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Business Planning: What is Keyman Insurance and Why Do You Need It?
As business owners, we are constantly looking to grow our businesses and seeking new opportunities. Our daily focus is on getting our products or services ready and out in the market, increasing sales, hiring people, and other areas of business operations. However, we often overlook some areas of our businesses that may not be urgent, but can be very important. One such area is the keyman insurance.
There can be extra measures taken to ensure health and safety at the workplace, however when it comes to death, critical illness, or accidents, these are not within our control.
The keyman of a business, as the term implies, refers to the key person in the business - the main people who are crucial to the business operations. In other words, without this key person, the business would not be able to function normally. Hence, keyman insurance is simply a life insurance that provides coverage on the key person in the business.
Identifying the keyman
In a small business, the keyman is usually the owner, the founders, or maybe a key employee who brings in the sales or oversees the whole business operation. Without these key people, business operations will be severely affected and even cease to function.
Some important questions to ask yourself when identifying who the keyman is, could your business survive if this person is no longer around? Who is irreplaceable in the company in the short term? Is this person crucial to the financial success of the company?
Sometimes, the departure of a keyman could also mean a loss of ideas and leadership.
How keyman insurance works
A company purchases and pays the premiums of a life insurance, usually a term insurance without cash value, on the life of the key person. The company is the owner, and also the beneficiary, of the policy. If the key person passes on unexpectedly, the company will be the one that receives the insurance proceeds.
Similar to a personal life insurance, a keyman insurance works the same way, just that the insurance coverage is paid out to the company instead of the individual himself or his family members. A keyman insurance is also subject to medical underwriting. Premium for a keyman insurance policy is calculated based on the key person’s age, health, lifestyle, amount of coverage and the term of coverage (i.e. the number of years of coverage).
Needless to say, the higher the amount of coverage required, the higher the premium will be.
Importance of a keyman insurance
This coverage is important because usually the death of the key person, especially in a small business, often causes the “death” of the company too. As such, a keyman insurance is also a form of business protection, as it covers any potential financial loss that occurs due a death or loss of the keyman. It covers the potential loss of profits, loan repayments, the costs involved in re-hiring and training to replace the key person who is crucial to the business operations, or in the worst case scenario, to close down the business in an orderly manner. For these reasons, keyman insurance should be part of business planning from the start.
A keyman insurance does not only cover the unfortunate event of death of the key person, it can also provide coverage for critical illness or total permanent disability, when the key person can no longer work.
This will also help to ensure business continuity, as sometimes losing an important person in the company will result in uncertainty and affect the morale of other employees, causing them to leave.
How much keyman insurance should you cover for?
Every business is different, and there should be no hard and fast rule as to how much coverage is enough. As a general guideline, you want to ensure that your business has a minimum amount of protection should you lose the key person in the company.
Consider how much money your business would need to survive until you could replace the key person, and get the business up and running again. The worth of the key person’s value can be measured by the net or gross profits that he is directly responsible for. As a general rule of thumb, you can calculate the amount you want to insure by multiplying at least two times the amount of gross profit, or five times the amount of net profit that the key person brings in.
Nevertheless, if your company is just you, and doesn’t have any employees or other people who depend on it, then keyman insurance will not be necessary. Otherwise, this is one aspect of your business that you should prioritize and do a review soon.
A term insurance is generally preferred to be used as a keyman insurance due to the nature of the policy - lower premium outlay required as there is no cash value. Furthermore, you may want to check with your accountant regarding the tax-deductibility of the premium of a keyman insurance for corporate income tax, as well as the tax treatment of a keyman insurance policy payout.
Lastly, it is important that you make an informed decision when it comes to choosing a suitable keyman insurance policy for you and your company. One key factor to consider other than the premium costs of the policy is, what happens when the key person resigns? Some insurers do allow the change in life assured of a keyman insurance policy unlimited number of times, while some do not allow any changes at all.
Want to get a keyman insurance quote? You can fill in the Interest Form and we will get back to you!