Every small business has that one or more key employees whose untimely death or sudden inability to work would jeopardise the profitability and survivability of the firm. Their talents and skill sets mean a lot for the business. It is for this reason that employers must set up a contingency plan for the loss of key personnel (also a succession plan).
Individuals invest huge sums of money on life insurance to indemnify their families in the event of their sudden demise. Similarly, businesses need to purchase Keyman insurance policies to cover the company’s financial losses in case of an unexpected exit of a key employee.
What do Keyman insurance policies cover?
Firstly the loss of an employee to a company leaves a gap in skills or responsibilities. Their position must immediately be filled either temporarily or permanently. This requires both time and money. Key man insurance policy chips in to offset the expenses incurred by the business during this period and in sourcing and training of a new employee.
It’s almost certain that the services of a key person are directly proportional to the level of company profits. When this person suddenly dies or becomes seriously ill, then business profits suffer. Moreover, this happens in so many ways.
A few case scenarios include a decline in sales, loss of valuable clients (attached to the key employee), cancellation of business projects the employee was involved, ruined company reputation, and much more. Being the beneficiary in case of the loss of an employee, the company will use the sum insured to cushion all these consequential losses.
Another category that Keyman insurance policy cover is the protection of the interests of partners or shareholders. The existing partners and shareholders can use this type of insurance policy to purchase the particular interests of their company.
If a company is experiencing cash flow problems, and the employer has purchased a Keyman insurance policy on any of his key employees, they can use it as security for a business loan. Banks and other financial institutions accept this policy as a guarantee for business loans. The total value of the insurance cover, however, should either be equal or exceed the value of the guarantee.
Eligibility for a Keyman insurance policy
The primary factor that renders an employer eligible to purchase a key man insurance policy is the profitability of the company. A company that makes losses cannot purchase this form of business insurance because the value of cover may be dependent on the return profits the key person brings into the business.
There is no prescribed formula for determining the total value of the cover needed though. Usually, the other universally accepted methods may take the form of a multiple of the key employee’s salary or a multiple of the gross profit of the company. For instance, three times the gross profit.
The other criterion used in determining the eligibility of a business for key man insurance policy involves a key person risk assessment. Like if they smoke, their age, health status, and whether the person flies to work on their plane. Also worth mentioning is that this insurance policy does not cover for when the key employee quits or gets fired.
The best term for this kind of arrangement is called “first-to-die” insurance policy. This is essentially suitable for a small business that is mostly focused on cost saving. ‘First-to-die” policy covers a group of key persons under the same umbrella. The assumption made here is that proceeds will be allowed to the company for any member of the group that dies first.
When one member has died, and the policy has been used, the remaining group becomes eligible for the cover. However, the assumption maintained is that there’s only one life covered at a time and the premiums allowed to the insurance company are for that single life.
There are other important aspects that key man insurance policy covers aside from financial losses that result from reduced sales. Moreover, especially since key employees are the lifeblood of company’s operations most of the time the proceeds may be used to offset debts, share funds among the investors, compensate the employers, and shut down business in a corporate style. The risk of losing key employees is inevitable in business, and therefore, every company must formulate a sound key person risk management plan.