A guide to key person insurance

Damian Youell makes a cast-iron case for key person insurance

For any business, one of the biggest and most hard hitting dangers is the death of an important member of the enterprise. To protect themselves against such an event, key person insurance is an absolute must.

It’s a hugely important form of business insurance yet many directors, CEOs and shareholders fail to develop an in-depth understanding of the concept. To clear up any confusion, we’ve put together a complete guide to key person insurance covering what it is, what the benefits are and whether or not the investment is worth it.

What is key person insurance?

In general, key person insurance is a policy that offers businesses financial compensation should an important member of the enterprise fall victim to death, serious illness or incapacity. The level of cover is determined by any financial losses incurred in the aftermath of losing a key person. This is generally paid out as a pre-specified fixed sum. Its core aim is to ensure the recovery, succession and ongoing success of the business in a worst case scenario. Pay-outs can be used to offset the cost of hiring temporary replacements, recruiting successors and covering any losses.  

Who takes outkey person insurance?

Unlike other forms of business insurance, key person insurance is generally taken out by the company. This means that any compensation is paid directly to the business, as opposed to its individual directors or employees. That said, there is no legal requirement that this should be the case. Sometimes policies can be owned and paid for by the insured person themselves, or another member of the company. Ultimately the policy holder is usually determined by assessing the individual needs of a business and deciding what arrangement would be most beneficial.

Writing up key person insurance policies can often be complicated, so companies are generally advised to seek the help of corporate lawyers. This will ensure that should any claims need to be made, the process is fast, efficient and stress free. 

Who qualifies as a key person?

To be classified as a ‘key person’ an employee must be directly responsible for a large portion of profits. They could also possess a unique skill or own intellectual property that is critical to an enterprise’s success. Titles include (but are not limited to) director, CEO, key sales person and project manager. Policies are based on an estimate of how valuable an employee is to a company, and what losses would be incurred should they no longer be able to work. In general, key persons can be categorised into the following:

  • People who have specific skills – e.g. professional sports players, graphic designers with an in-depth knowledge of specialist software, architects with intellectual investment in a project, musicians with unique talent.
  • People who have specific knowledge – e.g. IT managers with a complex understanding of a network, scientists carrying out exclusive research, lawyers with unrivalled knowledge of cases, engineers developing intricate projects. 
  • People who have valuable connections – those with corporate connections are also considered valuable, e.g. sales executives, marketing executives, entrepreneurs and managing directors.

Different types of cover

Key person insurance offers businesses compensation across two major categories:

  • Losses – When an important company member is killed or seriously ill, key person insurance will offset the cost of hiring temporary personnel and recruiting/training a successor.
  • Profits – Profits can seriously suffer in the aftermath of losing an important member of the business. Profit based key person insurance is in place to compensate for lost sales, project delays, loss of specialised skills and the inability to expand.  

What are the key advantages?

Like any insurance policy, key person insurance is in place to protect the best interests of the policy holder and their dependants. Below is an overview of the key benefits associated with taking out key person insurance:

  • The major benefit is the financial compensation it secures should the company lose an integral member of operations. This allows the enterprise to retain stability during the difficult time. It eliminates the need to borrow money in order to stay afloat which can quickly lead to unmanageable debts and eventual company closure.
  • When it comes to replacing an integral employee, key person insurance provides businesses with the cash flow to recruit the right replacement. It allows recruiters to spend the necessary time searching for the right skillset, rather than simply hiring the first applicant. Hiring new staff is a major cost for businesses, so by recruiting the right person the first time round, businesses enjoy long-term savings.
  • For executors, key person insurance provides the funds to pay off any director or partner loans. They may also want to see outstanding salary bonuses or dividends, as well as the repayment of any pension funds. Key person insurance essentially covers the cost of paying out the estate.

To sum up, key person insurance keeps cash flows running and ensures businesses aren’t financially crippled in the wake of losing a vital member of their team.

Is it worth it?

Today’s world of business is unforgiving. Any enterprise that fails to have the right crisis management plans in place is arguably taking an unacceptable risk. As well as endangering the ongoing success of operations, companies that ignore the need for key person insurance compromise the financial security of both their colleagues and their families. Of course, it’s not a legal requirement – but when a worst case scenario rolls around, it definitely pays to be insured.