as necessary. Do not confuse key man insurance with personal life insurance, if you have a spouse and/or children who depend on your income then you should have personal life insurance for that purpose. How do you determine who needs this insurance? Look at your business and think about who is irreplaceable in the short term. In many small businesses it is the founder who holds the company together–he may keep the books, manage the employees, handle the key customers and so on. If that person is gone, the business pretty much stops.
How much key man insurance do you need? That depends on your business, but in general you should get as much as you can afford.. Ask for quotes on $100,000, $250,000, $500,000, $750,000 and $1 million and compare the costs of each. Then think of how much money your business would need to survive until it could replace the key person, come up to speed and get the business back on its feet. Buy a policy that fits into your budget and will address your short-term cash needs in case of tragedy.
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