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Key person protection for business continuity
Key Person insurance refers to life insurance on a key person in the business. It is a policy taken out by a business to inject liquidity for financial losses that will be incurred due to demise of a key person.
Who can be a key person?
Key persons include, but not limited to; founders / co-founders, managing directors, company directors, sales directors, IT specialist, head of product development et al. Key persons are those individuals whose skills, knowledge, experience or leadership are important to a business’ continued financial success. Should something happen to one of these individuals, it is likely that the loss will have a detrimental impact on the profitability of the business and will cause financial strain.
Benefits of key person insurance
It protects businesses against the business risk in the event of the unfortunate death of the key person.
Peace of mind. Business owners, investors, and creditors can all rest assured that their business’ financial position is protected. For public listed company, investors may not offload the shares like fire sale.
Disruption of lines of business credit due to the death of the key person can seriously affect the business. Hence, the insurance money can help as a guarantee of loan repayment in case of death of the key person.
It protects the company's valuation. For example, in case of the company being put up for sale, prospective buyers are likely to put a higher value to the company if they know that it has a monetary back-up (insurance) to meet the cost of replacement of its key person.
How much key person insurance the business needs?
Valuing key employees is important, but it is usually also quite difficult. While the amount of coverage should address the specific needs of the company, the insurance company’s primary goal in valuing a key person for life insurance is to determine the realistic loss associated with the death of such employee.
There are various valuation methods to determine the amount of key person insurance:
Income Multiples Method – The simplest and most common method used to determine the value of a key executive or business owner is the multiples of key person’s annual income method.
Earnings Contribution Method – The percentage contribution that the key employee adds to the company’s bottom line profit is the basis of the contributions to earnings method.
Loss of Profits Method – The number of times the gross profit or net profit for the past few years.
What are various ways for company to manage the policy?
Company pays the premium and owns the policy.
Should the key person leave, company may choose to:
Change the life insured* to another key person to continue the policy
Cancel the policy and retain the cash value
Should the key person retire, company may choose to:
Change the life insured* to another key person to continue the policy
Cancel the policy and retain the cash value
Assign the policy as a gift / retirement bonus to the key person
In the event of an untimely demise, company receives the Sum Assured. The company may choose to give part of the proceeds to the family of the deceased key person.
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