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Key Man Insurance and How It Can Help Your Business

A company’s value is measured by its investment in the growth and well-being of its key employees, which substantially impacts its performance. Replacing those key employees, whether temporarily or permanently, can be costly. Hence, it is vital to insure these invaluable employees to ensure your company continues to operate smoothly under any unforeseen circumstances.

With key man insurance in Australia, your business can still carry on and thrive in the future even if it loses a key employee. However, more often than not, many business owners or partners tend to take key man insurance for granted in the grand scheme of things – there is always something more urgent or important to tend to. What they fail to realise is that without a proper contingency plan or insurance in place, key staff turnover, either from death or unforeseen events such as serious illness, can destabilise a company swiftly.

In this article, we will share what is key man insurance and how it can help your business carry on and thrive even after the loss of an essential employee.

What is key Man Insurance?

Key man insurance is a type of life insurance a company takes on its essential employee. This individual could be the owner himself, a business partner, a colleague, or an employee who has a special skill set or substantial responsibility and contributes significantly to the company’s profits.

The sudden absence of this key person would result in a loss of key skills, experience, and knowledge that are paramount to the daily operation of the business. To prevent this from happening, companies usually take on key man insurance by paying for the premiums and becoming the beneficiary of the policy. This ensures the company receives the insurance payout in the absence Insurance Back Office Pro of a key employee.

Businesses can utilise the funds to compensate for lost revenues and valuable assets, repay investors, and pay employees while seeking a replacement. If necessary, the policy can even be used to close down the business in an efficient manner without incurring extensive loss for relevant parties. This gives businesses extra options other than immediate bankruptcy.

If you are running a small business or a start-up, it is important to invest in this insurance policy as you would be most reliant on your employees in order to grow. Losing a key employee at this stage could severely impact your business, even resulting in its failure.

How Does Key Man Insurance Benefit Your Business?

Be it a small business or a multinational company, key man insurance payouts will provide your company significant advantages that will prove to be beneficial to your business in unexpected times. These include:

  • Being able to pay off debts, especially secured business loans.
  • Being able to fund employee severance and liquidation procedures in the event the business shuts down.
  • The ability to fund the recruitment, training, and salary of a replacement employee. It can even fund extra incentives and employee transfers to assist you in finding a top-calibre replacement.
  • Being able to buy off the equity or company share of a deceased key employee from their partner.
  • The ability to provide your customers with discounts or incentives to compensate and retain them throughout the transition period, especially if there has been disruption to the provision of your company’s goods or services.

Is key Man Insurance Tax Deductible?

This will depend on the purpose of the key man insurance:

  • A revenue purpose – replacing lost income and compensation for lost profits.
  • A capital purpose – repaying debts, discharging security over a guarantor’s property, or compensating for the loss of goodwill.

The Australian Tax Office has stated that premiums for revenue purposes can be deducted against tax. If the company makes a claim, the payment would be taken as income for the company and therefore taxation applies.

Premiums paid for key person insurance for capital purposes cannot be deducted against tax, but any payout in the event of a claim is not treated as assessable income. In addition, premiums for capital purposes may be subjected to Capital Gains Tax if the payout is received by anyone other than the policy owner.

Therefore, it is best to check with experienced financial advisors who are well-equipped to offer advice regarding this matter.

What Are The Different Types Of Key Man Insurance Policies available?

How key person insurance can help your business

Life Insurance

This is the most popular policy option as it pays out a lump sum of money after the death of a key employee or their terminal illness diagnosis. There are several types of life cover, such as term life cover, income protection insurance, and trauma insurance, among others. Your financial advisor will offer the life cover based on the events you would like to have your key employee protected against.

As companies are usually the beneficiary of key man insurance, they will receive the full benefit of this policy and will be able to use the funds to keep the business afloat in the absence of the key employee. Businesses are also required to pay a monthly or yearly premium. These premiums are influenced by several factors, including age, gender, occupation, and lifestyle of the key employee – for example, smoking habits.

Total Permanent Disability (TPD) Insurance

This insurance policy helps to mitigate the financial impact of a key employee becoming disabled, resulting in an inability to perform or fulfil work responsibilities. It provides your business with financial support in the form of a lump sum payment.

However, in order to receive the benefits of this policy, the insured individual must meet the definition of “total disability”. Your key employee must also have undergone all reasonable and usual treatment – including rehabilitation for injury or sickness – with a medical practitioner for at least six months. Next, you must provide your insurer with a certification from at least one medical practitioner stating that your key employee is totally and permanently disabled.

Trauma Insurance

A trauma policy may provide your company lump sum funds if your key employee suffers from a serious medical condition, such as a heart attack, cancer, or stroke. The benefits from this policy can be used to sustain the business while the key employee is absent from work during their recovery.

What Are Buy-Sell Agreements In Key Man Insurance?

Similar to key man insurance, a buy-sell agreement is used to ease the shock to the business if a partner or shareholder leaves, dies prematurely, or has a sudden serious illness, disability or any other condition that may prevent them from carrying out their work responsibilities as usual. It is not legally required but it is strongly recommended as part of business continuity planning.

However, where key man insurance is utilised to protect a business in a key employee’s absence, a buy-sell agreement is a legally binding agreement that determines what happens to one’s share of a company if something occurs to them. Typically, buy-sell insurance is used to fund a buy-sell agreement, ensuring the total amount of life insurance coverage taken is enough to cover the value of share ownership.

Nevertheless, if you are considering a buy-sell agreement when taking out a key man insurance policy for your business, it is best to weigh the agreement’s merits as its conditions can have an impact on which policy is ideal for your business.

Seek Professional Advice

The points in this article merely illustrate the general benefits of key man insurance on your business. It is always recommended that you speak to experienced financial advisors before taking on any financial decisions. The right insurance experts will advise the best possible investment for your business.