Key Person Insurance
What is Key Person Insurance?
Key person insurance, frequently known as key man insurance, is a life insurance-based cover that a business takes out on its most valuable person. In many small businesses, one or two people often hold much of the knowledge, client relationships, or skills that make the company successful. Key person cover provides a financial safety net if one of these indispensable individuals is lost unexpectedly.
How Does Key Person Cover Work?
The business arranges an insurance policy on the key person, where the business itself owns the policy and pays the premiums. If the key person experiences a covered event, such as a heart attack, or becomes permanently impaired, the policy pays out a tax-free lump sum to the company. This payout helps the business weather the storm and recover.
Identifying Your “Key People”
Not everyone in a company needs key person insurance. It’s reserved for the individual when their loss would cause significant financial strain. Ask yourself: Who are the people critical to our revenue and operations?
Common key persons include:
- Founders or Owners: They drive the vision and often wear multiple hats. Their deep industry knowledge or personal relationships (with clients, suppliers, or shareholders) might be irreplaceable.
- Top Executives or Managers: e.g., a managing director or a financial controller who runs day-to-day operations or has specialised expertise. Losing them could disrupt the business’s efficiency and strategy.
- Star Salespeople or Consultants: Employees who generate a large portion of revenue (such as a key salesperson or a highly billed consultant). If their absence would cause a noticeable drop in income, they are key.
- Technical Specialists: Perhaps a software developer who built your proprietary systems or an engineer whose skills win contracts. These individuals possess knowledge that competitors or replacements would take time to match.
- Silent Partners or Investors: A partner whose reputation and financial backing allow the business to secure credit and contracts. If they were gone, the business’s credit or investor confidence might falter.
Each business will have a unique set of key people. It’s not always about title or seniority but the financial impact if that person were absent.
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Why is Key Person Cover Important?
- Revenue Protection: Many businesses would face an income slump if a key person were absent. For example, losing your lead sales manager could mean losing clients to competitors. The insurance payout compensates for this lost revenue, buying you time to stabilise the business.
- Recruitment and Training: Replacing a talented individual is both difficult and can be costly. The payout can cover recruitment costs, hiring temporary consultants, sign-on bonuses for a qualified replacement, and training expenses to bring the new person up to speed. This ensures the business maintains momentum while rebuilding that role.
- Investor and Stakeholder Confidence: Having key person cover in place reassures investors, banks, and other stakeholders that the business has a contingency plan. In the event of a claim, the funds can be used to stabilise the company’s finances so that external parties continue to trust in the business’s viability.
- Equity Protection: In some cases, key person cover overlaps with shareholder protection insurance. If a key person is also a shareholder, the insurance payout can facilitate the buyout of their shares.
In summary, key person insurance provides business continuity. It gives you options and breathing room at a time when the business may be struggling emotionally and operationally.
How Much Key Person Insurance Do You Need?
Determining the right amount of cover is crucial. There’s no one-size-fits-all number, but here are some considerations:
- Financial Impact Estimation: Calculate the approximate loss in profit if the individual were gone. How much revenue would likely drop? How long might it take to recover or replace their contribution?
- Costs of Replacement: Consider recruitment fees, a higher salary for a seasoned replacement, training time and any consulting help needed.
- Business Value: Particularly for owners, some businesses insure for the estimated loss in overall business value that could result from losing that person.
Because these calculations can be complex, it’s wise to work with an experienced business insurance adviser. We at Capital Advice can help you quantify the risk and recommend a suitable coverage amount and structure.
Get Advice on Setting Up Shareholder Protection
Arranging shareholder insurance involves legal and financial considerations, from crafting the buy/sell agreement to choosing the right insurance policy and coverage amount. At Capital Advice, we specialise in helping New Zealand businesses put the right insurance cover in place. We’ll work with your lawyers and accountants if needed to ensure your shareholder protection plan is robust and meets your needs.
Don’t leave the fate of your business to chance or goodwill. With the right shareholder protection in place, you guarantee a fair outcome for all shareholders and their families, keeping your business on track even after a shareholder’s unexpected exit. Contact Capital Advice’s team today to discuss safeguarding your business ownership with a tailored shareholder protection plan.
