Key person insurance is an important form of business insurance. It is simply life insurance on the key person in a business (usually the owner, founders or a key employee or two). These are the individuals who are critical to a business – the ones whose absence would sink the company.
An employer may take out a key person insurance policy on the life or health of any employee whose knowledge, work or overall contribution is considered uniquely valuable to the company. The employer does this to offset the costs (such as hiring temporary help or recruiting a successor) and losses (like a decreased ability to conduct business until successors are trained) that the employer is likely to undergo in the event of the loss of a key person.
There are four categories of loss for which key person insurance can provide compensation:
- Losses related to the extended period when a key person is unable to work, to provide temporary personnel, and, if necessary, to finance the recruitment and training of a replacement.
- Insurance to protect profits—for example, offsetting lost income from lost sales, losses resulting from the delay or cancellation of any business project that the key person was involved in, loss of opportunity to expand, or loss of specialized skills or knowledge.
- Insurance to protect shareholders or partnership interests. Typically, this is insurance to enable shareholdings or partnership interests to be purchased by existing shareholders or partners.
- Insurance for anyone involved in guaranteeing business loans or banking facilities. The value of insurance coverage is arranged to equal the value of the guarantee.
Who can be a key person?
A key person can be anyone directly associated with the business whose loss can cause financial strain to the business. For example, the person could be a director of the company, a partner, a key salesperson, a key project manager, or someone with specific skills or knowledge that is especially valuable to the company.
The tax treatment for premiums paid for key person insurance and the treatment of monies received from a claim vary among countries. Premiums are tax deductible in the U.S. Please consult with your tax advisors for the most up to date tax law.
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